The Labour Party is eager to kick-start growth. A key part of its plan is the so-called National Wealth Fund, spearheaded by chancellor Rachel Reeves. It will see £7.3 billion of additional government funding diverted into the three-year-old UK Infrastructure Bank. In addition, reforms will be made to the British Business Bank, an often-overlooked success story.
Founded in 2014, the British Business Bank has provided more than £12 billion to smaller British businesses via equity and debt. It has been a key means for the government to channel funding to businesses. Earlier this year, it launched the Northern Powerhouse Investment Fund II, a £660 million fund designed to build on the success of the first Northern Powerhouse fund by providing loans from as little as £25,000 to businesses in the North, as well as the £400 million Midlands Engine Investment Fund II. The British Business Bank does not invest these funds directly. Instead, it relies on third-party fund managers, one of which is Mercia Asset Management (Aim: MERC).
Mercia Asset Management: a boon to UK start-ups
Mercia, founded in 2010, has 11 offices around the UK. Its funds provide venture capital finance, private equity and debt finance to fast-growing small and medium-sized enterprises (SMEs) based mostly outside London. Its equity-investment funds typically deploy investments of between £100,000 and £20 million.
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Mercia ended its fiscal year to 31 March 2024 with assets under management (AUM) of £1.8 billion, up 27% year-on-year, thanks largely to the award of several mandates from the British Business Bank (it won a £263 million venture capital mandate from the Northern Powerhouse Fund II). Of the £1.8 billion total, £1.6 billion was fee-earning third-party capital, with £200 million of Mercia’s own funds. The company is precisely the sort of business the new government wants to be partnering with, alongside the British Business Bank.
Mercia fulfils a crucial financing role in the UK's regional high-growth ecosystem, which suffers from a chronic lack of capital. It is also key to the country’s venture capital sector. Most larger private equity and venture capital providers won’t consider an investment under £1 million. So Mercia, which can invest as little as £100,000, is a real boon to smaller start-ups.
The company’s growth over the past five years illustrates the scale of the opportunity here. At the start of 2019, the group recorded AUM of around £500 million. Acquisitions and inflows from government initiatives have boosted that figure by 260% in five years; it was founded with assets under management of just £12 million. In addition to winning several mandates from the British Business Bank last year, the group was awarded a £100 million mandate by the Brownfield Regeneration Fund for the West Midlands. It also raised £60 million via the launch of a venture capital trust, the Northern 3 VCT.
Mercia has launched three VCTs (Northern 1, 2 and 3), and together they manage £356 million for investors. VCTs have been a powerful tool for investors to reduce their tax liabilities, gain a stake in the business of the future and make capital available to smaller companies. Investors receive income-tax relief of 30% on VCT investments upfront and tax-free capital gains as well as income. Over the past three years, these funds have raised £3 billion from investors. Mercia VCTs target a dividend yield of 4.5% and 5%. They have a bias towards software and electronics, and biotech and healthcare.
There are two ways Mercia makes money. It collects fees on the funds managed by third parties (management and performance fees) and profits from direct investments. Last year, its total revenue yield on third-party capital was 2.34%. No performance fees were paid (they were last paid in 2022 and added 0.35% to the total).
What's next for Mercia?
A core part of Mercia’s business since the beginning has been direct investing. But earlier this month, the firm announced that it would focus on its profitable and fast-growing third-party fund-management business. It will not make any new investments, but it will help support those businesses already under its wing.
The change from investment company to trading company is still subject to shareholders’ approval, but the plan is to focus on growing AUM to £3 billion and doubling earnings before interest, tax, deprecation and amortisation (Ebitda) in three years. With the state and investors throwing their weight behind initiatives such as the British Business Bank and VCTs, these goals don’t look too ambitious.
Over the year to 31 March, the group reported sales of £30.4 million and Ebitda of £5.5 million. Most of the large mandates from the British Business Bank were awarded towards the end of Mercia’s fiscal year, so the full impact on the bottom line wasn’t reflected in the annual numbers. Unfortunately, the group reported an operating loss of £12.4 million due to an £18.6 million impairment on a direct investment. With the loss stripped out, the company reported earnings per share of 2p for the year. It also ended the year with £47 million of cash, against its £147 million market value.
Analysts at financial services group Canaccord Genuity think Mercia can liquidate its direct investment portfolio (worth £120 million) within the next three years, which should give it scope for acquisitions to drive growth. The analysts have also pegged the group’s net asset value (NAV) per share – the value of the direct investments, plus cash and intangibles – at 42.6p. Based on that number, Labour’s investment plans, and Mercia’s three-year goals, the stock looks like an undervalued growth play.
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