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OPINION

The curious case of Quindell

The curious case of Quindell
April 25, 2013
The curious case of Quindell

In a little over a year Quindell has created a platform that offers to cut costs for a motor insurance industry struggling with profitability. If it can deliver on this promise business will flood in and strong growth projections will be underpinned. But the problem is that investors often overpay for the promise of growth and analysts can be hopelessly over-optimistic at forecasting it. James Montier points out in his book 'Value Investing' that when analysts apply discounted cash flows, such as those used in forecasts, then the 24-month forecast error is 95 per cent and the average 12-month forecast error 43 per cent. That is a pretty wide margin for error.

So what are my concerns with Quindell? First there is the claims handling operation, Ai Claims, which deals with credit hire and car repair. In the last results for Ai published as a standalone entity in March 2012 for the six months to the end of December 2011, things were deteriorating. Revenue had fallen by 21 per cent to £47.5m, and profit before tax fell by 30 per cent to £1.2m. Steve Broughton, chairman of Ai Claims before its acquisition by Quindell last year, said it was down to the continuing reduction in accident frequency and repair cycle times.

But those falling accident frequency levels and shrinking repair and credit hire cycle times have proved painful for other claims handling companies - as market conditions worsened throughout the year, by December competitors Drive Assist and Elite Incident Management had both called in administrators after the loss of a major client was too much for the cash flow, and the business, to take.

On 29 October, media reports said insurer RSA, one of Ai Claims' clients, had moved some of its business to Enterprise Rent-a-Car. Quindell responded by saying that Ai Claims is responsible for only a small portion of group profits and that Ai still works on other contracts with RSA. Which is all true, but when Ai Claims became a subsidiary in April 2012 it increased run rate revenues from £50m to over £150m.

However, such rapid revenue growth can strain cash. Let's not forget, revenue is vanity, profit sanity, cash reality. Quindell's trading update showed rapid revenue growth, decent profit margins and strong cash balances at the year-end. Sounds like a resounding tick in all the boxes. But in the final quarter of 2012, Mr Terry said Ebitda cash conversion was around 67 per cent, the reason being it makes payments to insurers up front and then has to wait on average six months for claims to finalise.

Quindell's half-year results to June 2012 showed the impact as debtors expanded faster than creditors, a difference that has to be funded somehow. Mr Terry was absolutely clear that the group has more than enough cash to fund expansion, noting that that cash combined with credit facilities of around £40m gives Quindell around £80m. Mr Terry told Investors Chronicle that "no more fundraising was required in 2013 to hit the 3p EPS target".

However, further dilutive fundraisings are likely if Quindell pursues more acquisitions. Already, to fund Quindell's rapid 2012 expansion plans shares in issue went from 2bn to 3.6bn. And its board still has the authority to issue around another 2.4bn shares. If deals announced in December close as anticipated in April, they will require the issue of another 267.8m shares. A large number of shares issued to fund deals in 2012 will also exit lock-up periods this year.

That all said, at 14.25p Quindell's shares trade on a fairly conservative 6.2 times house broker Cenkos's forecast of 2.45p EPS for 2013. But to achieve that revenue has to almost triple to £442m and adjusted pre-tax profits have to leap from £43.3m to £126m. Mr Terry assured me Quindell was well on the way to growing revenues after being awarded multi-year contracts with major insurance providers following the demise of Drive Assist. And the group is, of course, much more than just claims handling. Mr Terry says it is now the leading legal and medical supplier to the motor insurance industry.

So Quindell is well-placed, but chasing this kind of rapid growth brings risks. And, although some investors think its valuation multiple should be on an even higher PE ratio of 20 times, Quindell only paid 6.6 times forecast EPS for Ai Claims when it bought the company less than a year ago. I will be watching Quindell with interest in the year ahead, and hoping that investors aren't tempted to overpay for the promise of growth