The New Criterion: small cap exposures to life insurance and data centres

Tim Boreham

A low key listed life insurer is in an intriguing position following a recent acquisition. Meanwhile, a newly-listed data centre operator has the big players in its sights.

Freedom Insurance (FIG) 43c

While the banks are beating a hasty retreat from life insurance, the low-key Freedom stands to benefit through its recent purchase of the Bank of Queensland’s St Andrews business for a headline $65 million.

In one of those exquisite corporate games of pass-the -parcel, BoQ acquired St Andrews from the Commonwealth Bank of Australia for $60m in 2010. The CBA had inherited the business when it took over the distressed BankWest in 2008.

Life is tough in the life game, especially in the income protection sector but Freedom chief Keith Cohen is confident there’s a place for a niche player offering simple and understandable products.

Until now, 88 percent of Freedom’s has derived from death, rather than life, cover: funeral insurance. Post acquisition, funeral cover is diluted to 66 per cent of Freedom’s premium income, with St Andrews delivering a substantive position in mortgage and credit insurance.

These products are cover taken by lenders to protect their position with riskier clients.

Cohen says: “St Andrews is a B2B business and Freedom is a B2C business and so they fit together complimentarily.”

The cash and debt funded acquisition is chunky one for the $107m market cap Freedom, but it appears to be low risk. That’s because St Andrews will still sell to a captive audience of BoQ customers under a three year distribution tie up (extendable by two years).

Freedom also won’t be exposed to the risks (and rewards) of the in-force policies: these are assumed by a reinsurer that will fund $35m of the purchase cost.

As a pure-play listed life insurer, Freedom is a rare beast. Ranked in terms of new business written the company rates as third biggest direct insurer, which means it sells through its own sales force rather than agents.

The two biggest direct insurers are the Japanese owned TAL (formerly the listed Tower) and Comminsure (which CBA last year sold to the Hong Kong based AIA Group for $3.8bn).

Cohen expects Freedom can become second biggest in the medium term – or even the gold medallist. Not that he’s obsessed with league ladders.

“But what you need is scale and this brings more scale and opportunities to add good value products.”

Cohen notes that most of the issues have related to group cover (to companies or superannuation funds) that Freedom doesn’t offer.

But Freedom’s first half sales – down 11 percent to $28.3m –were affected by what Cohen dubs “lead quality issues”.

But these appear to have been overcome.

“We’re a well oiled machine. We had a bit of an issue but we are back on track,” Cohen says.

Freedom’s closest listed relative is Clearview (CVW, $1.21), although Clearview also offers wealth management and distributes its life insurance via advisers.

Freedom listed in December 2016, having raised $15m at 35c apiece.

The company is well backed, with Thorney Investments, the Packer-linked Ellerston Capital, Bennelong Funds Management and (more recently) Forager Funds all gracing the register.

Freedom is a punt for those convinced a niche operator can make a decent fist of what the banks have ballsed up.

Data Exchange Network (DXN) 29c

The data centre entrant has a clear and bold aspiration to rival the size of its listed counterpart NextDC (NXT, $7.66) which bears an eye-watering $2.5 billion market capitalisation.

Actually, scrap that: its real ambition is to take on the $US32bn, Nasdaq listed Equinix, the world’s biggest data centre operator with more than 700 outlets.

While Data Exchange shares have surged more than 50 percent since listing on April 11, the Perth-based entity is still worth a modest $26m.

But CEO Peter Christie notes NextDC – which recently raised $280m in an aggressive expansionary push -- was valued at $20m when it listed in 2010 with a single leased building in Brisbane.

“The difference is we have an operating business with $5m of revenue.”

There’s no doubting data centres are a sexy sector – insomuch as rows and rows of whirring servers can be.

Locally the data storage sector turns over $5bn-plus a year, with growth is all but reassured because of the rise of cloud computing, ecommerce and data hogging ‘internet of things’ applications.

Despite common perception data centres are not high-tech themselves, but temperature controlled and secure repositories for computers rented and controlled by third parties.

In a sense, they’re high falutin’ self-storage facilities.

A crucial requirement is access to reliable power, because the servers collectively sap more electricity that a decent sized aluminium smelter.

Data Exchange’s approach is different to that of NextDC or Equinix, as it has no plans to acquire its own property.

By leasing rather than buying, the company can build smaller ‘modular’ facilities that can adapt to customer needs more quickly.

Still, Data Exchange’s core facilities will be its substantive outlets be in Sydney and Melbourne, with the company signing 20-year leases on two warehouses in Sydney’s Homebush and Port Melbourne.

These will be converted to collocated data centres at a cost of about $4.5m each (most of the company’s $16m IPO raising is earmarked for this purpose).

Christie says the company initially has targeted 200 ‘racks’ per facility, rising to 1000.

For the uninitiated, a rack is a cupboard of a standard size of 2.3 metres by one metre, housing about 40 servers.

Each rack attracts rent of about $2000 a month, which implies Data Exchange should chalk up $50m of annual revenue when the two sites are at full capacity.

Despite the cost of power – by far the biggest outgoing – Christie expects ebitda margins of 65 per cent.

(In comparison, NextDC cites an 85 per cent margin, although this excludes head office costs).

To date, Data Exchange has generated $4-5m of revenue a year from its ‘manufacturing’ business that builds data centres for third parties.

This business is already profitable and Christie expects the colocation business to break even after about eleven months.

In the longer term, Data Exchange is casting further afield, with its Singapore-based chairman Richard Carden scouring for partnerships in Asia.

Christie reckons countries such as Malaysia and Vietnam are ripe for the modular data centre approach because property trusts have overinvested in huge centres that are too big to fill.

Tim Boreham edits The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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