A Growing, Dividend Paying Microcap

Harley Grosser

HD Capital Partners

A recent addition to the fund is Prime Financial (ASX:PFG), an integrated wealth management, accounting and capital advisory business. The company provides a broad range of services from financial planning, investment advice, life insurance, accounting & tax compliance, SMSF establishment and corporate advisory.

Prime’s Wealth Management business directly employs qualified advisors and oversees $1b+ in FUM servicing 3,000+ clients. Prime’s accounting network through wholly owned businesses, wealth management JV’s and equity stakes in accounting firms services a network of over 40,000 clients nationwide.

In 2016 Prime embarked on a new strategy that has thus far delivered strong earnings growth and provided a catalyst for the share price. The company’s previous model involved acquiring part ownership in accounting firms as a means to generate distribution for the wealth management business. They would partner with accountants to help them build financial planning businesses through the establishment of wealth management JVs. This model proved successful but limited and had downsides as a listed public company, namely rather messy accounts.

The new strategy involves wholly acquiring accounting firms with the vendors receiving significant equity and remaining in key management roles. MPR, a Melbourne based accounting and advisory firm, was the first deal completed under this new strategy in 2016. Then Altezza, which is Brisbane based, was acquired last month.

Beyond just the earnings growth generated through these 100% ownership acquisitions, which has already proven substantial, is the improved ability to cross sell services across the group, the greater control over the company’s destiny granted to management and the much improved simplicity of Prime’s accounts. These factors should support growing revenue, higher margins and earnings multiple expansion from the market.

On the wealth management side, Prime have managed to achieve strong FUM growth in FY17. Since Prime’s wealth management business generates the majority of its revenue as a percentage of FUM it is an important forward indicator. And with the current cost structure in place equipped to handle significant growth in FUM most of that additional revenue should drop down to the bottom line.

As a result of the above the wealth management business need only generate moderate revenue growth in order for attractive operating leverage to become evident. Given FUM started FY17 at $977m and ended at ~$1.1b it is likely that FY18 will see earnings growth for this part of the business.

The increase in FUM is partly attributable to the industry-wide end of year rush for super contributions as the new rules came in as of 1st July. But it is also the result of Prime’s increased focus on building out their funds management business. Their SMA products have grown FUM from $19m to $157m over the last two years, an international fund of funds product has been added and a VC component is in the works.

The added bonus of building out its funds management arm is the ability to provide these services to external groups for a fee. Prime have secured the first of these relationships with a $1b advisory mandate. There is the possibility of further growth in this area and it highlights the scalability of the business.

In accounting, which is a naturally low growth but largely stable market, growth will be derived through Prime’s acquisition strategy. MPR, the first acquisition under the new strategy, continues to perform well while Altezza was only acquired in June, meaning a full year contribution from that business will go a long way to seeing Prime generate growth in FY18.

Prime appear to be buying these businesses for ~5x PBT, which provides a nice private to public multiple arbitrage if well executed. It is not an aggressive roll up strategy by any means, rather the company is seeking only to do deals with vendors that wish to take large chunks of equity and remain as key managers in the business. They want vendors seeking a growth strategy, not an exit strategy.

As a legacy of the previous minority acquisition strategy Prime still have a number of partly owned interests in accounting firms which provide opportunity for further rationalisation. Whether some of these firms are divested (freeing up capital) or wholly acquired remains to be seen, but it does provide a relatively low risk pool of potential targets given Prime’s management presumably know these businesses very well.

In June Prime gave FY17 earnings guidance of $3.4m-$3.6m NPAT, representing 23-30% underlying growth over FY16. With a market cap of $35m Prime is trading on ~10x trailing earnings. The dividend was bumped up too, resulting in a grossed up yield of 6-7% at current prices.

Keen observers may have seen the recent listing of Kelly Partners (ASX:KPG), a company with a similar strategy to Prime. KPG listed at a 40% premium to its IPO price but what is interesting beyond just the similarities to Prime’s strategy are the financial metrics.

KPG is forecast to generate $3.2m NPAT in FY17 and $4.1m in FY18. PFG gave guidance of $3.4-$3.6m NPAT in FY17 and should generate $4m+ in FY18. Both companies have net debt of ~$8m. Yet KPG is capped at $65m and PFG at just $35m.

For the KPG bulls out there, there may be a case to argue that KPG deserves a premium to PFG but you would be hard pressed to argue that the premium should be in the order of 100%. And it is not as though KPG is trading on an exorbitant multiple either. At around 15x forward earnings KPG is trading largely in line with the market. So it appears it is Prime that is indeed undervalued.

There are some strong tailwinds now coming into play for Prime. It is becoming clear that the service provider with the integrated offering across wealth management and accounting will likely be the winner. And the requirement for accountants to be licensed in order to provide advice to SMSFs was originally anticipated to see opportunity flow to the accounting market and those who license them. But it appears in practice that opportunity is flowing to the wealth managers, as accountants refer their clients on to an adviser. As everyone is rushing to become the SMSF partner of choice Prime, as an integrated player, is well placed.

There is also increased corporate activity amongst the listed players in this space. Easton (ASX:EAS) acquired GPS, a large wealth management group. Sequoia (ASX:SEQ) acquired InterPrac. Countplus (ASX:CUP) continues its strategy to rationalise its existing portfolio. Centrepoint Alliance (ASX:CAF) has become a cashed up pure wealth management play with a growing direct advice business. And at the larger end of town there is ongoing talk of the banks selling their wealth management businesses.  KPG’s listing and the flurry of corporate activity should result in increased attention on Prime. There is currently no broker coverage, though that may change as the market wakes up to the story.

What is particularly attractive beyond just the cheap valuation based on FY17 guidance is that growth in FY18 appears highly likely. Altezza, which was only acquired in June, should contribute $300k+ to NPAT. And with FUM starting out this year considerably higher than last year the wealth management business should see revenue and earnings growth. Any further acquisitions are likely to be EPS accretive.

It is rare that you find a growing microcap company that also pays a high yield, but at 6%+ grossed up Prime ticks both of those boxes. The dividend was bumped up this year, which appears to be more a sign of confidence from the board than anything else. Indeed investors should expect the majority of excess capital to be deployed to the acquisition strategy, rather than a growing dividend, but for buyers at current prices the stock pays a healthy yield. A nice bonus.

From a risk perspective the two factors worth keeping an eye on are cash flow and general market movements. The debt facility was recently expanded with Westpac to $12m to facilitate further acquisitions as well as working capital needs. And market movements do need to be kept an eye on as they can impact FUM.

With a single digit forward P/E, healthy yield and growing earnings Prime looks good value and exceptionally cheap compared to peers like KPG. Given a full year contribution from Altezza, growth in FUM leading to rising earnings in the wealth management business and ongoing acquisitions in accounting, Prime should be able to generate $4m+ NPAT in FY18. If PFG traded on similar multiples to KPG the stock would be 30c+, but to be conservative I think a business like this can comfortably trade on 12-13x forward earnings. If that is proven correct then there is 40-60% upside in PFG at current prices, along with a generous dividend. Time will tell but as it stands today the risk-return profile looks quite attractive.

For expanded thoughts on the thesis click here.

1 stock mentioned

Harley Grosser
HD Capital Partners

Co-founder of HD Capital Partners and founder of Capital H Management. Portfolio Manager of the Capital H Inception Fund. Previously worked for Pie Funds and Bligh Capital.

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