IPO Review: Kelly Partners Group (ASX: KPG)

IPO Review: Kelly Partners Group (ASX: KPG)

Company Overview

Kelly Partners Group (ASX: KPG) is a chartered accounting firm established in 2006. The company serves private SMEs via a network of 16 operating businesses. Kelly+Partners provide accounting, taxation, audit and wealth management services to over 5,300 client groups.

KPG’s network of businesses includes 15 throughout Greater Sydney and 1 in Hong Kong. Among these, 3 specialist businesses advise on tax consulting, wealth management, and business strategy. The company has a controlling interest in all but 1 of the businesses.

 

Company Kelly Partners Group Holdings Ltd
ASX Code        KPG
Website http://www.kellypartnersgroup.com.au
Listing Date June 21 (TBC)
Capital Raising $7.3m
Issue Price $1.00
Market Cap. $45.3m (approx.)
Lead Manager Morgans

 

Market

In 2016, the Australian accounting industry recorded $20bn in revenue. While revenue in the tax and compliance sector is considered stable, the industry’s structure is highly fragmented. There are a significant number of providers offering a broad set of services, while smaller practices often lack a succession plan.

According to KPG’s management, the industry may be categorised into 4 segments (Figure 1). Kelly+Partners operate within the largest of these segments. Its target clients, SMEs, grew in volume by 2.4% p.a. from FY12 to FY16. By the end of 2015, SMEs represented 97% of all Australian businesses.

Figure 1

In terms of annual tax compliance, $34bn is spent by individuals, SMEs and SMSFs. This represents 89% of the industry’s total tax compliance expenses.

Senior management for KPG estimate SMEs have an average tenure with service providers of 10+ years, more than double that of large companies – including the “Big 4”. Peers in the same sector are considered to have: small client bases, limited expertise, 1 office, and under $2m revenue p.a.

The increasing complexity of Australia’s taxation system has also been cited as an industry trend. Tax law volumes have grown from a little over 1,000 pages in 1951, to topping 15,000 pages. Furthermore, The World Bank recently reported Australia lags the likes of Canada, New Zealand, Singapore, China, the UK and several others when it comes to the ease with which a medium size business may pay taxes.

Kelly Partners believe the above factors have contributed to the increasing dependence on tax agents to manage tax returns (Figure 2).

Figure 2

Globally, other taxation trends include:

  • Unsustainable budget deficits;
  • Increasing corporate reporting obligations;
  • Economic growth policies involving lower corporate tax;
  • Increasing tax complexity and government focus on tax avoidance;
  • An aging population prompting tax recuperation in other areas;
  • Wealth equality and higher taxes for those on high incomes

Figure 3 depicts the size of the total SMSF market. Kelly Partners Group engage with over 1,000 SMSF accounts with a combined asset value of $1.5bn.

Figure 3

 

Offer Details and Use of Funds

The IPO, underwritten by Morgans, is valued at $7.3m. This includes 2.88m new shares, and 4.46m existing shares being sold by current shareholders – all priced at $1 each. Funds are being raised to pay down debt and “provide greater financial flexibility”.

Figure 4

 

Kelly Partners Operations

 

Business Model & Strategy

Kelly Partners operate an owner-driven business model to retain and align the interests of its operating business owners, while also leveraging scale. Businesses are typically run as partnerships, with KPG holding a controlling interest (Figure 5).

Figure 5

Other key terms of the partnerships include:

  • Access to centralised services and intellectual property (branding, marketing, systems, procedures, training, risk, accreditations, quality assurance, etc.);
  • Access to centralised functions (management, back office);
  • Succession plans;
  • Debt arrangements against each business;
  • Defined KPIs and distributions;
  • 10 year contracts with a further 10 year roll-over (with the exception of 2 businesses)

The provision of these terms are intended to lower overheads, optimise efficiency, recruit the best personnel, and provide a diverse range of services. KPG’s management also argue these aspects afford the businesses an offering that improves clients’ experiences, and results in increased cashflow and revenue growth.

As part of its growth plans, Kelly Partners has identified:

  • Organic growth: market penetration and the increasing complexity of Australia’s tax system;
  • Network expansion: 8 locations already identified. Acquiring private firms with aligned criteria and no clear succession plan, or through greenfield sites; and
  • New services: particularly within the area of tax consulting and wealth management

 

Sales & Assets

As the controlling business, Kelly Partners Group receive income through equity distributions in each operating business, management services fees (for centralised functions), and IP fees (for access). Fees are paid monthly based on a fixed percentage of each operating business’ revenue.

The company’s consolidated revenue is predominantly via accounting and taxation services (85%), deemed predictable, recurring and which offer a premium price. Clients are charged a fixed fee, or according to time and materials. Average churn among clients is currently 2% p.a. KPG’s top 20 clients account for 16% of total pro-forma revenue (FY17).

As well as a unified brand and central technology platform, KPG hold intellectual property in the form of an ‘Integrated Client Advice Model’, and a ‘Flight Plan’.

The former consists of the company’s validated processes which “assess and optimise the financial management” of clients. The latter is a planning framework for SMEs to pursue financial objectives.

Apart from Kelly+Partners Central Coast, where KPG own a majority stake in the property, all businesses operate under leases between 3-8 years.

 

Company Management

Name Title Experience Salary
(excl. rights)
Brett Kelly Executive Chairman & CEO Founded Kelly Partners and has overseen its network growth. Over 20 years’ accounting experience. $360,000
Pauline Michelakis Executive Director & CFO Chartered accountant. In excess of 20 years’ experience working for financial services & investment businesses in senior roles, including AFP Group, Lang Corporation, and Kaplan Funds. $325,000
Paul Kuchta Executive Director Chartered accountant. Specialises in accounting compliance, taxation and advisory. More than 17 years’ experience. Founding partner & operating business owner of Kelly+Partners Norwood. *profits from Norwood business
Stephen Rouvray Non-Executive Director Deputy Chairman. Over 45 years’ in financial services. Senior leadership experience includes CFO for AUB Group, GM for ING. $30,000
Ryan Macnamee Non-Executive Director Business technology executive. Over 25 years’ in IT management, including CIO at Laing O’Rourke. $30,000

Table 1

For their services, senior management received a combined total of 453,000 shares before the IPO. These shares are in addition to their previous holdings.

 

Capital Structure

The company’s capital structure before and after the IPO is shown below, as well as the leading shareholders. No options have been issued.

Figure 6
Figure 7

Kelly Partners issued a $6.5m convertible note to Ellerston, who converted it into shares in KPG. Escrow arrangements prevent Ellerston from selling 30% of its holdings within 6 months, unless the price exceeds $1.40 or a profit downgrade is announced.

The 453,000 shares received by senior management remain in escrow until 1 month after KPG’s 1H18 results. Other restricted shares cannot be traded until 1 month after Kelly Partners FY18 results. Figure 8 shows escrowed parties.

Figure 8

 

Financials

In the 10 years since Kelly Partners was formed, there has been a CAGR of 37% in consolidated revenue.

For FY17, the Directors have forecast a 10.9% increase in pro-forma revenue from FY16, to $34.62m. EBITDA is forecast to rise 16.6% across the same period.

Mature operating businesses have been set a goal of 5% revenue growth per year. All operating businesses are targeting EBITDA margins of at least 32.5% (11.5% higher than the estimated average for the accounting industry).

The offer price of $1 per share represents a PE ratio of 10.9 x FY18 earnings.

A target dividend payout ratio of 50% has been nominated by the Directors based on Kelly Partners statutory NPAT. Payments are intended to be made quarterly, with the first expected to be declared in relation to Q3 2017.

The following financial statements do not include explanatory notes or adjustment breakdowns. Refer to the prospectus for the relevant details and assumptions.

Figure 9
Figure 10
Figure 11

 

Risks

Company specific risks include:

  • Key Personnel: KPG’s success could be impeded if key staff depart, including directors, founders, employees and operating business owners
  • Clients: Client losses, or a deterioration in client loyalty and satisfaction could lead to earnings uncertainty
  • Competition: The loss of market share or margins against aggressive pricing, greater resources
  • Margin Compression: Wealth management is particularly exposed due to competition
  • Compliance: KPG must comply with regulations (including a stricter burden if adopting a franchise model), or face potential penalties including licence suspension /cancellation
  • Litigation: Clients or business owners could pursue legal action
  • Acquisitions: Integrating new businesses could overburden management and resources, leading to oversights. Synergies may not eventuate. Purchase prices, costs, and disruption could be higher than anticipated.
  • Reliance on Subsidiaries: The dependence on operating businesses to pay distributions means shareholders’ returns may be impacted if businesses face challenging conditions
  • Asset Impairment: Kelly+Partners Sydney contributes large intangible assets (goodwill, client relations), which if impaired, would impact profitability
  • Financing: Further funds may be required for development, with no guarantee over the terms. Default risk is borne by KPG’s subsidiary.
  • Privacy: Security breaches could result in access to confidential information, as well as breaching legal or client guidelines (financial and reputational repercussions)
  • Operational and Technology: Disruptions to systems, services and the like can impede business. Inadequate leases could be detrimental to profits.
  • Trademark: Rejection of the pending application could lead to rebranding, higher costs, infringement

 

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IPO Review: Kelly Partners Group (ASX: KPG)
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