Stock pitch - NAH (300%-500% upside)

Current share price - 43p

Break up value - c.£1.50/share

FY23 valuation - £2+/share

Overview

NAHL Group plc (LON:NAH) is listed on the AIM market in the UK. It is the holding company for a group of business that operate in (or adjacent to) the consumer legal services market in the UK. Following a streamlining during FY2020, the group now consists of two divisions:

1. Consumer Legal Services (CLS) – this division contains:
   1. a personal injury (PI) focused claims management company (National Accident Helpline), which generates enquiries from people who have suffered injuries and believe they may have a claim;
   2. a wholly owned law firm, which processes claims for claimants from initiation to settlement (National Accident Law);
   3. two law firms that are joint ventures between NAH and in each case an independent law firm. These were established to test the concept of internally processing enquiries. They are responsible for the large Minority Interest Payments that appear on the P&L; and
   4. Searches UK – a provider of the requisite conveyancing searches that form part of the legal completion process in UK property transactions.
2. Critical Care – this division consists of:
   1. Expert witness provision services, which assists claimants in finding expert witnesses to support their claims for very serious injuries (£100k+ in damages, more often £500k+); and
   2. Case management and rehabilitation services, which help those who have suffered catastrophic injuries assess their future and present needs and plan for those needs being met in the future.

Except for Searches UK, each of these businesses is non-cyclical and due to the UK’s statutory PI damages framework, the legal services businesses’ earning power is not diminished in higher inflation environments. 

Sentiment around the group is very low at the moment, following the reform of whiplash claims in the Civil Liability Act coming into force on 31 May 2021, which limited damages for whiplash to £240. However, I believe that sentiment is misplaced, as NAH do not actually generate many RTA enquiries, and those they do generate are now being processed in house. For the purposes of the below, I have omitted RTA claims revenue and profits, as the model is untested still.

NAH is currently trading at a market capitalisation of c.£20m and carries c.£14m of net debt, giving a current EV of £34m. This report will demonstrate:

1. that the current break-up value of the group exceeds £70m (£1.51/share) using conservative assumptions; and
2. the group is highly likely to be generating pre-tax profits of £9m+ (at 12x - £2.33/share) by the end of calendar year 2023, again using conservative assumptions.

In-house claim processing earning power

The CLS division has been going through a transformation from a pure play claims management business (National Accident Helpline), which generates enquiries from potential claimants through marketing activity and brand strength, to pass on to a panel of law firms in exchange for a ‘finder’s fee’, to a flexible model in which the enquiries generated can be processed in house as well as passed to the panel. Enquiries passed to the panel result in payback of c.100% of the cost of enquiry generation, with cash being received within 30 days. In house processing requires higher levels of upfront cost and working capital, as cash is not received until a case is settled (c.24 months), but returns are considerably higher than if passed to the panel, at 150-200% ROIC. This transformation has consumed large amounts of capital and most costs associated with it have been put through the P&L. This, along with the large minority interest payments made to the JV law firm partners, have dramatically reduced the division's earning power over the past 2 years.

That transformation process is now complete, and enquiries are being processed in house where appropriate. NAH indicate in their recent interim results that in the last 12 months £2.4m of operating profit has accrued in the work in progress (WIP) built up in that time.

Those profits and the associated revenue will not be recognised until liability is admitted, although much of the costs associated with the claims (including the enquiry generation costs) have already gone through the P&L, which supresses profits in the near-term.

The group has a lot of experience of triaging enquiries to determine if claims have merit and are likely to be successful (that is the primary role of a claims management company in the UK) and so the WIP building up is unlikely to suffer from significant write-offs before settlement. Furthermore, the counterparties to these claims are nearly all insurance companies, so there is little counterparty risk.

It is my estimate that once the ramp of enquiries processed in-house levels off (due to working capital restraints), there will be a rolling operating profit of c.£2.8-£3m p.a., as the costs of processing new claims is more than offset by the revenues and profits being recognised from mature claims. Given the c.24 month claim cycle, this should begin to happen towards the middle of 2023.

Traditional claims management earning power

In addition to the operating profit earned by cases processed in house, NAH will continue to generate profits from the passing of enquiries to its panel of law firms. Management have indicated that they will balance the placement of enquiries between in house processing and panel law firms in such a way as to manage working capital and cash generation. I estimate that by 2023, as the in-house processed claims begin to settle, NAH will be passing c.£6m of enquiries to panel law firms, which at the historic 30% operating margin, will add £1.8m of operating profit to the CLS division’s earning power. For the last 2 years, this operating profit has been used to subsidise investment in the transformation of the group, but once in-house processing moves into an equilibrium in 2023, that will no longer be the case.

Searches UK

Searches UK adds c.£400-500k of operating profit, but it is non-core so will not be discussed further.

Valuation

CLS Break-up:

Management reported in September that there is currently c.£7m of unrealised profit within the WIP carried on the balance sheet. The National Accident Helpline brand is the most recognised in the claims management market and consistently achieves the number 1 natural search result on Google. In a non-pandemic year, the group generates c.40,000 enquiries, c. 80% of which become claims. Each claim is worth c.£1200 to a law firm. The PI business goodwill is carried on the balance sheet at £40m, but to be conservative let’s assume that it could only be sold for 50% of carrying value, or £625 per annual claim generated, plus WIP, which gives a saleable value of c.£27m.

Based on UK residential market transactions, Searches UK could be sold at an EBIT multiple of c.6x (£2.4m). However, management considered a sale of this business earlier this year but decided not to go through due to a Competition and Markets Authority investigation into the searches market, so to be conservative we will exclude Searches UK.

CLS Earning power:

By FY 2023, National Accident Law should be capable of comfortably generating £2.8m of EBIT through internally processed claims.

The panel of law firms should still be generating £1.8m through the traditional claims management business.

Searches UK should continue to earn between £200k-£500k EBIT.

Total - £4.8m of FY23 EBIT

Critical Care Break-up

Prior to the pandemic, this division was earning £5m of EBIT and was on a growth trajectory of 5%-10% p.a. 2020 EBIT was £3.6m. The business is the market leader and has already been the subject of an attempted takeover by another UK listed group (Frenkel Topping) looking to add the best in class NAH critical care to its catastrophic injury support offering. Given it is widely recognised in the industry as an excellent business (but not the market), it is not a stretch to assume that an EBIT multiple of 10x-12x of normalised earnings would be realised. Averaging FY19 and FY20, that gives a normalised EBIT of £4.3m or a saleable value of between £43m and £51.6m.

Critical Care Earning power:

Critical care looks likely to return to growth over the next 2 years, meaning that it is not unreasonable to assume FY23 EBIT at the same level as FY19 of £5m of FY23 EBIT

Conclusion

I hope to have demonstrated that NAH is significantly undervalued on several valuation metrics, albeit not on backwards looking financial metrics, due to the costs of the transformation suppressing near and medium-term earning power. In addition, the pandemic has significantly reduced enquiry numbers, meaning it has taken longer for management to be able to invest in internal processing to the extent they had planned.

For a couple of years, this has looked like a ‘good business, bad business’ investment, but by FY23 it will be clear that it is actually two good businesses.