Small Caps | Mar 10 2015
-Accelerated capability in UK
-Valuation sensitive to UK profitability
-Australia still significant
-Investment not for faint hearted
By Eva Brocklehurst
Praemium ((PPS)) is poised for growth in demand for its separately managed accounts (SMA). Praemium provides SMA systems to brokers, banks and financial planners in Australia and the UK. A number of company initiatives and a favourable industry environment means funds have been rising strongly. Morgans expects the company will surpass $3.5bn in funds on its platforms this year, providing a high degree of operating leverage and a high proportion of marginal revenue accruing to gross profit.
Recent changes to UK regulations makes these SMA services highly attractive to local wealth managers and financial advisors. Inflows have meant that Praemium's business, a loss maker in the UK for some time, is now on track to generate profits within the next three years. Australia is already highly profitable and the swing to profit in the UK lines up the company for strong profit growth for 3-4 years.
Risks lie with the fact that Praemium has a number of very large customers. The loss of just one would have a negative effect on earnings. As the user base grows over time, Morgans believes this risk will diminish. The other main risk is the assumptions embedded in the revenue and earnings multiples. There is risk of a sharp correction should the company fail to meet market growth expectations. Hence, the investment is not for the faint hearted, in Morgans' opinion. The broker has a positive view of the investment prospects and initiates coverage with an Add rating and 46c target.
Earlier this month the company announced the acquisition of Plum Software, based in the UK. This should accelerate the integration of the UK platform with the company's WealthCraft, and further replicate its Australian business model in the UK. Canaccord Genuity highlights a key strategic necessity for success in the UK market is the provision of third party data feed and product interfaces. Plum Software does this job. Consideration was GBP1m and 7.5m Praemium shares, or $4m.
Plum is expected to deliver annualised revenue of $2m. Any immediate earnings uplift is a bonus, in the broker's view, as the accelerated capability represents a significantly more compelling offer from Praemium in the longer term. Moreover, the acquisition is a sound strategic move, given the uncertainty that exists around costs and time needed to build such a capability in house. Canaccord Genuity makes modest earnings upgrades on the back of the acquisition and raises its target to 39c from 37c. A Buy rating is retained.
Although the UK operations are expected to improve, Morgans expects Australia will remain the powerhouse behind the company. This is projected on the assumptions of the benefits of V-Wrap customer accounts from adding the self managed super fund capability in 2015 and the continuing penetration of V-Wrap and SMA products. Morgans accepts its valuation is highly sensitive to the moment the UK becomes profitable. The UK business has large accumulated tax credits and any profit will be the same as free cash flow, thus having a large impact on the terminal value.
That said, Morgans does not believe Praemium needs to win any new clients in the UK to become cash flow positive and profitable. It simply needs to engage better with clients and achieve a better penetration rate. The acquisition of Plum Software will significantly expand the cross selling opportunities. Praemium has no debt and, following the Plum acquisition, will have at least $8m in cash, Morgans observes. The company has no significant capital spending requirement and free cash flow generation is therefore very high.
Praemium has three discrete but complementary offerings in Australia – its investment portfolio management system – V-Wrap – which allows investors and advisors to manage accounts holding equities and fixed interest securities on a single platform, the SMA investment platform and the WealthCraft financial planning management system, of which Hong Kong-based Dah Sing Bank is the largest single customer. V-Wrap remains the mainstay of the company's business. while the SMA platform is the growth driver. The SMA principle allows investors and their advisors to place any investment in the account and retain all the tax benefits with flexibility one of the main attractions.
DISCLOSURE: FNArena has partnered with financial services provider Pulse Markets ( www.pulsemarkets.com.au) to offer SMSF operators and other investors the opportunity to invest alongside a FNArena-recommended Model Portfolio via SMAs on the Praemium platform.
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