Share — Update 27 October 2016

Share reported that trading in the third quarter was in line with management expectations, with revenue before interest 7% ahead of the same period last year. The level of assets under administration has increased by 34% y-o-y or nearly 6% compared with the end of June to £3.6bn. It has also agreed to acquire a book of 8,000 client accounts. This will further the process of inorganic growth in assets under administration that it has also been pursuing through partnership agreements such as those announced earlier this year with Computershare and a (yet to be named) wealth manager. These transactions are expected to benefit revenues in 2017.

The Q3 changes in revenues for Share and its peer group are set out in Exhibit 1. Taking these in turn, the increase in fee income appears modest in comparison with the 29% increase for the ComPeer-compiled peer group. Share attributes this to changes peers have made to fee structures in order to compensate for lost trail and interest income and, as these are often based in the value of AUA, this also means higher fees at higher market levels. Share revenues did benefit from the inclusion of investment club and other dealing accounts transferred from Barclays Bank in February.

Next, dealing income was up 9%, again below the peer-group increase of 14%, but Share highlights that it had a particularly strong prior year period. The overall London Stock Exchange data for retail transactions (Exhibits 2 and 3) shows that there was an even greater increase in the number of transactions in the third quarter (+26%), suggesting the investor base at Share (and to a lesser extent the peers included here) are more measured in their trading habits than the retail market as a whole.

Finally, interest income for Share was down sharply (-35% y-o-y), despite an increase in client money on deposit, reflecting the reduction in base rate to 0.25% and reduced appetite at banks for deposits given the regulatory environment. The 5% increase at peers looks odd in these circumstances, but the ability of bank subsidiaries to secure more favourable treatment and willingness of other players to place deposits with counterparties paying higher rates (potentially entailing higher risk) are seen as playing a role here. Interest now accounts for under 5% of Share revenues, moderating the impact of the reduction on total revenue. When rates eventually increase the low starting point should allow reasonable upside in interest income.

Share’s market share within the ComPeer-compiled peer-group was 7.72% compared with 7.87% in Q116 and 8.41% for Q315. Excluding interest, market share was 10.08% compared with 10.88% in the same quarter last year. As shown below, while there have been fluctuations, on a longer view Share’s share has increased over time.

The agreement to acquire a book of accounts reported with the update covers 8,000 client accounts, which are mainly ISA accounts, with c £200m under administration. Completion is expected in April 2017.

Share management has highlighted for some time that consolidation among retail broking/ investment platforms was likely to take place, given the potential for economies of scale and the relatively small size of competitors compared with market leader Hargreaves Lansdown (last reported AUA £67.6bn). It had been reported that TD Bank Group might be considering the sale of its loss-making European business, TD Direct Investing (TDDI), and recently Interactive Investor (II) announced that it would buy the business. The transaction is expected to complete in the first quarter of 2017 and is backed by private equity investor JC Flowers, which is set to become the biggest investor in the combined business.

No financial terms have been disclosed, but combined AUA would be £18bn (£14.5bn from TDDI), ranking it in second position behind Hargreaves Lansdown and ahead of Alliance Trust Savings, for example (£12bn). The chairman, CEO and CFO of II will retain their positions in the enlarged company.

From Share plc’s perspective, the merger could be seen as increasing the competitive threat, but equally, with its ‘customer first’ ethos evidenced in its low and flat fee structure, it could be a beneficiary of any fallout that might arise from the integration of the businesses. II has indicated that there will be no immediate changes for either companies’ clients, but in due course decisions are to be expected in key areas such as IT integration and pricing.

Pricing will be an important consideration for competitors; if the enlarged company chooses to adopt a structure in line with II’s existing tariff, then the implications for Share should be modest as it has a broadly similar structure, although small differences may make each more attractive for different investors depending on their trading patterns/portfolio size. A migration to a higher fee structure (perhaps with an ad valorem component) could start to generate more attractive returns for investors in II but leave competitors with more flexibility to follow suit or, for Share, the possibility of further market share gains through maintenance of its attractive pricing.

Given trading has been in line with expectations we have left our estimates unchanged at this stage, while noting the sensitivity of dealing commissions to market sentiment in the remaining part of the year.

On this basis there is no reason to modify our discounted cash flow model assumptions. As we set out in our last note in August, we expect Share’s investment programme to result in losses/negative cash flow in the current year and possibly also for 2017. However, we look for a swing back into significant profitability subsequently. We allow for this in our DCF by factoring in two years of very strong growth (60% for our central case) in 2019 and 2020 followed by seven years at 5%. This gives a central value of 29p (unchanged). Exhibit 5 shows the sensitivity of this value to changes in the assumptions for 2019/20 growth and the discount rate.

While it does not provide clear valuation guidance, we have refreshed our comparison of valuation metrics with Alliance Trust Savings and Hargreaves Lansdown in Exhibit 6. This underlines the larger scale of Hargreaves Lansdown and, reflecting its history of sustained growth and profitability, the higher rating it stands on in terms of value to revenue and AUA. Nevertheless, since we last wrote Hargreaves Lansdown’s multiples have declined through a combination of lower market cap and revenue/AUA growth.

The range between valuations remains wide, reflecting the different profiles of the businesses. Share trades on a higher value relative to AUA than Alliance Trust Savings but also earns a higher yield on AUA and is on a lower multiple of revenues. Prospectively for Share, continued success in adding to its AUA both organically and through acquisitions together with the expected return to profitability following implementation of the IT investment programme would help earn a higher valuation on these metrics.