Mercia: undervalued specialist in private markets

Mercia Asset Management is scaling up fast and generating significant cash. It's valuation looks strange, if not patently incorrect.

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Today I initiated coverage of Mercia Asset Management (AIM: MERC) on behalf of Equity Development. It’s a fascinating business - one of the largest investors in ‘regional’ (ex-London) UK growth businesses.

You can read the full (36 page) initiation note here

Scaling fast

Mercia’s primary focus is managing funds of around £1.6bn for third parties (FUM) in structures such as Venture Capital Trusts, EIS funds and funds for institutional investors. It deploys c£220m per year across venture capital, debt and private equity (100k to £20m per investment).

The business is scaling fast. FUM has more than doubled in two years. Record net flows exceeded £0.5bn in FY24. And growth is by far the highest among a London-listed peer group.

FY24 revenue grew 18% y-o-y to £30.4m, EBITDA 7% to £5.5m, a margin of 18.2%, likely to ratchet up over the longer term as the business scales further. Indeed, the newly announced Mercia 27:100% growth strategy aims to reach £3bn AUM (FUM + proprietary capital) and £11m EBITDA in 3 years.

Impressive investing record

Mercia also invests its own capital into a portfolio of ‘direct investments’ (NAV: £189m on 31 Mar 24). Its record is impressive. Since listing on AIM in 2014, it has realised nine exits, every one with a positive return and an aggregate return of 3.0x.

However, FY24 highlighted the highs and lows of venture investing. Mercia successfully exited nDreams, realising £30.2m at a 2.7x return. But it wrote down its entire investment in Impression Technologies, taking an £18.6m impairment.

A strategic change is to be proposed at the 2024 AGM - to focus primarily on the profitable and fast-growing fund management business, and to stop making new direct investments (while supporting existing investments). This allows Mercia to reclassify from an investment company to a trading company under AIM rules, allowing gains made on shares to be IHT-exempt (under certain conditions).

Based on fundamentals, Mercia shares look mispriced

However, in my initiation note I argue that the business looks deeply undervalued.

A ‘direct investment’ portfolio NAV of c£117m would be around 91% of Mercia’s market cap of £129m (on 28 Jun 24).

This would imply that the market is applying a significant discount to the direct investment portfolio NAV, which seems strange, if not patently incorrect given Mercia’s record of exiting investments well above holding NAV.

Also, bear in mind that the group had £47m of free cash on 31 Mar 24, and a substantial fee-earning asset management business as well.

My sum-of-the-parts valuation is summarised as follows:

• ‘Standalone’ fee-earning asset management business: 13p per share

• Cash on balance sheet: 11p per share

• Direct investment portfolio: 27p per share*

• Total fundamental value: 51p per share

*We see no reason to discount this to NAV given Mercia’s track record of consistently realising investments at a premium to holding NAV.

With a fundamental value 65% above the share price (on 1 Jul 24), at Equity Development, we see potential for a significant rerating.

Read the detailed (36 page) initiation note here.

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Disclosure: At the time of writing, Paul Bryant covered Mercia Asset Management as an analyst on behalf of Equity Development Limited. Read Equity Development’s research on Mercia Asset Management here. (Please read this link for the terms and conditions of reading Equity Development’s research).

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