A placing and a meeting: more than meets the eye

Steve Clayton - Fund Manager

18 May 2017

Last week, we mentioned that Fidessa had recently issued a downbeat outlook in their trading statement. Since our note, we met with their CEO and CFO for a more in-depth analysis of the factors at play, and have included our conclusion below. Elsewhere in the portfolio, GB Group announced an acquisition which we believe should benefit the firm’s long-term position.

GB Group - Well placed

GB Group is the smallest company in the HL Select UK Shares portfolio, with a market value, back when we first invested, of around £350m. The company provides verification services that allow employers to trust their new hires and online retailers to be sure of their customers’ IDs. With the huge growth of e-commerce, that makes GB Group a very hot property indeed.

Our first investments were pretty modest; the stock was not easy to find in meaningful size and the price was squeezy in the first few weeks. Gradually we were able to build a position and recently we have taken the opportunity to back the company in a new deal. GB Group have announced the acquisition of PCA Predict, which provides address verifications, mainly to smaller and medium-sized businesses who want to know for sure that their customers are bona fide.

The business is costing about £75m, and GB are funding this mainly through an institutional placing of new shares, which we signed up for. PCA Predict is highly profitable, making higher profit margins than GB itself does. It should fit well with a couple of existing GB operations and some synergies ought to be possible as the Group’s wider product offering is introduced to PCA’s clientele. Overall, earnings at GB should be enhanced by a high single digit percentage.

When companies want to issue shares at short notice to institutions, a discount is typically offered to encourage the funds to stump up. In this case, there was a discount of almost 4% on offer. We committed £1.1m to the deal, raising the funds from cash balances and a modest trim of some of our larger holdings. Market reaction to the deal has been very positive and the shares, which were placed at 340p are now close to 390p. Our average purchase price across the entire holding is 289p, so the fund has made a profit of more than £2.5m so far.

All well and good, we are firmly pro-profit. The flip side is that GB has risen as a percentage of the fund to the point where it is now our second largest holding. That’s not a problem; the whole point of our concentrated portfolio style is that it allows every holding to make an impact, and so far, GB Group is proving the point, just the way we like it. Remember past performance is not a guide to future returns.

Fidessa - Headwinds

Fidessa’s software systems link stock market firms together, allowing trading to be executed and settled electronically. They are the global leader in their niche and currently busily engaged trying to repeat the success they have enjoyed in the equities markets by moving into the derivatives markets.

A recent trading update alluded to the rising impact of political uncertainties around the world on customer confidence. This, said Fidessa, was leading to some potential clients deferring decision-making. We set up a meeting with Fidessa’s management to get a better view of the situation.

Fidessa’s products are embedded deep within their customers’ day to day operations, and without it, brokers and institutions alike would struggle to trade with each other. But life in the stock market is not as rosy as the level of the FTSE100 might suggest. For the brokers, which make up the large majority of the clientele, profitability has been under pressure for some time as institutions cut the commission rates they will pay.

Now, new rules governing the cost of research are coming in that will put the incomes of both fund managers and their brokers under strain. This could continue to hold Fidessa’s new business flows back for a while to come. We’d always been aware of this risk, but the magnitude is proving a little greater than we had expected. On balance, we’ve decided to hold on to our position. Few companies are as strong in their own niches as Fidessa and its cash generation track record is excellent. Not many UK business crack the US market organically, but Fidessa did. Crucially, if their new derivative service proves a winner, then it will move the needle by far more than a regulation-induced wobble.

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