Gresham House powered up for highly profitable growth

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Simon Thompson from Investors Chronicle, writes a very positive piece on Gresham House – its success story to date and its exciting growth prospects

Simon Thompson from Investors Chronicle, writes a very positive piece on Gresham House  – its success story to date and its exciting growth prospects. Read the full article here:

I feel that investors are seriously underestimating the scale of the likely profit growth at specialist asset manager Gresham House (GHE:470p) in the coming years.

The company increased assets under management (AUM) by 148 per cent to £1.6bn in the first half of 2018, buoyed by the £27.5m acquisition of Oxford-based FIM Services, a specialist alternative fund manager specialising in forestry and renewable energy. FIM added 83,000 hectares of forestry (AUM of £635m) to increase Gresham House’s forestry business to over 100,000 hectares (combined AUM in excess of £900m). The asset class has a positive correlation with inflation, offers investors exposure to a growing global supply and demand imbalance, and benefits from favourable UK tax legislation.

FIM also added 127 megawatts (MW) of renewable energy generating assets in offshore wind farms and ground-mounted solar parks, which helped more than treble Gresham House’s renewable AUM to £344m. Offshore wind and solar parks have low operating risk, are cash-generative, income-producing assets, and their share of the UK’s total electricity generation is set to rise to over 50 per cent by 2023, up from around 30 per cent in the first quarter this year.

However, growth in electricity supply from intermittent renewables will increase the variability of power supply on the National Grid. That’s a problem because the electricity grid has no means to store excess electricity generated and effectively represents an additional bill consumers are being forced to pay at a time when they are already facing rising energy bills.

Utility-scale Energy Storage Systems (ESS) solve this problem by providing services to the National Grid to maintain grid stability as they can absorb and release energy as required in real time. So, to capitalise on the investment opportunity, Gresham House is launching a new fund on Tuesday, 13 November, Gresham House Energy Storage Fund (GRID:100p), to offer infrastructure and renewable investors a diversified and robust source of income, independent of renewable subsidies or the absolute level of power prices.

The aim is to deploy up to £200m of capital in tangible projects within 12 months (financed from the £100m gross proceeds of this week’s IPO and a placing programme that will run until 16 October 2019), targeting an annual net asset value total return (NAVTR) of 8 per cent. Once IPO proceeds are fully deployed, the fund will be leveraged up, which could increase NAVTR to 15 per cent. Shareholders can expect a first year dividend a share of 4.5p, rising to 7p once the fund is fully invested.

It looks a solid investment opportunity especially as the potential of energy storage is currently limited by a lack of experienced operators, and this situation will only intensify as demand for storage escalates, deployment of renewable energy installations ramps up, and traditional coal and gas-fired generating plants are retired. Importantly, the fund can generate multiple revenue streams that are not dependent on renewable subsidies and are uncorrelated with the absolute level of power prices.

Reassuringly, Gresham House’s New Energy division, which will act as investment manager, has proven expertise in developing and operating ESS. To date, its team has worked on 28 solar projects with a total capacity of 290MW, and on five energy storage projects with a combined 70MW of capacity. Gresham House New Energy and Noriker Power, a specialist in the design of battery control systems in which Gresham House has a 28 per cent stake, have collaborated to develop 70MW of operational ESS projects since 2016, which will form the seed portfolio for the new fund. Moreover, the fund has exclusivity over an additional 132MW ready-to-build projects, and a pipeline project of 80MW, thus offering scope to deploy 200MW plus within 12 months of IPO.

I not only feel that there is an opportunity for income investors in the new fund, but that it’s not factored into Gresham House’s current valuation. That’s because the company will receive an annual management fee of 1 per cent of the new fund’s net asset value (NAV) below £250m, 0.9 per cent when NAV is between £250m and £500m, and 0.8 per cent above £500m. It could make for a very lucrative recurring income stream for Gresham House shareholders. It’s not the only one, too.
 
Earnings accretive acquisition
That's because last Friday Gresham House announced the materially earnings enhancing acquisition of Livingbridge, the fund management group that runs the Baronsmead VCT and two open-ended vehicles, LF Livingbridge UK Micro Cap Fund and LF Livingbridge UK Multi-Cap Income Fund. The initial consideration is £30m and is being funded by the issue of £7m worth of shares to the vendors at 448p each, a placing of 2.6m new shares at the same price to raise £11.7m, and a new £10m three-year credit facility with Banco Santander.

It looks a sound deal to me as not only is Livingbridge a well respected brand and one with a strong track record - AUM have risen by at a compound annual growth rate of 8 per cent for the past five years to around £500m -  but it creates a platform to accelerate Gresham House's organic growth while at the same time offering cross selling opportunities across the asset manager's enlarged investor base. The deal is sensibly priced as Livingbridge posted a pre-tax profit of £5m in 2017, and deferred consideration of £10m is dependent on the business hitting future earnings targets.

AUM are set to get another major boost too. That's because at the time of Gresham House’s half-year results, chief executive Tony Dalwood revealed plans to raise £100m for new energy funds  as well as launching the Gresham House Energy Storage Fund (GRID). In addition, the asset manager is targeting a second-half £80m raise for its British Strategic Investment Fund, a closed-ended Guernsey Limited Partnership that invests in relatively illiquid investments in UK housing and infrastructure-related assets, having already committed 40 to 50 per cent of the original £150m raised.

Aside from the new energy and forestry funds, Gresham House’s mandates include one to manage the £45m portfolio of Aim-traded Gresham House Strategic(GHS:950p), a company I am also positive on, by applying private equity techniques to UK and European smaller public companies with a view to generating a 15 per cent annualised return over the medium term. The strategy is to focus on shares that suggest a company is intrinsically undervalued, such as low valuation multiples and tangible asset cover. There is a strong focus on cash generation, scope to improve return on capital and enhance value through strategic, operational or management initiatives. Gresham House also has the mandate to apply similar investment techniques to the £63m portfolio of investment company LMS Capital (52p).

Gresham House has also revealed that it's trading in line with analysts estimates for the full-year which point to it posting 2018 underlying pre-tax profit of £2.6m on revenue of £12m to produce EPS of 12.8p. Analyst forecasts are under review for 2019, but by my reckoning with the benefit of a full 12-month contribution in 2019 from the FIM acquisition, Livingstone VC, and all the aforementioned fund launches, Gresham House should easily make north of £10m underlying pre-tax profits. Please note that a key driver of profit growth is the operational leverage of the business which means that a greater proportion of rising incremental management fee income drops to the bottom line given that the fixed cost base is already covered. The combination of sharply rising operating margins and organic revenue growth is an enticing one as is the high proportion of recurring revenue.
 
Significant asset backing
The investment case gets even better because prior to the Livingbridge acquisition Gresham House had £17.4m of net cash, is due £2.1m deferred payment from Persimmon from a land sale, and holds £13.8m of other liquid assets including a £6.8m holding in Gresham House Strategic (GHS:950p).
Adjust for the £10m Banco Santander credit facility, and I reckon Gresham House currently has net cash and liquid investments of £23m, a sum worth 93p a share. Even that doesn’t tell the full story because the company’s cash pile is set to rise sharply in 2019. In fact, after factoring in my estimate of post-tax profit of £9.9m Gresham House is likely to earn between July 2018 and December 2019, and a £5.5m likely cash inflow next year from the exercise of 1.715m of shareholder and supporter call warrants, both of which have an exercise price of 323.7p and expire on 31 December 2019, then Gresham House’s cash and liquid resources could balloon to £38.5m by the end of December next year.

Please note that the outstanding 946,000 shareholder call warrants in issue are listed on the London Stock Exchange (GHEW:145p) and trade on a bid-offer spread of 135p to 145p, so are a geared way of playing the upside in Gresham House's ordinary shares. Moreover, there is hardly any 'time' value embedded in the call warrant price as it is 94 per cent 'in-the-money'.

So, after taking into account the exercise of the remaining supporter and shareholder warrants, and based on a closing 2019 fully diluted issued share capital of 26.5m shares, then the company’s cash and liquid resources could easily be worth 145p a share in 12 months' time. On this basis, at the current offer price of 470p, Gresham House’s shares are rated on around 10 times cash-adjusted 2019 EPS estimates based on my models.
For a fund manager targeting organic growth from assets uncorrelated to equity markets that’s a low rating. For good measure, analysts are anticipating a maiden dividend of 2.5p to be declared at annual results, with a progressive dividend policy to follow.
 
New target price and methodology
So, having included Gresham House’s shares at 312p in my 2016 Bargain Shares portfolio, and last rated them a buy at 475p (‘Operationally geared for profitable growth’, 19 Sep 2018), I remain positive on the investment case, so much so that I am upgrading my 12-month target price again from 575p to 650p.
If my target is reached then Gresham House would have a market value of £172m at the end of next year and an implied enterprise value of £134m net of my £38.5m cash and liquid resources estimate assuming all the call warrants are exercised by December 2019 when they expire. That  enterprise value looks sensible for a company well set to make £10m plus of pre-tax profit in 2019, and one that is building a series of lucrative income streams from investment mandates across multiple asset classes.
Moreover, if my 650p target price is achieved on the ordinary shares then the shareholder call warrants (GHEW:155p), which have an exercise price of 323.7p anytime before 31 December 2019, would more than double in value to 326.3p. This highlights the fact that the warrants are a geared play on the ordinary shares, which is why I also rate the them a buy. Buy.