Equities

A little over a year ago I wrote about CountPlus (ASX:CUP) and outlined why there was significant strategic value in their relationship with the CBA owned, and much larger, Count Financial.

The details are in that wire but the quick version is that Count was enormously reliant on CUP as the largest customer. When their formal agreement expired, or sooner, CUP would be very well positioned to take advantage of the leverage that presented, one way or another.

This week CUP announced the acquisition of Count Financial for the sum total of $2.5m.

While the word ‘transformational’ is over used in investment analysis, this deal fits that definition.

The Transaction

CUP will pay $2.5m for Count and in return will get c.$8b of Funds Under Advice (FUA), 160 firms in the network, 360 financial advisers, $90m of revenue ($25m net), $12m of net cash and a $200m indemnity against historical advice failures (as have been well documented in the media).

Count is expected to be profitable in its first year of ownership under CUP.

Quite a deal.

If the numbers look too good to be true, then it is worth considering the background to this transaction.

CUP were the only logical buyer of Count. If CBA wanted to find a new home for the business that made sense they only had one place to go. CUP had significant leverage in their favour, although it is a credit to the management team to actually pull it off.

A transaction, one way or the other, in which CUP were the net beneficiary was always highly likely. It was the details and timing that we had to wait for.

Count has performed poorly under CBA’s ownership. This was a business generating $25m of net profit when CBA first acquired it for $373m in 2011.

It won’t go back to that level of profitability. Adviser numbers have halved since then.

But as an independently owned financial advice network Count still has the potential to be an excellent, and materially profitable, business.

It is the perfect fit for CUP who was already the largest customer of Count and knows the market and the acquired business inside out.

It is a massive step towards their stated goal of becoming the leading independent accounting and financial advice network in Australia.

It is also the perfect fit given the current industry landscape and shift towards accountant driven financial advice. The business model did not work under institutional ownership but has the potential to thrive once again as a genuine independent.

When I first wrote about CUP last year it was in the middle of a turn around. But today most of that hard work on the core business has been done.

The core business, pre-transaction, is run-rating at c.$9m EBITA based on the 1H19 results and the individual firms continue to improve as measured by firm-level profit margins, revenue per FTE and employment costs as a % of revenue.

The company pays a healthy dividend (1c/share in 1H19 fully franked) and the balance sheet has over $20m of net cash post this transaction with a market cap of $74m.

Now Matt and his team have to do the same thing with Count.

I’ve been chatting to CUP management for two years now. One thing I am highly confident in is that they are a conservative team. They won’t risk the business on any one transaction.

This is reflected in the $12m of net cash acquired for a $2.5m outlay with the acquired business expected to be profitable in the short term. The $12m buffer will be used to cover anticipated restructuring costs. I expect this is conservative.

While Count was loss making for CBA in 2018, when you strip out expenses related to payouts for poor advice, it actually generated a small underlying profit.

CUP was granted a $200m indemnity for any further claims relating to poor historical advice by Count licensed advisers, which is $56m more than already budgeted for by CBA in their accounts. Any future claims up to this amount will be funded by CBA.

I expect this too will prove conservative.

What is the Stock Worth Now?

To be honest, I don’t have a specific number for you.

This acquisition is completely transformational but the first 12 months for Count under CUP’s ownership, while expected to be profitable, will involve significant restructuring and realignment of the cost base. It remains to be seen how profitable the Count business can become in future years.

However, what I do feel confident in stating is that the valuation for CUP is likely to be substantially higher than the current share price, even after the initial jump post announcement.

The existing CUP business was run-rating EBITA at close to $9m per annum based on the 1H19 results with key metrics trending higher.

Count brings with it $90m of revenue ($25m net) and the expectation for a positive first year contribution.

Having been owned by CBA, Count has an institutionalised cost base. That cost base can be massively reduced by CUP, the extent of which we will have to wait and see.

There may be changes to the Count business model under CUP management to better position it for the future. The precise details will come out over time.

CUP acquired $12m of net cash in the deal. They already had $11m of net cash on their balance sheet so they now have well over $20m with which to fund restructuring costs and, eventually, further acquisitions.

One thing that may potentially weigh on the share price is the fact that CBA’s 35% shareholding in CUP will now be sold. Larger funds will wait for that to be completed (expected August/September post shareholder approval of the transaction) before jumping in to the stock.

A line that big will be done at a discount to the market. I am certain there will be sufficient demand to complete this line. The only question is the price.

That may provide opportunity for smaller funds and investors to get set before then, but it will ultimately depend on what price the line is sold for.

From an earnings perspective I think it is reasonable to expect Count to achieve a 10% run-rate EBITA margin (based on net revenue) in the first 12 months under CUP ownership. That would equate to roughly $2.5m of EBITA.

If the existing CUP business continues its current performance (c.$9m run-rate) then we could expect CUP to be run-rating EBITA at around $11m-$12m at some point in FY20, before any further acquisitions.

My personal view is that this would support a share price north of $1/share, assuming a 9-10x EV/EBITA multiple, which is well within reason.

Wilson’s, the only broker to cover the stock, has a target price of $1.13.

There is execution risk with a deal this size but if any management team is best placed to succeed it is this one.

The opportunity for growth beyond the next 12 months, both organic and through further acquisitions, is substantial. The firms in the acquired Count network provide an attractive pipeline of potential acquisitions and the balance sheet has plenty of firepower.

Catalysts and The Coming Re-Rate

With deals like this it can take time for the market to fully appreciate both the significance and the opportunity.

The best comparison in recent times was when Specialty Fashion (now CCX) sold all but it’s City Chic business. It was a transformational deal that saw the stock march higher for months as the market fully digested what it meant for the valuation of the company.

I think something similar will now happen with CUP, notwithstanding a potential pause when it comes time for the CBA line to be sold (after which I suspect it will kick on).

More details will come out shortly in the Independent Expert’s Report, required before the shareholder vote, which I suspect will support the fact that CUP got a bargain.

Over time we’ll get updates on the progress being made by the CUP management team in turning around the Count business.

Both of the above provide additional information for the market to digest and if it is as positive as I expect then they will be powerful catalysts.

The stock jumped when the announcement was released, but from very oversold levels. It is still trading at roughly the same price that directors have accumulated over $1m of stock through on-market purchases.

I think it still has a way to go before it reflects full value.

And, as always, the CEO's letter regarding this acquisition is well worth a read.

The Capital H Inception Fund owns shares in CUP.



Comments

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Mark Eaglesham

Nice work Harley

FC Choong

I read your note and was very impressed with your research - this one seems spot on!. I also read your other on millenium group which did not turn out well but you were quick to admit the oversight and learn from them. I look forward to you wires in the future. Keep up the good work....

Guy Freeland

Great analysis Harley.

Harley Grosser

Thanks Mark and Guy. FC, thank you for the feedback. CUP took a little bit of time but is now playing out in line with the original thesis. I'll get some right and (unfortunately) some wrong too, but if I've shared my thoughts publicly and the facts change I'll do my best to update them as quickly as possible. Hopefully the winners more than offset any errors. Glad you're enjoying the wires, I'll write about a new company shortly.