Portfolio (As at 30 June 2023)
Performance Since Inception
Commentary
For the Month of May 2023, the portfolio returned +1%, bringing the consolidated total return for the 2023 calendar year to date to -5.1%. However, since the first investment write up posted in June 2019, the CAGR for the portfolio has been +23.5%, a stellar result.
Note that last month I started a privately held unit trust for investors, mainly organised via. direct rapport. If this sounds interesting to you, feel free to email or twitter DM for more information. As I anticipated in last month’s update, I have allocated the full amount of raised capital within the Hurdle Rate Unit Trust.
I will be continuing to report results on a ‘consolidated basis’. That is, including all portfolio’s I am running which going forward will be the Hurdle Rate Unit Trust and my own personal SMSF.
Sequioa Financial Group (ASX:SEQ) - 24.8% Weighting
First, if you haven’t done so already, I have released the deep dive during May which you can read below:
During June the group announced the successful receipt of the 1st tranche payment on the Morrison Divestment. An amount of $15m. With this condition met, there is a transfer of control now in effect and we should see the consolidated financial statements change drastically to reflect a change in accounting treatment from controlled subsidiary to equity method associate. Lastly, this milestone puts into effect the call option which allows them to buy back the 50.1% of the shares transferred for a consideration of $17.85m. Given that they have received $25.5m already, this would net them a benefit of $7.65m if New Quantum was unable to pay a final tranche.
Furthermore, it was revealed during the month that a NASDAQ listed SPAC shell company approached New Quantum to acquire them for $1.1 billion AUD. This is a differential of $1.06b to the amount spent on Morrison securities, which is quite frankly an absurd valuation for a Sydney based fintech business. But as a Sequoia shareholder I will certainly not complain, as we are gaining extremely cheap exposure to one of their main subsidiaries now.
Lastly, during the month Sequoia announced a 20% investment into Euree Asset Managment for $1m inclusive of a goodwill services agreement. Sequoia will work with Euree to launch a range of multi-asset funds into the advice market. Euree is headed by ex. AFL player and coach James Hird (yes, the one involved in the Essendon doping scandal). It remains to be seen the EBIT contribution from this business as it was only just established.
Diverger (ASX:DVR) - 23.3% Weighting
Per the Financial Adviser register, Diverger closed the month with 401 advisers, down 5 from the previous month. Typically there is a lot of movement in advisers around the financial year end. Importantly this data is up to 29 June 2023, whereas there very well can be more exits on the 30 June which is typically the worst day of the year.
The stock remained cheap during the month, and I managed to allocate all the Hurdle Rate Unit Trust capital at the low price of 80c per share.
Prime Financial Group (ASX:PFG) - 18.5% Weighting
During the month, once again there was no news for Prime (outside of a few buyback announcements), and LinkedIn insights show no material move in employees over the month. There is no change on the previous month in terms of thoughts as a result.
Industry magazine Money Management did feature an article with CEO and co-founder Simon Madder however, which you can read here. Some of the more interesting quotes are highlighted below.
“The cultural change Madder referenced referred to the firm’s policy of equity ownership with 45 per cent of the business owned by staff. From November, this was set to increase to 48 per cent as more staff reached the equity level.”
“Madder said the firm is presently exploring 4-6 acquisition opportunities and would narrow this down to 1-2 each year. The firm is seeking to expand its SMSF and corporate advisory arms but Madder said acquisitions could be made in any of its four divisions.”
“We want to keep scaling up and acquisitions will feature more prominently. We will only consider those businesses which can add more value to the business and fit in with our model.”
DSW Capital (LON:DSW) - 11.8% Weighting
During June, the group made no RNS announcements to the market however, there was 4 deals advised on announced as shown below.
LinkedIn hiring trends suggest a good month for employment as well with +2 headcount for the month.
James Dow (Co-Founder) has also written a 90 page book on Porter’s 5 forces which you can find on Amazon, with all profits from the book being donated to the National Autistic Society.
Lastly, DSW Ventures posted it's investor report for March 2023 on LinkedIn, which is great as it can give us a view into how they are performing.
Notably the angel investing business has 4 of the nearly 100 fee earners within it, so it's not a particularly labour intensive part of the business, but investing is not an area that scales in profitability with additional labour necessarily.
You can read the report here.
AF Legal (ASX:AFL) - 8.1% Weighting
Last discussed in my Q1 2023 Portfolio Update, AF Legal has a bit of a history with me. When I started the Hurdle Rate Unit Trust I decided that I was to aim for 6-8 securities, with 5 held prior to May.
I have invested back into AF Legal because I view it as an opportunity whereby the initial unit economics I saw when i invested in December 2020 unhindered by the larger than expected corporate costs as potentially being able to shine under new management.
In that initial write up I estimated that the business could potentially reach post-tax profit margins of 20%+, which is likely a bit too optimistic given the groups lower gross margins compared to the likes of Kelly Partners. Actually, Prime Financial is a good idea of the margins it could get to as the gross margins are comparable.
Intriguingly, as exposed by the chart above (note I do not have parent entity data for 1H23), management were taking a consistent amount of corporate costs with ~20% before tax (~15% after tax) impact to margins attributable to the parent entity. However, we saw improving operating margins into declining gross margins which is very intriguing. As of June 2022, Operating expenses accounted for about 23% of revenue which is an impressive figure. In June 2021, it was closer to 33%. The question is where is the improvement coming from?
The above chart breaks down the 9.5% variance between opex as a % of revenue and we can see here that half of it is accounted for via. bad debts (elevated bad debts during 1st watts mccray year), marketing and SBC. A myriad of flatter fixed costs including listing, accounting and premises costs are also contributing to margin accretion at the partnership level. However, with a gross margin decline we only saw a 7.5% or so improvement at the PBT line and ~5.5% at the NPAT line as corporate costs were largely steady YoY as % of revenue.
In Q3 2023 the business reached a post-tax profit margin of 5.3% so it is showing very good improvement. If they can restore the gross margins, which presumably declined due to a tight labor market, and improve the corporate costs, I don’t see why they couldn’t approach a 15% NPAT margin over the medium term. I will be looking forward to the full year results and full financial statement notes to analyse the changes in cost base further to see how it develops over time.
There is still much work to be done that is without a doubt, but with improved management, almost 3x greater revenue and at 1/3 of the price, AF Legal shows a much more appealing investment today than at the time I initially invested. At a valuation of ~0.55x EV/Sales a 15% margin would equate to a low single digit earnings multiple on the margin expansion alone. But if they get good revenue growth then it can become even more appealing.
Getbusy (LON:GETB) - 6.4% Weighting
First, if you haven’t done so already, I have released the deep dive during June which you can read below:
In terms of RNS announcements, Getbusy announced that it would report 1H23 financial results on the 5th of September and that it continues to trade in line with market expectations (Full year 2023 Revenue of £21.1m and Adjusted EBITDA of £0.7m, representing analyst expected growth of +9.4% and NIL respectively).
Reckon (ASX:RKN) - 6.3% Weighting
Reckon is the only business that I have not owned in previous months or years in the portfolio. At the end of last month I spoke to Sam Allert which I highly recommend listening to.
I also came across a good succinct investment thesis on Reckon during the month written by
Furthermore, in October 2019 I actually did a longer form deep dive into Reckon.
The group has continuing NPAT of ~$5m at an enterprise value of ~$60m, which by itself certainly isn’t a no-brainer and actually looks reasonably expensive in relation to other things I own. But perhaps the main reason Reckon has stolen some of my money is due to management’s active approach to capital allocation (specifically divestments) and the new incentives around that, as described in the Getbusy deep dive. They themselves have said the following in a recent Chairman’s letter.
Your Board is very aware of the disconnect between the value of your Reckon shares represented by the share price and implied valuations based on revenue or EBITDA multiples usually applied to software companies, including the multiple applied to the sale price of the Accountants Practice Management Group. We firmly believe that there is considerable unlocked value in Reckon, more so than our current share price, and our management team are working hard to crystallise this value. To that end, we have included a cash incentive plan for our CEO and CFO that is subject to shareholder approval. The reward under the plan is significant, but so too are the targets. A return to you in cash of approximately three times the current market capitalisation of Reckon for any payment over the next six and one half years, up to approximately six times the current market cap for the maximum payment. It is indeed a large hurdle, but it is one that we believe is achievable if we can execute on our strategy. The sale of Accountants Practice Management Group shows that our management team can unlock unrealised value and deliver shareholder returns that exceed that of our ASX-listed peers.
~2022 Chairman’s letter
The incentive noted above exists with another incentive to sell the legal group, which incentivises heavily the 24% NCI interest to look for a purchaser of the legal group with the following components.
Reckon proposes to offer the Management Co-Investors who did not participate in the March 2023 capital raising:
“top-up” securities in nQ Zebraworks if nQ Zebraworks, or its business, is sold for more than USD $70M and up to USD $100M.
The number of “top up” securities to be offered will be determined on a sliding scale depending upon the sale price for nQ Zebraworks, or its assets. At a USD $100M sale price the Management Co-Investors are made “whole” as if they had participated to their full entitlement under the March 2023 capital raise.
The maximum number of “top up” securities that will be offered is 274,790 securities. This equates to approximately 2.85% of Reckon’s nQ Zebraworks securities and USD $2.17M of the sale proceeds that Reckon would otherwise have received if not for the transfer of the “top up” securities.
If the sale price is greater than USD $100M, Reckon will offer to all Management Co-Investors additional securities in nQ Zebraworks which are held by Reckon:
On a sliding scale determined by the sale price between USD $100M and USD $200M.
The maximum number of securities that will be offered is 475,690 (4.93% of Reckon’s interest in nQ Zebraworks) and would equate to approximately USD $3.75M of the sale proceeds at a USD $200M sale price.
There is no further benefit to be provided by Reckon at a sale price above USD $200M
The maximum number of nQ Zebraworks securities that may be offered by Reckon to Management CoInvestors is 750,480 or approximately 7.78% of Reckon’s nQ Zebraworks securities (USD $5.92M at a USD $200M sale price)
Of course, there are legitimate reasons for Reckon being valuable without this strategic value, such as the fact they are spending money on a loss-making product subsidised by the profit-making product. The business group generates a PBT margin of 30%, which if you take the corporate costs out implies a group NPAT of ~$7.2m attributable to shareholders, Implying a ~8x PE multiple. At the groups 60% payout ratio that is a >10% dividend yield inclusive of franking credits.
But really, Reckon is a bet on a strategic transaction occurring at some stage in the next decade and receiving a hold-return that makes it worthwhile waiting.
Closed Positions
No sales were made during the month.
Conclusion
Thank you for reading, these long form portfolio reviews are part of both my diligence to stay on top of my positions and the value for my paying subscribers, so I hope you get as much out of this as I do.