FinnCap – Trading Update Preview

Background

In March I wrote about finnCap, explaining why they were my preferred play amongst the brokers and demonstrating how their performance could be largely established from publicly available information.

Unfortunately the piece was not completed before a strong trading update was issued, confirming my findings. Fortunately they were a significant part of my portfolio when this happened:

Monthly holdings update
Top 5: Brokers (#ARDN, #CNKS, #FCAP, #NUM), Cash, #CRL, #UPGS, #WEY
Next 5: #CAPD, #PGH, #SBIZ, #STAF, #VTU
Significant: #APP, #CLIG, #CMCX, #CRS, #HVPE, #MCRO, #MMX, #RAI, #SCS, #SOM, #VMID, #WYN

Alphabetical within sections. More on brokers soon.

— Leo (@LeoInvestorUK) March 1, 2021

Even more fortunately, trading for March continued to be strong, leading to a further beat in their full year results to 31st March 2021.

However there were many one-off positive factors in this period, including COVID-related refinancing, exceptionally strong demand from retail investors stuck at home, and a scare over inheritance tax. Thus it is perhaps not surprising that finnCap’s share price has drifted back since:

With a trading update for their H1 to 30th September imminent, either at Thursday’s AGM or in early October, now seems a good time to look at them in detail again. I’ll start by following the same format as my earlier article, but without repeating some of the detailed explanation.

Retainers

Retainers were down from around 125 clients in mid 2020 to 119 at the end of March. Since then they have lost four in the capacity of AIM NOMAD to other brokers and gained two. Nor was natural attrition in the form of acquisitions counterbalanced by the single AIM IPO in the period. There is less visibility outside of AIM, but it would be prudent to assume that total retained clients are slightly down year-on-year.

Although retainers have the advantage of providing recurring and relatively predictable revenue, they are also valuable in providing a client base for more lucrative transaction revenue. This makes pricing competitive and price increases difficult. Furthermore, at the last count nine of finnCap’s NOMAD clients had market capitalisations below £10m. Although fees here may be lower, they may also be a significant part of the issuer’s total admin costs leading to further downward pressure or even moves to delist, as was seen this week at client Real Good Foods (RGD).

Accordingly revenue of £3.0-£3.1m is highly likely for H1 and £5.9-£6.5m for the full year.

ECM Transactions

In the full year results it was stated that Q1 was 5-6% ahead year-on-year overall, and the included graphs showed the comparator as £4.6m. Based on publicly available information collected by @dangersimpson and myself we estimate closer to £5.0m which is consistent with 5-6% growth given my estimates for the other areas.

Q2 is looking slightly ahead of Q1 at around £5.3m, giving a total of £10.3m versus £10.1m in H1 2021. Given the degree of estimation and uncertainty it is probably best to just say H1 looks to be flat on the previous year.

H2 is looking particularly uncertain with a wide range of possible outcomes and low external visibility as we come out of the summer lull. I think the greatest opportunity here is potentially in IPOs. At the time of the FY 2021 results on the 1st July they said:

The pipeline looks good with a number of IPOs expected for H2.

Of these, only the launch of Blackfinch Renewable European Income Trust has been announced, with £300m to be raised and finnCap named as second joint bookrunner. This should equate to in excess of £2m of revenue and bodes well for their strategic focus on ESG. We do know that a number of IPOs are gearing up, with the following smallcaps announced in the last few weeks:

That’s twice the number in progress at this time last year, but unfortunately, apart from Blackfinch, none of the above appear to involve finnCap. Monday’s market volatility particularly affected finnCap’s smaller client base and is a reminder that demand for equity can be fragile, but still, there’s every indication that this is going to be a strong IPO season and a further finnCap win could be announced any day.

Accordingly the range of possible outcomes for H2 is wide. It does however appear that 2020 H2 revenues will be beaten, giving a likely range of £4.5 – £12m for H2 and £14.5 – £22.6m for the full year.

Institutional Stockbroking

During the six months to 31st March they reduced their net market making exposure close to zero. This means that finnCap are less exposed to making exceptional gains or losses as a result of market movements, leaving volumes as the only observable indicator of performance.

Using the stocks where they act as NOMAD as a proxy for all market making activity, revenue here looks likely to be somewhat down on both H1 and H2 of 2021, but remains far above pre-covid levels. Exceptionally high volumes continue at Avacta while Synairgen and Tremor reached record levels. Accordingly I estimate revenue here of £2.6-£3.4m.

It seems imprudent to assume that these elevated levels of activity will continue indefinitely, but nor is there any immediate reason to believe they might fall below the levels seen in the year to 31st March 2020. On this basis I forecast revenue for H2 to be between £1.8m and £3.0m, giving a full year total of £4.4m – £6.4m.

Sell Side M&A Advisory

As discussed last time, research here is mostly dependent on marketing statements on their website. Deal sizes are often not given, requiring further research in the trade press or even ad-hoc valuations based on filed accounts.

This work is both time consuming and error prone which limits how much detail can be justified.

As I was writing this piece, news of the sale of the founder’s stake in Pimlico Plumbers for £125-£145m, advised by finnCap’s Cavendish division was released. This is a jumbo deal, both in terms of size (second only to last year’s Spring Home Buyers in the deals I have identified) and profile. It is also an example of how large deals can arrive at the end of a period and materially affect results, especially at this time of year.

My forecasts from collected data have consistently come in too low, but for what it is worth, following the above deal I am seeing H1 revenue significantly ahead of my estimates for this time last year, assuming revenue is recognised in the period.

Given the uncertainty I will lean more heavily on company guidance. At the end of Q1 they said:

The deal pipeline is stronger than at this time last year with three deals currently awaiting regulatory approval.

The assumption therefore has to be that H1 revenues will be modestly ahead of the £4.2m seen last year, with a range of £3.8-£5.5m.

The last few months of the year ended 31st March 2021 were dominated by concerns over possible inheritance tax changes in the budget, or as finnCap put it:

As capital markets recovered and funding and confidence concerns eased, we saw a significant increase in activity with a rush to complete multiple deals in March 2021 due to the perceived uncertainty around the impact of the UK budget.

The prospect of increased inheritance tax on business assets was apparently not popular on the backbenches and no changes were in fact made. While it is more than possible that changes might be floated again in the run up to the Spring 2022 budget, it would be highly imprudent to assume that the exceptional performance of £8.0m in 2021H2 will be repeated. Nonetheless, there does seem to be underlying growth here and therefore I forecast a range of £3.5m – £6.0m in H2, far ahead of the 2019H2 figure of just £2.4m. That puts the full year at £7.3m – £11.5m.

Other / new business areas

While the company has reduced its market making float, they retain some direct exposure to market valuations in the form of shares and warrants taken in lieu of fees. They also retain a small stake in PrimaryBid, though there is no trigger for a fresh valuation foreseen in the full year.

The company has ambitions to widen their offering as well as expanding existing capability. In the latter case, some of these benefits may increasingly come through in H2 and are included at the upper end of the forecast ranges. However, they also have significant free cash available for acquisitions and with six months ago these could make a material contribution that I have not factored in.

Conclusion

Adding the revenue ranges together and compressing them slightly to maintain the same level of confidence as their component parts gives a range of £19.5m – £22.5m for H1 and £34.0m to £45.2m for the full year. Plugging this in to my model gives H1 EPS between 1.4p and 2.1p, and FY EPS between 1.5p and 4.0p.

Overall then, full year guidance of £40-£50m and forecasts from Progressive of £44m require a lot to go right over the next few months. Shorter term investors will need to watch carefully for further IPO announcements over the next couple of weeks and, especially if it comes first, guidance in the upcoming trading statement.

Longer term investors should worry whether the strength of management’s vision and the relatively cheap valuation compensates sufficiently for the inherent weakness of a people business operating in a highly unpredictable market.