Should I buy shares in Quindell Portfolio?

15 May 2013

Shares in Quindell Portfolio have lost almost half their value over the past six months, but analysts are advising investors to buy the stock.

Quindell is a supplier of software, consulting and outsourcing services within the insurance and telecoms industries. At the centre of its strategy is an offering to drive down the cost of claims for the UK insurance sector.

Its vertically-integrated legal claims business platform is compliant with industry requirements and by leveraging Quindell's technology and economies of scale, targets a 20% reduction in the cost of claims for the industry.

Quindell provides a broad range of outsourcing including legal services, medical reporting and accident management, as well as other brand-extension offerings within financial services, utilities and telecoms.

Why have the shares fallen?

The stock has been subject to speculation about an equity swap and active shorters, who have questioned the quality of the group's debtors.

However, the company soothed investors on 9 May, confirming the equity swap did not expose it to any further share issue or cash payment. Quindell also assured investors it had "a strong balance sheet and continues to trade profitably with significant traction in the insurance sector".

Sophie Blandford, analyst at Daniel Stewart & Co, also pointed out that Quindell had undertaken a number of placings in 2012, raising a total of £93.5 million to fund cash elements of acquisitions and increase working capital requirements.

Andy Bryant, analyst at Cenkos Securities, echoes her sentiment, explaining: "Investors worry about cash conversion, but even after financing outsourcing working capital growth [in 2013], we project the group will generate free cash flow of c. £24 million, a yield of 4%."

Acquisition strategy

Central to Quindell's strategy is its ability to make acquisitions, which enable it to maintain its wide selection of outsourcing services.

Bryant believes its fast-paced acquisition policy and the increasing complexity of the group complicates the fundamentally compelling growth story for investors. He says investors focus on the acquisition-driven growth of the company and the implied challenge for management in integrating the businesses.

Year-to-date, for example, Quindell has completed a number of deals worth about £50 million, including the purchase of cloud-based software provider iSaas; Compass Costs, a specialist in high-value and clinical negligence costs recovery; claims-management firm Crusader Assistance Group; and Canadian insurance software company Iter8.

However, in practice, most of the businesses are run by the acquired management teams; Quindell employs a group chief operating officer, divisional chief executives as well as an integration team.

The acquisition focus in 2013 has primarily been driven by growth in the insurance sector, falling into three primary groups: legal services, health services and claims-outsourcing services, as well as the underlying technology platform necessary to support these.

Insurance review offers opportunity

From 1 April, the UK government has prohibited the payment or receipt of referral fees for passing on client data in claims for damages in cases of personal injury or death, in an attempt to cut the cost of civil litigation. Under the rules, known as the Jackson Review, solicitors, claims management companies, insurers and all relevant regulated businesses will be covered by the ban.

Due to the highly fragmented nature of the legal industry, with over 6,000 small solicitors and legal firms operating in the UK, Blandford predicts the number of firms operating in this area could halve to 3,000 in light of the changing regulation.

"The subsequent reduction in the number of legal firms operating in the industry will be an advantage to Quindell, enabling them to take a larger market share and resource their growth at minimal cost, and hence increase their revenues," she says.

She also points out that through its unique end-to-end claims management system, Quindell is able to offer insurers cost savings of more than 20%, as well as being able to address the issue of insurers' decreasing profit margins as a result of the referral-fee ban.

High demand for Quindell Portfolio's services

Together, the top 20 UK motor-market participants represent over 90% of the UK car-insurance market. Quindell has agreements in place with a significant proportion of these firms, with outsourcing and referral partners including telecoms companies, insurance companies and vehicle manufacturers, as well as other intermediaries.

Over 40 independent outsourcing and referral partners have agreed to and are providing significant outsourcing volume to Quindell following the Jackson Review. In total, the motor-claims market is estimated at £10 billion, with the value of personal injury and legal costs around £3 billion.

The Jackson review has driven a number of key pilot programmes into full contracts, the most important of which being with breakdown service company RAC. RAC has more than seven million members and covers 3.6 million consumer cars on the road. The initiative with Quindell is targeted at encouraging these breakdown customers to use the RAC claims process, which is managed by Quindell, in the event of an accident.

This contract followed a successful pilot during which conversion rates (i.e. breakdown customers using the RAC claims process) increased by over 50%. In addition, RAC is economically incentivised to promote this service, with Quindell management believing the breakdown service group has the potential to address around 5% of the £10 billion motor claims market (car repair, medical claim, car hire etc.) i.e. c. £500 million of volume.

The service provided by Quindell Portfolio seems to speak for itself. "Quindell have announced a 100% success rate in converting pilots into long-term contracts - in some cases new clients are bypassing the pilot phase in light of this success rate," notes Blandford.

Property claims expansion

Quindell has recently announced an expansion into the property-claims market with the acquisition of Quindell Property Services, a newly-formed group providing outsourcing and technology solutions to the property-insurance marketplace. The company has already successfully completed a pilot programme with a major listed insurer.

Bryant estimates the property-claims market's worth at around £3 billion per annum, compared to £10 billion for motor insurance. He adds: "We therefore believe there is a major opportunity for Quindell to 'ramp' sales in this sector which is backed by the warranted profit target of £10 million in 2014."

Move to a full listing

One of Quindell's 2013 objectives is to make the transition from AIM to the premium full list "as soon as possible".

Bryant stresses that a move to the full list, currently planned for the fourth quarter, "will remove many of the obstacles to a re-rating and we maintain a view that the shares have the potential to track towards a fairer value of c. 40p".

Attractive valuation

According to Blandford, Quindell Portfolio is trading at a c. 60% discount to mid-cap peers on a 2013 enterprise value/EBITDA ratio of about four times and a price/earnings (P/E) ratio of about six times.

She also points out that Quindell's main competitor in the insurance software space, Guidewire Software, trades on a 2013 P/E multiple of 77 times.

Investment risks

However, with every investment, there are a number of risks to consider.

Firstly, Quindell's structures are replacing deals deemed to be non-compliant under the Jackson review. However, Bryant notes that in structuring these agreements, Quindell has taken legal counsel from leading lawyers in the sector.

Secondly, a typical working-capital requirement to launch an outsourcing arrangement from a standing start requires funding of six months of working capital. Again, Bryant is quick to point out that there are several factors that should improve the working-capital cycle as these deals evolve.

Analyst view

"In our view management have certainly delivered on their strategy to build a major outsourcing platform for the insurance claims market but frustratingly for shareholders the shares have not re-rated alongside," acknowledges Bryant. Still, he reiterates his 'buy' recommendation on the stock "in the belief that the shares can track over 40p a share over the next 12 months".

Andrew Noone, analyst at GECR, adds: "We feel these trading updates, contract wins and earnings-enhancing acquisitions all support the investment case, and add further upside and revenue visibility for 2014 and beyond.

"We also believe these developments are testament to management's continued efforts to grow the business. We maintain our stance of 'buy' with a 40p target price."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

This article was written for our sister website Interactive Investor

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