You could look at AFH Financial purely as an arbitrage opportunity – though, as we will see, that massively undersells what chief executive Alan Hudson and his team have achieved.
AFH is an acquisitive independent financial adviser (IFA), which since November has completed six transactions, the last of which was Bay Financial Management for £1.4million. The average size of these deals is £1million, so they are modest.
It buys smaller IFAs at no more than four-times post-completion profitability, while AFH itself is valued by the stock market at around 12-times forecast earnings.
Advice: AFH buys smaller independent financial advisers at no more than four-times post-completion profitability
It means these bolt-ons are immediately earnings accretive; that is the arbitrage transaction. And, AFH is able generate additional income by introducing new customers to its discretionary wealth management platform.
This growing firm has a number of tailwinds. Legislation – and in particular the layers of onerous bureaucracy heaped on by the Retail Distribution Review – have forced the smaller outfits to consider whether the independent life is for them.
At the same time many IFAs are approaching retirement – the average age is 58. In other words, there are plenty of willing sellers.
In fact, AFH is approached with more deals than it could possibly ever handle. This means it can be choosy about what and who it brings on board. Culturally, the fit must be right, particularly when the owners then come to work with AFH.
‘We don’t buy businesses for purely financial reasons; we buy them because we like the people and they share our values,’ chief executive Hudson says.
‘To date, we haven’t done a deal where the vendors have joined us and left. Apart from retirement, the vendors are still with us.’
Where the company makes a purchase it ensures it is indemnified against possible mis-selling. That, Hudson says, ‘tends to be self-sifting’, though it should be noted AFH has never made a claim.
‘We are a long-standing IFA that hasn’t just been cobbled together to take advantage of consolidation in the sector,’ says Hudson.
It means AFH is a solid, cash generative business, which, if left to its own devices, is likely to grow organically fairly strongly.
In the year to October 31, when AFH made just two acquisitions, the company’s revenues increased 15 per cent, while earnings per share grew 20 per cent as its margins improved. More than two-thirds of its revenues (68 per cent) are recurring.
Here’s a firm, which when it last updated the City, was sitting on £6.7million of cash – or enough to complete £13million-worth of acquisitions (based on handing over 50 per cent of the deal consideration upfront). It also pays a dividend.
So, there is a lot to commend AFH.
The company’s broker, Liberum, reckons underlying earnings (EBITDA) will rise to £5.8million this financial year from £3.6million in 2016.
It is worth noting, however, that the Liberum analyst does not factor in the most recent batch of acquisitions to those figures.
Neither does the forecast include the impact of potential acquisitions likely to be made in the next 12 months. How could he? The point is the figures look conservative.
The company has a number of well-known institutions on the share register which provides future access to additional capital for its expansion plans. But importantly, founder Hudson still has plenty of skin in the game with 31 per cent of the company.
‘From an investor perspective that’s a big plus,’ he says. ‘I’m not going to break something I have spent my lifetime building. That should give a lot of comfort.’
The shares spent most of 2016 effectively treading water, although they’ve nudged up 11 per cent since the start of this year.
‘We seriously tick all the boxes, yet we have flown under the radar until very recently,’ concludes Hudson.