Erinaceous Group Plc

Simon Gordon

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ERG is a stock I have been invested in for the past four months.

Just now they are taking over Hercules Property Services and the new ERG will move into the Small Cap Index in December.

Below is some data I have compiled on this stock and I hope it is of interest to you.

ERINACEOUS GROUP PLC (ERG)
Floated on AIM, November 2003, it is a one-stop shop for property services in the public and private sectors. There are three main divisions:

1. PROPERTY SERVICES DIVISION - HAYWARDS PROPERTY SERVICES
Comprised of four sub-divisions: Public Sector Housing, Residential Management, Building Consultancy and Facilities Management.

2. RESIDENTIAL LETTINGS DIVISION - HANOVER PARK SERVICES
The market leading provider of tenant referencing, rent guarantees, insurance and software solutions to 8,400 lettings agents and 3,200 registered brokers/IFAs.

3. INSURANCE DIVISION - HANOVER PARK COMMERCIAL
Provides policies for Haywards, Hanover Park Services and selected niche markets.

FINANCIALS
2004 - actual
T/O - 42.2m
PBT - 6m
EPS - 9.8
DPS - 1.75
2005 - forecast
T/O - 67.2m
PBT - 8.4m
EPS - 13.5
DPS - 4.5
2006 - forecast
T/O - 78.9m
PBT - 10.6m
EPS - 16.6
DPS - 5.5

SUMMARY
An ambitious group, operating in growing markets, that are fragmented and ripe for consolidation. Profit lines are visible, long term and recurring.

UPSIDE
EPS Growth Forecast - 2005 = 38%, 2006 = 23%.
Forward P/E of 10.5 at £1.42 per share.

DOWNSIDE
Management - over reaches.
ISG Occupancy - integration goes pear shaped

‘A company’s chosen strategies - for product quality, technology, vertical integration, cost position, service, pricing, brand identification, and distribution channel focus - drive its performance and competitive position. A company’s strategic choices, in combination with its skills in executing them, determine its prospects for creating value.’
A. Rappaport and M.J. Mauboussin from the book Expectations Investing.


After visiting the HQ in Croydon and being briefed by Neil Bellis for two hours, I confidently state that ERG are totally focused on, professionally, driving and executing the strategies articulated by Rappaport and Mauboussin.

The following is an outline of some key points accumulated from the meeting and published material:

Residential Lettings Division
They process 1,000 tenant references per working day at £20 a pop. Growing to 2,000 per working day, which will happen this financial year, means a lot of profit dropping straight to the bottom line - due to technology infrastructure and system productivity.

The two joint managing directors complement each other - one is strong on technology, the other marketing. They are of boardroom calibre.

There are no plans to make takeovers, growth will be organic.

The additional fifteen sales people have been intensely trained, one has dropped out.

Jordans - the plan is to franchise; with a top notch management team in place.

Property Services Division
The public sector division which has the Westminster Council contract will get orders but they will be lumpy in coming. When landed they will be long-term and profitable. For instance Croydon Council are looking to outsource their property requirements and ERG are now able to offer a one stop shop for the residential and office requirements. The current order book stands at more than £200 million for this division.

ISG Occupancy cost ISG Interiors £27m to assemble and ERG bought it for £10m, with 50% of future payments on the outstanding £6.6m able to be made in shares.

With the ISG Occupancy takeover ERG now has the opportunity to expand it’s service offering outside the South East of England, with offices in Bradford, Bristol and Manchester.

Productivity as a Competitive Advantage
ERG has a clear focus on using productivity to be cost-efficient, drive sales capacity and invest capital profitably. Utilising people, property and technology; such as teleconferencing, document imaging and computer software.

The new HQ in Croydon is a sleek set-up which will act as the nerve centre to steer the divisions effectively.

Neil Bellis
A youthful 50 year old, with bags of charm and the skill of explaining complicated processes in a clear insightful manner. Not anxious or hurried, he is a grounded and centred man, who connects with people immediately. Optimistic, yet this is tempered with realism when explaining ERG’s business opportunities. He is a winner who oozes ambition.

Goals
ERG has a goal to become a FTSE250 stock. They could either do this in two or ten years. Two years would be by further acquisitions, probably using paper - if rated higher by the market. Ten years would be by organic growth.

Share Price
ERG had expected the share price to be around £1.80 by now and realise they must build a deeper rapport with the City. ERG is presenting to the City and I expect they will lock-in some business minded investors.

Dividend
ERG is managed by people who own a large chunk of shares and they plan an aggressive dividend policy, as it is part of their remuneration.

Management Incentives
They are growing this business as entrepreneurial owners not as executives. The main board directors and operating-unit executives are heavily incentivised to deliver. Middle managers and frontline employees are well paid.

Profit Drivers - 2005 Forecast
Residential lettings - 5.3m
Haywards - 4.2m
Insurance - 1.5m
HQ Cost - minus - 2.3m
Interest Charge - minus - 0.3m
Profit before Tax - 8.4m

Beating Expectations
2005 EPS of 13.5 and DPS of 4.5 are forecast. Neil mentioned Mears and it’s history of beating expectations. ERG’s 2004 earnings surpassed expectations and I expect ERG to the follow the Mears policy.

City Living
The City’s understanding of ERG is gradually building. The buy-to-let connection is a perceptual hindrance, as is the acquisition strategy for growth. It will either take a big Haywards contract or December’s interims for the City to awaken further to the ERG business model.

Taken Over
ERG would accept £3.00 per share, as of 26/8/04.

Dangers
Neil thinks the main danger to stop ERG delivering would be management execution; he has his eye on this!

ISG Occupancy integration goes pear shaped.

Management over reaches.

Summary
Profit lines are visible, long term and recurring.

Balance sheet is finely calibrated.

Will they succeed?

Rappaport and Mauboussin succinctly state it best:
‘The probability of this outcome depends on management’s vision and execution skills - as well as on top management’s ability to convince the market that the company has a sound business model that deserves a higher stock price.’

HPS Takeover Musings - 28/29 September

2005 - March
T/O - 100m
ERG - 12 mths. - 9m ebit
HPS - 9 mths. - 9m ebit
Ebit - 18m
Interest - 3m
Tax - 4.5m
Profit - 10.5m
DPS - 4.5

EPS fully diluted 100.6m shares - 10.4
EPS fully diluted 106.6m shares - 9.84

2006 - March
T/O - 124m
ERG - 11m ebit
HPS - 13m ebit
Cost Savings - 2.5m ebit
Ebit - 26.5m
Interest - 3m
Tax - 7.05m
Profit - 16.45m
DPS - 5.5

EPS fully diluted 100.6m shares - 16.35
EPS fully diluted 106.6m shares - 15.43

I base the EPS on 89m shares in issue and options of 11.6m making a total of 100.6m shares fully diluted.

I base the EPS on 95m shares in issue and options of 11.6m making a total of 106.6m shares fully diluted.

89m x £1.20 = 106.8m market cap. plus 11.6m options
95m x £1.20 = 114m market cap. plus 11.6m options

Net Debt - 33m

The way I see it is that ERG are basically at the same place as before the takeover but that now they will go into the Small Cap. Index and have the opportunity to sell themselves to the fund managers who will ultimately get the share price up.

Groupama dumped them so they lost their underwriters.

September 11th caused premiums to rocket whilst Groupama was ditching them and they lost clients and margins got compressed. They now use Munich Re.

Also from what I can see they bought lots of companies but didn't integrate them under specific brand names, with central management. Too many sub-divisions. They are putting this right now, hence some divisional profits are down for 2004.

The main brands now are:
Cadogan Insurance
Farr Insurance
Dunlop Heywood Lorenz
Wood Management
Gross Fine
Harman Healy

It will be interesting to see which ones will be re-branded Haywards.

After this ERG will still have three main divisions:
Property Services
Residential Lettings
Insurance

Shareholders will now have to wait and see if Neil Bellis can sell the company to the Small Cap. fund managers.

But on a forward p/e of 7.2 for 2006 and a DPS of 5.5p it looks good value!

At the moment I can see only two possible counter bidders - MITIE and Mouchel Parkman.

Before the takeover ERG was valued at 63m for 11m ebit in 2006. Now the new ERG is valued at 104m (at £1.20) for 25.5m ebit in 2006.

I think the balance sheet is fine and that is why ERG only offered 10m, as it didn't want too much bank debt.

I think after this deal ERG will build to get into the FTSE250 in 2006 - probably by using deferred debt when taking over any new companies - I don't see them doing another big paper deal like this.

The cash flow of the new ERG will be very strong and debt I think will be paid down swiftly.

So at the moment the new ERG is valued at around 100m, to get into the FTSE250 you need to be around 300m. So if they do the integration well and the profit lines keep humming and Neil Bellis impresses the fund managers the share price could be £3.60 in 2006.

Takeover History
At the beginning of 2000 HPS comprised:
Deacon
Dunlop Heywood
Harman Healy - commercial
DGA
Simmonds Partners

2000
Farr - 20m
2001
Baker Lorenz - 5.75m
Cadogan - 4.8m
Kounnis Brokers - 5m
Wood - 1.75m
Michael Courcier - 1.3m
Maingould - 0.5m
2002
Gross Fine - 13.2m
DOR - 4m
2004
Berkeley Simmons Davies - 1m

Total = 57.275m

The one take over that sticks out for me is Gross Fine for 13.2m, as it had turnover of 3m and profits of 0.8m, but was landing some big contracts at the time - still it looks pricey.

FORECASTS

ERG - 3/06
Sales - 124m
EBIT - 26.5m
EPS - 17.88
DPS - 5.5
Share - £1.33
M’kt Cap. - 122.3m
Net Debt - 33m
P/E - 7.43

MTO -3/06
Sales - 830m
EBIT - 50.5m
EPS - 10.4
DPS - 3.2
Share - £1.37
M’kt Cap. - 421m
Net Debt - 2m
P/E - 13.2

MCHL - 3/06
Sales - 306m
EBIT - 23m
EPS - 14.8
DPS - 3
Share - £2.16
M’kt Cap. - 228.4m
Net Cash - +50m
P/E - 14.6

RPS - 12/05
Sales - 195m
EBIT - 27.15m
EPS - 10.62
DPS - 2.4
Share - £1.38
M’kt Cap. - 266.5m
Net Debt - 3.5m
P/E - 12.99

WSH - 12/05
Sales - 330m
EBIT - 16.5
EPS - 17.9
DPS - 5.8
Share - £2.19
M’kt Cap. - 132m
Net Debt - 48.7m
P/E - 12.23

Please note this info is mainly historical and fast changing because of the Hercules dynamics!
 
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Here is a report from my brother who attended the EGM:

Erinaceous EGM Report

The board were present along with 3 or 4 staff from other parts of the Erinaceous group, a representative of their brokers and two shareholders.

I started with a chat with the other shareholder. He had invested in May, having spotted the company in the Investors Chronicle and conducted substantial research. We discussed what we liked about the company. He mentioned that he liked the takeover of HPS, mainly to reduce the volatility in the share price (‘small trades are having a negative effect and influencing the price too much’). I mentioned the options issue – he told me that his calculations showed that in fact HPS has just 5% of stock options compared to ERG’s 10%.

The meeting began with questions and topics were addressed as follows:

1) The other shareholder asked about the erratic profits of HPS over the past 3 or 4 years.

Neil talked at length about the issue of Deacon – they went from a £6 million contribution to the profits of HPS to just £1 million. As you know, this is all related to the problems of losing their insurance coverage just as Sept 11 happened. The main point here was to say that HPS went from £7 to 70p but that the reasons for this were addressed and new management and new directors have changed the model so that it could never happen again. HPS profits are now on the rise.

2) The other shareholder also asked about liquidity and share price volatility.

Neil explained that the new ERG (with HPS) will have a free market capitalisation of around 70%. This should reduce volatility. All being well, we will be listed on the main listings within days of the Tue 19th HPS meeting.

3) I questioned the issue of brand consolidation.

The Chairman said that they have looked at the various ‘strong’ brands that HPS have and will consider how to blend these with ERGs brands once the deal is complete.

4) I asked about the new directors.

They are permanent. Interestingly, John Gooding one of these directors, has worked with ERG before (around 4 years ago in a non executive capacity)

5) I asked about economies of scale and the potential for bringing various offices together to gain cost savings.

The board smiled. They all shifted in their seats and Neil was happy to explain that although no firm decisions have been made at this time, they envisage making changes. The chairman pointed out the HPS have not been as effective in getting non-essential operations out of Central London to a cheaper location. ERG would look at this. They would also look at consolidating the offices. Finally, Neil pointed out that HPS have 3 freeholds they like the look of.

6) I asked about exceptional items.

The Chairman said that they had a good idea of what was coming up, ‘especially at the high end’ (i.e. getting rid of the top people). Further calculations would be made and reported in December.

7) A member of staff asked about stock option lock-ins

The Chairman explained that the lock-in would not change (i.e. they are locked in for 50% until end of November). Neil then said that none of the board would be selling in November and that the new directors would also not be selling. They will also be ‘encouraging other HPS staff to rollover into ERG’.

8) Another gentleman asked about the timing of things

The Chairman explained that they expected no delays. Listings particulars would now be prepared (i.e. after Tue) and they would go straight into the main listing (I think he said by the end of the following week).

A vote was then called and the proposed takeover unanimously carried.

After the break up, I took my chance and cornered Neil. Two other board members joined us (sorry names forgotten).

I then asked a general question along the lines of, so are you guys happy about all this. They all grunted a unanimous yes and Neil explained that they were delighted. They had had their eyes on HPS for 4 years! The feeling was that they had got the company for a very good price, the P/E of 7/8 was ideal. ‘The two companies are made to gel together’ said another board member. The vibe was that they couldn’t believe their luck!

‘The only down side was the share price’, continued Neil, ‘but that is just a temporary issue.' I suggested that the movement into the main listing would bring a lot more interest. He also came up with the following interesting points:

1) He mentioned that 5 market makers were now involved with ERG.
2) He has done 47 presentations on this takeover (more than for the initial offering).
3) He is being interviewed by the FT today (for Monday article).
4) Once we get on the main markets many more analysts will follow ERG and the tracker funds will have to buy around 4% of the business.

I suggested that the combination of him selling the new company (I complimented him upon his presentation skills), the arrival on the small caps index in December and a good set of figure in December would surely push the share price up. ‘I assume that trading is going well’ I dropped in. Oh yes said all three in unison – Neil added that they were very happy with things.

I would take this to mean that the December figures will be good.

Finally, I moved onto the general strategic view. Neil feels that the FTSE 250 in two years is possible. A rating of 12 to 14 would be fair and that organic growth can achieve this aim. ‘Is that your objective’, I asked. He said that it may take a touch longer but that they would like to do it in two years – assuming a generally positive stock market.

I thanked them and went for a coffee, hoping to get one of the others for a chat, but they all quickly left. I then went for the lift and saw Neil again. I asked him about the contract bids (Medway and Croydon) - they are long term and nothing will happen for several months. But so far, so good.

Summary

The board like the takeover. They have dreamed of it for 4 years and think that the price is a good one. They think that the shares are undervalued and that once they prove that they have the new company under control and making profits, the City will like what they see. No share price predictions, but a strong feeling that December will see a movement upwards.
 
At the moment I think 91m ordinary shares will be in issue and 9m options!

The consensus 2006 EPS is 17.8p.
 
Erinaceous

If you are looking at firms outsourcing for local authorities there are better candidates than Erinaceous which is small and starting at the bottom end of the value chain. There is also a danger that they are in partnership with a bigger firm in Keller and will they get their fair share of the deal?

IMHO the hot stock in this field is Carillion which has gone from strength to strength since the Tarmac days. It has several good PFI ITNs going at present and there is likely to be steady growth for the foreseable future. They have also impressed by their strategy of selling on PFI contracts after two or three years having grabbed the value.
 
ERG feed off the top end of the value chain. They service white-collar areas of the property solutions market. They do have some blue-collar services but if you study the ERG margins it is clear they operate in a higher margin niche.

They bought out the partnership with Keller in 2003.

A case in point to understand the ERG model is to look in-depth at the Residential Lettings division and the ability it has to generate free cash.
 
As a shareholder pondering this company the phrase that keeps leaping into my mind is Ultra Dynamic.

Since buying shares in June, I received a 1.75p dividend, with 2.25p 14/1/05.

The company has moved from AIM to the Main Market and will join the Small Cap. Index in the next few weeks. They have develpoed three divisions which all have scale and exciting cross-selling opportunities. They are probably the largest company of their kind in the UK now!

Organic growth is strong:

T/O
Residential Letttings - 24%
Property Services - 41%

PROFIT
Residential Lettings - 8% subdued new sales staff.
Property Services - 135%

On a future P/E of around 9, organic growth rates that are market beating and acquisitions turbo charging growth.

EPS forecasts:

Collins Stewart - 17.4
Charles Stanley - 17.7
Investec - 17.8

The Mean - 17.63

P/E 10 = £1.76
P/E 12 = £2.11
P/E 15 = £2.64
P/E 20 = £3.53

Merry Christmas!!!
 
From the FT by David Blackwell:

"Erinaceous, which last month acquired Hercules Property Services, almost doubled turnover in the first half to September on the back of two previous purchases.

The company, which paid £63m in a mixture of cash and shares for Hercules, said the integration was well under way. Meanwhile, organic growth was continuing across all its businesses, which provide property services for both the public and private sectors.

Turnover jumped from £20.9m to £38m, including a contribution of £12.7m from the purchase of ISG Occupancy and Jordans, acquired in April and June respectively. Pre-tax profits rose from £1.2m to £1.6m.

"Acquisitions have been important," said Neil Bellis, chief executive. "But leaving them aside we have shown consistent growth in turnover, profits and earnings."

More than half the cost savings expected from the takeover of Hercules had already been made. Next year the enlarged company would get the full benefits of the promised synergies.

The company is being reorganised into three divisions - residential property services, commercial property services and property insurance services - to make the most of cross-selling opportunities and operating efficiencies. "Our difference is that we can offer a one-stop shop, providing, as principal, every service as an integrated solution for the property sector," said Mr Bellis.

The company will report its results for the nine months to December 31 early next year, and will change its year end to December 31. On the acquisition of Hercules last month it moved up to the Official List from Aim, where it floated in November last year.

The shares - 129½p at the time of the acquisition - closed up 6p at 169½p yesterday. Earnings per share increased from 1.9p to 2.1p, and there is an maiden interim dividend of 2.25p."
 
Key points for me from the Finals last week:

Dividend - 1.75p

ISG Occupancy - 0.4m operating profit

Farringdon Office

IT Focus

London Offices - imminent sale

Premier Agents - +18%

Board of Directors - set up for FTSE250

20% Organic T/O Growth

21% Organic Profit Growth


After the recent sell-off from individual shareholders, who bought in below £2, the share price is probably entering a period of consolidation.

Institutional buying will be the main force in the future, as ERG has moved from the micro-cap sphere into the top 500 stocks on the FTSE All Share.

Patience will be the virtue; as management illustrate flawless execution and a wise strategy going forward.
 
AGM REPORT

CASH IS KING

THE BOARD
Neil Bellis - king of strategy.
Lucy Cummings - queen of infrastructure.
Michael Pearson - sound as a pound.
Nigel Davis - very upfront.
Nigel Turnbull - imperial.
Keith Peraux - studious.
Lord Razzall - jolly.
Nicholas Fry - smooth operator.
Lord David of Poole - to join board soon.

MARKET PROFILE
Strong institutional buying.
Market absorbed Danny Innes five million shares.
Williams De Broe initiating coverage soon.
Neil still in a hurry to get into the FTSE250.

DHL
Has much recurring revenue streams and is not transaction based like DTZ/Savills.
London Borough Councils tender news soon.

ACQUISITIONS
Will be infill and geographic in the Commercial Division.

2005 FOCUS
Integrating HPS into the ERG model.
 
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At 2.66 ERG is looking fully valued.

Could pop higher but fair value is probably around 2.30 for now.

Could be one for the shorters.
 
* ROUND UP *

ALTIUM FORECASTS

12/05
T/O - 139m
PBT - 24m
EPS - 17.6
DPS - 5
P/E @ £2.65 = 15.05

12/06
T/O - 154m
PBT - 27.8m
EPS - 20
DPS - 5.8
P/E @ £2.65 = 13.25


COMPARISIONS

MCHL - 06/06 P/E @ £2.69 = 15.1

MIT - 03/07 P/E @ £1.80 = 15.5

ETR - 12/06 P/E @ £3.69 = 11.7

ETR is looking good value. Just landed a couple of big MOD contracts. Price is down probably because market is worried on take over indigestion. ETR have a history of delivery.

FTSE250

For ERG to reach this goal they would need a share price close to £4.00 - 50% upside - they have £50m headroom on bank debt to finance accquisitions.

NEWSFLOW

Trading update in December.

Contract wins.

Take overs.
 
Peer comparisions:

MER - 12/06
EPS - 13.46
P/E - £2.68 = 19.91

CNT - 08/06
EPS - 43.28
P/E - £7.45 = 17.21

INSP - 12/06
EPS - 10.03
P/E - £1.50 = 14.95

ERG - 12/06
EPS - 21
P/E - £2.98 = 14.19

I personally think ERG are now better positioned in offering a fully intergrated property outsourcing solution.

Once they land a contract like Westminister with say Medway/Liverpool/Croydon the multiple could move toward what MER and CNT receive.

I think ERG are becoming a market darling. If you scan the historic charts for CPI and SRP you can see how a stellar growth stock increases in price.
 
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