Equiniti Group shares (LON:EQN) fell by over 20% in early trade this morning as the payments specialist put out a profit warning on its forecast earnings this year. This was perhaps one of the best examples of ‘soft’ profit warnings we have seen, as it was accompanied by a bullish forecast:
The share price movement has been very volatile and the shares have rebounded quite sharply from the lows seen inside the first hour. While it is impossible to time the bottom clearly some people have made a quick profit from this dip. At the time of writing the share price gained even more than the pic, going up to as much as 210p then falling back.
Equiniti is an interesting company which operates on a B2B basis, administering services for firms such as share registrations, pension fund services and payment executions. The range of services over the years has increased steadily to cover many different parts of the enterprise.
Performance for investors has been mixed. The IPO came in 2015 and shares initially fell from their 165p initial price and climbed strongly in 2017, doubling in this year alone. Since reaching 300p there has been little momentum and the price has dropped back down to the 200p range.
What’s gone wrong at Equinity Group?
This is perhaps a soft profit warning, as the trading RNS couches it in pretty good terms:
The Group’s performance in the period has been reassuring and we expect 2019 full year results to be towards the upper end of market expectations* for revenue and towards the lower end for underlying EBITDA due to weaker higher margin UK corporate activity.
Helpfully, the expectations are quantified: revenue is £550m-£567m, underlying EBITDA is £136-142m. We have some further detail about their businesses, which are performing well. We are short of the reasoning for why the UK activity has declined, but the market expectations are in a fairly tight band, so we can presume that the fall has been modest.
Even the outlook is good:
Whilst we expect the uncertainty in the macro environment to continue, Equiniti remains well positioned. We expect further organic growth in the UK as we build on our relationships with our exceptional client base. The US offers a platform for accelerated growth based on market opportunity, the potential to take market share and the opportunity to cross-sell digitised services into our blue-chip client base.
Equiniti: A changing company
Equinity clearly has some goodwill in the market as evidenced by the bounce in share price. Their business deals with the complex transactions many blue-chip operations face and are organised across four divisions: Investment Solutions, Intelligent Solutions, Pension Solutions and US. The number of difference services provided by these divisions is extremely diverse and may take some time to go into.
Growth here has not been organic, and has been by acquisitions and plenty of them. The IPO raised cash to pay down debts, but even then there has been an impressive spree of acquisitions, 14 since 2014. A broker note (available on Research Tree) shows that the latest one is Corporate Stock Transfer (CST), which focuses on stock transfer facilitation in the US market. Acquisitions tend to be of the ‘bolt-on’ variety and are small in cost.
Equinity have a good track record of this: turnover is set to double in the space of six years and margins are set to be broadly maintained, suggesting that acquisitions have been bedded in nicely although with no significant improvement in margins, the synergies promised is yet to come.
Stretching the balance sheet?
Many of these acquisitions were done without diluting shareholders too much: a rights issue came in 2017 and raised an additional £139m in proceeds, but represented a c.10% expansion in the share base. Looking at the accounts, debt has been the main tool: this metric has risen quite sharply.
It comes as no surprise that net tangible asset value is negative due to the amount of goodwill. Many firms here will be asset-light and intangibles rich due to the nature of the business.
In terms of immediate liquidity, the working capital is good: cash and receivables are bigger than current liabilities. The receivable balance has jumped sharply, but then again so has turnover.
Debt is a more relevant topic, and there is plenty of it here. It has increased as the cost of business acquisitions has been much greater than operating cash flows. A snapshot from the annual report shows just how much:
According to the broker note, this is expected to stabilise over the next few years and then start reducing, implying that the spree of acquisitions may slow. With EBITDA set to increase of this period, the leverage ratio gets progressively better.
What we can deduce from the interest charges is that this loan is not expensive: indeed the accounts say LIBOR + 1.75% for both loan and RCF. There is only one covenant, which is helpfully detailed as the net debt ratio to EBITDA being 4.00 or less, clearly on this point business would have to deteriorate quickly or the cash balance depleted for this to be an issue.
Another point is that these loans mature in 2020 and appear almost to the limit in headroom, so for things to continue they need to be extended or alternatively another rights issue could raise cash.
Are Equiniti shares good value?
There are plenty of things to like about Equiniti: they enjoy a strong leadership position in many of the markets they operate in. Much of the advantage can be put down to the proprietary back-end they operate, and therefore this represents a large barrier to entry for competitors. It may be also easy to see that there can be significant operation leverage if the business can be expanded.
They are also growing quickly via acquisitions which appear to be well managed. With large amortisation costs every year, the business generates cash at a better rate than what profits show although the historic cost is real.
So, I have positive impression of the share overall. the negatives being the debt load resulting in a negative tangible asset base and the increasing number of moving parts in the company.
On the price, I don’t think this bargain territory yet, although under 150p I might have changed my mind but I view the potential upside as bigger than the downside. 4/5.