Davenham -- prospects for growth

Here's that "Share Weekly" tip I mentioned.

Bold entrepreneurs turn to Davenham for their funding
Friday, December 16, 2005

My attention was drawn to Davenham by Dunedin Enterprise Trust. They invested £5m in the company back in 2000 and have seen the value of that initial investment multiply fourfold at the latest flotation price. They must think there are more gains to come since they have retained a 10 per cent stake worth £7.4m at the latest price of 290p, a useful premium to the 254p issue price.

Business Summary

Davenham group is a specialist finance company. The company offers a range of short-term lending such as trade finance, asset finance, property loans and invoice finance.

One reason why I like Davenham is that the business has already grown so strongly. At the time of the management buyout in 2000 the group had a loan book of £40m and made profits of less than £2m. Latest profits were £9.25m on a loan book of £160m. The company is hopeful that strong growth will continue into the future. This seems quite likely.

The company used the £27.5m of new money raised in the flotation to repay subordinated loans and mezzanine financing of £17.5m and add £10m to net assets taking them from £30m to £40m. Net assets are important to an asset finance business like Davenham because they determine how much the company can safely lend. A big increase in the asset base creates scope for a big increase in future lending and so in profits.

Don’t put your Christmas shopping on Davenham’s credit!

Initially I must confess I was shocked when I asked chief executive, David Coates, how much the company charged for money. The answer was credit card rates between 18 and 20 per cent. How, I wondered, could the company’s typical SME (small and medium sized enterprise) customer borrow such expensive money and still be profitable. The answer is that they borrow for relatively short periods against projects expected to deliver predictable high returns.

He gave me two examples. The first was in property, which accounts for over 40 per cent of the group’s loans. He imagined a property developer with £200,000 in cash. He wants to buy a derelict property for £1.5m and spend £500,000 on refurbishment to create a property with a final value of £2.7m. He would be unlikely to persuade a more traditional bank to finance such a deal. Many banks operate mechanical loan evaluation procedures and such a deal would fail to meet their rigid criteria.

By contrast, Davenham would lend the £1.8m needed to do the deal if they were happy with the numbers and the skills of the developer. He pays them 1.5 per cent a month for his money but if he can complete the project in say five months his total cost including interest would be £2.15m for a property worth £2.7m leaving him £550,000 in profit.

Davenham can lend money faster than the banks

Davenham can also make decisions fast, which is important if you are trying to snap up a bargain in the property market. Banks have too many layers of decision making to give an answer in two or three days. Not surprisingly many of Davenham’s entrepreneurs become repeat customers. Nor is the business as risky as it looks since the properties provide excellent security.

Another typical deal might be an entrepreneur wanting to source cane furniture in China for sale to a multiple store. He wants to buy the furniture for £1.25m and sell to the store chain for £1.5m. Unfortunately he only has £50,000 of his own money so the banks will not be interested. As long as he has a firm order from the store Davenham can finance the deal. The entrepreneur needs three months funding, one month for shipping and two months to allow for the fact that big store groups buy everything on 60 days credit. Davenham can give him a letter of credit to make the purchase and also factor the credit so he receives his money as soon as the goods arrive in the UK. He pays three months interest to Davenham but still ends up with around £200,000 of profit, not a bad return for an investment of £50,000.

Financial Data
Year Turnover PreTP Change 2003 15.9m 5.8 NA 2004 21.7m 6.3 8.6% 2005E 28.4m 9.3 47.6%


Strong management key to success

Good management is essential to make a business like Davenham a success but we know this team is good. Firstly, they have been highly successful in growing the business through some bumpy times in the UK economy. Secondly, Dunedin will have crawled all over them and their business before investing its £5m in 2000 and Dunedin’s top of the list criterion for investing is strong management.

According to David Coates the shares are on a prospective PE around 10 and a planned 45 per cent payout ratio means there will be generous dividends. Past growth has come from the group adding new branches. It is based in Manchester with branches in Liverpool, Leeds, Birmingham and most recently, Newcastle. It is looking to open a branch in the South-East in the next few months. I am confident good growth will continue making the shares an attractive investment.