KPG - Kelly Partners Group Holdings Limited provides chartered accounting and other professional services to private businesses and clients, owners, families, and high net worth individuals in Australia.
KPG is a business I have looked at a couple of times, the main stumbling block for me has been the debt - especially when considered as a proportion of equity - its basically 1:1 and that is way higher than I have ever considered in a business I am looking to invest in. Because I really like the metrics of the business otherwise and the culture of the business as expressed in the KPG "Owner's Manual" is as good as I have seen in any business, I have kept coming back to look at it. It also has a unique model for rollups, using debt not equity, and the acquired businesses retain 49% ownership so they retain skin in the game. I have finally got past the debt issue by talking with a friend online, Tristan Waine, I said,
"Hey Tristan,
I am doing some more work on KPG to see if I can find enough conviction to take a position. After your comment to me the other day I downloaded the owners manual and went thu the pages on debt, but I really struggle to understand it.
In my mind, its all debt that ultimately the parent company is potentially responsible for - hence its on the balance sheet, it massively exceeds my hard limit for debt to equity, but I remember you said I shouldn't use that metric for services businesses, it still looks like a lot of debt to me, and I really don't want to own businesses with anything but very minimal gearing!
I may have a blind spot on this, so thats why I am asking you to see if there is something I can learn here not just for KPG but also other companies I may research. Cheers, RIck"Yeah no worries.
So first thing is that comment about 'ultinately the parent is responsible for' is just flat out wrong.
Partners have a 49% stake in their own partnerships and the vast majority of the debt they are responsible for. Not the parent
And the second thing is that you're viewing gearing on a debt/equity basis, this is a business that doesn't need much equity so it's just a flawed way of viewing gearing
Ultimately leverage is lower risk the easier it is to repay. And in this case, the parent attributable debt can be paid with a year of cash flows. Interest and principle
The interest coverage is some 20-30xOn my other metrics I really like the business, it has a fantastic ROIIC - mainly because its such a capital light business, the FCF yield is pretty decent at 7% despite the business being fully priced at around $4. I think its one of those businesses that I will never get an entry point if I wait for it to be cheap, its probably good enough that you just have to pay up a bit more and wait for the power of compounding to work its magic.
PremortemKPG partner businesses lose a couple of their founders to Covid and the families want out of the businesses, KPG suffers significant write downs and cash expenses which both impact growth and profitability. The share price falls back to $2.50
Interest rates have risen sharply as inflation takes off, Covid continues to cause the collapse of many SME's, the interest costs impact profits and cash flows as does the loss in business revenue across the accounting sector. The share price falls back to around $2.50
KPG has grown revenue steadily in line with guidance, no significant additional acquisitions though so growth is on the lower end of expectations, share price has remained in the range of $4
KPG has grown revenue strongly, beating guidance, a number of new acquisitions were announced during the previous couple of years and share price has continued to grow to around $5.50 with FCF increasing to over 40c
So price expectation, $2.50*10% + $2.50*10% + $4 * 50% + $5.50*30% = $4.15 so only a slightly positive expectancy which reflects the fully valued nature of the current price.
Other reading -
KPG Owner's ManualAddress to London MBATristan's thesis9/08/21 I bought KPG today at $3.65 - over 8% down from its last close after releasing its 2021 results.
I think I made a mistake, what I failed to understand is that the ASX entity, KPG has to distribute half its profit/FCF to the partner businesses it owns 51% of, so in reality its only delivering half the return to shareholders. This makes all my calculations wrong and after spending most of today trying to understand how this all fits together I have to admit I dont have the slightest idea, the terms and metrics used by the company change all the time and its impossible to really distill out what value accrues to shareholders in the business.
At the moment my inclination is to sell straight away and escape from a position I should never have taken.
11/8/21 Sold at $3.50, I got this one wrong, the sudden drop in price on Monday led to an impetuous decision to take a position before I had finished my analysis. It was reading the Annual report after I had bought that made me aware of how I had completely missed the opaque nature of the financials, the effect of all the partners only being held as 51% interests, and I started to notice how promotional the founder was and in particular what grated with me was the claim of being Buffett like in his thinking and then seeing him use Owners Earnings in a way quite different to how Buffett uses it, and also seeing his claims for CAGR to shareholders - using the share price as a metric! The most un-Buffett like thing imaginable, nearly all of the "gains" are from multiple expansion - so its not Mr Kelly, but Mr Market who has given the return to shareholders!
Anyway, out at a small cost, a position that I would have had no conviction in and would have worried about - something I dont like doing!
