HL. Hargreaves Lansdown Plc

OPEN LETTER TO THE CHAIR OF HARGREAVES LANSDOWN PLC REGARDING LANCASTER INVESTMENT MANAGEMENT'S CONCERNS OVER THE BOARD'S SUPPORT FOR THE CONSORTIUM PRIVATE EQUITY OFFER

Dear Alison,

BACKGROUND AND SUMMARY

We appreciated our recent call to discuss the Board's support of the private equity consortium ("consortium") offer ("offer") for Hargreaves Lansdown PLC ("HL")[1].  However, we remain unconvinced that this offer is fair for all HL shareholders.  We are writing this letter to set out our concerns; we intend to publish it because we believe the matter is highly important for HL shareholders.

In summary, Lancaster Investment Management's ("Lancaster's") Global Equity Funds are investors in and supporters of HL, with our interest representing c. 1.9m shares.  We made an initial investment earlier this year and have been building our position since then.  Regarding this offer, we question: firstly, the valuation of the offer; secondly, the Board's assessment of HL's weak historic operating performance against HL's potential for strong future growth; and thirdly a risk of potential conflict of interest in the terms of the current offer.  We question the fairness of a deal where we expect only a small number of shareholders will be able to remain invested via a private "rollover equity alternative"[2], while we expect the majority of shareholders, including Lancaster's Global Equity Funds, will not be able to participate by going private.

Your main rationales for the Board supporting the offer were: the timeline you expect, of two to three years, for HL to achieve full recovery of operating performance; the non-linear path towards that goal; and the risks involved.  We argue that these should be manageable parameters for public shareholders, and that the company should not be sold out cheaply in our opinion, ahead of a potential recovery path to growth that has been confidently articulated by management[3].  Moreover, we see strong drivers underpinning HL's recovery and growth potential: the considerable investment HL has already made; its excellent executive team and strategy which the Board supports; and the potential for political and regulatory support to drive client engagement long-term.  It seems inequitable to HL's smaller shareholders to transfer these potential gains to the private equity consortium at a low valuation in our view, with, we expect, only a minority of existing shareholders/stakeholders able to maintain potential upside through rolling into a private vehicle.

Finally, we consider this offer the latest in a stream of de-equitisation events in the UK market which cause us dismay.  We are not averse to private equity offers where there is also a "win-win" along with public shareholders and other stakeholders.  However, here we find it an unfortunate irony that HL, as a champion of open access to financial services, may itself now be close to exiting the public markets without full value offered to public shareholders in our opinion.  We note that both the main UK political parties are committed to stemming the de-equitisation of UK capital markets.  Labour's Plan for Financial Services points out: "the number of London listed companies has dropped by 40% since 2008…more than 5,000 UK growth companies have been acquired by overseas buyers in the last decade"[4].  The Conservative's March 2024 Budget and July 2023 Mansion House Speech made similar findings[5].  In our view, this situation is linked to what we see as a troubled backdrop for national savings and investment, with a wide financial "advice gap" and low engagement from retail investors and savers.  HL's own research highlights this backdrop in our view: "only 13% of UK households are on track for a comfortable retirement and one third of people (34%) have less than £1,000 in savings"[6].  As the UK's leading investment platform based on scale, longevity, brand recognition and strength[7], we believe HL has an important role to play in addressing these long-term national-level issues.  We believe this further underpins HL's future growth potential and intrinsic value. 

Below we set out our concerns with the consortium's offer, and in conclusion, we raise the following important questions for the Board:

·      What timeline do existing shareholders view as acceptable for HL's recovery to growth as a listed company? 

·      What proportion of existing shareholders would be able to take up the private "rollover equity alternative" which we view as central to this offer?

·      Does the cash offer reflect fair value given the points made below on valuation and growth potential?

·      Will the Board support smaller shareholders by offering a separate vote for those who are not able to take up the private "rollover equity alternative"?   

We also urge the board to give itself more time in its current form to assess HL's strategic options and to assess shareholder support for different outcomes.  If management can execute on the strategy as the Board and we expect, then in our view there is plenty of growth and upside potential for this private equity consortium or others to come back at a very different price and valuation in the future.  We believe that path would create a far better outcome for HL's public shareholders, HL's clients, and indeed British savers.

OUR CONCERNS WITH THE OFFER AND THE BOARD'S SUPPORT FOR IT

1)   The offer valuation is depressed compared to listed peers and to HL's own trading history. 

1140p (including final dividend) represents a multiple of c.17x earnings per share on our calculation, which is a c.-14% discount to AJ Bell's multiple, as the closest listed peer, currently valued at c.20x earnings per share[8].  It is c.-40% below HL's own 10-year average PE multiple of 28x on our calculation[9].  HL has only sustained at a lower multiple than that implied by the offer for a brief period during the "Global Financial Crisis" 2008-09, and over the last c. two years, since early 2022[10], when we would argue HL's problems combined with global geopolitical and macro-economic upheaval to affect the valuation multiple. 

It is insufficient in our view to argue simply that HL's recent troubles make valuation history and comparison less relevant to an offer today, meriting crystallisation of lower multiple for shareholders today.  We agree with you that there is good momentum in the operational turnaround of the business[11]; however we see the multiple as reflective of the past few years not the future.

AJ Bell and other peers clearly have enjoyed higher growth than HL in recent years[12].  However, we would argue HL has strengths which should be weighed against this when considering a valuation multiple.  For example, HL is the largest UK platform by assets under administration (AUA); it has the largest client base; it has the longest history and best-known and strongest brand[13]. 

In our view HL's problem areas are within the bounds of acceptable risk for an industry-leading, listed business: technology, marketing, client experience in particular.  We argue the Capital Markets Day Plan (CMD, 22^nd February 2022) together with current management's strategy have already invested to tackle these issues.  Indeed, against the CMD plan of £175m investment plus £50m dual-running costs, a considerable proportion (£99.8m) had already been executed by Interim Results announced February 2024[14].  We have not heard or seen any evidence to suggest the CMD plan does not remain on track.  We cannot help but perceive that public shareholders have taken the historic pain of this investment plan, reflected in our view by depressed margins and valuation multiple relative to history, while the upside potential to us looks set to be captured by the private equity consortium and importantly, those who can continue to hold HL privately.

2)   Growth potential ignored

We are excited by HL's current strategy to recover growth and agree with the Board that the management team is excellent and very well-placed to deliver for shareholders.  Below we consider recent operating performance demonstrating initial signs of business momentum returning.

We are also excited that the regulatory and political backdrop appear to us to be becoming supportive of investment platform industry growth, with a focus on increasing retail investor participation, institutional allocations, pension saver returns and ultimately a robust capital market supporting national growth.  We see this further underpinning future growth prospects at HL.

We are encouraged by the FCA's recent "Advice Guidance Boundary Review", with the consultation closed 28^th February 2024 and we believe further plans could be announced in the coming months[15].  In our view this regulation has great potential to open financial understanding, financial engagement, and financial security across the UK population.  We believe it will address the "advice gap" and retail investor disengagement.  We view this as a matter of national importance. HL's own research points to a troubled backdrop for UK savings and investment as "only 13% of UK households are on track for a comfortable retirement and one third of people (34%) have less than £1,000 in savings"[16].  As the UK's leading investment platform on key measures, it seems very probable to us that HL will play a leading role in implementing the new regulatory framework.

We also perceive a welcome consensus developing across the main UK political parties to drive UK investment and growth, again likely benefitting HL in our opinion.  Labour's Plan for Financial Services notes that as a result of UK capital markets "de-equitisation", "investment in UK companies has suffered, and UK pension savers are missing on higher long-term returns from growth assets".  It continues that "participation by retail investors in UK public equity markets remains well below comparable markets".  It concludes: "Labour is committed to strengthening our capital markets", via increased retail investment participation and pension reform among other initiatives[17].  The Conservative Government's Budget Speech March 2024 also called for "a new generation of retail investors to engage with public markets", it brought initiatives to encourage UK investment by pension funds, and a British ISA to engage UK retail investors[18].  These positions were also seen in the Chancellor's Mansion House Speech July 2023[19].  Both parties note the lower returns to UK pension savers compared to other countries; and both note the alarming trends of companies leaving UK listing and of institutions de-allocating from the UK. 

We are very encouraged by these political and regulatory developments.  We see them as very supportive of industry tailwinds for UK investment platforms.  As the industry leader, we believe HL is well-placed to lead this growth, partnering with regulators and politicians as they shape the best outcome for UK savers and investors.  We see HL as a trophy asset in the UK and the UK public market.  This unique position for HL should be reflected in any valuation framework in our view.  We do not believe it is sufficiently reflected in the consortium's offer.

3)   Timelines: acceptable horizon for recovery to growth; time taken for the board to strategise

One of the Board's key arguments in favour of the consortium's offer, as we understand it, is that the timeline to recovery is too long for listed investors at two to three years, and the path non-linear, making private equity a more suitable ownership model in this stage of HL's evolution. 

As we state above, we are not averse to private equity offers where there is a genuine "win-win" alongside public shareholders and other stakeholders.  We are prepared to support offers whose valuations and terms are equitable to existing shareholders.  Here however, we question whether the timeline for recovery really is outside the scope of most HL shareholders.  We urge the Board to address this question as a priority.

We believe a recovery period of two to three years should be acceptable to most HL shareholders, especially at current valuation multiples.  We also believe HL shareholders should be patient on the timing of HL's recovery, given there is already evidence of momentum in HL's business today in our view.  We note that HL's operating results to March 2024 saw improved net flows and client additions, revenues exceeded market expectations, and encouraging trends were reported as continuing into the new quarter[20].  We see this as a rare positive report for the company in recent years and a possible early sign that HL's performance is improving. 

Finally on timelines, we are also concerned that this offer process has occurred early in the incumbency of the management team and the Board.  HL's CEO has been in place for less than one year up to now.  HL's CFO has been in place for less than two and a half years to now, during a period which we assess as difficult for HL both for internal and external reasons.  As Chair, you have been in place for less than six months[21], and the first private equity offer seems to us to have occurred within 100 days' tenure[22].  We have huge respect for HL's excellent management team, strategy and Board, and we recognise that the timing of an offer is outside the Board's control.  Even so, respectfully, we are concerned whether sufficient time has passed since the Board took its current composition a few months ago, to weigh such an important matter as the company's future ownership.

4)   Risk of potential conflict of interest

We are concerned by the opportunity for up to 35% of shares to roll over into a private vehicle without an attractive alternative for those who cannot participate.  We suspect that only a minority of shareholders by number will be able to take up the "rollover equity alternative", as many institutional funds such as ours will have restrictions on private investments, as much as we would like to remain invested in HL were this offer to proceed.  We cannot help but perceive this as a two-tiered offer, and in our opinion, it does not seem equitable to those shareholders unable to go private.

Further, we fear that the "rollover equity alternative" introduces a situation where the Board may recommend the majority of shareholders to sell at a price - even though other investors, with greater flexibility of ownership structure, may be allowed to make an explicit statement that this price does not represent full value to them, and would not be forced to sell at that price.  This situation may risk a potential conflict in our view, which we urge the Board to consider.

We also fear that a shareholder vote on this deal structure could be skewed, as shareholders who can take private rollover equity would have an extra incentive to vote in favour of the deal.  Further, assuming these shareholders took up the 35% "rollover equity alternative" in full, we fear this size of voting support, comprised of potentially a small number of shareholders, could significantly advance the vote and risk marginalising the voice of smaller shareholders.  Given the risk of potential conflict here, we urge the Board to address this question as a priority: what proportion of shareholders are able to accept the "rollover equity alternative"?  We would like to see, and we urge the board to offer, a separate vote on the deal for those shareholders who are not able to go private.

We also are concerned by risk of a potential for a conflict of interest between shareholders and HL's executives on the Board.  We have the highest respect for this excellent team, and we are excited by their professional track records and the potential they bring to HL.  We understand the Board does not yet know whether they would be involved with the company under consortium ownership or not, however we note the Board's endorsement of them in the Offer Update.  We would highlight our opinion that even with the best of intentions, there could be a risk of potential conflict, should members of a management team have the opportunity to benefit from future upside under private equity ownership, when many shareholders may not.    

OUR VIEW OF VALUATION AND STRATEGY

We are pleased to be shareholders of HL and not surprised that other parties recognise its exciting value and growth opportunities too.  However, if the company's internal recovery plan is on track, if the Board remains supportive of this excellent management team's strategy and execution, and if the question is simply one of timelines and certainty; then we struggle to agree that this offer represents best value for shareholders.  It certainly does not capture HL's significant recovery and growth potential as we see it. 

We would be far happier to maintain our support of management in an independent listed company, as they execute recovery to growth over the two to three years you suggest.  We expect other shareholders may take a similar view, especially if like us, they are not among the small number (we assume) able to take the private "rollover equity alternative". 

Part of the difference in our approach to valuation compared to the Board's, we believe, is that in many cases, where the Board perceives threat, we perceive opportunity.  HL has the largest client base of UK investment platforms at 1.8m clients, however we see this as a small proportion of the UK saving and investing population, which we believe is set to grow, and to grow assets under administration (AUA) if political and regulatory tailwinds allow.  HL has the highest AUA among UK platforms and we believe there is "low-hanging fruit" to modernise and develop a best-in-class client experience to improve client activity and recruitment.  HL offers a broad product set, however in our view the opportunity of a more flexible regulatory regime (advice/guidance) offers potential to empower and engage clients to a far higher level. 

In conclusion, we urge the Board to address the following important questions we have raised above to ensure fairness on behalf of all shareholders before it progresses support for this offer: 

·      What timeline do existing shareholders view as acceptable for HL's recovery to growth as a listed company?  

·      What proportion of existing shareholders would be able to take up the private "rollover equity alternative" which we view as central to this offer?

·      Does the cash offer reflect fair value given the points made above on valuation and growth potential?

·      Will the Board support smaller shareholders by offering a separate vote for those who are not able to take up the private "rollover equity alternative"?   

We also urge the board to give itself more time in its current form to assess HL's strategic options and to assess broad shareholder support for different outcomes.  If management can execute on strategy as the Board and we expect, then in our view there is plenty of growth and upside potential for this private equity consortium or others to come back at a very different price and valuation in the future.  We believe that path would create a far better outcome for HL's public shareholders, HL's clients, and indeed British savers.

We do not take the decision to write this open letter lightly.  We very much hope the Board will receive it as a constructive effort to voice the concerns of a smaller shareholder, and that it will aid the Board's important deliberations regarding HL's future.  We look forward to hearing back from you.

Yours sincerely,

James Hanbury, Portfolio Manager

Lancaster Investment Management LLP, on behalf of Lancaster's Global Equity Funds

James Spalton, Investment Analyst

Lancaster Investment Management LLP, on behalf of Lancaster's Global Equity Funds