Description

Now that no one will care about my ideas for a while, it’s time to sneak in my annual VIC posting requirements.

Mortgage Advice Bureau (MAB) grew 40% in 2014 with 16.5% FCF margins and 85% ROE. The shares trade at 13X EV/FCF on a trailing basis. With a strong regulatory tailwind and good operating leverage, I expect EPS to increase by 60% by 2016. As a very capital-light business, MAB is also committed to paying out 60% of earnings as a dividend, and thus sports a nearly 4% yield.

MAB came public on the London AIM in November 2014. The market cap is very small. Liquidity had been tepid because insiders own 51.6% of the shares, but has improved somewhat since a 3mm share volume day occurred on March 30, 2015.

Business Description

MAB operates as an intermediary in the UK mortgage market. On one end, MAB operates as a mortgage brokerage franchisor. It provides the MAB brand, IT platform, backend infrastructure, compliance, FCA regulatory authorization, etc… to about 110 Appointed Representative firms (ARs). Over 75% of MAB’s ARs have long-term contracts with MAB. At May 15, 2015, 702 advisers work for MAB’s ARs, up from 634 at the end of 2014. These advisers broker mortgages and insurance products to end customers.

On the other end, MAB is a demand generator for lenders and insurers. MAB collects fees from lenders, insurers, and clients, which are then shared with the AR firms. The number of advisers in the MAB network is a key driver of revenue.

UK Mortgage Market Review (MMR)

The UK Financial Conduct Authority (FCA) implemented the MMR (http://www.fsa.gov.uk/static/pubs/policy/ps12-16.pdf) in April 2014. The MMR requires that all interactive (e.g., face to face or telephone) sales of mortgage must be made on an “advised” basis. During an interview with a borrower, the adviser will assess the borrower’s finances, their ability to repay a loan, and provide advice on the best mortgage option. This advised process can take up to three hours to complete.

For borrowers, this makes shopping for mortgages at individual lenders extremely painful as the borrower would have to go through this advised process at every lender. For lenders, this increases their costs as they must hired qualified advisers to sell mortgages. Both borrowers and lenders have a great incentive to use mortgage intermediaries like MAB. The borrower only has to go through the advised process once to access a full array of mortgage options. For lenders, intermediaries offer a lower cost of distribution.

The MMR has already increased the intermediary share of the UK mortgage market. Around 62% of UK mortgage transactions went through intermediaries in 2014, up from 55% in 2013. MAB and other intermediaries expect this number to increase to 75% over the next several years. The MMR is a big regulatory tailwind for MAB and the intermediary market.

Financial Model

I have a MAB model, but you should build your own. Here are the key assumptions that go into it.

Revenue

The two key drivers of MAB’s revenue are the number of advisers in its network and revenue/adviser. MAB added 69 advisers in 2013 and 113 in 2014. The revenue/average adviser was £83,000 in 2013 and £98,000 in 2014.

MAB has added 68 new advisers through May 15, 2015. The regulatory tailwind from the MMR should allow MAB to grow adviser numbers for some time.

MAB’s revenue/average adviser grew a brisk 18.2% in 2014. The mortgage advice process obviously gives MAB’s advisers a captive audience to sell more financial products to, like insurance (which is a third of revenue) or wealth management (which is being incubated). MAB has also opened three call centers to service customers on an ongoing basis (i.e., sell them more stuff). MAB has a very data driven approach to responding to customer needs: https://www.youtube.com/watch?v=z2WgZz2oKOQ 

Gross Margin

MAB’s main cost is the share of fees paid to its ARs. Gross margins have inched down over time and will continue to slowly decrease because ARs are paid an increasing share of revenue as they generate more revenue.

Operating Expenses

There is good operating leverage here. Staff costs per employee increased by 31.5% from 2011 to 2014, but net revenue (revenue minus payments to ARs) increased by 80.8%. Thus, SG&A as a percentage of sales has decreased from 19% in 2011 to 11% in 2014.

Cash Generation

Working capital is a source of cash. Payments to the ARs are made on a weekly basis after the related revenue is received. Capital expenditures are de minimis.

Management

Peter Brodnicki is a co-founder and the CEO of MAB. He owns 36% of the company. The COO, David Preece, owns 5%. There are some RPTs, but nothing egregious and the amounts involved are very small. Management is aligned and competent. The executive bonus plan is based on a high watermark of pre-tax profits, which is nice to see.

Summary

MAB should compound value for a long time. The regulatory tailwind from the MMR combined with the development of additional revenue streams should enable MAB to grow at a substantial clip for many years. The business requires very little capital to grow and thus generates a lot of FCF, which management is committed to returning to shareholders in the form of a dividend.

Catalyst

Growth in earnings.