K3 CAPITAL LOOKS WELL PLACED FOR GROWTH - 11/02/22

For a while now, I have had K3 Capital on my watch list, where the intention was to speak with management at the earliest opportunity.

Having had a previous slot lined up delayed, the catch up duly came earlier this week on the back of what appear to be excellent Interim Results, and where, as a result, I have bought some shares in the company.

The business is best described as one that provides extensive professional services, spanning M&A, Tax and Restructuring which sees it concentrated across the smaller to medium sized enterprise space, each of which are underpinned by the companies own software platform titled Globe.

The company has both been scaling up and expanding in recent years with strong and positive delivery on both organic and in particular acquisition driven growth.

Revenues have increased from £8.5m in 2016 to £47.2m in full year 2021 and the expectation is for the delivery of £56.8m in the current financial year, where, despite it largely being seen as something of a cyclical play, it is doing rather well.

To emphasise the point, adjusted pre-tax profits have also increased markedly during the aforementioned period, moving from £4.9m to £13.6m with a figure of £17.7m pencilled in for the current full year 2022.

The positive growth and level of returns has - aside reinvestment - enabled the company led by CEO John Rigby to embark on a progressive dividend policy which now appears to be accelerating somewhat impressively and is an added attraction for what is essentially a growth play.

Although due to the pandemic uncertainties the 2020 dividend payment of 7.5p was not surprisingly curtailed against the 2019 7.6p, it was last year increased to 9.1p with an expectation for an upping to 12.1p this year moving to an impressive looking 15.5p next year.

The adjusted earnings per share number for next year also looks attractive, with broker FinnCap forecasting 24.3p which at the current price of £3.10p puts the stock on a forward PER of under 13.

That looks decent value even in a choppy small cap market, given the performance announced for the first six months of the current year along with the prospects going forward, which look increasingly positive as the economy returns to something resembling normality.

Indeed, speaking with John Rigby and CFO Andrew Melbourne not only were they delighted with the Interim performance, they also sounded a confident note on future prospects.

Rigby says that the aspects of the group are very much volume businesses whether that be from the M&A division, Tax or Recovery.

“During the H1 period we had 4,200 invoices alone, with 700 a month where the average fee of those invoices was £7,350.00”.

Going further, the CEO adds that what is clear and integral to the story is that the business isn’t built on fewer and much larger figures that are sometimes seen in the area it operates.

“As you can see, we are a very much a volume player in this market and we have seen strong organic and inorganic growth across the divisions during the period on both revenue and profit.

We are also launching new service lines that we feel fit really well with what we are doing, giving us the ability to cross sell clients into those”.

In brief, the M&A business spans areas of merger and acquisitions utilising the Globe platform in conjunction with a significant database assisting in the sale or purchase of businesses with transaction fees being a driver.

It is an extensive market that is likely to continue to grow and present further opportunities for this arm.

K3 also supports business across tax, enabling them to claim R&D payments which is another area that should continue to provide growth opportunities and given the sticky nature of the operation sees solid recurring revenue providing visibility.

Last but not least, there is the restructuring arm which is active in aiding businesses that have lapsed into difficulty and require the likes of refunding.

Although, the last year or so hasn't seen the levels of distressed businesses as many predicted due to Government support, that is likely to change and accelerate moving forward. Importantly, from an investment perspective with K3, there are now distinct connections and additions across the group enabling the cross selling and thus, increased organic growth opportunities. Looking at the Interim numbers that were announced and which followed a previously positive trading update, the business looks well placed to further execute and deliver on the forecast full year numbers and perhaps - dare I say it - even go beyond that to an upgrade. I throw that one out, as the announced figures were marginally stronger than originally flagged in December and that month, which is usually a quieter period for the company, proved to be highly active which perhaps bodes well for the current timeline.

Revenues for the Interim period came in at £31.2m considerably higher than the corresponding 1H21 with EBITDA up to £9.4m which is just over half of the expected £18.2m figure for the full year. Speaking of the various arms of the group Rigby says that the M&A division is effectively its heritage and really what it was all about until the summer of 2020 and the pandemic. The CEO says to see the M&A arm perform so well during the period following on from the momentum it had throughout last year is particularly pleasing. “It has seen double digit organic growth with revenues here up 66% to £9.8m with EBITDA up 72% to £5m”. He also adds that the quality of earnings has been good and with KPI activity trending really strongly it gives them a good idea of what the future looks like. Although the M&A arm has historically been the driver of the business and is clearly going well, the 2020 pandemic ushered in a new period, as the CEO embarked on accelerating K3 into additional and complementary areas. This saw acquisitions made across the sectors previously mentioned, those being Tax and Restructuring which were supported by the raising of firstly £30m in 2020 and subsequently a further £10m during last summer. Whilst some market watchers may well be wary of the company seemingly dashing out on the acquisition trail, the CEO sounds an extremely bullish note on the execution strategy and maximising the growth opportunities, with particular progress being made via that cross selling within the group. The underlying confidence and pathway, has importantly been well supported by some impressive Institutional names where Miton heads the list with 14% of the company and which also sees Schroder, AXA and Henderson on board. To emphasise the progress being made, Rigby highlights one aspect of the M&A business that was only launched last July, in the form of the Knight Transaction Services operation, consisting of just three people at the time. This successfully invoiced some £250k over the first five months where importantly, two thirds were from cross referrals. The headcount there has since doubled to six and is now regularly invoicing £50k per month, where looking ahead, the CEO expects that to scale and grow adding that as the volume builds further, so margins also tick up. Cross selling appears to be a key theme in supporting and driving ongoing organic growth and given the performance to date from the business in what has been a harsh backdrop for many, it would appear to be demonstrating a credible ability to deliver. Summing up on this arm Rigby says he couldn’t be happier than what has been going on within the M&A business at present as seen by the numbers and the extremely positive organic growth performance. Moving on to the Tax segment, the CEO says, “we are creating scale and diversity within that business and we have gone from just one brand this time last year to four brands today, so we now have a great spread of revenues and profits”. There has however been what he describes as something akin to indigestion in achieving specific claims for clients with HMRC across the area relating to R&D. This has come despite their doubling the number of clients and claims being processed across the division and is due to a range of issues including what appears to be a more rigorous approach by HMRC inspectors in relation to claims. Still, it doesn’t appear to be anything major, affecting just three or four claims a month says Rigby and is not considered significant, leading him to state that he isn’t concerned.

He describes the quality of their R&D focused business as being very high and enjoying a 100% success rate on claims that are made to HMRC and with it being a growing market he adds that he is pretty confident of further ongoing progress. The tax division achieved revenue for the period of £4.8m, the majority of which was acquisition driven resulting in EBITDA of £2.4m and is on track to deliver market consensus figures for full year revenue of £10m with EBITDA at £5m. Speaking of the Restructuring arm of the group Rigby says that the pandemic not surprisingly created a lot of challenges, but that is now beginning to get back to the levels seen prior to that onset. Despite a difficult backdrop he says, “we have still seen double digit growth with an increase in our market share and that is on the back of the way the market conditions have been, so we are really pleased with the progress that has been made”. In a wider context, Rigby adds that they have made great progress with their overseas footprint where they have been keen to extend their presence into other key financial centres and areas for growth. A small acquisition was concluded in the Caribbean along with a rebranding of an operation in the Cayman Islands, whilst there are offices in Dubai, Singapore and also Poland and further expansion of the footprint looks very much part of the growth plan. Commenting on overseas operations the CEO adds, "We are really delighted with what we are building with a network of offices which are starting to pitch for and win some of the more sizeable and more lucrative opportunities”. Investment is also key to the future growth and Rigby adds that they have done that a little ahead of demand, which has resulted in a slight drop in margins, although he sees this as merely a temporary thing. The restructuring division includes contribution from the previous acquisition of Quantuma and numbers here came out with revenue of £16.6m and EBITDA at £3m. In terms of moving forward across the group, Rigby says that that they are both hearing of and seeing levels of activity picking up and he is really confident for the medium to longer term outlook for the business as a whole, which suggests to me that at current levels upside for the patient could be nicely rewarded, with capital upside complemented by a handy growing dividend. Further earning enhancing and complementary acquisitions also look to be firmly on the agenda as the CEO says, “we have things in our line of sight and have employed a corporate acquisition advisor who is very adept at identifying and ultimately helping integrating some of the businesses we acquire”. In terms of future funding, Rigby isn’t reliant on having to raise new money on the market, as he says there are a range of options open to the company. “It will depend on the size of any purchase, but we have strong cash balances despite the dividends we are paying and sit on around £9m of cash at present. We also have an unutilised £15m facility with HSBC which is there to give us that nimble approach, so it gives us the fire power if we need it”.

Broker FinnCap has earmarked full year 2022 revenues of £56.8m providing for adjusted pre-tax profits of £17.7m which moves next year to an expected revenue figure of £69.5m and an adjusted pre-tax profit of £21.7m. Earnings per share should come in at circa 17.4p for this year, rising to 24.3p next year, although another earning enhancing acquisition could alter that figure positively. The same broker is also forecasting a closing net cash position this year of £16.2m increasing to £22.2m next year which provides for an increased level of comfort and headroom. Although acquisitive companies can often find being overzealous or biting off something too big to be their undoing, K3 appears to be getting it right and is led by a CEO who is intent on making the right purchases along with delivering on the numbers.