Aiming for Mainstream
We have heralded for some time the long-term attractiveness of the investment sector, with a growing national superannuation pot. This, along with a changing regulatory landscape, which has led to rising compliance costs, is creating opportunities for a number of industry participants. One such company is Mainstream Holdings (ASX:MAI) which occupies a unique slot in the supply chain, offering the entire gamut of Middle-to-Back Office services as the “Back Office for Hire”.
Source: Company Website
The company has exhibited exceptional growth since being founded in 2006, having grown to service a diverse client base of over 340 institutions and more than 800 funds, with in excess of $138 billion funds under administration. The company has also expanded in other regions, including the Americas (USA & Cayman Islands), Asia-Pacific (Hong Kong & Singapore) and Europe (Ireland, Isle of Man & Malta) from its home base in Australia.
But before we give out our verdict, we look at the company’s background:
Company Overview
The Mainstream Group (ASX:MAI) is a specialist 3rd-party (i.e. independent) fund administrator which provides services for a client base of fund managers and superannuation trustees. The Company operates in three major businesses, namely Mainstream Fund Services, Mainstream Superannuation Services and ShareBPO (Share Registry).
The company was previously known as MainstreamBPO and was established in Sydney in 2006 by current-CEO Martin Smith (pictured below) and Byram Johnston, OAM (ex-CEO, who stepped down 01 May 2017) along with 7 pioneer employees offering fund administration services.
Since then, the company has achieved numerous milestones eventually adding Superannuation Services (2007) and Share Registry Services (2010) to the fold along with the expansion outside of Australia to cover Asia, Europe and the Americas. The company also IPO-ed back in 01 October 2015, for a modest $10 million capital raising at A$0.40 a share and has raised additional capital a few times since.
Image Credit: Finance News Network
As noted above, the company’s main services are split into 3 lines with the Mainstream Fund Services providing investment administration, fund accounting, unit registry and middle office services to a range of investment managers, and operates in all geographies.
Next is the Mainstream Superannuation Services which provides outsourcing services for superannuation funds, including member administration and communications, fund accounting and client reporting. The unit is involved in administering a range of superannuation products, including complex defined benefits schemes and pension and income streams. Its clients include industry funds, corporate funds and master trusts.
ShareBPO provides share registry services for listed companies and exchange-traded funds. Management notes that this side of the business is largely still in the ‘start-up’ phase with limited market share. However, given that there are limited players in the space, we believe the company can gain footprint with its full range of offerings.
However, on a filing basis, the company only makes a distinction on regional operations and not across business lines. As referenced in the graphic below, the majority of the company’s revenues come from the APAC (Australia and Asia-Pacific) region with Americas (~13%) and Europe (~12%) making up a smaller but fast-growing portion. Note that the first instance of reporting regionally occurred in October 2017 with Americas (~10%) and Europe (~4%) providing much smaller shares.
Source: 21 August 2018 Company Presentation
The company generates its revenues via consulting and administration fees based on service agreements with the clients. The fees, which are fixed and indexed annually, are based on the client’s size (number of investors in the fund & dollar value) as well the number of transactions processed, and annual fees based on the number of individual funds administered.
The fund’s fees per client scale up as the client’s business grows and benefits from the expansion in Australia’s superannuation business as well as the growth in the Asia-Pacific Wealth Management sector. With the sector facing growth, we also note the regulatory changes that has led to rising compliance costs and has led many players in the sector to outsource Back-Office functions.
We like that the fund is branding itself as a “Back-Office for Hire” wherein it focusses it operations on essentials for a client’s business but which the client wants to outsource. In fact, an industry study by consulting firm, Accenture, has identified that Fund Managers have been looking to outsource Middle- to Back-Office functions for years to reduce costs, increase flexibility and to allow Fund Managers to focus on their core business.
Now, with the company operating in 8 countries, it consolidates different Middle- and Back-Office services across different regions making it easier for clients to do cross-regional operations without having multiple providers.
This also makes the company’s client base is relatively ‘sticky’ given the relatively high transition cost and business disruption risk for an investment manager to switch to another outsourcing provider. A diversified and ‘full service’ offering provides protection from competitors as well.
The company’s growth strategy also involves adding other services in growing markets and compounding it with bolt-on acquisitions which it has successfully done over the years. So far this year, the company has recently launched Custody Services (in 11 October) which now allows it to provide the entire Middle-to-Back Office functions.
Source: Company Filing
Mainstream (ASX:MAI) has also an impressive track record of growth with revenues surging almost 200% from the $14.72 million prior to the IPO. Funds Under Administration (FUA) have grown from circa $50 billion to over $138 billion over the same time frame.
Source: 21 August 2018 Company Presentation
The graphic below provides a sampling of the now over 343 clients the company has and which it has grown almost fivefold since its IPO:
Source: Company Website
With all the above factors stacked in its favour, we now turn our attention to the latest round of results:
FY18 Results Review
For the year Ended 30 June 2018, the company has delivered another year for momentum with revenues up 42% year-on-year to $41.8 millionon the back of robust FUA growth which surged 17% year-on-year to a record $138 billion. According to management, a bulk (~86%) of the revenues came from organic growth with strong inflows from existing clients and the remainder from acquisitions.
Management also pointed out the increasing diversity in revenue sources with 25% of annual revenue coming from overseas sources for the first time, a split we highlighted in the preceding section.
Source: 21 August 2018 Company
We are also seeing evidence of Operating Leverage with Operating EBITDA growing at a faster pace of 60% to $10.5 million while EBITDA Margins surged 280 basis points to 25.3% reflecting the increasing scale. These profit gains held despite the 27% increase in staff to over 245 and a boost in Share Based Incentives (SBI) to $1.3 million (+62.5% yoy).
Overall, Statutory NPAT rose 22.0% year-on-year to $1.74 million. However, with the increase in SBI as well as the acquisition of Trinity Fund Administration (Ireland and Cayman Islands Office) for $6.4 million (partially funded by equity), EPS grew only 3% year-on-year to A1.63 cents.
Guidance
With the company exhibiting solid momentum as evidenced by the results and management looking to provide additional services (Custodian) to existing clients as well as tapping the new markets from acquisitions, revenues and earnings are set to grow much further. Expectations for FY19 are for an increase of between 19.6% and 31.6% while EBITDA gains are pegged at between 17.2% and 40.63%.
Source: 26 September 2018 Company Presentation
On the charts, and the daily Mainstream (ASX:MAI) has entered a corrective phase in recent weeks in line with the broader market pullback. After reaching a high of 85 cents in July, successive Fibonacci retracements have given way, and prices have fallen below the 50 and 200 day moving averages. A hold above support at 61 cents and the upward sloping green trend-line would improve the technical picture.
On the monthly the corrective phase is also apparent, with the 61.8% and 50% Fib levels at 69 cents and 65 cents respectively, giving way. Prices need to hold above the 38.2% Fib retracement at 60 cents to avoid a more protracted decline to the next layer to support at 45 cents.
Summary
The Mainstream Group is an independent fund administrator which provides the entire gamut of Middle-to-Back Office services for fund managers and superannuation trustees across 8 countries.
We like that the company has an exceptional track record of growth since inception and its IPO, growing the client base to over 340 institutions and over 800 funds with an excess of $138 billion funds under administration globally. The company has also made quite a few successful bolt-on acquisitions to drive growth in new markets.
On the valuation front, the shares are currently trading at a premium with forward FY19 PE of 51.6 times and far above its sector median of 10.5 times. No surprise given that it’s still at the rapid growth pace in its lifecycle.
With the technical picture also in corrective mode, we believe it is best to adopt a “buy-on-weakness” mentality in the shares, and considering the lofty valuation. We are also cognisant of the relatively sizeable Share Based Incentive scheme for Employees and Management which have a dilutive effect on earnings per share.
Accordingly, we issue a Traffic Light alert on Mainstream (ASX:MAI) and await a better entry point at a more reasonable price.
