Amid the current turmoil surrounding the Credit Crunch plenty of investors have got their fingers burned after mistakenly believing that shares in financial services companies, particularly banks, could not get any cheaper. Indeed, a golfing friend of mine got a particularly sick feeling in his stomach recently after learning of Bradford & Bingley’s nationalisation just a week after buying shares in the bank (his first foray into the stock market as it happens).
However, in certain other areas of the financial services industry the Credit Crunch is creating opportunities for both sector participants and their investors.
Take the IFA (independent financial adviser) sector, for example. Yes, thousands of jobs in this sector are at risk as hundreds of IFA firms themselves have perilously high levels of debt (source: Plimsoll), but this also represents a chance for those few profitable, well-capitalised IFA firms to pick up bargains among rival businesses in order to grow much bigger in the longer term. We think Lighthouse Group is one such firm.
Lighthouse Group is a financial services business that has been quoted on London’s Alternative Investment Market since 2000. In May this year Lighthouse completed its merger with another AIM-quoted financial services business, Sumus, making the group the largest quoted independent supplier of financial advice and wealth management services in the UK.
The group’s core activities comprise the provision of services to IFAs and pension scheme administrators throughout the UK. The services are delivered through a number of divisions that cater for networked IFAs, employed IFAs and self-employed IFAs.
For example, LighthouseCarrwood – which generated £6 million of the group’s £52.9 million turnover last year – is a division that is made up of salaried advisers whose clients are accountancy practices. Meanwhile, LighthouseTemple (£11 million turnover) is a branded IFA business, which owns the clients and any income deriving from them in spite of its advisers all being self-employed.
LighthouseXpress – the group’s biggest division by revenue (£28 million of turnover) – services networked IFAs. These are several hundred advisers, each operating under their own brand as sole traders, partnerships or limited companies. The group provides regulatory cover, professional indemnity insurance and collects income due on their behalf.
The thinking behind the merger of Lighthouse and Sumus lay in both management teams’ view that the respective firms had complementary activities. For instance, Sumus brought two new businesses to Lighthouse: Falcon Group and Financial Services Advice and Support (FSAS).
Falcon Group (turnover in 2007: £15 million) has more than 130 advisers who supply financial advice to both companies and high net worth individuals. Its corporate financial planning function helps firms with employee benefits such as staff pension schemes and medical insurance.
FSAS is geographically focused on Scotland. Headquartered in Dunfermline, it is one of Scotland’s leading IFA networks with more than 160 IFAs and, at the time of Sumus’s acquisition, it had approximately 60,000 clients and around £700 million of assets under advice.
In a highly fragmented industry the enlarged Lighthouse Group now comprises 870 IFAs, representing 3% of the UK’s IFA profession or 2% of this country’s retail financial services sector by Annual Premium Income (API). This scale of course gives it advantages over rival IFA businesses in terms of profits and margins thanks to the spreading of central costs over a broader business base, but Lighthouse has also gained enhanced strength and depth in its advisory, investment and business development teams as well as enhanced distribution opportunities.
According to Lighthouse’s management the merger with Sumus has already realised annualised cost savings of £1 million, the full benefit of which will now flow through into 2009. This has been achieved through the early integration of the two firms’ financial reporting, IT, human resources and senior executive functions.
Meanwhile a further £1 million of cost savings has been identified, which should start to have an effect on the group’s figures in 2009/10.
Of course, Lighthouse’s business has suffered as the economic and investment background has become more challenging. Even during the group’s first half, which having ended on 30 June benefited from a couple of months of contributions from Sumus, revenues declined to £25.5 million (from £26.6 million in H1 2007) while pre-tax profits were 44.3% smaller at £442,000.
But despite this, the group is still profitable and generating strong cash flow. And it is has adopted a defensive strategy in that it is focusing on growing the proportion of its turnover that comes from recurring revenues by continuing to develop long-term relationships with its clients. In the first half, recurring income increased by roughly 20% to £4.9 million.
As a result of weaker trading conditions since the second quarter, at the end of September Lighthouse’s broker Shore Capital reduced its expectations for the group. Accordingly, pre-tax forecasts for 2008, 2009 and 2010 have been reduced to £0.4 million, £1.9 million and £2.6 million from previous estimates of £1.5 million, £3.2 million and £4.5 million respectively. The new estimates translate to earnings per share of 0.66p, 1.5p and 1.86p for 2008 through to 2010.
Consequently, the group’s shares have fallen and they now trade for approximately 12p each after having been over 20p at the start of September.
Although Lighthouse’s management does not expect any recovery in the short term, it does aim to take advantage of the fact that it is a well-capitalised firm in a sector that is currently poorly capitalised. With cash on the balance sheet of more than £12 million, and a team that is experienced in acquisitions and integration, the group sees itself as a consolidator in the IFA sector and it is well positioned to take advantage of further acquisition opportunities that may soon occur.
Certainly, Lighthouse’s directors appear to be upbeat after having bought 1,075,000 shares between them in October and November at prices of between 10 and 10.25p each. Another positive was the introduction of a maiden dividend (0.2p per share) after the interim results.
For potential investors, Lighthouse represents an interesting case. No doubt, the emergence of the Credit Crunch and its knock-on effect on individuals’ assets is having, and will continue to have, a detrimental impact on wealth management businesses and advisers, but for a firm like Lighthouse – which is cash generative, cash rich and sizeable in comparison with its peers – there is an opportunity to emerge from the current financial crisis as a much stronger entity.