HUB 24 – TOP 10 holding—"the giant slayer”

Background

From my start in the financial industry in the mid-1980s, I have dealt with the independent financial advisor (IFA) market, on and off for many years. My observations of that industry and its efficiency can be summed up by a saying at the time (para), “in the office at 9 am, at lunch by noon and on the golf course by 3 pm”. Of course, there are good and poor advisers. Still, the efficiency and incentive conflicts indicated that the industry was ripe for a clean-out and the implementation of modern efficient processes. With the Hayne RC came the cleanout, the end of trailing commissions, and the need for IFA’s to be much more productive to earn a living. Secondly, the technology revolution opened the opportunity for new players to digitise a predominantly manual process, cluttered by time-consuming paper forms (eg Statement of Advice) and disparate data sources. Putting these onto a single source of truth and tying the multiple tasks onto one platform would revolutionise the industry.

The above was self-evident to me, the missing part was how who and how long would the process take. Something had to give and it did.

Potted History

I first met HUB CEO AA and his IT lieutenant Jason Entwistle circa 2014. They were about to move offices and were a newly formed upstart but were listed. The tasks confronting them were simply enormous. Gaining acceptance of new technology in an incredibly conservative industry was a big ask. There were times when the firm's existence was threatened. At that stage, management mentioned that $4b FUM was a breakthrough target. IFAs were willing to use them but wanted proof of operational efficiency at scale.

After they reached that scale, momentum began to build. HUB24 and competitor new entrant Netwealth (NWL) had one serious advantage compared to the monstrous competitors, they could counter-position them. The incumbents were enormous and were mainly the bank-owned platforms, MLC, Commonwealth, WBC as well as IFL, AMP etc. The problem they had was the vast technological debt and embedded historic processes. To change these without completely disrupting themselves was a huge risk. Panorama (BT/WBC) spent an enormous $0.5b trying to change its platform and compete, but it failed. Of all the incumbents, only the newest, Macquarie appeared to transition anywhere near well.

In October 2015 IFL bid for HUB24 at $2.75 a share. For reference, we had entered the company at $1.20. What this did for me was confirm that the new entrants were indeed a threat and buying them was cheaper and easier than building. The takeover by IFL was rejected by HUB24.

From then on, the procession in market share gains was methodical. Adding, about 1% a year for HUB and NWL.

One interesting aspect of analysing Hub24 was that I noticed that my revenue numbers were always very close to the actual results. That was very interesting to me because it meant I would accurately forecast the top line. That phenomenon has continued. On the other hand, my cost estimates have been continually too low. The reason for this is that both new companies continue to invest aggressively to chase the prize.

The growth has been through adding advisor networks, then progressively moving the advisers over to the platform and then the advisors progressively moving their client books onto the platform. The overall process drives strong ongoing organic growth. Both platforms now stand around 7-8% of the market. The overall increase in various asset prices also drives profit growth.

Fy24 result

Was disappointing across all the numbers for me. There are clear signs that the management is building and spending. That comes at a cost, and the market appears much more forgiving now than it has in the past. Maybe that changes at some point. I have come to accept and see the longer game here and am prepared for what that entails, ie no optimisation in the ST. operating leverage is being stunted by reinvestment and embedding.

The trends that have been apparent for some time continue, share gains, client expansion, adding new features and products, margin dilution, costs ongoing and accounting “one-offs”. The CFO did say that the expectation was one-offs (strategic investment and large client migrations) to reduce or be eliminated as one-offs, a good sign.

HUB bought back shares at $35 for what that is worth.

The issue with HUB24 is that intrinsic value is increasing strongly over time, so buy levels should materially move up year to year.

Where to now? The main issues to consider.

As with all long-term growth stories, where a successful outcome is more likely, looking at a stand-alone PE can be quite deceiving. The big questions IMO for the two “newbies” are where will the market shares stabilise and what margins can we consider LT?

While both management teams clearly realise the strong position their companies occupy and the opportunity ahead they have taken slightly different paths. NWL appear to be a bit more conservative than HUB24. Hub has expanded into ancillary areas that on the surface appear to dilute the platform business. One such acquisition is the Class SMSF administration business. there have also been digital personal wealth acquisitions. At first, I viewed these as distractions or dilutive “diworsifications”. Maybe they will ultimately be that as well. The strategy that HUB24 is undertaking is building and broadening the relationship with the client, embedding their platform to be multi-purpose and in time offering several income streams. We shall see where that leads.

Back to market share. That is difficult and I think that no one really knows. The risk is that, as the incumbents disappear they push the price lever or do something drastic since they then face extinction (management salaries disappearing). There could also be a rump of IFAs that just don’t move for whatever reason. Defining an ending market share for both new entrants is a critical part of any DCF. Personally, ATM I feel 30% each is a defensible target but it is up for grabs. At some stage, market share growth could slow as well as we reach the “rump”. At the moment there is plenty of white space so I don’t want to overplay share.

Margins are maybe even more important. Currently, both HUB and NWL are prepared to dilute margins to gain a greater share. Despite outstanding growth for both, they are not dominant, volume growth to establish dominance is important. There has been a steady decline in margins that have been more than offset by volume gains. The declines come from “waterfall” tiered pricing that offers discounts for volumes and some cyclicality in the margin that both take on cash holdings where they arbitrage the wholesale retail markets. The cash margin is vulnerable to structural decline.

When I think about this I come to the conclusion that at some point the balance of power on pricing will shift to the new entrants. HUB24's strategies to embed themselves through multiple income streams start to make more sense in this regard. In my DCF I assume a steady decline but then a levelling off as scale is reached and the benefits of scale equal the decline in volume promotions. There is a good chance that the outcome is better than that. There is also the risk that once dominant NWL and Hub do not form a cosy oligopoly but go at each other in a battle to the death. That would be a poor outcome, possible but not probable and is a way off.

Putting in these assumptions I get $47 per share. Would I sell above that level, not likely. Maybe way above it but with the DCF variabilities like I have described above, it’s a mistake believing you can be precise with LT valuations. I am much more concerned if there is an unforeseeable negative change in the industry dynamic. A new competitor does not overly concern me given the trials and tribulations we went through with HUB24 earning its stripes. The risk, IMO, is more around execution and regulatory or market shifts. What will the incumbents do, can they do anything? Nothing that I can see is too concerning at this stage but things can change. Add below $40 is my view At this stage, I am not a keen seller of this story.

From a personal point of view, I was glad that the combination of leaving the fund management industry and C19 offered me the opportunity to get on board myself!

Disc Held