Diverger (ASX:DVR) - Deep Dive
Australian AFSL Licensee & Accounting Training
Executive Summary
Diverger is a company characterised by a focus on providing training and compliance services to both accounting practices and financial planning firms. They own a number of key brands industry participants would be quite familiar with such as Knowledge Shop for Accountants & GPS Wealth for financial advisers.
Rapid growth of the core business has been scarred with normalisations and corporate activity.
Potential for continued strong growth in Membership firms under Knowledge Shop, particularly so if they choose to raise prices which have long been flat.
Wealth division to experience a slow in outflows of advisers and continued price pressure leading to a move from a drag on earnings to a flat to positive contribution from Licensees. Managed Accounts to continue to experience dual effect of inflows and return on assets, with significant operating leverage.
Optionality of the Hub24 Stake having purchased their position at a valuation of 9x EV/EBITA, a 61% premium to the current multiple.
Management incentives align strongly to high TSR of 25% p.a. through to 2025, fundamental targets to triple net revenue and grow wealth segment EBITA margin to 40%. Doing so yields >$0.35 in FCF per share, compared to the current EV per share of ~$1.00.
=The Opportunity
The important thing here is that the business has struggled with its identity for a long time having conducted several mergers and subsequent divestitures that have obscured their focus and erected a smoke screen on the current underlying core businesses the group owns today. The degree of this is intense as the business from 2013/14 has grown the “underlying profits” (a pre-tax EBITA, however reasonable adjustments are made here) from a poor 2.5c per share in 2014 to now 19.1c per share, a CAGR of 33.7% over a 7 year period. In comparison the statutory earnings per share has grown from negative 8c per share to positive 7c per share. Lastly, during this time the stock has returned a compounded 7.5% return for shareholders, 4% of which is attributable to dividends.
Therein lies the opportunity here, the rapid growth of the core business and blend of the obscure corporate activity has resulted in what i believe to be a very attractive price for a quality business dead centre in my core circle of competency as someone with a degree in Accounting & Financial Planning having used the majority of this businesses services in the past. Nonetheless, it is worthwhile spending the time to go through what the actual business does, which I can split into 2 broad categories.
Accounting
The accounting side of the business predominately concerns itself with providing training to accountants on the small and medium spectrum of the industry. This includes the Knowledge Shop,Taxbanter and Taxbytes brands. This division makes money through providing membership to ~1.3k accounting firms across the country, in addition to on-demand training to around 3-4k firms inclusive of those membership firms, putting this into context with the apparent opportunity, there is some ~35k firms across Australia, and only 100 of them have revenue of greater then $4m. As you would expect, some ⅔ of this revenue comes from training revenue which, whilst somewhat steady, is not as recurring in nature as membership fees.
Lastly, the management wants to grow the client base of this division by 40% from the period 2022-2024 on what is a purely organic basis. Assuming that translates similarly to revenue and margins, we should see an incremental 2m in pre-tax profits by 2024 here. It’s my belief that I do not see why this shouldn’t be the case, given the quality of these businesses. I have been to several workshops and they have always been of the highest quality and quite affordable to accountants of all sizes. Furthermore, I believe that the pricing of Knowledge shop has remained steady over the past 5 years on a per firm basis, leading to potential for increased subscription fees in the future should inflation pressures arise, namely wages. Furthermore, the rapid pace of training hours does not reflect the pace of training revenue, implying some degree of shared scale economics with member firms, strengthening the value proposition.
Wealth
This division is where I expect more uncertainty, and I will explain why. Firstly to explain, this business consists of 3 Licensees or ‘dealer groups’ including GPS Wealth, Merit Wealth & Paragem. These are operated under a ‘hub and spoke’ structure with a decentralised sales team and a centralised operating hub to share operating costs. In addition to these licensees, GPS Wealth also offers advisers the use of their managed accounts business, which takes a % based admin fee (which seems to be somewhere around 0.25-0.3% of FUM) on client FUM , which amounts to $2.3b as at 1H FY22. Importantly, this is not pushed on clientele, instead to avoid a breach in fiduciary duty the accounts just have to meet client goals well. Lastly, the accounts are offered through both the Netwealth and Hub24 Platforms here in Australia.
Back on Licensees, to provide advice relating to financial products here in Australia, you must have what is called the Australian Financial Services Licence (AFSL), and this is a costly process which is a substantial barrier to entry for any small operator. Furthermore, with the advent of the Banking Royal Commission (FP related recommendations), there are many advisers exiting the issues with increased compliance and education standards. This has resulted in significantly increased costs associated with continuing to operate. To mitigate the regulatory burden, advisers can utilise a dealer group in order to gain access to not only their AFSL, but also standardised compliance documents, approved product lists, financial planning software and more.
However, the support comes at a cost, and the trend of rising licensee fees has pushed advisers into seeking an alternative. This has culminated in self-licensing. That is, advisers getting their own AFSL and then taking that regulatory burden head on. Diverger has accommodated for this, offering the new ‘Easton X’ service as of late to self-licensed advisers
Also important is to note that advisers who operate through the services of a licensee are ‘Authorised representatives’ appointed by an AFSL holder to provide financial services on their behalf. These can be broadly classified in two classes, a ‘Full’ Authorised representative (AR) and a ‘Limited’ one (LAR), with the latter being limited predominately to Accountant’s providing relatively small amounts of advice particular to SMSF clients. Due to the increased regulatory burden and costs however, becoming a LAR is not seen as worthwhile to most, as such there has been a multi-year downtrend in LAR’s exiting the industry. Nathan has mentioned this stabilised in our discussion together around 200-225 at a fee of ~4k per adviser, which represents just ~7%
Part of my thesis here is that Licensees pass on some of the costs that are experiencing rapid inflation through their licensee fees, as such there is industry wide pricing power on fixed fees with continuous industry wide evaporation of grandfathering commissions (Product related revenue share). The CEO, Nathan has mentioned to me that the pricing model for Diverger is largely converted as of January 2022 to a fixed pricing model, and was transitioned over the previous 18 month period. For 1H22 ~30% of net adviser revenue came from revenue share arrangements.
As aforementioned, the managed accounts business also generates a % of FUM related revenue stream and as a result should carry a significant operating leverage potential, which has been diluted in the short term by way of removal of a specific platform fee being charged to advisers which they viewed as potentially having regulatory issues. This was an impressive choice and can see they are fully interested in remaining compliant.
Lastly, Hub24 has taken a strategic stake of ~31% of the business, which gives Diverger priority access to their Hubconnect platform in return for assisting them to develop this platform. In addition to this HUB24 can assist in technological operating efficiency in the business, further driving margins. This stake also holds significant optionality having been initially carried out via. Partial offer at a price of $1.20 per share in January of 2021. This implied a valuation of 9x EV/EBITA, a 61% premium to the current price the business is trading at in the market today.
Strategic Intent
I’ve spoken at length about the business today, but what I should mention is the management intentions over the next few years. And this is revealed clearly with their 2025 strategic plan below:
Tripling net revenue is something that would most likely occur predominantly through acquisition, and given past execution here, they have generally done OK on this with a cumulative spend of $29m and upfront earnings of 1.9m (excluding organic growth), implying price discipline of an upfront 6-7% earnings yield. But these businesses have grown quite strongly organically. For example Knowledge shop has close to 2x the members they had in 2014, a CAGR of 8.6% since. Another example is GPS wealth which despite the rapid decline in AR’s (GPS has lost 117 or -38% since the deal - as per Wealth Data) due to the royal commission, has managed to impress on the CARE side with platform FUM growing from ~600m to ~2.3b in 3 years, maintaining earnings and even growing them through an increase in margins over time. In any case, execution of M&A is something very much worth watching over this time, as I am leaning on my analytical edge here being an industry participant along with justification through a low entry price for the group.
On the other 2, the client base as we discussed I believe to be quite an achievable goal through just organic growth in increasing market share of the small and mid tier accounting firms (~25% of the market uses Diverger services now). Lastly, the EBITA margin is also something I believe should be achievable through CARE operating leverage and increased operating efficiency through licensee scale and Hub24 partnership work.
Management does not own a significant stake (albeit still material) however, the long term incentive vesting tied to this strategic plan requires management to execute 150% in Net revenue growth through to 2025 and a 25% TSR on shareholder returns (including dividends) weighted 40% towards the revenue target and 60% towards the TSR. These are straight line tested between 100-150% for the revenue and 15-25% for the TSR. Below those lower thresholds management gets nothing. This implies a stock price of $2.01 in mid 2024 for the higher threshold to be achieved. For CEO Nathan Jacobsen, this would amount to ~1.3x his total annual salary package upon vesting and ~1.8x his cash remuneration.
Lastly, It’s worth mentioning Kevin White’s (Founder of Crowe Howarth Australasia, one of the only successful Accounting roll-ups on the ASX) involvement being the chairman and owning 5% of the business who has quite refreshing chairman’s letters, no matter how promotional you may find it this sort of commentary is reassuring to me for example:
“Several factors have and continue to weigh heavily on our share price, some of which are Company related, such as size (market capitalisation currently of the order of $30m) and low share liquidity (affecting the ability to trade shares without impacting the share price and hence discouraging larger investors in particular from investing). It is also worth noting that earnings growth, and hence the Company’s market rating, has been tempered by on-going investment in future organic growth opportunities and initiatives, as well as under-performance by our Document businesses.
Of course, a weak share price has lessened the appeal of issuing shares to fund new business acquisitions. This has made the Company more reliant on organic growth and accessing debt for acquisitions than directors would ideally like, especially given the Board’s keenness to accelerate earnings growth, maintain a strong balance sheet, increase market capitalisation and improve liquidity as important steps in strengthening the Company’s share price.
It is in this context that the Board announced in August of this year that it had decided to explore all avenues and options that are considered capable of enhancing shareholder value.”
~ Kevin White, 2019 AGM Diverger Ltd
Business aside, the valuation of Diverger is what initially excited me given my tendency to search aggressively for businesses that can grow in a lollapalooza fashion, that is through various mediums such as sales growth & volume, profit margins, buybacks/dividends and a multiple re-rating. I believe this business has all of the above in its future and limited downside due to the underlying business quality and Hub24 backing.
If they were to achieve their financial targets, even assuming that 3x net revenue growth is more like 2x on a per share basis with a consistent 40% EBITA or a ~25% FCF margin, it would put us at ~$1.50 in revenue per share and more like ~$0.37 in FCFPS, a substantial increase from the current ~$0.12 FCFPS the business has currently (adjusting for acquired intangible amortisation and impairments). At the Hub24 valuation mentioned earlier this would amount to a stock price of >$5 per share in late 2025, excluding any dividends collected along the way. Of course that is a best case scenario! In any case, Diverger is a business I am very familiar with that just so happens to offer a nice risk/reward opportunity for my portfolio.