Stockwatch: Good time for a takeover

A normal market size of 200 shares can make mid-250 financial trading solutions stock Fidessa Group volatile, although a price of about 2,370p equates to £4,740 anyway. It helps explain a 30% jump after 2015 prelims and currently the stock is showing daily swings in the order of 100p.

The reason is US takeover talk which may or may not be an April Fool, that comes amid sterling weakness and approaches such as for Premier Foods. Fidessa is the industry leader in systems for brokers (sell-side), and set to benefit from the fashionably "disruptive" theme of "MIFID II" regulations - a Markets in Financial Instruments Directive from the EU, supposedly to improve markets' functioning.

It's thought to offer substantial opportunities and, allegedly, Fidessa has in the past enjoyed a circa 30% revenue boost after regulation changes, although the table shows fairly flat performance over the last five years. So is its risk/reward profile attractive?

Chart recovers to 2014/15 levels

The five-year chart shows the price recovering to where it traded during 2014 (with a high of 2,615p set two years ago) and the first half of 2015.

Fidessa is a prime example of how stocks can more reflect central bank actions than underlying fundamentals; its main rally was from about 1,300p in early 2013 when quantitative easing boosted markets.

In principle this should have benefited Fidessa's services, although the table shows flat performance in 2013 and slightly down in 2014. Company REFS shows an annual average price/earnings (PE) ratio close to 30 times for 2014/15, so the stock has nearly regained a rating it enjoyed for about 18 months.

Interestingly, when I drew attention last October at 1,935p, it followed not only directors' buying but also a bullish "bowl" formation on the chart. Traders, who bought into mining stocks to profit hugely from their February-March rally, have said they ignored all the noise about fundamentals to focus on such bowl patterns.

Enhanced dividends offer 3.7% yield

Another aspect of my 'buy' case was continued special dividends boosting the prospective yield to 4.5% - now about 3.7%. They follow from the group's strong cash generation (note cash flow per share of about 2.5 times earnings per share [EPS] over the years) and 85% of revenue on a recurring basis; hence at end-2015 it had £78.3 million cash and no debt.

The "special" dividend has, therefore, become ironic, given management assures its investment programme is unlikely to compromise further special dividends in the future - i.e. special is now normal.

Investors can see how a 4.5% yield proved a support point, in context where the 2015 results then showed a 60% rise in derivatives-related sales helping group revenue up 7% to £295.5 million. Otherwise, pre-tax profit was flat at £39.8 million, as financial markets remained volatile and affected clients: "The closure of the Jeffries Group's Bache futures unit and the Standard Chartered global equities business during 2015 will result in an increased impact from consolidation, restructuring and closures on revenue in 2016."

Fidessa's near-term outlook is therefore good in parts, with some checks besides genuine new progress, but its yield should continue to be supportive.

New services coincide with aspects of market recovery

Within a convoluted results message, management also cited "a new phase of recovery, with structural and regulatory changes starting to have an impact".

Asia is the fastest-growing region, with revenue up 16% or 12% at constant currency (albeit representing 19% of the group total); it is expanding the Singapore operation and signing various new deals in Japan and Hong Kong. The Americas grew 12% or 6% at constant currency (12% of total revenue) with good progress across North America and new opportunities in Latin America. However, Europe slipped 1% (39% of total).

Such a global reach likely helps Fidessa capitalise on new opportunities such as larger equity platforms where new deals have been signed. Its new platform for Direct Market Access enables brokers' clients to be in full control of trading, and is said to have rapidly-growing prospects.

Progress in derivatives platform deals are extending into commodities trading also, e.g. after winning a "sell-side system of 2015" award. Research into new opportunities in the fixed income market continues. So, the underlying growth story - at least for sell-side technology - reads well.

Continuing a "good in parts" theme, however, buy-side technology revenues saw a 3% slip in 2015, with sentiment "relatively muted". This was where client consolidations and closures had a negative effect; headwinds that are expected to ease this year and hence aid performance.

A new version of an investment management system has been introduced, also a new system for post-trade affirmation (on both the buy and sell-sides) which has achieved an award for best industry solution.

Good timing for a takeover

Fidessa's global leadership and innovations, in context of benefits from regulatory change, make speculation understandable about private equity interest. What's dubious is a sale price that could induce long-term holders, such as Lindsell Train fund managers with 13.8%, to sell at this stage, now the dividend constitutes a prop and there's a chance Fidessa outstrips forecasts.

Moreover, a private equity-type buyer would have a medium-term objective to sell the business on, at a value representing upside for a fresh buyer. It's a lot to presume. The speculation does at least underline Fidessa's technology prowess: rivals can't match it, while also having the scale and infrastructure to satisfy regulators.

On a two-year view, the odds, therefore, favour buying on market weakness than cashing-in after the rise.

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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.