Shore Capital Group — Diversified business model

Shore Capital describes itself as an independent investment group. Its two main operating activities are the Capital Markets and Asset Management businesses, while the Principal Finance activity makes opportunistic on-balance sheet investments on a highly selective basis. Over the five years to end-2017, the businesses have contributed 68%, 24% and 8% to revenues, respectively (Exhibit 1).

Exhibit 2 shows how the diversification of the group has supported the overall level of revenue generated, the strong growth in asset management revenues (from £7.3m to £12.9m) and the potential for Principal Finance to make a significant episodic contribution (over £9m in 2015 related to the profit on sale of radio spectrum licences by an investee company).

The first-half results announced in mid-September highlighted the benefit of the diversity in the group’s activities. Normal fluctuation in activity levels for Capital Markets, together with the initial effects of implementation of MiFID II, meant a lower revenue and profit contribution from this division. However, a strong performance from Asset Management (and lower central costs) more than made up the shortfall, allowing both revenues and profits to move ahead at the group level (see Exhibit 3). Key features of the results included the following points (comparisons are with H117 unless stated).

Looking more closely at Capital Markets, the company reported that the retained corporate client base increased (in the 2017 annual report this was shown as over 70) with the addition of five new clients during the period (Sirius Minerals, Produce Investments, Savannah Petroleum, Cake Box and Echo Energy).

Since the results announcement, Shore Capital has been appointed as joint broker to Marks & Spencer. The first half saw the completion of a number of significant transactions including: joint bookrunner roles in a £198m placing of GVC shares on behalf of Playtech and a £70m placing for Dairy Crest; lead managing the readmission to AIM of Savannah Petroleum; acting as bookrunner, nomad and broker to the IPO of Cake Box Holdings, raising £16.5m; and acting as nomad, global coordinator and bookrunner in Applegreen’s acquisition of a majority stake in Welcome Break, including a placing raising €175m.

The group emphasises that it has continued to invest in servicing clients and has added to its corporate broking capabilities and research resources, including the addition of industrials to its core consumer and financial sector research coverage. Shore Capital is pleased with the take-up of institutional investors of its research services in the post-MiFID II period while noting, in line with other commentators, that all participants are still adjusting to the new environment for research and institutional sales services. Revenue in this area is not broken out separately but Cenkos in its half-year report covering the same period showed research revenue down 12% versus H117. The Shore Capital market-making activity continued to perform well in the first half, with revenues only slightly down on the prior-year period. It is one of the three largest market-makers on the London Stock Exchange.

For Asset Management, the 13% increase in AUM highlighted above arose from fund-raising in its private client business (Puma Investments) and valuation gains in the institutional portfolios. Assets under management have grown from £680m to £915m from the end of 2014 to the end of the first half, compound annual growth of 9%. The division provides a diversifying source of profits for the group and itself has a range of products with a range of asset class exposures; equity assets account for a minority of AUM.

Within the private client, tax-efficient investments area (Puma Investments) the Puma VCTs have raised cumulative funds of over £230m since 2005 and the latest fund, Puma VCT 13 remains open for investment. Puma enterprise investment scheme funds (managed by the same team as the VCTs) now have total assets of £70m, with the number of investments made standing at 13. The Puma Heritage company gives investors access to the property finance and construction team’s expertise in the provision of secured, first charge, prudent LTV loans made across commercial , residential and specialist areas within the property sector. The fund seeks to counter long-term inflationary pressures and is intended to provide investors with 100% relief from inheritance tax after two years. The AIM IHT service, which reached its fourth anniversary at the end of the period, also seeks to mitigate inheritance tax through investment in selected AIM stocks.

Shore Capital has many years of experience in providing finance for social care property. This has provided a network of contacts in the area and enabled it to partner with external funds investing in supported living accommodation and to offer a full service sourcing, structuring and negotiating acquisitions. Last year, Shore Capital made an investment in a supported living property portfolio (Puma Social Care Investments) alongside two US family offices. The portfolio was sold opportunistically later in the year, generating an IRR of 27%. In the first half of this year, a 75% stake in a company (EA Capital) investing in supported living accommodation was purchased for a cash consideration of £0.892m, in line with the net assets acquired.

Institutional asset management includes the management of Brandenburg Realty (focused on high-quality property in Germany), Puma Brandenburg (a diversified portfolio of properties in Germany) and St Peter Port Capital (a pre-IPO fund now in the process of realising its remaining investments). Activity for Brandenburg Realty included steps to obtain condominium title for three assets acquired at the end of 2017 and investment with Puma Brandenburg in Mixer Global (operator of co-working spaces founded in Tel Aviv, which is expanding geographically). For Puma Brandenburg, additional actions included work to add restaurants at one hotel investment and apartment conversions to provide further furnished accommodation. At St Peter Port Capital, the manager reported that investee companies had a more positive outlook but, on a prudential basis, two investments were written down to reflect illiquidity. The company’s life has been extended to July 2019 to allow further time to realise the remaining assets (net assets at end-March £12.1m).

The Principal Finance division reported that DBD, a company where it holds an investment and which holds 32 licences for radio spectrum in Germany, intends to challenge the German telecoms regulator's recent decision to withdraw the licences and offer licences for an alternative frequency band (albeit with fewer restrictions). The gross carrying value of the investment was unchanged at £2.2m.

In response to an uncertain global geopolitical and macroeconomic background, equity markets have seen a rise in volatility and a marked correction during October (UK equity market indices shown in Exhibits 4 and 5). The FTSE All-Share and FTSE Small cap indices were down 10% and 9%, respectively, over six months (at 3 December) while the FTSE AIM All-Share was down 14%. This creates a more challenging background for capital markets activities, potentially dampening new and further issuance activity.

While this is likely to be having an impact, it has yet to become clear in overall London Stock Exchange issuance figures, given that significant monthly variations are a normal feature of the market. For the year-to-date to end-October, the value of Main Market issuance was ahead of the prior-year period by 14%, while AIM was up a more modest 4%. For the month of October alone, Main Market issuance was up 4%, while AIM issuance did experience a substantial 47% fall versus October 2017.

More volatile markets could have a similar influence on the level and timing of M&A activity as corporates defer decisions on transactions. Conversely, an easing of uncertainty and stabilisation of markets could generate a bounce-back in activity. In this context, the continued growth in Shore Capital’s corporate client base and investment in servicing institutional clients should provide the basis for longer-term growth through market fluctuations.

On the Asset Management side of the group, the equity-exposed part of the business is clearly sensitive to market levels although this is only a small part of the business and the division has continued to accumulate assets under management, benefiting from strengthened distribution of tax efficient products in the IFA market. Looking ahead, the strategy is to make use of management expertise and the track record that has been established within the private client area to market to institutional investors, focusing initially on the property lending part of the business.

To this end, the group has announced (on 4 December) a new institutional funding commitment of up to £200m with funds advised by RoundShield Partners. Loans will be sourced and arranged by a newly incorporated company (Puma Property Finance), in which RoundShield is entitled to acquire a stake of up to 25% as funds are deployed. RoundShield may also be entitled to payments on exit. The funding will be used by the property finance teams to meet significant demand in existing areas of expertise, including residential developments, hotels, retirement living, student accomodation and care homes.

Our estimate for FY18 is detailed in the financial summary (page 8). We have assumed a marginal overall revenue increase (+0.8%) compared with FY17, with capital markets lower and asset management ahead, in line with the pattern seen in the first half. After a 5% increase in administrative costs, this results in a 9% reduction in pre-tax profits versus FY17 or 10% at the diluted earnings per share level (11.5p).

As noted above, the balance sheet remains strong with end-June net cash of £18.7m compared with £25.9m at the end of 2017, with the cash outflow primarily reflecting a £4m working capital outflow in the period (well within the historical range of half-yearly variation) and dividend payments to ordinary and minority shareholders.

Our updated peer valuation is shown in Exhibit 8, which should be seen in the context of the significant differences between the companies as well as the potentially volatile and lumpy nature of earnings across the sector. While the Shore Capital P/E ratio is above the average, this is based on reported earnings and current market conditions are likely to put capital markets earnings under pressure. In these circumstances, Shore Capital is likely to benefit relative to peers from the earnings contribution from its asset management activity. The price to book ratio at 0.8x is below the peer average (1.4x) and its historical average level of 1.1x since end-2011.

The strength of Shore Capital’s balance sheet has tended to depress the return on equity, which was 5.5% (annualised) at the interim stage. A catalyst for a move to a higher price-to-book valuation would be the expectation of a higher return on equity, potentially prompted by continued growth in the asset management business and more favourable conditions for capital markets activities. The output of a ROE/COE model shown in Exhibit 9 indicates the sensitivity of the valuation to different assumptions for cost of equity and return on equity. Other assumptions used here include growth of 3% and a book value per share of 270.5p. To match the current share price (225p at the time of writing) at a cost of equity of 8% would require an assumed return of equity of 7.2%, arguably a cautious assumption on a longer view and similar to the 2014–17 average (6.8%).

Finally, in this section we show the recent share price performance for Shore Capital and the comparator stocks. Here, Shore Capital has demonstrated significantly greater resilience than the average, albeit standing 24% below its 12-month high following recent market weakness.