Cenkos Securities PLC CNKS.L
January 30, 2021 - 10:44am EST by
florence99
2021 2022
Price: 62.00 EPS 0 0
Shares Out. (in M): 57 P/E 0 0
Market Cap (in $M): 35 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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Description

 
In 2019, business confidence in the UK was hurt by protracted Brexit negotiations, changes in the Conservative Party leadership and the general election. As a result, only £3.8bn of funds were raised on AIM. That’s 30% less than in 2018 and the lowest level since 2012 (L10Y average ~£5.0bn p.a.). Further, Cenkos managed to raise just £0.6bn of funds for clients, vs. a long term annual historical average closer to £1.3bn. As an equity-focussed house, Cenkos’ fortunes are intrinsically linked to the health of financial markets and investor sentiment. Despite the difficult backdrop, Cenkos still managed to break-even and to arrange a market leading 30% of the year’s AIM IPOs. Cenkos’ results represented a significant under performance vs. prior years. The depressed current share price reflects that.
 
I believe that the market is mis-pricing the long term earnings power of the business. I see a purchase of Cenkos’ shares at current prices as representing an attractive investment opportunity. My view is based on two key premises. One, that there is very limited long-term downside risk to the business. Two, that there is substantial upside potential to the current market price and that shareholders are likely to be paid well while waiting for that upside. “Heads I win, Tails I don’t lose much”. Below I outline the rationale underpinning these two premises.
 
KEY FINANCIAL DATA:
Summary financials (in £m) and ratios as of the most recent earnings release 30-Jun-20:
 
Market Cap                £35.3 m (62p / share, 56.9m adj. DSO)
Total Cash                  £22.4 m
Total Debt                    £5.5 m (lease liabilities)
Enterprise Value         £18.4 m
 
6 mos Net Income         £0.6 m
6 mos FCF                    £4.9 m
6 mos Dividend             £0.5 m
 
5 y Avg Net Income       £5.8 m
5 y Avg FCF                  £6.4 m
5 y Avg Dividend           £5.1 m
 
10 y Avg Net Income     £7.3 m
10 y Avg FCF                £7.9 m
10y Avg Dividend          £5.5 m
 
* As of Jun-20, cum. £114.6m cash returned to shareholders since listing; minimum annual dividend payment £2.5m; long term average dividend paid £5m+ p.a.; record of using excess cash for significant capital returns in boom years e.g. £18.8m buy-back + £9.7m dividend payment in FY15 against £90m-120m market cap range in that year.
* Inherently cyclical business but never reported a Full Year loss; last few years hurt by Brexit uncertainty; FY19 cost cutting programme removed £3m of ongoing fixed cost at one-time cost of £1.3m.
* Delta between NI and FCF largely due to ~£0.6m average IFRS 2 share-based payments within staff costs.
 
Put in perspective historical Revenue / NI / FCF (OCF Capex) trends (£ in millions):
 
2007:     53.8    /    16.8    /      9.8
2008:     28.3    /      3.7    /      1.1
2009:     46.5    /      5.0    /    28.0
2010:     58.5    /      4.4    /    15.1
2011:     43.7    /      4.5    /    (8.4)
2012:     43.2    /      5.2    /    16.1
2013:     51.4    /      8.6    /    13.1
2014:     88.5    /    21.3    /    11.6
2015:     76.5    /    15.4    /    26.5
2016:     43.7    /      3.2    /    (4.7)
2017:     59.5    /      8.2    /    18.7
2018:     45.0    /      2.4    /      2.8
2019:     25.9    /      0.0    /   (11.4)
 
5Y Avg:   50.1    /      5.8    /     6.4
10Y Avg: 53.6    /      7.3    /     7.9
13Y Avg: 51.1    /      7.6    /     9.1
Cum.:    664.5    /    98.7    / 118.3
 
Key ratios:
* EV / 5Y Avg Sales: 0.4x
* PE (Market Cap ex. Cash / 5Y Avg NI): 2.2x
* P (Market Cap ex. Cash) / 5Y Avg FCF: 2.0x
* 5Y Avg Dividend / Market Cap: 14.4%
 
* EV / 10y Avg Sales: 0.3x
* PE (Market Cap ex. Cash / 10Y Avg NI): 1.8x
* P (Market Cap ex. Cash) / 10Y FCF: 1.6x
* 10Y Avg Dividend / Market Cap: 15.7%
 
Shareholders’ Equity is £24.6m, nearly all of which is tangible.
* P/B: 1.4x
 
Average ROE over L5Y, L10Y and L13Y is 20-25%. ROTA has been ~10%.
 
Cenkos’ net margins have on average been in the 12-15% area.
 
Comparatively, Numis and FinnCap (the two closest listed UK peers) are trading at 1.3-2.8x EV/Sales, 10-17x+ P(ex. Cash)/E , 8-15x+ P(ex. Cash)/FCF, 3-4% dividend yield and 2.5x+ P/B; both achieved similar ROE profiles historically (Numis 13-17%, FinnCap low-to-mid teen). FinnCap recently acquired Cavendish Corporate Finance for ~1.0x Revenue. Cenkos’ own P/E has typically been in the low-mid teen range over the L13Y. The market appears to be pricing Cenkos off cyclically-low recent performance rather than the long-term profile of the business. I disagree with that approach.
 
DOWNSIDE:
Below I outline my assessment of the key potential downside risks to the business. I conclude that there is little that can go horribly wrong for Cenkos given their flexible operating base, strong cash position and strong market position.
 
Low risk of sustained operating losses. 60%+ of Cenkos’ cost base is typically Staff Costs. The company has neither financial debt nor any material lease liabilities. If revenue is cyclically depressed, management can quickly scale back the cost base by firing people. They did so in FY19. Revenue hit an all time low of £25.9m largely due to Oct-19 Brexit-deadline uncertainty. Cenkos spent £1.3m to remove £3m of annual fixed cost. The business broke-even despite the revenue trough and, pro forma for the cost savings, may even have shown up to ~£3-4m of net profit. Taken to the extreme, if needed the business could be scaled back to just a handful of key members of personnel and still operate profitably until the market recovered, at which point they could scale back-up. This characteristic of the operating model suggests that the probability of a multi-year period of losses is low.
 
Low risk of future liquidity issues. Cenkos currently holds £22.4m in cash. It has another £4.2m in liquid current financial assets. I estimate that the current minimum cost base, pro forma for the restructuring, is ~£20-23m. Current liabilities were £13.5m as of Jun-20. The business currently has significant excess cash to cover any future surprises. Coupled with the flexible operating model, and barring any stupid management decisions, I view the risk from future liquidity issues as low. On mismanagement risk, I take comfort from the businesses’ long term average (highly liquid) Current Ratio of 1.9x and trough of 1.5x. Management have always left plenty of water between the ship and the rocks.
 
No evidence of adverse structural shifts. My investment thesis is fundamentally based on reversion-to-the-mean. A key risk is therefore that the next 5 years could be significantly worse than the last 5-10. Brexit and Covid-19 do present uncertainties in the near term your guess is as good as (or likely better than) mine as to the specifics of how those play out although Brexit has already been weighing on performance since 2016. I see little evidence that the appetite for UK listings, equity raises, corporate finance advice or corporate broking will be materially worse in the future than experienced historically. I also see no reason that, with their Top 3 market position and strong brand, Cenkos cannot continue to win a healthy 10-20% of AIM transactions while maintaining their other activities. The risk from obsolescence, technological shifts or disintermediation is also low. Assuming a long term required earnings yield of 10% and given the excess cash, current prices suggest that the market is expecting less than £1.6m of sustainable earnings power (I apply the 10% yield to current EV given the large net cash balance). That seems extremely conservative given the business’ long term track record, their strong market position and the cost savings already achieved in FY19
 
Personnel. Losing key people could create problems for the business. I take comfort from the levels of insider ownership as well as the “eat-what-you-kill” compensation structure. Jim Durkin (outgoing CEO) holds c. 9% of outstanding shares. Founder shareholder Nick Wells, the Head of Corporate Finance, holds c. 4%. Founder Andrew Stewart, while no longer an employee, holds 9% and re-acquired the majority of his shares as recently as Dec-19. Other employees own a further 35%. All variable compensation is subject to a 3 year deferred vesting period (“Golden Handcuffs”). Cenkos also structures key deal-maker compensation with low base salaries and big performance-related bonuses. For example in FY19 Joe Nally, founder shareholder and Head of Natural Resources, earned a base salary of just £54,000 (less than a first year Investment Banking analyst at a Bulge Bracket!) and total compensation of £132,000. In FY18 he earned £812,000. Clearly this is an attractive proposition for “rainmakers” inside the firm as well as potential future hires. It is also likely to deter weaker deal-makers from joining / staying with the firm. 
 
Regulatory Risk. As a regulated entity this is an inherent risk to the business. Overall the track record to date is positive, although in 2016 Cenkos was fined £530,000 by the FCA for its work on Quindell’s listing. Since that event the business has tightened its compliance processes and implemented the FCA’s remediation recommendations. The subsequent record has continued to be positive and I see this as an inherent risk that I can live with. I again take comfort from the levels of insider ownership. In some ways, having a minor but public failure in recent memory may actually serve to further mitigate some of this risk. One tends not to put their hand on a hot stove twice. More generally, the strength of the balance sheet, the flexibility of the business model and the reduced fixed cost base, means that Cenkos are very well positioned in terms of solvency testing. As of 1H20 Cenkos had a capital resources surplus of £15.8m over and above its Pillar 1 regulatory capital requirement.
 
In summary: flexible operating model should help maintain minimum net profitability somewhere between break-even and £2-3m in lean years minimising the risk of sustained operating losses derailing the business; the significant strength of the balance sheet reduces liquidity risks to practically zero; healthy levels of insider ownership and remuneration structures that heavily incentivise employees on the upside; good regulatory position from a solvency perspective and a re-focussed compliance function. 
 
UPSIDE:
Below I explain why I see strong upside to the current price. I conclude that there is a at least 2x upside to the current market valuation and that I expect shareholders to be paid well while waiting to realise that upside.
 
Private Buyer / “Common Sense” Valuation. The current market price fundamentally undervalues Cenkos’ long term earnings power. If a private buyer acquired the business at today’s EV of £18.4m, they would only need to achieve a long term average net profit of £1.8m to reach a 10% earnings yield. This is far below the £6-7m p.a. average earning power achieved over the last 13 years. I see no evidence that the future record will be so much worse than that of the past. Even if one were to discount the past record by a material 50% (i.e. anticipating just £3-3.5m p.a. of long term future earnings power), a knowledgeable private buyer would still surely value the enterprise at a minimum of £30-35m. Current prices therefore look well within intrinsic value and provide a healthy margin of safety. On the basis of the conservative assumptions baked-into the current market price, I see valuation upside of at least ~2x to current levels
 
The Comps. While my levels of conviction place little weight on comparable company analysis, I find it interesting that when FinnCap bought Cavendish Corporate Finance in FY18 they paid ~1x LTM revenue (~£14m). Given Cenkos’ relative size and long run record of achieving £40-60m of annual revenues (achieved in 9 out of last 13 years) this again suggests attractive upside to current prices. It is also interesting that Numis and FinnCap presently trade at EV/Sales, P/E, P/FCF, dividend yield and P/B levels which, when compared to Cenkos, imply that either Cenkos will remain no more than a £20-25m / £1.5-2.5m revenue / net profit business or that there is at least 2x upside to current levels.
 
Management Focussed On Shareholder Value. Management’s record of returning capital to shareholders is strong. As of Jun-20 Cenkos had, by way of dividends and buybacks, returned £114.6m of cash to shareholders since listing. Per the FY19 report management remains focused on shareholders returns: [Cenkos’] goal is to pay a stable ordinary dividend, reinvest into our Firm and return excess cash to shareholders subject to capital and liquidity requirements and the prevailing market conditions and outlook.One of the company’s publically stated strategic objectives is to “Increase Shareholder Distributions”. The business has never paid less than £2.5m (FY19) in annual dividends and in recent bumper years (FY15&14) has paid more than £9m. They have also periodically returned capital through material share buybacks e.g. FY15 when they bought-back £18.8m of shares. Given the capital light business model, the current £22.4m cash balance and the £15.8m regulatory surplus, it is likely that shareholders will continue to see very satisfactory distributions relative to the current market price. Anything better than the long-term trough level of FY19 dividends would likely represent a >10% dividend yield on current market capitalisation.
 
SUMMARY:
The market is offering up a business with £6-7m average historical annual earnings power and a £22.4m cash balance an at EV of £18.4m; private buyer value and comparables imply at least 2x+ upside; the combination of a cash-rich and debt-free balance sheet, a flexible operating base and a strong market position suggest very little downside “heads I win, tails I don’t lose much”; Cenkos’ record of returning capital to shareholders along with current cash balances indicate high likelihood of being satisfactorily remunerated while waiting for the price to revert to intrinsic value; market is mis-pricing long term earning power due to recent, cyclically lowmacro and company performance.
 
CATALYSTS:
The business has a proven track record that I believe is cyclically depressed. Reversion to the mean should drive share price re-rating. The main catalyst will be time. The business needs to post results showing better performance than the Brexit-impacted figures seen in FY19. This is unlikely, albeit not impossible, to happen
when FY20 results are released in the coming months (positively, on LinkedIn last week they announced that FY20 funds raised for clients reached ~£1.1bn a marked improvement on the £0.6b raised in FY19 and in-line with FY18 & FY13 levels). If not in FY20, the historical record suggests we are quite likely to see results closer to the historical average in the next 2-3 years. Meanwhile, shareholders are likely to continue getting paid at attractive rates to wait.
 
Resolution of Brexit negotiations should provide more certainty to potential clients that were in “wait-and-see” mode for last few years. Covid-19 vaccine roll-out in 2021 should also be helpful.
 
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Time / posting strong results
  • Recent resolution of Brexit negotiations
  • Covid-19 vaccine roll-out
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