Always look under the hood
Count Plus ('CUP') owns and partners with accounting and financial advisory firms, forming a network largely focused on Australia's eastern seaboard.
It provides value to partner firms in several ways:
- Financial - Providing capital backing to member firms
- Operational - management support, best practices and cost efficiencies via group buying
- Strategic - support in terms of growth strategy, succession planning
The company’s finances are unremarkable, with small losses being incurred the past couple of financial years. The balance sheet has been strengthened in recent years with the divestment of various investments and the reduction of debt. Commonwealth Bank ('CBA') owns almost 36% of CUP via their subsidiary Count Financial ('CF'), which they have disclosed they will divest in time.
CF's core business is to allow third-party accounting practices to provide financial advice to their clients, under CF's Australian Financial Services Licence. Historically, CF has relied heavily on receiving trail commissions and rebates on funds under advice with approximately 75% of revenue derived from this source. This revenue stream will be banned from the 1st of January 2021, as a consequence of recommendations put forth via the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
Count Financial acquisition
CUP have agreed to purchase CF from CBA for a price of $2.5 million, relative to net tangible assets of $14.8 million. This 'bargain' sale price is reflective of restructuring costs and ongoing losses from Count Financial - CBA guided FY19 losses at $13 million post-tax.
As part of this deal, CBA agreed to reimburse CF for customer remediation or refunds stemming from historical misconduct, up to the value of $200 million. $144 million has been already recognised as a provision by CBA, so the actual net indemnity is for $56 million.
The deed specifies that the indemnity cap may be increased in 2 circumstances: $12.5 million in new customer remediation claims before deal completion; or should the customer remediation rate materially vary from a figure of 24% of historical CF revenue dating back to 2009. We note that the indemnity cap adjustment is not legally binding nor are the specific terms referred to defined. We also note the lack of disclosure from the CBA announcement regarding this 'good faith' adjustment and note that the cap adjustment is reliant on APRA and ASIC consultation. In effect, we don't believe that the cap will be ever adjusted.
Importantly, we note that the indemnity deed only indemnifies CF for the remediation of customer claims for 4 years post the deal's completion. Broadly speaking, the statute of limitations for claims in financial services litigation are generally 6 years from the date of a purported contravention; except in the case of statutory and negligence claims. We also note that there are some circumstances in where the statute of limitations periods may be extended, for example by a court of law.
The indemnity deed elegantly excises any future statutory liability via clever and specific wording. We note recent media commentary from ASIC regarding fresh litigation post-royal commission. The language from ASIC has been quite assertive in terms of bringing offenders to account. In particular, the recommendation that ASIC no longer settles cases before opening up a formal investigation we consider to be a material risk; as we consider it likely that CF under CBA ownership settled claims rather than engaging in litigation. Once again we highlight that the CBA indemnity is specifically for customer remediation only and does not cover statutory fines or penalties by ASIC.
Excess claims scenario
Should the CBA indemnity be insufficient to cover customer remediation payments, CUP have disclosed that they will not guarantee CF's business operations and as such will likely be liquidated.
Shareholders should also note that should CF liquidate in the case of customer remediation indemnities being insufficiently covered by CBA or fines incurred from ASIC, amounts paid from CF to CUP may be 'clawed back' during the liquidation under certain sections of the Corporations Act 2001.
Effectively CBA has shifted the reputational risk to CUP, in the case of winding up the company, for a relatively nominal fee. Should this occur, shareholders should question whether the non-performance in terms of customer remediation for CF customers would affect the underlying businesses owned or those that are in a commercial relationship with the firm?
Count Financial revenues are expected to fall by 60% once all expected reforms stemming from the Royal Commission are enacted. The expected date of the ban is approximately 15 months away.
The new revenue model going forward relies on CUP increasing average revenue from member firms by over 3x current revenues. After running the numbers and conducting an analysis of competing firms we consider this forward assumption to be aggressive. The expert report on the acquisition itself mentions the inherent uncertainty of transitioning existing franchises to the new pricing model. As such we expect firm attrition to increase largely as a result of the new pricing structure.
There may be an increase in overhead expenses as Count Financial will lose the benefit of using CBA shared services including rent, IT & systems costs. CBA will provide services to manage claims and transition for a cost to Count Plus.
It is our opinion that even though prima facie CUP are acquiring CF for a 'bargain' price according to Net Tangible Asset calculations; the potential quantum and scale of contingent liabilities may prove that CBA stakeholders are the real beneficiaries over time.
Effectively, CUP have sold CBA a put option which caps CBA's downside financial risk to the detriment of CUP's shareholders should the risk eventuate.
CUP may turn things around longer-term in spite of the potential risks, but in the interim many question marks remain.
We're always looking for new investment ideas
Datt Capital diversifies investments across asset classes and duration to reduce risk while maintaining relatively concentrated exposure to attractive investment opportunities. To find out more, click the 'contact' button below.