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Lighthouse's amazing 'hidden value': rare insight from a top investor

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Lighthouse's amazing 'hidden value': rare insight from a top investor

Following this week's surprise Quilter £46 million deal for IFA network Lighthouse, Citywire has been in touch with the key holders of the stock.

The latest to contribute is second largest holder, Melwin Mehta of the top performing Discretionary Unit fund. 

Mehta is not one to court the media, however the Quilter bid has inspired him to share his view on what an incredible deal the firm is getting for a company he has invested in for almost a decade. 

Metha writes: 

It is no surprise that Lighthouse has been in the news after the Quilter cash offer. As the second largest institutional shareholder with a 13% stake in the business, I have been asked several times: do you think the shares are undervalued?

This is a rhetorical question. As an active money manager, I am suppose to be investing in undervalued quality businesses run by top managers. Lighthouse met that criteria and hence I invested.

Lighthouse is my largest position and has been for a while (see table below). Not only was I proud of my ownership but MI Discretionary Unit fund had 10% allocated (the maximum allowable under Ucits rules) - it was a high conviction holding. 

Position Name of holder %
1 Helium Rising Star 17%
2 Allan Rosengren 16%
3 MI Discretionary Unit Fund 13%
4 Liverpool Victoria 7%
5 Cavendish 5%
6 Quilter Cheviot 4%
  Total 63%

 

As a fund manager I study well over 500 companies and personally meet over 200 companies annually. The financial advice business is tough, and difficult to scale. Regulatory requirements and administrative costs are increasing.

Lighthouse was listed on AIM in 2000 and is one of the few companies surviving from that vintage. It is also one of the largest advisers in the UK market and for these reasons it is followed closely by retail investors and other competitors including wealth managers.

The management of Lighthouse has done an incredible job: the numbers speak for themselves. In 2012, the company reported losses of £3.5 million. The company currently subsidises its auto-enrolment and nascent asset management business. Adjusting for this, in the year ended 2018, the profits were £3.5 million – a £7 million swing over six years. The management has executed a superb turnaround.  

Few advice firms are profitable and the ones that are profitable are highly coveted by buyer, who are willing to pay top dollar. This is a relationship business, clients rarely change their adviser, and recurring revenues are high. Not many are able to reach a point where they start enjoying tailwinds. Lighthouse is one of the few who have reached that tipping point.

Lighthouse is no ordinary adviser and very different to other listed peers, however. The management have built a wide moat through 23 affinity groups with more than six million members, including Unite (1.4 million members), Parliament Hill (1.7 million), Unison (1.3 million), British Airways and teachers union NEU.

What value would this affinity be worth?

Equity investing is about weighing the downside and painting a possible upside. My assumptions are forward looking and merely estimates.  

  • If six million affinity members invested a mere £10,000 each, total assets would be £60 billion. If we assume a fee margin of 10 basis points, that would be an annualised profit of £60 million.
  • Under a different scenario, if only one million investors invested £50,000, total assets would be £50 billion. On a same parsimonious margin, annual profits would be £50 million.

Average fees in our industry exceed 1% but I have assumed only 10 basis (one-tenth of 1%), to be conservative, assuming a competitive digital solution to be part of route to market.

Of course, these fat profits of £50-60 million are futuristic, would take additional investment, and at least three years before they start to materialise but I can understand why some investors would feel angry about Quilters £42 million offer.

Quilter has rightly identified Lighthouse’s hidden value where others failed. I am not part of Quilter and nor have I ever met the management, but I can offer the following reasons why Lighthouse might be considered undervalued.  

The core IFA business is £3.5 million in profit – with further synergies excluding board, Plc and central costs to any acquirer

Lighthouse has relationships with 40 accountancy firms

It serves 80,000 clients with assets under advice of £5 billion

It holds a very strategic investment of 5.3% in Tavistock Investments, valued at £1 million

The current marketcap of Lighthouse is £41 million. Net of cash and Tavistock, Lighthouse's adjusted market cap would be £31 million which translates into a price to earning multiple of less than 10 (30% below industry average).

Quilter has received irrevocable undertakings from 39% of external investors which immediately extinguish, if a competing offer that is 10% higher emerges. This is not an insurmountable hurdle.

Much like me, Quilter believes Lighthouse is undervalued and wants to capture the upside. Quilter has followed the rules and tabled an offer. The question everyone is now asking: Do we expect other bids?

That is the answer, only time will tell.  

* The MI Discretionary Unit fund has returned 54.5% in the three years to the end of February. It is ranked seventh in its peer group where the average return is 34.5% 

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