MERC-ky...okay okay okay

13th Jul '20 by mojomogoz

19 comments 1886 reads

Mercia reports tomorrow. Its got a merky rep and price...but tomorrow I think its going to bop https://www.youtube.com/watch?v=9ClYy0MxsU0

Its a company with a fair degree of disinterest and disappointment kicking around. PI support waned hugely on their Dec 2019 fund raise feeling both peeved that they did it and then double annoyed that it wasn't done as a rights issue for existing shareholders.

The stock was in a hole back then. It was clear if one analysed the available info that they were likely to do a raise. They had been signalling that they were not yet at the stage of profitably realising balance sheet investments and that made it obvs that they needed more investment capital...

That put it in a hole as they were caught with a bad shareholder register with Woodford and Invesco as dominant key holders. How can you raise with those guys ruling the roost?

They pulled off the raise by tagging in the sweetener acquisition of Northern Ventures and their 3 VCTs. The good things about that is takes their asset management activities to an earning positive position. This activity seems to have something between low and zero value attached to it by the market. Overall, its looks like a good deal.

Overall, I think PIs had been neglectful of reality not to see the funding issue coming and then threw their toys out of the pram through exasperation and frustration at lack of share price appreciation. Pre the Dec 2019 raise I'd built an initial position in 27p area...even though value looked great was cautious of taking too much. Then I took part in the accelerated book build...I bid at 20.5p and was knocked back and everyone was corralled in at 25p. I felt the brokers had done exceptionally well to get a 25p price given the shareholder register etc and so I only took part lightly as my hunch was that between raise and final results newsflow was unlikely to be very positive (its a J curve business so little bad news is likely before big good news)...

...then came covid and the price headed south fast...so I "filled my boots" in the 14p area. It seemed a give away for something that had clear value underpin and growth upside.

I don't buy for value but its nice if you can get. I think…

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mojomogoz

14th Jul '20

Well. The market is underwhelmed with today's results.

NAV was >30p at 32.1p but not as high as the 35p i thought it could be trying to parse the public information disclosed before today. I was cautious that 35p was on the optimistic side. My range was 30-35p and I thought more to the high side. The calc was done on the hoof after last week's Native Antigen sale and Edison update note. I haven't quite reconciled my estimate with results toady but I think it was around cash and not factoring in the impact of short term liquidity investments too.

Its slow burn. Value is easy to identify (see summary below) but growth is harder (early stage private investment J-curve). They are at the show me the money phase re proving out their growth ability now with portfolio companies nearing the maturity whereby exits are sought (eg Native Antigen).

Value through a sum of the parts perspective:

Mkt cap £86.5m (intraday -3.9%) and NAV 32.1p compares to sp of 19.7p

Direct investment portfolio (conservatively) valued at £87.5m -> 20p of NAV

Balance sheet cash of £24.4m and short term liquidity investments of £6.2m -> 6.9p of NAV

Asset management business (£660m of 3rd party funds excluding balance sheet inv and cash) makes up the rest of the NAV -> 5.2p of NAV (or £7.4m of book value)

Note, 3rd party asset management at Mercia is valued at 1.1% of AUM. On a standalone basis asset managers trade at a premium to BV and a market cap that is 2-5% of AUM is more typical. Mercia's long duration, high-ish fee mandates should push it to the higher end all else being equal sort of thing.

(3rd party funds split £476m VC, £60m PE and £122m debt)

So we can crudely equate market cap to carrying value of direct balance sheet investments -> cash and 3rd party asset management biz has zero value.

Note, as cash will be deployed into long term private investments its not unreasonable to discount its value somewhat particularly before the company has shown it can get itself on the positive side the investment J-curve.

The nature of Mercia portfolio is that carrying values are relatively conservative (of course assuming underlying businesses remain a going concern) until a transaction clarifies value. We just saw that with Native Antigen where it was sold for 50% above carrying value at 31 March (and 94% above 30 Sept 2019 value).

The J-curve effect works such that negative events are earlier and more frequent whereas the positive events come latter and less frequently. During the early part of J-curve mark downs are likely to be more aggressive than mark ups. They've been on the early part of J-Curve to date and seem to have probably ripened to mid stage now (or pre covid anyway) but we can only be sure with more exits. The direct investment portfolio valuation as at 31 March has aggregate £10.5m write down for 3 companies Warwick Acoustics, Impression Technologies and Crowd Reactive (here's a further £5.3m write down other businesses).

The first two stay in portfolio backed by Mercia. Their write down is driven by importance of auto industry to their prospects (higher end auto). The write downs are large relative to carrying value and assume significant negative. Obviously it has been done at the peak of covid problems and bleakest moment. There will be risks to realising or growing that value but it is well (and aggressively discounted now). The write downs place valuation in position whereby future value can be achieved through either a pick up in business again or a commercial sale of the underlying technological capability.

Crowd Reactive is in events management and given lack of visibility they decided not to support the company anymore (ie continue to provide working capital) and sold holding back to founders at loss. They have taken similar decisions in the past and its good imo that they do this rather than live in hope and bleed cash into an uncertain situation.

As Mercia operate at the small end of the VC market and tend to lead deals and own large stakes they do not participate in the up escalator of revaluations that a company like Draper Esprit (LON:GROW) or other VCs do. These cos tend to have small stakes in large fashionable VC investments where there are regular additional funding rounds pushing up valuations. Many of these cos have such large private valuations that an IPO is the only likely exit (and IMO many will fail to make that an so valuation will fall). To a significant extent this process relates to stock market and macro liquidity dynamics.

By comparison Mercia valuations are conservative and even operational growth of a company will tend to have low impact on mark up in valuation. Their top two holdings nDreams (36.4% ownership valued at £16.1m,VR game co) and OXGENE (30.2% ownership valued at £11.7m, biotech) both doubled revenue over the year but only a £1.6m revaluation up (and £1m invest...suggesting that the cos are operating a low cash burn and/or in and around profitable operational performance despite growing so fast).

IPOs by Mercia would likely be particularly accretive but the business is more conservatively focused on industry exits. The good thing about this is that makes transactions and revaluation write ups more possible even in a tougher market and macro environment. IMO Mercia is safer more secure value-growth than something like Draper which could be vulnerable to changing market conditions. Notionally, I see them as a long-short pair for a variety of reasons (although I tend not to short...and I don't like pairs trades!)

I totally understand that there is some discounting of value and scepticism on the growth engine. But the overall valuation of Mercia implies the market thinks this business is broken.

Of course, they may show they cannot exit the J-curve if they have a portfolio of duds....record to date through broader EIS and VC investments in the asset management business suggests they are capable investors (unlike many others in that world particularly EIS)....but its a risk.

A couple of more exits in next 12 or so months (or one large one) would give revaluation. In addition, the company has tentatively talked about paying a dividend as asset management moves to cash flow positive (has now) and balance sheet funds its own reinvestment through divestments. I suspect covid will delay the latter....although it may accelerate the former for some businesses that benefit from it.

Risks obvs. DYOR!

Doh! Annoying. Put wrong numbers in on the book value of asset manager...don't know why I didn't sense check myself as I knew the figure wasn't £7m! Corrected offending segment below. The asset management business remains undervalued as part of overall market valuation BUT NOT in terms of carrying value on book.
----------------------------
"Asset management business (£660m of 3rd party funds excluding balance sheet inv and cash) makes up the rest of the NAV -> 5.2p of NAV (or £22.9m of book value)

Note, 3rd party asset management at Mercia is valued at 3.5% of AUM. On a standalone basis asset managers trade at a premium to BV and a market cap that is 2-5% of AUM is more typical. Mercia's long duration, high-ish fee mandates should push it to the higher end all else being equal sort of thing."
-----------------------------

So the value proposition remains in that total is valued at the current (conservative) carrying value of direct balance sheet investments and no value is given to considerable cash holding of £30.4m or the 3rd party asset management business (venture cap focused) carried at a BV of £22.9m for £660m of external fee paying assets (which is around fair value territory ex organic growth prospects).

The key uncertainty is over the success of portfolio direct investments which are probably good (rapid revenue growth for key businesses) and probably held at conservative values.

Apologies for messiness/errors in representations above if you are in the minority interested in this -> my view is attractive combination of value, growth and positioning (platform and how it dissects a messy market)

ambrosia

this is one of those companies with really hard to read financials, normalised EPS is positive while op cashflow is negative (where did that profit come from) F score 3 out of 9, goodwill is almost 8% of assets, price has been unable to break above 50 day moving average.

Too hard for me to understand

It is true it doesn't fit into accounting framework neatly. Partly function of being a hybrid of an asset manager and an exchange listed fund. Ignore earnings as they go up and down as a function of asset revaluation. Focus on operational cash flow to see where it is in terms of operational maturity (as an asset manager).

3 pieces:

1) A portfolio of venture capital investments. At the moment the market cap of Mercia is at slight discount to the (conservative) valuation of these VC holdings. If these are good investments then that standalone discount is 'cheap' and if they are bad investments its still expensive

2) £30.5m of on balance sheet cash to be used for investment in existing and new VC investments. This has no value in the market cap...if we assume simplistically that (1) takes it all

3) A £660m funds under management asset management business (excluding the balance sheet investments). This is relatively sticky and high fee business. Lots of arguments to be had as to what percentage of AUM it should be valued at. If they have growth in AUM and high margin then some would push up to say 10% of AUM. I'm plumping for 2-5% as a range and they are held at book value at 3.5%....however with reference to (1) above this has zero weight if we assume all the market cap is in direct VC portfolio. Note, this piece has just hit payout and now should (barring economic apocalypse asset write downs) make a positive and growing cash flow contribution (which they have suggested will turn into dividends but I'd prefer reinvestment)

Feedback between (1) and (3):
Negative = (3) has extra operational costs embedded in it as it must support the extra diligence of (1)...these are modest given the scale of third party asset management but cannot be easily disentangled
Positive = The 'exchange listed fund' that is (1) has its operational costs paid for by (3) rather than directly dipping into the pockets of shareholders (as would normally be the case to support costs for a pure exchange listed fund). This along with coming realisations of mature VC investments leads to what mgt call 'evergreening' whereby the whole business sustains itself through internally generated cash flows both as an operating company and as investment vehicle.

If Mercia Asset Management (LON:MERC) is a good situation then (1)+(3) is a value creating marriage. If its a bad situation then (1) destroys value in (3) as well as just p1ssing away money itself. Obvs I'm seeing the positive....which as I've said before is initially disguised as investment portfolio moves along J-curve.

I agree that they could report more neatly and greater clarity (which can be held against them)...but is partly its a bit of complex juggle even if not obfuscation is intended. Could do better is the grade there for sure though.

Hopefully this is more succinct than my earlier messier descriptions. Its a bit special sits and hidden risk-return IMO. Its not a trend idea and could take time to play out. I've accumulated to wait. I've had contact a few times and my view is that they are real and decent investors...but still got to prove it through the J-curve 'quickening' (Highlander obvs). If its proves out then its both great value and great growth...if not then its a bit illiquid and asset realisation play (being very simplistic).

IMO the business is at a sort of reflexive moment whereby its going to shape shift at some point from dull and scepticism to a bit more belief in the proposition. I feel this is nearly entirely independent of market factors...so true 'alpha'.

DYOR and not for everyone

1st Mar '21

Less merc-ky now....

At start of day share price the announced transaction means that half the market cap is in cash....obvs this is cash they use to invest so its not coming back to you.

https://www.londonstockexchang...

But they also say in TU that they are well ahead of expectations from an adjusted operating profit perspective (ie not gains from investments)

Hard to tell exactly where that will be but I think £2.8m was the adj OP for 2021 and if they beat significantly lets say its a round £4m -> 12.5x EV/EBIT at start of day share price....

That's decent for a standalone asset management biz with a 'high growth' tech investment portfolio and very sticky AUM (as VC not public market).

Then you get the portfolio of investments for something like free.

Today's announcements should be transformative for perception of Mercia Asset Management (LON:MERC) and put it on course for premium to NAV.

(The fy report needs to be read carefully when it comes out to get hold of moving pieces. From my quick maths I think the £23m consolidated income update, so inc investment gains and losses, is very conservative unless they have already had write downs they are recognising for H2 2021...but they say that adj op profit is well ahead so if no net write downs ex Oxgene then they are on to beat £23m by many £m...I suspect that the news is good enough today that they have left good news in the tank...with fingers crossed not any big write downs...but note they did do that quite aggressively for covid so quite a bit of that impact is in and perhaps there should be some cyclical rebound in their industrials that got hit?)

turbo

"The Board is pleased to announce that trading has continued to be robust since the Group's interim results were announced in early December 2020. A positive combination of revenue growth in the second half of the financial year coupled with lower than anticipated staff related expenditure, in part due to the Government's most recent stay at home lockdown restrictions, now means that the Group's full year adjusted operating profit* is expected to be materially ahead of current consensus forecasts."

Mercia16

3rd Mar '21

Excellent summary mojomogoz. I recall there was a hefty write-down on MHC (formerly Concepta) in the last finals and if the recent good run there is not a flash in the pan but backed up by covid testing contracts there will be a decent write-back.

Thanks Mercia16...interesting name!

My comment on Mercia Asset Management (LON:MERC) is unfortunately messy (and with errors) as done quickly and the pieces are a bit tricky to unpick

4th Mar '21

Mercia was a conviction buy when I joined Stockopedia a year ago ;-)

6th Apr '21

6 April 2021

MyHealthChecked plc signs major contract

Mercia Asset Management PLC (AIM: MERC), the proactive, regionally focused specialist asset manager with c.£872million of assets under management, notes today's announcement by its AIM quoted direct investment portfolio company MyHealthChecked plc (AIM: MHC), that is has signed a significant commercial contract with Boots UK Limited, the health and beauty retailer and pharmacy group.

MyHealthChecked plc is a fast growing personalised healthcare company. It became a direct investment in 2016, and, as at 30 September 2020, Mercia's 14.6% beneficial stake was valued at £675,000 based upon the closing bid price of 0.8 pence per share. Mercia currently holds 101,992,932 shares in MyHealthChecked plc, representing a direct beneficial stake of 14.1%.

Mark Payton, Chief Executive Officer of Mercia, said: "We are pleased to note this significant commercial milestone for MyHealthChecked plc, which will enable it to provide its expanding product range of personalised healthcare products to a much larger number of customers.

12th Apr '21

The Mercia (MERC) Brief Tuesday 20th April 2021, 4pm - virtual event

TamzinPiworld

23rd Apr '21

Here's the Mercia Asset Management (LON:MERC) virtual event from 20.4.21. This showcases Mercia’s team, portfolio companies and an overview of the Group’s recent performance. Led by Mercia’s CEO Dr Mark Payton, this provides insight on the progress that Mercia is making on its three-year strategy. Mark was joined by Martin Glanfield, CFO, Julian Viggars, CIO and Jill Williams, Investment Director. The event includes short presentations from the CEOs of several Mercia investee companies within both its direct investment portfolio and third-party manage funds’ portfolios. At the end there is a short Q&A. Video & podcast.

23rd Jun '21

Positive performance fee entitlement and trading update from Mercia today.

"Mercia is entitled to receive gross performance fees totalling £3.3million. This revenue will now be included in Mercia's full year consolidated financial statements for the year ended 31 March 2021."

Full year results due on 6 July 2021.

9th Jul '21

Some decent director share dealings in the last couple of days:

I.R. Metcalfe BUY 50,000 @ 39.40p £19,700

J.G. Viggars BUY 160,000 @ 38.09p £60,944

M.A. Payton BUY 157,445 @ 38.17p £60,096

M.J. Glanfield BUY 383,112 @ 39.41p £150,984

I tend not to put a lot of weight behind director dealing particularly when they have option based incentive comp too. However, I thought this might be a decent signal in that they are meaningful purchases relative to cash comp (salary £235k CEO and £200k CFO and CIO...although 2021 will see nice cash bonus boosting that considerably). I've met the CFO once and interacted a few times email/call and I was a always a little suspicious that he didn't buy more stock. He seems canny-cautious sort of person and as CFO not likely to be so caught up in the 'exciting stories' in the portfolio. Him buying a decent amount to me hinted that he saw clear value (not that I think £150k will be a lot of money for him!).

My hunch is that they have sight of at least one meaningful realisation (or grounds for significant revaluation of biggish holding) coming down the pipe. On a conservative sum of the parts the stock is worth between approx 40-43p depending on valuation given to 3rd party asset management (ie approx between 3-5% of AUM ex balance sheet investments).

This is conservative as 1) I believe that the portfolio is generally held at pretty conservative valuations relative to other PE/VC businesses in tech (software, med and industrial) that they hold (accentuated by the covid write down process for particularly some the industrial holdings as the write back is slower even as they recover...the shot of pessimism leaves hangover) and 2) the asset manager has high fees and time locked up investments so 3-5% of AUM might be conservative. And I could add 3) that they are probably in a good position to grow AUM as they offer something quite unique in terms of non London or pure Oxbridge corridor VC that may place them in good position to acquire business (asset management works whereby need some scale to make institutional money feel safe with you).

For sure the exciting move has most likely run from covid lows but depending on how things go this has 15-30% growth potential (including going to fair value and then a premium as is not untypical for this sort of investment with time).

Management through Edison seem to want to make a case that they can be valued at 20x reported earnings. That would be nice and would see >£400m market cap....but that feels a stretch to me on the basis that a lot of those earnings would be asset revaluation and realisation. I'd make a really rough guess that 25% premium to NAV of balance sheet investments is where 'fair value' peaks out (that's £25m to £37.5m extra market cap depending on whether you value portfolio only or portfolio + cash).

illiswilgig

11th Jul '21

mojo - thank you for this post and the update which I have only just stumbled upon. Quite Excellent! Probably my fault for not finding it earlier - but stocko doesn't make it easy to browse the share chats? A great shame because the assembled wisdom and experience of everyone here could contribute so much more in my opinion.

I was late to the MERC party. From memory I started buying at around 24.5p. If I'd found this writeup at the time I might have committed a bit more. Or maybe not. I agree with your thinking, this is a nice little company that does what it says on the tin and a way to get access to non-London centric deals which in my limited experience can be more fruitful, even in the quoted space.

Sure there is less short term upside but with the recent exits , a nice pipeline of interesting companies and a profitably asset management business the downside risk is much lower. After the recent results the management has more credibility (with me at least) and there is still room for some nice suprises to the upside over time.

I only have a small holding, about 1% of my portfolio, probably a little less than I'd like - but I was buying Polar Capital at the same time and split my funds, so perhaps I'll add a little more if it dips a bit in the next few months,

cheers

Mark

12th Jul '21

Intermediate-Term Bullish signal generated on 16 April 2021 would seem to agree with your prediction of 40-43 prediction:

Volume 332,838

Close Price 33.50

Target Price 42.00 - 43.75

Pattern Duration 35 days

Inbound Trend Duration 32 days

just tbc…

15-30% is an annualised return estimate by me for approx 3-5 yrs forward from here.

I tend to only seek to initiate positions where I think I can see 100% return over 2-5 yrs with the emphasis on 2-3yr period. That means I take high risk and I'm looking for situations where I believe there is quite significant misperception (so unlikely to be popular).

But once I own something the return target becomes less religious as I’m willing to run the ‘proof’ and operating momentum in the stock with the view that I have a lower risk position due to proof and greater personal knowledge (which includes discovery where I’m wrong as well as right on a good performing share).

So tbh I’d not be a buyer of Mercia today even tho I’m a happy holder at the moment as I don't see 100% upside through misperception. I’m a bit ‘contrarian’ in that sense and not a trend follower so much. But that doesn’t mean that Mercia won’t make my 3ish year return target, it just means that it doesn’t have the out of consensus surprise potential driving that

17th Sep '21

Mercia close to the Bullish signal generated on 16 April 2021 (target 42.00 - 43.75). Decent buying volume today, perhaps people buying before ex-div dates of next Thursday? I will continue to hold.

MERC-ky...okay okay okay

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Mojomogoz

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