The fundamental case for investing certainly favours a move to new highs as the financial results for the 12 months to end January 2014 revealed a massive cash windfall from the sale of 80 per cent of BP Marsh's stake in global insurance broker Hyperion Insurance to private equity company General Atlantic in a £29.2m deal. Allowing for redemption of director loans, the tax liability on the disposal and the payment by BP Marsh of a 1.25p a share half-year dividend to shareholders last year, the company currently has net cash and treasury investments of £14.8m, equivalent to 50.5p a share.
In addition, B.P. Marsh retains a further 2.79 per cent equity in Hyperion, which is in the books for £7.3m, or 25p a share. General Atlantic has a call option to purchase the balance of BP Marsh's stake in Hyperion for £7.3m. This option expires on 8 July 2016 or when the company undertakes an initial public offering (IPO), whichever is the earlier. I fully expect General Atlantic to exercise its option because at the exercise price Hyperion's equity is being valued at £260m, a realistic valuation for a fast-growing company that generated cash profits of £35.9m last fiscal year on revenues of £166m.
BP Marsh also has a loan of £6m outstanding to Hyperion currently earning annual interest of £450,000 and which is due for repayment on 3 October 2017, or earlier if there is an IPO, or change of control of the company. In total the carrying value of the loan to Hyperion and the equity stake accounts for £13.3m of BP Marsh's net asset value of £58.9m. That's the equivalent of 45.5p a share.
Or put it another way, cash and cash equivalents, and the investments in Hyperion account for 96p a share of the 202p net asset value as of 31 January 2014. So with the shares being offered in the market at 149p, this means that the remainder of BP Marsh's investment portfolio, worth 106p, is in effect being valued at only 53p, or half its carrying value in the company's accounts.
Clearly, such a huge discount would be warranted if the portfolio was performing poorly. But this is not the case as in the 12 months to end January 2014, the company's net asset value increased by 6.3 per cent. And it was not an isolated performance either because BP Marsh has generated a compound annual growth rate on its investment portfolio of 11.6 per cent since it was founded in 1990, albeit the returns made from Hyperion account for a large part of this performance. That said, the sale of a 20 per cent stake in the Portfolio Design Group for £1.25m post the financial year-end crystallises the value of that holding and one that has achieved an internal rate of return of almost 25 per cent for BP Marsh, including all income achieved.
It's also worth noting that the board have adopted a sensible dividend policy to redistribute some of the gains back to shareholders. Following the payment of that 1.25p interim dividend, investors can expect a 2.75p final dividend following the annual meeting in July. The shares go ex-dividend on Wednesday, 25 June and the payment date is 25 July. On this basis, the 4p a share total payout equates to a 2.7 per cent dividend yield. The board has committed to paying out a final dividend of at least 2.75p a share for the financial years ending 31 January 2015 and 2016.
Importantly, operating expenses of around £2m are well covered by dividends, income from loans and receivables and fees earned. This means that operating costs are not proving a dead weight on the assets held, so the company is not reliant on investment sales to fund its annual overheads. In turn, this offers the board the flexibility to pursue further investment opportunities to create value for shareholders. Indeed, allowing for current commitments, BP Marsh has around £8.7m of cash available for new investments.
A portfolio with potential
The dividend and large discount to book value aside, it's worth pointing out that BP Marsh's ongoing equity portfolio actually increased by 14 per cent in value in the financial year to the end of January 2014, following on from a 13.3 per cent uplift the prior year. Such a performance is not just impressive, but it makes nonsense of valuing the ongoing portfolio at a 50 per cent discount to its underlying net asset value as I have noted in my calculations above.
Furthermore, it's not as if these investments lack potential for future growth as the portfolio includes a £1.8m stake in Aim-traded Randall & Quilter (RQIH: 148p), a specialist in managing the run-off of insurance companies and Lloyd's of London syndicates that have stopped underwriting new contracts, but have already settled liabilities arising from policies written. The shares are modestly priced on a little over book value and that's after accounting for a 5p a share capital return this week. The dividend yield on Randall & Quilter shares is 5.6 per cent.
B.P. Marsh typically targets investments up to £3m by taking minority equity stakes of between 15 and 45 per cent in companies. In the last financial year, three investments were made, following a rigorous screening process. In fact, of the 61 proposals received, only a quarter were taken to the confidential negotiating stage and just 10 warranted continued detailed investigation, of which five proceeded to the Heads of Terms stage. Of the proposals, half fell within the insurance sector.
Of the new investments made, BP Marsh acquired a further 12 per cent stake in LEBC, an Independent Financial Advisory firm providing financial advice to individuals, blue chip corporations and partnerships. LEBC is a growing specialist financial services company, operating 14 branches across the UK with funds under influence around £2bn, generating annual turnover of £11.3m and operating profit of £700,000 in the year to end September 2013. This represented growth on the prior year when revenues were £10.4m and operating profit was around £544,000.
The additional £1m investment takes BP Marsh's stake to 34.9 per cent and the company has also provided LEBC's Employee Benefit Trust with £1m of funding via a secured short term loan facility (repayable within 12 months) to enable the management team to increase their shareholding in LEBC.
Other new shareholdings made in the financial year include an A$800,000 (£444,000) investment for a 40 per cent stake in Sydney-based MB Group, a managing general agent and a market leader in prestige motor insurance in Australia. BP Marsh has provided loan funding of A$1.4m to develop MB Group's market position by delivery of new products. Dan Topping, a director of BP Marsh, has joined the board. MB Group made operating profits of A$930,000 on a margin of 39 per cent of revenues last year, so the acquisition was sensibly priced. Indeed, in BP Marsh's accounts to end January 2014, the equity investment has since been revalued to £819,000, a significant uplift on the original acquisition cost.
BP Marsh's investment in Sterling Insurance looks smart, too. Sterling is an Australian specialist underwriting agency offering a range of insurance solutions within the liability sector, specialising in niche markets including mining, construction and demolition. BP Marsh invested £1.95m last summer in return for a 19.7 per cent equity stake through a joint-venture company. This shareholding has since been revalued at £2.27m. Sterling is already very profitable, having reported a 140 per cent rise in operating profits to A$1.2m on revenues that more than doubled to A$5.8m in its last set of accounts. BP Marsh is not the only party that sees the potential in Sterling as Steadfast Group, one of Australia's largest network of insurance brokers, owns a 39.5 per cent shareholding in Sterling. Steadfast has more than 430 offices across Australia and New Zealand, and generates around A$4.1bn in insurance sales each year.
Other notable investments in BP Marsh's investment portfolio include a 37.94 per cent stake worth £7.2m in Besso Insurance, a profitable insurance broker in the North American wholesale market. The carrying value of the investment has risen by £1.2m in the last year, only part of the increase was down to the holding being raised by 1.23 percentage points. Indeed, it largely reflected a much improved financial performance from Besso according to BP Marsh's chairman and major shareholder Brian Marsh.
Unwarranted discount to book value
In my opinion, there is a strong prospect of further capital growth across the portfolio in the years ahead which makes BP Marsh's shares anomalously priced on a 25 per cent discount to book value. In the near term, we can expect more positive newsflow as I understand that BP Marsh is in talks to sell one of its other investments and is also looking at an acquisition in the London insurance market.
In the circumstances, I believe my share price target of 160p is now too conservative and I am raising my fair value estimate to 170p. Please note that I have factored in the fact that BP Marsh is small cap company with a market capitalisation of £43m, founder Brian Marsh holds a majority stake which limits the free float, and the company's investment portfolio is largely made up of unlisted equity investments.
Needless to say, on a bid-offer spread of 148p to 152p, and offering 12 per cent upside to my new target price, I rate BP Marsh's shares a medium-term buy.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
