Cavendish Financial (CAV) - a free, highly leveraged bet on improving UK equity markets
Even if IPOs and corporate activity don't recover, I would argue there is no downside risk to the current 12p share price
Bought in Jul24 between 11.4p and 12p. A small size position (0-5% of portfolio), given the very low liquidity in this share. Would have bought more if liquidity was better.
A brief summary of what they do
The names Finncap and Cenkos would be familiar to any seasoned small and mid cap investor. Cavendish was formed in 2023 by the merger of these two companies.
Their clients are small and mid sized listed companies, and the services they provide are pretty much anything that is in the “corporate activity” bucket. M&As, IPOs, advisory services, investor relations support, brokering (for buybacks, equity fundraisings), research (eg broker reports and forecasts), and more. The list is long, but the gist is that they make money from listed companies, by providing them corporate services.
The merger between Finncap and Cenkos was done to consolidate, in market that had way too much capacity. 2020 to 2022 saw a boom period, with lots of IPOs as well as fundraisings. As these dried up in 2023, and the medium term outlook for UK equity markets turned bleak, the whole industry has gone through major consolidation. Lots of mergers, takeovers.
The scale of the market downturn is evident when looking at revenues for Finncap before the merger: £52.6m in FY22, and a 38% drop to only £32.7m in FY23!
Today, we are a few quarters in to the “new normal” of low activity levels. The merger, which kicked off in summer 2023, is now complete. Now is the time to assess the “phoenix” that has risen from the ashes of two dead brands; what does the future look like for Cavendish?
Why I have invested
There are four drivers that could cause a substantial re-rating of Cavendish in the next 12-18 months.
#1 - Increased IPO volumes
The first half of the year saw London do the same volume (on a £ value basis) of IPOs as the first half of 2023. Yet, in Europe, IPO volume quadrupled in the same period year on year.
One could argue this is a structural shift; London may now be an inferior venue for equity listings going forwards. However, my belief is that it is more of a temporary thing. A healthy IPO market require confidence, and I think there are four things that will change in H2 to boost IPO confidence:
New Labour government. More certainty in the regulatory and political environment.
The European IPOs in H1 have performed decently, so more confidence in IPOs in general now.
FTSE 250 performance in H1 has been pretty decent (+13% 12m, +7% YTD). Not quite as good as the US markets, but in the mix compared to European markets, and above average globally. At least its not at the bottom of the list like it was in parts of 2022 and 2023…
Imminent regulatory shakeup of the listing rules. More relaxed rules = more interest in IPOing in the UK. You may or may not agree whether this relaxation is good for shareholders… but it certainly will increase the number of IPOs and thus revenues for Cavendish.
#2 - Employee comp ratios returning to normal levels
The ratio of employee compensation to revenues hit an eye watering high of 73% for FY24. However, management explained this was a one-off; they needed to pay extra to keep people on as the merger progressed, to ensure continuity. Now that is done, they have explicitly stated that the comp ratio will go back to normalised levels.
This has already progressed as the comp ratio in H2-FY24 was only 68%, compared to 83% in H1-FY24 (giving a full year of 73%).
And if you dig back into historical reports, for FY20 to FY22 we had the following comp ratios:
FinnCap was 61.5%, 58.6%, and 60.8% respectively
Cenkos was 64.0%, 60.4%, and 95.5%
I’m taking the Cenkos one at 95.5% for FY22 as an outlier; but it seems clear that comp ratios could get back to the c60% mark. Especially with all the industry consolidation and lay-offs, there are probably more qualified people than available at the moment, so it definitely is not a job-seeker market yet.
Based on H2-FY24 revenue run-rate (£35m/HY), a drop from 73% to 60% comp ratio will be an extra £9.1m PBT. To put into context, FY24 was a -£4.3m loss.
Clearly this positive movement in the comp ratio will radically change the profitability of the company in FY25.
#3 - £7m cost synergies keep being mentioned
I usually take these “cost synergies” calculations with a grain of salt. As they can easily be fudged, and hard to validate. However, more than is usual, management here have very repeatedly mentioned this number. Suggesting that (1) the cost synergies have really been delivered, not just management fluff. And (2) the number is probably quite real.
Now, there’s probably some overlap in this £7m number and the comp ratio normalisation benefit (+£9.1m PBT) above. However, even if the non-overlap is only small, like £2-3m, that will still be a sizeable boost to EPS.
#4 - Structurally higher margins from a consolidated industry
Lots of mergers and acquisitions have taken place amongst the competitor set. Zeus Capital has bought out WH Ireland and Arden Partners. Panmure Gordon has merged with Liberium. Deutsche Bank have bought Numis. Cavendish is the combination of FinnCap and Cenkos.
With consolidation usually comes pricing power, and potentially we will see the remaining players able to form a sort of quasi-cartel, and make higher margins.
I read somewhere that Cavendish will now be the third largest in the market, behind Numis and Peel Hunt?
Numis was bought by Deutsche Bank for £410m in 2023. Peel Hunt’s market cap (as of 17/07/2024) is £175m, EV of £125m.
Cavendish market cap is £45m, EV is £38m.
This, of course, is not a proper peer valuation process to do, but it does suggest that Cavendish could be cheap, when compared to the #1 and #2 in the market.
#5 - Surplus cash pile
At the end of FY Mar24, there is a £21m cash pile. This looks like a healthy surplus to operational requirements. Although I have not yet checked whether Cavendish is required to hold a high amount of cash, for regulatory requirements. This question was pointed out to me by a fellow investor in a SIGNET meeting, which could be a valid point?
But lets say this £21m is truly 100% unrestricted cash. Now that the merger activities have completed, and that the combined entity is back to profit (H2 = £1m PBT), this cash can be used for something.
My personal preference would be buybacks, given what I see as a depressed share price. Dividends won’t have credibility unless healthily covered by earnings. Acquisitions seems too early, given they’ve only just finished digesting a big merger.
I think that at least £14m of the cash is probably surplus to requirements, so that’s 3.64p per share of surplus cash, 30% of the current share price.
Risks to be cognisant about
#6 - Activity continues to be muted
Maybe the FTSE is in terminal decline; we won’t get a pickup in new IPOs, and London’s market will just continue to decline. Maybe.
If we assume there is no further improvement from what H2-24 (Oct23 to Mar24) had to offer, that will still leave Cavendish making £2m PBT (double the H2-FY24 PBT). And with the benefit of a reduced compensation ratio, probably £7-8m PBT. And maybe up to £10m+ with some of the £7m cost savings they keep harping on about. At a market cap of £45m, and only £31m adjusted for surplus cash, that’s still a bargain single-digit PE ratio at the 12p current share price, which leaves me to believe there is no further downside here.
The true downside scenario is the London equity market going into a death spiral; loads of companies delist or get bought out, and a complete dearth of IPOs to replace. It could happen. But in my mind unlikely.
#7 - The market consolidation hurts, rather than helps
I have not looked into detail into the entire competitive landscape. It could very well be that one or more of the mergers/acquisitions, ends up creating an unstoppable goliath that usurps Cavendish’s #3 position, steals their market share.
#8 - The merger has created a worse company than before
The restructurings, the mass lay-offs, the dispiriting budget cuts (£7m yearly!); not all restructurings are a success. Many create toxic cultures and low morale work environments, that poison the company over time. Maybe key personnel, in what is a relationship-driven industry, end up leaving this new company. This I do not know, without an inside track.
The potential I see
Almost no downside risk - as mentioned above, even if revenue never recovers and we are stuck at H2 levels (£70m/yr). With the compensation ratio normalising, Cavendish will get to £7-8m PBT easily, 1.45p EPS, and that fully supports a £45m market cap / 12p share price.
Credible upside potential - I can see a +20% revenue run-rate growth evident within the next 18 months, i.e. a £84m revenue business.
Taking an employee cost ratio of 61%, some inflationary assumptions on other fixed costs, and lopping off another 10% for “exceptionals / adjustments / unexpected costs” that always comes up, I can see a path to a £11.5m PBT, which is 3.0p EPS.
If the market is in growth mode, and also Cavendish, there is no reason why it cannot trade at a 12x PE minimum, which gives a 36p target share price.
Surplus cash of £14m gives an extra 3.6p per share of cash.
So I do think, credibly, this could trade at 39-40p a share within the next 18 months. Giving a more than 3-bagger potential on the current share price.