McLean Partnership

Why has the UK stock market not consolidated as much as expected?

November 6, 2019

Almost exactly a year ago, the UK mid-market stock broking industry was awash with rumours of impending mergers and acquisitions.  Santander was going to buy Peel Hunt, apparently.  Liberum was going to be absorbed into Macquarie – so we heard.  Other rumours were well known involving several other firms, but none materialised. Here’s why:

 

Personalities

The people that found or run these businesses tend not to lack conviction in their own judgement and capabilities. Fair enough.  Setting up a business with huge personal risk, in arguably the largest financial services centre in the world, takes some self-belief.   Put simply, if trying to merge or absorb these businesses together, it requires one set of management to yield to the other.  Rarely have I attended a meeting with the management of these firms where they have not run through a list of why their competitors are in some way flawed and where their firm has competitive edge.  It’s hard to buddy up with that mindset prevailing on both sides of the table.

 

Money:

These businesses struggle to accept anything other than a premium valuation for their companies.  Away from the stock market, human capital intensive businesses with similarly profiled headcounts tend to go for anywhere between 5 and 7 times profits after all staff and operating costs on average.  It is rare indeed in the services sector to find multiples exceeding 10 times. These valuations are accounted for post bonus pay-outs, not prior profitability.  A smaller broker turning over fees of say £30million a year would struggle to show much more than 5 – 10 % profitability and thus a likely valuation ex cash of c. £15 – 20million.   Yet some seem to firmly believe there is a reason why the multiples should be higher.  This means that no transactions take place – unless out of financial necessity. In such circumstances, the mergers rarely succeed.

 

Money 2:

Many brokers are paying staff less per head than they did a decade ago.  This is due to a combination of significantly higher regulatory costs and risk/compliance oversight, but also a reduction in secondary revenues, (MiFID II) and, certainly this year, lower volumes of transaction revenue. The employees are, on the whole, staying put and accepting lower income over time.  Why?  Put simply, it’s an industry still suffering from over capacity.  The next best paid job many of their employees could do outside of stockbroking is likely to be on a lower income.  So lower compensation is accepted or, if forced to move jobs, many price themselves back into work in the same industry with lower financial expectations. In turn, the companies continue to survive with either smaller headcount and/or lower earnings per head.

Two of the better regarded European secondary platforms of the last decade have been sold, or part sold, (Autonomous and Redburn respectively), but both sets of founders would probably accept that they did not initially envisage very long term lock ins, (Autonomous) and minority stake sales (Redburn) as the drivers to keep going.  Both were arguably defensive transactions in some respects.   From a UK mid market perspective, two of the stronger names continue to be Numis and Peel Hunt.  Rumours, however unfounded, of attempts to drum up interest from the likes of Barclays and Goldman Sachs continue to circulate round the industry.  But if you want to bolster your UK corporate client base, just hire twenty of their best bankers and analysts and save yourself 80-90% of the transaction cost surely?

So it is a strange time to be in stock broking in the UK.  Invariably, wherever you work, management are either trying to sell the business you work in or are considering participating in consolidation strategies. Or in the case of Macquarie recently, choosing to exit the industry all together in certain geographies.

 

What happens next?

I do believe we will see consolidation in 2020/21.  2019 is likely to be a tough year for most of these firms, hot on the heels of a weak 2018.  2017 in many ways was a false dawn as many UK houses enjoyed a comparatively strong corporate revenue run.  Human capital businesses struggle if they are standing still and there will be pressure to evolve and keep moving from within their own work forces.

Compensation structures need to be renewed and altered; the inflation of basic salaries post the financial crisis was an appeasement in many ways; a nod to reduced overall compensation as a side effect of increased regulatory scrutiny.  It is unlikely to be a long term solution and does not exist in any other industry I can think of.  A transition that sees earnings linked to an understanding of revenue allocations and shared risk with the employer will likely become the norm over time.  MiFID II is taking its time to impact real operating change on the sell side – but it’s coming.

Stockbrokers will continue to work hard to take market share in the private capital arena, but to date no one has achieved this with any notable scale.  They will need to move quickly though to avoid continued disintermediation as fund managers themselves build their own private capital capabilities and engage directly with private companies.

 

And before you finish reading this and think, smart arse, you go and try it if you think you have any of the answers.  Well, we did and lost a small fortune in the process covering sector research at Lazarus!

 

 

McLean has had an established presence in both stockbroking and fund management recruitment that pre-dates the financial crisis.  We have serviced a long term client base of investment banks, stockbrokers and asset managers, providing both human capital advice and recruitment as well as strategic support to help develop their capabilities in an industry experiencing rapid change.  For a confidential discussion, please contact Nick Gebbie on 020 35976407 or NicholasGebbie@mcleanadvisory.co.uk