Lots to like at Merc
Mercia Trading Update provides tantalising clues
Dear reader,
Not a car or car dealer, Mercia ticker MERC was the 25th OB25 for 25 idea. Did I wait till the end to leave the best till last?
I picked this since it was effectively two businesses where you pay for one and get a second for free. (and not supermarket nonsense where you pay double and get one free). Mercia the Post-Roman 6th Century Kingdom, stretched across the Midlands, before uniting into “England”.
While today Mercia, the Asset Manager, is active in the regions providing debt and equity capital to growing businesses contrasting with others tending to be based (and focused) in London, Oxbridge or Edinburgh. Having first refusal on large geographies is a large advantage.
And judging by the MERC locations map, the Kingdom of Northumberland wouldn’t be too happy about Mercia’s incursions either.
MERC has for a number of year used its own capital to back companies but times are-a-changing and the plan is to run those down by some 70% by 2027 and to use those freed up funds to finance its own Asset Management growth and expansion.
To focus on expanding third party asset management i.e. EIS/VCT funds and government funds (debt and equity) via the British Business Bank. MERC’s strategy is to expand its Assets Under Management from both audiences. It tells us in its update that since 1st Jan 2025 it expanded those funds by £0.25bn. They achieved in 3 months about the same as in the 12 months of FY2024.
As at 30/09/24 AuM were £1.836bn so at FY year end (31/3/25) funds of ~£2.1bn (including its own balance sheet holdings of £120.9m. Its goal is to reach £3bn.
Government Funds are managed on behalf of the British Business Bank and this is a government quango. Reeves raised £40bn of new taxes in October promising growth. I remember some commentators could only see the leakage from the economy. Oh no! Employer NI taxes spell doom. As a classically trained economist I quickly realised the implication that the increase to T (Taxes) roughly equated to G (Government Spending) and I (Investment).
In other words Reeves wasn’t seeking to balance the books!
So the implication was there would be winners and losers and I spent time considering the winners. Labour believes the government knows best and can use “State Capitalism” to drive growth. It does so via “arms length” institutions like the British Business Bank. So one area of government spending on growth is….. investment. 23,100 businesses received investment in 2024 from the British Business Bank, receiving a mix of debt and equity. That is not insignificant.
Especially when further funds of over £1bn were committed to the BBB in October’s budget and this is one of the ways the government believed it could deliver growth in 2025 and beyond.
MERC earns revenue through the following ways:
• Fund management fees …. NB this is recurring revenue (Sep 2024 81% of revenue)
• Initial management fees
• Portfolio director’ fees
• Share offer fees
• Performance fees
• Custodian fees
• Business services fees (other revenue)
Speaking of revenue and fees MERC also tell us they expect FY25 EBITDA is materially ahead of expectations.
Pre announcement broker consensus (according to Stocko) was EPS 0.961p, today post announcement it has risen to 1.118p per share, assuming those are accurate. Those numbers in isolation don’t really mean much. 1.118p is £4.98m net profit.
EPS in 1H25 was 0.4p implying a 0.718p 2H25 performance.
In my prior article I tracked the asset management business back to 2020 as below. Just to be clear I’ve included 75% of the costs to Asset Management, assigning the other 25% to MERC’s direct investments business. I’ve added in the “materially ahead” net profit of £4.98m as below.
In 2H25 I’ve assumed the same costs as 1H25 but working backwards from that using my 75/25 split of costs implies the Fund Management business made a ~£5.4m net PROFIT
(i.e. -£2.8m Direct BS + £0.6m fin income + £5.4m Fund Mgt = £3.2m 2H25 net profit)
The Direct BS Portfolio with zero newsflow (other than a secondary funding to one of its holdings in December) I’m assuming lost -£2.8m (like in 1H25) due to attribution of admin costs and Finance Income was a little lower (since Cash was £40m down from £47m at 30/09/24).
This graph is where that £5.4m number comes to life. The line in blue shows the jump in earnings compared to the yellow (trend) line.
The (other) direct investments business has had ups and downs as you can see here losing money in 2020 and 2024. Making extraordinary gains in 2021 and 2022 too. So should you be concerned about its potential for a loss in 2H25? Not really the nature of it is lumpy revenue…. feast and famine.
I don’t know only a £0.2m gain is correct. That might be too conservative?
It is interesting to note that MERC tell us that that side of the business made “good overall technical and commercial progress”. Hence me assuming a £0.2m fair value gain, nothing more. Is £0.2m gain and a -£2.8m segment loss “good overall”?
There were three broker notes who also covered the trading update:
One claimed Mercia had cut costs and the strong performance was due to cost cutting. I found no evidence to that effect. In fact if they did so then in 2H25 reversed cost increases over multiple years (where MERC have added cost to support growth). There is no evidence to support that assertion.
Another said they “see upside given outperformance”. You don’t say.
Another said they noticed the uber-shrewd Christopher Mills had taken a >3% position. Who knows perhaps he’s an avid reader of the OB and liked idea #25. :)
The update ends with this sentence. Fund inflows were “coupled with” a strong trading performance.
So couple is TWO and that suggests there’s MORE news than just the £250m increase to AuM. What do you think that might be? That £250m inflow earned fees at the very most for just 25% of FY25, so it doesn’t explain the forecast EPS. Something else must have done that. A £0.2m Fair Value increase to direct portfolio might be way too low perhaps?
Well I did say “tantalising clues” in the title, didn’t I?
The Direct Holdings
On average over the past 4.5 years MERC has delivered a £40.9m realised & unrealised return on its portfolio. More ups than downs. The 2024 down was a bit of a one off.
In the above chart you’ll notice a vast unrealised loss in 2024. This was specific to a single holding called Impression Technologies that suffered an -£18.6m total write off. Mega Ouch.
If you forgive this single outlier then you’re looking at a £59.5m total return over 4.5 years. So between a £9.1m-£13.2m average return. That equates to a P/E over 4.5 years of 9.8X - 14.2X.
That’s not an unreasonable valuation when you consider it has regularly achieved some serious upside to its past portfolio realisations.
Current Top 20:
Last update at #1 holding Voxpopme is positive with progress towards breakeven and “particularly progress evident” in reductions in customer churn rates.
While #2 holding Netacea has moved from a loss to profit in its latest accounts -£6m to £6.9m profit! Follow on funds were committed 4 months ago due to strong growth!
While #3 Warwick Acoustics is clearly heading towards profitability in 2025 with a first automotive contract and prospectively more following, as well as growing sales of its headphones.
The Other 17 are below
MERC tell us that they will support the existing portfolio with follow on cash where required, but intend to realise and run down this portfolio over its second “Three Year Plan” period to March 2027. If MERC can achieve further strong realisations then it proved in the past to be able to reduce its discount to NAV to zero, implying a 33% upside to the share price, let alone that average realisations are around 33% premium to book too.
Conclusion
I await the full year results with eager interest. This idea is down -1.4% YTD. I suspect it won’t end 2025 down, and will help me in the 2025 Share Ideas Fun Run.
Regards
The Oak Bloke
Disclaimers:
This is not advice. Make your own investment decisions.
Micro cap and Nano cap holdings might have a higher risk and higher volatility than companies that are traditionally defined as "blue chip"