A History of the Fairpoint Business

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1 Fairpoint Group Delivering on all fronts The appointment this month of David Harrel as the new Chairman of Fairpoint confirms his predecessor s statement that its recovery stage has been completed. Mr Harrel was, until his retirement, the senior partner of S J Berwin, one of the most prestigious city law firms, so this appointment appears quite a coup for the Company. In the two years since our first major report (their shares at 51p then) Fairpoint has made great strides in its programme to diversify and de-risk its business. The diversifications (see p.2) build on the group s known strengths and/or generate synergies. IVAs still generate a majority of revenue but that from the other two divisions nearly doubled (up 97%) between H and H Each division contributed a similar amount to operating profit in H The core IVA business has proved more robust during the latest downturn in the sector with more than 1m taken out of overhead costs in the IVA business and advertising spend better focused. Company Details EPIC 25 November 2013 FRP FRP Share price p week High/Low p 134 / 82 Market cap m 55.6 Share Price, p Nov/12 Feb/13 May/13 Aug/13 Nov/13 Source: ADVFN All our research is available at The cash position has improved dramatically from net borrowings of 8.4m at end-june 2011 to net cash of 2.8m at end-june Fairpoint s financial strength (it has a 13m financing facility on top of its cash) has enabled it to buy up back books of IVA and DMP clients from weaker competitors exiting the sector. And to maintain a progressive dividend policy From start-up to 2007 Fairpoint was virtually a one-product company with a couple of small sidelines in selling DMP leads and remortgage broking while it rode the near-exponential growth in IVAs as both lenders and the then government encouraged fecklessness. So the first downturn in the IVA market pushed Fairpoint into loss and indebtedness and bankrupted its largest competitor. So, to a lesser extent, did the second. By now, all of Fairpoint s listed competitors have gone bust, withdrawn from the IVA sector or de-listed but Fairpoint has weathered the latest downturn virtually unscathed and is set to grow its profits in despite thereof. At the current price Fairpoint is still undervalued, yielding nearly 50% more than the FTSE All-Share index (more than five times the average for AIM) and a PER (whether historic or prospective) less than two-thirds of the All-Share and barely half that of its General Financials sector. Equity Development contacts John Borgars johnb@equitydevelopment.co.uk Hannah Crowe hannah@equitydevelopment.co.uk Please refer to the important disclosures shown on the back page and note that post MiFID this information is categorised as Marketing Material

2 Fairpoint Group 25 November 2013 Share ratings Forecasts Year to 31 Dec 2011A 2012A 2013E 2014E Adj Pre-tax 000s 3,840 7,552 8,000 8,500 EPS, p PER Div, p Yield % 3.4% 4.2% 4.6% 4.9% Source: Company historic data / ED estimates State of play Fairpoint remains one of the leading companies in the IVA sector and so cannot be immune to the changes in the market for IVAs but is far less vulnerable than when IVAs accounted for over 90% of profits. Despite the downturn in its core IVA market the group s profit in H was the highest since they changed the year-end in 2007 (so a pedant could claim highest-ever). The first chart below shows the seasonally adjusted 1 number of IVAs. The farworse-than-expected slump in (during the creditor s strike) after the near-exponential rise and the unexpected 9% downturn in H both resulted in Fairpoint briefly falling into loss. However it has weathered the drop in numbers (and worse drop in value) relatively unscathed: the last two half-years have each shown a rise in profits over the corresponding period in the previous year. IVAs (seasonally adjusted) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Source: industry sources, ED IVAs (seasonally adjusted) 1 unadjusted data would have misleading dips in the first quarter and bumps in the summer quarters as very few admit to being insolvent just before Christmas and it takes several months to process an application for an IVA and get creditors to agree 2

3 25 November 2013 Fairpoint Group The group responded to its core market going ex-growth by cutting costs and developing complementary revenue streams. The chart below shows the strong growth in non-iva business over the last four years: Diversification of revenues H H H H H H H H H1 DMPs Other IVAs Source: Company, ED The diversification strategy is to build on the group s known strengths and to look for synergy. Debt Management Plans have two major benefits: the obvious one is that the advertising cost is the same for a group providing both IVAs and DMPs as for a firm providing just one and much of first contact is also duplicated as one often cannot tell whether a prospective client needs an IVA or a DMP until their circumstances have been thoroughly analysed. The second major benefit is that the initial payments for DMPs help to balance the heavy initial cash outflows of IVAs where most of the work is done before the IP receives a penny. Clients PPI claims generate windfall receipts which increase their ability to repay their creditors and Fairpoint typically receives fees of 15% of the additional amounts paid to the creditors so all three gain. Other diversifications have centred on providing services to IVA (and more recently DMP clients): the two most important being claims management and price comparison services the first increasing the income and the second reducing the living costs of clients. Although moneyextra.com turned out to be worth less than expected, the price comparison service developed from that base is a significant benefit to Fairpoint s client base. It also attracts solvent customers who may later use or recommend Fairpoint s services. The group trialled an unsecured short-term loans business for which its understanding of ability to repay should have provided a competitive advantage. It gave up when it found that this only made profits if borrowers rolled-over loans getting further into debt and this did not fit within a group whose raison d etre is to help people escape debt problems. IFRS theoretically unsound treatment of advertising costs that causes a major seasonal bias to reported profits on IVAs, and the excessive charge for amortisation of intangible assets distort reported profits but the gains from increased diversification are clear. 3

4 Fairpoint Group 25 November 2013 The pre-tax figure in the understated first half swung from a loss of 1.65m in 2011 to a profit of 2.15m and then to 2.48m. In cash terms the change was even greater: net cash moved from -8.42m to -2.02m to +2.85m. The chart below shows first half operating profits (pre-amortisation and excluding exceptionals) by division and total: Divisional profits H H H H H1 IVAs DMPs Other Total Source: Company True profitability is (excluding the seasonal distortion) somewhere between that reported under IFRS and the pre-amortisation figure since back books do shrink as clients complete their IVAs or DMPs, but Fairpoint s attrition rates are well below industry averages so the amortisation charges are too great. We may 2 not have access to data that would enable us to calculate a precise number so, like most brokers, we use pre-amortisation figures for adjusted profits and forecasts. The future Fairpoint now has a secure financial base from which to expand. In the short term that will be from buying some more back books from weaker rivals and from its diversification programme. Its efficiencies and economies of scale enable it to manage these books at lower cost than the vendor and so obtain a good return on capital. In the medium-/longer-term we expect to see a return to growth in the IVA market when interest rates return to somewhere near normal and lenders recognise an IVA where they get as much of their money back as they can in five years has a higher dcf value than the promise of a trickle in depreciating currency over 15 or 20 years. This does not need a rise in consumer debt since hundreds of thousands have not yet resolved the debt problems that they incurred precrash. There are signs that the number of vendors of back books is increasing after Mark Carney signalled that base rate could stay at 0.5% (-2.5% real) until In the first eight months Fairpoint purchased three back books of DMPs adding 20% to its total cases under management. 2 Data Protection Act 4

5 Fairpoint Group Claims management is expanding. They started by referring IVA clients who might have a PPI mis-selling claim to a claims management company (cmc), then set up their own cmc to handle PPI claims for DMP clients. Their in-house company is now handling claims for those acquired through back book purchases and looking at pursuing other categories of mis-selling claims for clients, such as mortgage mis-selling and packaged bank accounts (where customers pay a service charge for services that they neither want nor need). The group is running a pilot project processing semi-routine paperwork for legal services as Fairpoint has specialised in processing semi-routine legal paperwork for a decade and developed systems to optimise this where most legal firms have never had the volume to justify developing such systems. We are maintaining our forecast for adjusted profits of 8m, leading to eps of 14.5p and dividends of 6p for 2013, followed by 8.5m, 15.4p and 6.4p for At anywhere near the current share price the group s yield is significantly higher, and its PER significantly lower, than the market. As Fairpoint is both cash-positive and simultaneously cash-generating, and growing its business, we are of the view that it remains undervalued. 5

6 Fairpoint Group Financials Detailed forecasts Year to 31 Dec m 2011 A 2012 A 2013 E 2014 E Revenues Insolvency revenue Debt Management revenue Claims Management revenue Other revenue Total revenue Cost of sales (14.9) (14.8) (14.4) (14.1) Gross profit Other operating expenses (11.0) (10.9) (9.7) (9.6) Unwinding of discount Operating profit/(loss) Net finance income/(cost) (0.3) (0.4) (0.3) (0.1) Profit before abnormal items Tax on normal profits (1.1) (1.8) (1.9) (2.0) Attributable Abnormal items (5.1) 2.9 (2.0) (1.6) IFRS Profit/(loss) before tax (1.0) Adjusted earnings per share (p) IFRS earnings/(loss) per share (p) (2.20) Dividend (p) No of IVAs passed 5,840 5,391 5,300 5,300 Source: Company historic data / ED estimates 6

7 Fairpoint Group Notes 7

8 Sales Contacts Head of Corporate Gilbert Ellacombe Direct: Tel: Investor Access Hannah Crowe Direct: Tel: Senior Analyst Contacts Consumer, Support Service Ben Maitland Natural Resources Conor Fahy Technology Denis Gross Financials John Borgars Special Situations Paul Hill Pharma / Biotech Robin Campbell PhD robin@equitydevelopment.co.uk TMT John Walter johnw@equitydevelopment.co.uk Strategy Andy Hartwill andyh@equitydevelopment.co.uk This report is intended for Professional Clients, Self-certified High Net Worth or Sophisticated Investors Only. Equity Development is regulated by the Financial Conduct Authority Equity Development is retained to act as a financial adviser for various clients, some or all of whom may now or in the future have an interest in the contents of this document. In the preparation of this report, we have taken professional effort to ensure that the facts stated herein are clear, fair and not misleading, but make no guarantee as to the accuracy or completeness of the information or opinions contained herein. This document has not been approved for the purposes of Section 21(2) of the Financial Services & Markets Act 2000 of the United Kingdom ( FSMA ). Any person who is not a relevant person under this section should not act or rely on this document or any of its contents. Research on its client companies produced and distributed by ED is normally commissioned and paid for by those companies themselves ( issuer financed research ) and as such is not deemed to be independent, as defined by the FSA, but is objective in that the authors are stating their own opinions. This document is prepared under UK law. Companies quoted on AIM are subject to lighter due diligence than shares quoted on the main market and are therefore more likely to carry a higher degree of risk than main market companies. This report is being provided to relevant persons by Equity Development Limited ( ED ) to provide background information about its subject. This document does not constitute, or form part of and should not be construed as, any offer for sale or purchase of (or solicitation of or invitation to make any offer to buy or sell) any Securities, which may rise and fall in value, nor shall it or any part of it form the basis of or be relied on in connection with any contract or commitment whatsoever. ED s reports are intended for professional investors (as defined by the FSA COBS handbook), or Self-certified High Net Worth or Self-certified sophisticated investors only. ED and/or persons connected with them may have acted upon or used the information herein contained, or the research or analysis on which it is based, before its publication. ED may in the future or may have in the past provided investment banking services to the Company. ED or its Directors or officers may in the future or in the past have had a material investment in the Company. More information is available on our website: Equity Development, 65 London Wall, London, EC2M 5TU. Contact: info@equitydevelopment.co.uk,