SimplyBiz (SBIZ:204p), a provider of compliance, business and technology services to 3,726 financial intermediaries, has announced the earnings accretive acquisition of Defaqto, a financial technology business operating a fintech platform for 8,500 advisers and providing independent ratings of financial products and funds.
Trading for over 25 years, Defaqto is a high margin cash generative business that is built on a regulatory and capital light model. Around 96 per cent of its 2018 revenues of £12.8m came from repeat and recurring business which delivered cash profit of £5.3m at an eye-catching profit margin of 41 per cent. Defaqto makes its money by collecting data on over 40,000 financial products and funds and then providing independent information to help banks, insurers and fund managers to get a complete overview of the financial products available to consumers so that they can make more informed decisions. The business also provides comparison sites and product manufacturers with information to assist consumers.
The £74.3m acquisition is being part funded by a £29.1m institutional placing of new shares, at 180p, a £37.5m increase in SimplyBiz’s revolving credit facility, the issue of shares worth £7.5m to the vendors, and using £3.1m of cash on SimplyBiz’s balance sheet. There is a strong strategic rationale behind it.
Strategic acquisition
Firstly, it fits with SimplyBiz's stated core growth themes, namely to increase its support to existing customers, and to diversify into new, strategically-linked markets, whilst increasing product innovation and market insight to its offering.
Secondly, combining the two companies creates a single fintech and support services group which will benefit from an increased number and range of distribution channels. Significantly, Defaqto will help SimplyBiz to advance its services into general insurance and banking markets as it aims to expand its offering. Defaqto's dominance in these two sectors provides considerable opportunities to grow SimplyBiz’s customer base and use technology to expand its footprint within retail financial services. Similarly, SimplyBiz will offer Defaqto access to its knowledge and experience of the advisory and asset management markets.
Thirdly, the increased analysis and insight derived from the Defaqto business should generate considerable synergies and benefits for the enlarged group's customers. It will enable SimplyBiz to integrate its existing compliance and regulatory services into Defaqto's powerful technology platform to support the development of enhanced regtech and fintech capabilities to meet the needs of its customers.
Fourthly, there is clear potential to accelerate revenue growth across the enlarged group, and enhance profitability through the increased scale Defaqto brings to the combined business.
Expect earnings upgrades
Importantly, the deal makes sense financially. The combined group delivered proforma cash profit of £16.7m on revenue of £63.5m in 2018, and free cash flow of £12.6m. That represents a free cash flow conversion rate of 75 per cent.
After taking into account SimplyBiz’s net cash pile of £6.4m at the end of 2018, the £3.4m of cash on Defaqto’s balance sheet, the payment of SimplyBiz's final dividend, and £2.9m of transaction fees, then the combined group will start life with net debt of around £38m, or 2.3 times last year’s combined cash profits.
Factor in analysts’ previous estimates of £1.6m growth in cash profits for SimplyBiz in 2019, and £800,000 growth in Defaqto’s annual cash profit which management is guiding investors to expect in this morning’s announcement, and I expect SimplyBiz’s 2019 cash profits to be at least £17.6m when analysts update their numbers after taking into account a nine-month contribution from Defaqto. This suggests that with the benefit of this year’s free cash flow generation then the closing 2019 net debt to cash profit ratio will be well below 2 times.
Based on a new share count of 96.2m shares, the company has a market capitalisation of £197m and enterprise value of £235m, or a reasonable 13 times my 2019 estimate of cash profits this year, and that’s before taking into account any synergy or revenue benefits derived from the acquisition.
Moreover, expect earnings per share (EPS) upgrades in due course when analysts update their numbers. My conservative financial models suggest SimplyBiz could easily deliver 2019 EPS of 13.6p (based on a net profit of £12.5m and a weighted average share count of 91.8m shares), up from 11.9p in 2018 and the current 2019 EPS estimate in the market. The 2019 upgrade could even be higher. This means the shares are rated on a forward PE ratio of 15, hardly expensive for a company that could now deliver mid-teens EPS growth this year, and one with solid prospects of maintaining a decent growth rate thereafter. Indeed, factor in a full 12 months contribution from Defaqto in 2020, ongoing growth in SimplyBiz's exisiting businesses and the company could easily deliver EPS of 16p in 2020 based on a net profit of £15.5m.
Target price
When I suggested buying shares in SimplyBiz, at 190p, in my July 2018 Alpha Report, a key bull point was the likelihood of the company using its paper to make further earnings accretive acquisitions. The acquisition of Defaqto has more than delivered on this commitment, and further vindicates my decision to maintain my positive stance a fortnight ago when the company issued its annual results (‘SimplyBiz does the business’, 20 March 2019).
So, with analysts’ earnings upgrades highly likely in the coming weeks, I continue to rate SimplyBiz shares a buy and maintain my 272p target price. New share price highs beckon. Buy.
■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.
