Quick Pitch: STM Group (STM.L)

STM Group (STM.L) – Potential Buyout – 30%-40% Upside

This idea was shared by Tom.

This is a potential buyout situation in the UK. The opportunity is not for everyone as the target company is listed on AIM and is very illiquid (£20k daily average volume). Bid/ask spread is very wide, around 10%, so opening a position is pretty difficult.

Pension SuperFund Capital (later PSF) has made a non-binding offer to acquire pensions administrator STM Group at £0.7/share. That’s an upside of around 30-40% from the current prices even after taking into account the wide bid/ask spread. STM’s management has permitted due diligence and said it will support the offer if made binding. The put-up-or-shut-up date is set for August 8, with the possibility of extensions, which is not uncommon in the UK. Interestingly, rumors of this offer came out just one day before the announcement with Sky News highlighting PSF’s interest, while also noting other potential suitors circling around STM. The presence of potential other bidders offers some degree of downside protection, however, the share price gap to pre-announcement levels is huge and STM shares might drop 50% if the offer fails. Despite the large potential downside, the situation holds appeal, characterized by a highly strategic buyout led by a credible/serious buyer, that is capitalizing on opportune timing. It seems like there’s a very solid chance PSF will follow through with a binding offer soon. Once the offer becomes binding, I expect the spread to narrow significantly.

PSF is led by Edmund ‘Edi’ Truell, who is regarded as one of the most prominent financiers in London and a veteran in the UK pensions industry. He founded Pensions Insurance Corporation in 2006, which is now a giant in the space having written £4.1bn premiums last year and boasts a £40bn investment portfolio. Edi’s current main vehicle Disruptive Capital claims to have delivered 33% IRR over the last 27 years. He was also an advisor to Boris Johnson, when Johnson was a mayor of London.

PSF’s acquisition of STM is part of a strategic move to launch one of the first pensions superfunds in the UK. Superfunds were proposed by the UK government in 2017 ago to consolidate the troubled direct benefit pension schemes into giant ‘superfund’ entities. Although the direct benefit pension framework is no longer available, there are still around £1.7 trillion of funds tied up in these legacy schemes. This poses a considerable burden on employers sponsoring these schemes, limiting their ability to invest or raise capital. Many of these schemes are underfunded and unable to opt for an insurance buyout (in which the liabilities are transferred to an insurance company in exchange for a premium), which has been the primary exit option for most companies. Superfunds would consolidate these schemes, run them more efficiently, make better investments, and free UK companies from the administrative/balance sheet burden. PSF has been trying to launch a superfund for several years now, however, the whole process got significantly delayed due to internal issues (more on this below) and regulatory uncertainties. When the superfund framework was initially proposed, concerns have arisen regarding the potential governance issues and the fact that UK regulators were not equipped to regulate such funds yet. This caused most industry players and sponsors to remain on the sidelines while waiting for more clarified ground rules from regulators. After several years of dragging their feet, regulators have finally begun addressing this issue more seriously and last month affirmed a plan to create a permanent superfund regulatory regime with the reforms to be set out in the Autumn. In response to this impending regulatory go-ahead, PSF has resumed preparations to re-launch its superfund and has recently had ‘an injection of further capital in preparation for several significant pension risk transfers’. STM buyout is understood to be another stepping stone in this direction.

Another factor that increases the likelihood of Pension Superfund Capital proceeding to a definitive offer is the potential reputational damage it could face if it were to back out. PSF has already had a fair share of internal issues, creating doubts about its ability to successfully launch and grow a superfund in the UK. In 2018, Edi Truell teamed up with US PE giant Warburg Pincus ($82bn AUM), which agreed to finance the fund. Additionally, he appointed Alan Rubenstein, a highly regarded industry veteran and former CEO of the Pension Protection Fund (£28bn AUM), as the new CEO of PSF. The whole story in the media was that Rubenstein will grow PSF’s superfund into something really big. However, just six months later, both Warburg Pincus and Rubenstein walked away due to internal disagreements. This incident caused significant reputational damage, leading the industry to question the future of PSF’s superfund. Since then, PSF’s superfund still hasn’t been launched. Given this history, there are extra incentives for Edi Truell and PSF not to falter in the re-launch this time around.

The offer comes at a massive, almost 3x, premium to pre-announcement prices, which might raise eyebrows at first. However, I think this might be justifiable due to several reasons. The buyer, PSF, is likely under time constraints and may not be overly concerned about the price due to the massive scale of superfunds they intend to create (some industry insiders previously said superfunds will be viable only at £3bn-5bn asset levels). STM buyout is a speck for PSF in the grand scheme of things. Additionally, the fact that STM’s CEO owns 11% of the company and the involvement of multiple competing bidders could have necessitated a sizable premium to expedite the deal. Lastly, the offer comes at 8.8x 2022 adj. PBT, which arguably is not even that expensive (at least compared to the perceived premium size) given STM’s very stable business with 91% of recurring revenues.

The buyout will be conditioned on several regulatory approvals from UK, Gibraltar and Malta. Although STM faced historical tax issues in Gibraltar about a decade ago, the small size of the transaction and a credible UK buyer should help mitigate any regulatory concerns.