Lombard Risk Management (LRM.L)

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1 20 th October LRM LOMBARD RISK ORD 0.5P Lombard Risk Management (LRM.L) Riding the regulatory surge: Interim results 10 Q Q Q Q Source: Fidessa Price: 12.5p 12m High 14p 12 m Low 8p Mkt cap 33m Shares Sector Market Broker Website 266m Software & Computing Services London AIM Charles Stanley Description: Lombard Risk provides financial software systems to banking and asset management clients. Solutions are focused on collateral and risk management and regulatory and transaction reporting. Lombard Risk Management s product suite is focused on GRC (governance, risk and compliance) solutions and is thus an essential part of the plumbing in the global banking system. The September 2014 order backlog of 5.1m remained near its all-time high reported six months prior. Strong new contract growth came through 1H15, e.g. 121 COREP contracts including 62 new names over the life of the programme (27 new last year). 1H15 reported 16/10/14 : Sales 9.3m +27.7%; EBITDA 0.8m (vs small loss); PBT 0.01m (vs small loss); EPS 0.0p (vs loss 0.43p); Net cash 2.2m ( 1.8m) Lombard Risk Management s core client base has always been large banks. 30 of the top 50 global banks currently are customers. Across the eight segments where the company is strategically positioned, none of the other top five competitors (all of which are much larger organisations such as IBM, SunGard etc) have a good offering in more than five (mostly in only three or four). Upgrade trend. We have not changed FY15E numbers (bar a reduction in estimated tax charge hence FY15E EPS upgrade). However it is important to recall that at the FY14 stage six months ago, full year 2014 achieved sales of 20.4m vs 19.0m estimated, leading to a FY15E upgrade by 6% to 22.5m. As to profits, FY14 achieved 4.4m; we had estimated 3.8m. We thus at that stage upgraded FY15E from 4.6m to 5.0m PBT. Investment for the future: Technology spend has been increasing, with development capitalisation alone running at 25% of growing sales in FY12, FY13, FY14. Visibility: In addition to strong software spending, Lombard Risk Management is expanding on two fronts. Regulatory frameworks remain core and in more recent years, collateral and commercial risk management has driven client demand also. New partnerships have been set up: early days but upside from here. Regulatory updating and change is the only constant really and this creates ongoing demand in Lombard Risk s marketplace, hence underpinning the metrics behind its strong software development cost which of course impacts profits today but fuels sales growth, which stood at 21% last year. Mike Foster +44 (0) mf@hardmanandco.comhe en made March Year end FY11 FY12 FY13 FY14 FY15E FY16E Sales ( m) EBITDA ( m) EBIT ( m) PBT Reported EPS Reported (p) DPS (p) Net cash ( m) 1.8 (2.4) P/E (x) EV/Sales (x) EV/EBITDA (x) Dividend Yield (%) 0.2% 0.4% 0.5% 0.6% 0.7% 0.8%

2 Growth in a mandated spend market Mandated client spend with LRM holding 30 of top 50 UK banks as clients Strong historic (and continuing) technology spend has delivered strong order book rises Major new product to begin to impact calendar 2015 The Lombard Risk Management s product suite focuses on GRC (governance, risk and compliance) solutions in the global banking system. This is mandated spend: required to meet both regulators ever more demanding requirements and the banks desire for best-of-breed risk (collateral etc) technology. The regulatory drivers are diverse, so a series of legislative requirements in different jurisdictions provides a range of large complex requirements whose implementation and enforcement timescales overlap. This gives specific visibility on specific current known regulatory drivers for well beyond This comes in a wide range of waves of legally mandated industry spending requirements. This regulatory innovation will not stop. Interestingly this industry now extends well beyond banks or brokers. An increasing number of large and also medium sided investment managers are now seeking advice and implementation in Lombard Risk s product areas. We anticipate ongoing growth opportunities from regulatory drivers but importantly, also new product areas e.g. ComplianceASSESSOR product being developed currently to guide clients as to which compliance issues they need to be acting on delivery Asset Encumbrance is a core new area for future revenue growth. Lombard Risk offers templates and instructions to ensure harmonised reporting of asset encumbrance across the organisation. In general, collateral and asset encumbrance has become a front office issue for clients and thus is as important a growth driver as Regulation: not mandated spend but a crucial profit and risk generator for clients. So how has Lombard Risk been performing, given this strong demand? Order book (backlog) 6.0 m FY12 FY13 FY14 Source: Lombard Risk The end March (year end) order backlog has translated to a 28% revenue rise in 1H15 figures just reported vs 1H14. The order book has gone sideways from its particularly high level of March, standing at 5.1m September 2014 and somewhat higher currently. 2

3 c.46% recurring revenue Lombard Risk Management s sales growth in the past two full years is 31.4% and 21.6% respectively. We see a slow down to 10.3% FY15E and 12.0% FY16E but would anticipate that the risk to these estimates is on the upside. It is important to note that circa 46% of group turnover is recurring and of our H2 estimates, over 60% was already either recurring or in the end September order backlog or term renewals. Judging by past performance this should underpin full year estimates strongly. The higher growth numbers of previous periods remain indicative of Lombard Risk Management s potential as its policy is to invest strongly for the future. This is in three regards. Three types of drivers: software spend; senior people and partnering driving newer areas; new products rollout to newer areas; First, the quantum of investment in software is strong. In each of the past three years total technology spend has been in excess of 30% of sales. Secondly, an additional client-facing senior manager in USA has been appointed and a selection of partners, again client-facing, have been teamed up with, particularly with a view to building on recent important wins in the Far East. COLLINE is now installed in a regional Japanese bank and this is crucial in building a targeted skill set with partners to expand in Japan in the very important Asian marketplace. Partners include NTT Data (Japan), Broadridge (US) as well as several others. Thirdly, at a detailed level, new product development in newer focus areas of regulation is ever more important (on top of adding new clients in new versions of existing product lines). An excellent example is ComplianceASSESSOR in advanced development (pre-revenue). This is a web-based compliance and audit application accommodating an unlimited library of multi-jurisdictional regulations mapped to internal policies and procedures. Individual senior officers of clients are impacted personally by these heightened regulations. Putting these issues of i) software development investment, ii) people investment, iii) new product suites together, Lombard Risk Management is set for strong growth. Lombard Risk Management is in the sweet spot of regulation but in addition, the rising need for instant collateral (and margin) response is a significant ongoing, rising positive. Historic growth is visible and straightforward to understand, driven by investment and order backlog. There are two main markets, with different but inter-related dynamics: Regulatory Compliance and Collateral assessment and management. The former is regulatory mandated. The latter is more a commercial decision but bears directly on the reputation and thus existence of the bank client. There are six main geographies. For the US, clients are foreign branches in the US and (not so large a client base currently) US banks in US. The same applies in UK. As to Asia, the market is both too. In total, Lombard Risk Management has over 300 customers including banks and also hedge funds, asset managers, commodity firms. 121 clients in total are now signed for European Banking Authority COREP (co-reporting) of which 62 were new names in the last half year. Repeat income intrinsically forms a strong backbone. 3

4 Key financial drivers Cash generation The business is expected to be cash generative in FY15 and already holds net cash on balance sheet. Although growth does lead to a working capital requirement, total working capital was 2.7m at the last balance sheet date (there are no stocks, by the nature of the business) so cash-requirement growth here is not a meaningful figure in the context of a business the size of Lombard Risk. Capital expenditure (on software) is a core part of the Lombard Risk model and our model factors in capitalised software expenditure of 24%+ ratio to sales. (The ratio in FY13 and FY14 was 26.8% and 28.1% respectively). Our model indicates modest net cash generation during our forward estimate horizon, in the face of good growth and sustained, robust strong development expenditure. EBITDA margins We estimate a modest rise in EBITDA margins. Lombard Risk s gross margins are over 99%. Its costs are predictable, with two caveats. First, there is a modest element of overseas cost (employees globally) and a somewhat greater element of foreign currency income. This is not a major issue. The other minor caveat is that FY13 operating costs growth was slightly below trend, enhancing EBITDA margins. The cost base is rising with modest underlying macro-economy inflation and selective investment. This cost growth we estimate to be below our 10.3% FY15E and 12.0% FY16E revenue growth estimates. This will drive EBITDA margin expansion further, on a sustained basis. We are strongly of the view the EBITDA margins for Lombard Risk will have a propensity to rise from the current levels, driven by growth in the group. EBITDA margin % - FY12 FY13 FY14 FY15E FY16E Source: Lombard Risk accounts, Hardman & Co estimates Note, FY12 reported profits rose significantly. They benefitted from reduced operating costs, with a significant rise in capitalised technology expenditure. This latter raises amortisation in subsequent years. 4

5 Longevity and visibility Well established products (as well as the new ones) New areas such as collateral adding on to the regulatory driver Well established products also benefit from new market demands constant evolution and updating The group s core risk product, which is constantly evolving, is the wellestablished COLLINE. A key driver for some recent development in COLLINE has been regulatory change with increased use of Clearing Houses for derivatives mandated by regulators, and other developments required by the US Dodd Frank legislation, the European EMIR legislation and by the International Securities regulators IOSCO. Other drivers have been the addition of modules for repo and securities lending, and collateral optimisation. Collateral used to be a process that was driven by efficiency in the back office, but now it is an important part of a bank s liquidity and attracts increasing interest from the front office. All these developments mean that even if customers signed up for COLLINE a few years ago, there can be appreciable extra spend by those customers on COLLINE now to keep up to date with new regulatory features and the additional modules. Lombard Risk Management s core regulatory reporting products, REPORTER and REG-Reporter, are respectively market leaders in the UK and for foreign banks in the US. Since the 2008 crisis the regulators have mandated more and more reporting, for example capital and liquidity reporting. In addition the European Union has for the first time passed legislation requiring UK banks to produce some of the same regulatory reporting required by banks in all other EU countries. This has had a major positive impact on the level of business in the UK. A new type of reporting called XBRL has been introduced to the UK for the electronic submission of regulatory data, and this has also been a good opportunity for Lombard Risk to gain market share. The core geographical markets at present are UK and US, but this is an international business, addressing a market which is global but with distinct regional characteristics. In summary Lombard Risk Management is a market leader in its chosen markets and these markets are growing well. It has achieved compound annual revenue growth of 23% p.a. in the last four years. Through investment in technology it is well positioned both to build on its position with existing clients and to move forward with higher value contracts. Strengths This is a mandated spend for the purposes of regulation but it also is a potential profit generator for clients, helping Tier 2 banks to move up to Tier 1. Additionally Lombard Risk Management products enable focus on the risk management for the banks own in-house use. From the Lombard Risk Management margin point of view, it is important that, whilst all products are adapted to fit perfectly the client requirements, they are predominantly driven off software which is useable across different clients. Weakness There is significant spend required and undertaken on technology. This is the lifeblood of the group. Past expenditure raises future amortisation rates, though, of course, this is not a cash item. Cash generation is expected in FY15. 5

6 Opportunities Geographical expansion is an important driver, along with the recent emphasis on global alliances. And, of course, regulations are likely to continue to evolve, creating more opportunities. Threats Several Lombard Risk Management products have been in existence for decades but inevitably for such a high-profile product, there is a danger if it fails. Professional services / training are key inputs for mitigating potential misunderstanding. 6

7 Financial analysis 1H15 results Revenues 9.3m +27.7% Costs 8.5m +18.1% EBITDA 0.8m (vs small loss) PBT 0.01m (vs small loss) EPS 0.0p (vs loss 0.43p) Net cash 2.2m ( 1.8m) We initiate FY16 estimates. FY15E unchanged estimates, bar reduced tax charge estimate (now estimated at 5%, principally US driven): hence upgrade to EPS. We initiate FY16 estimates March Year end FY11 FY12 FY13 FY14 FY15E FY16E P&L ( m) Sales Gross profit Tech spend expensed (2.7) (1.2) (1.9) (1.8) (2.3) (2.6) Tech spend capitalised (0.0) (3.3) (4.3) (5.3) (4.8) (5.0) EBITDA Operating profit PBT Reported EPS Reported (p) DPS (p) Cashflow ( m) Operating cash flow Interest & tax (0.0) 0.0 (0.0) 0.1 (0.1) (0.1) Capex / Acquisitions (0.1) (5.5) (5.0) (5.7) (6.0) (6.2) Dividends (0.0) (0.1) (0.1) (0.2) (0.2) (0.2) Equity (0.0) Other items (0.0) (0.5) 0.5 (0.0) - - Change in net cash 1.1 (4.2) Closing net cash 1.8 (2.4) Balance sheet ( m) Net assets Key metrics FY11 FY12 FY13 FY14 FY15E FY16E Growth (%) Sales Gross profit Operating profit nm nm Reported PBT nm nm EPS nm nm (6.3) 20.0 DPS - nm Operating ratios Gross margins EBITDA margins Operating margins Effective tax rate (credit) nm (0.7) 4.7 (16.6) Leverage Gearing nm 44.3 nm nm nm nm Net debt/ebitda nm 0.8 nm nm nm nm Interest cover nm nm nm nm nm nm EPS/DPS Source: Lombard Risk accounts, Hardman & Co estimates 7

8 The results were in line with expectations and we maintain our estimates (bar the tax rate which we reduce to 5% as a function of taking more properly into account the accelerated tax relief which derives from global R&D spend and is an established feature of Lombard Risk). There has been a restatement of 1H14 figures by 0.1m for very minor changes in policy on timing of capitalisation of software costs. FY14 numbers were already stated as per this slightly changed methodology so no restatement of full year FY14. 8

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