FDM Group Holdings Plc

High dividend, and ROCE, interesting business model, cheap

Apr 05, 2024

This article is NOT an investment advice!

The service they provide

FDM is a somewhere between a consultancy and a recruiter. In the industry the style of business is known as Recruit, Train and Deploy (RTD). They mostly hire youngsters just out of university, give them training in the latest technologies (Cloud, AI, or whatever is in vogue) or business analysis and hire them out to end clients who are mostly banks (53%), diversified financials (14%) or insurance (7%). They also have a segment of ex-forces and later returners but these are fairly small.

Unlike a pure consultancy FDM mostly just provides consultants (which they call “mounties”) to business clients. As such they take little delivery responsibility for projects.

Unlike pure recruiter such as Hays they place their resources with the client, who has an option to take them on permanently after two years. In that time FDM collects the difference between what they pay the mountie and what they bill the client - the margins are very good. The client has the option to take the mountie (they have to pay FDM a lump sum if they do) on permanent basis. The mountie has the option to accept or not.

For the client it’s a decent deal because they can return the mountie if they don’t perform well in return for another one. They can request more training be provided. Compared to other types of resources mounties are not that expensive and have the potential to become valued permanent employees.

I’ve personally worked with several mounties and they were invariable very bright. I’ve spoken to a couple of people who’ve hired mounties and their experience was also good - it’s a small sample though.

Good business?

The business model is quite unique (at least in the UK) – I didn’t find any other listed company operating like this as their main activity.

They are very effective in what they do – they claim utilisation of above 90% (currently 93% - down from 97% in 2022). They continuously train new people and let them eventually join the employers they were placed with and keep on finding and training new people. I like that model a lot – if I ever wanted to fully own a business it would be this – give the youngsters an opportunity by teaching them – it’s like a university but better since it’s aimed at practical skills. It also requires very little capital. They can pay huge divi like they do ~10% yield at the moment. I suppose this model only works in flexible job markets like UK and US – less so in Europe but US is massive market and encouragingly they have a biggish presence there with a long runway.

The model is more flexible than the traditional consultancy who has to maintain a bench in a downturn. FDM are also more profitable than a traditional recruiter. FDM is more flexible in that it can train fewer consultants if demand starts to slow. The training only takes 12 or so weeks so they can quickly ramp up too. They have a certain buffer of (somewhat) secure revenue during the time the consultants are hired out to clients. Some clients seem to commit to a number of resources for an extended period of time, some opt for more flexible arrangements. Hence, the income is not fully guaranteed but in a downturn the clients may be reluctant to let the mounties go. The reason for this is that these resources are fairly cheap compared to for example IT contractors and permanent staff. The client also sees the FDM resource as future long-term employees. The mountie can go back to FDM who would attempt find him or her a new engagement.

Financially, FDM makes a massive 45-48% gross margin. Operating margin has eroded to about 16% from 21% a few years back. This is mostly due to FDM starting to pay the mounties a salary while they are being trained - this could supposedly be improved on by making the training shorter, more effective, improving the hiring pipeline and other efficiencies. Their return on capital employed (ROCE%) is in the range of 40-70%. They actually don’t have that much opportunity to deploy it aggressively as it’s very capital light. Nowadays even for the training you don’t need premises – they have just £20m in tangibles. No debt and ~£40m in cash. Cash conversion consistently around 100%. So, what do they do with all that cash? They mostly pay dividends – current yield around 10%.

In my view it has a long runway – they have currently only about 4000 assigned consultants – this is up from merely hundreds about 15 years ago. They can grow both geographically, domain and industry wise. The opportunity is there – businesses need new skills (like prompt engineering) which universities are too slow to provide so a player like FDM could do quite well.

What they don’t do

They don’t do acquisitions – good in my opinion – shows good focus
They don’t buy back their shares – not so good as I think they are cheap at the moment

Controversy about exit fees

There was some controversy about FDM and others charging exit fees if the recruit didn’t complete the training and the two year engagement. It seems those were largely dropped - https://www.cityam.com/exit-fees-get-the-axe-from-top-grad-recruiters/. If I was the management of FDM I’d have tightened the recruiting filter to weed out anyone I’d have any doubt about completing - not sure if that happened but suspect so.

Management and incentives

The CEO – Rod Flavell is also the founder. He started FDM in 1990 and has been with the company ever since. Interestingly it has been listed (on AIM from 2005 to 2010) once before and taken private with the help of private equity – more about it here: https://realbusiness.co.uk/how-to-buy-back-your-business. It might appear from the article that Rod is too money oriented and disregards the customers, values etc but I view it as a sign of healthy self interest which in this case is aligned with me as another shareholder in getting the best value out of the business. There are also a few reports from the time about the business:

The CEO and COO (his wife Sheila) own together just under 14% of the stock. CFO owns around 0.5% and another executive owns around 3.7%. They do give themselves quite large cash salaries (£4m among the four top management in 2022 or approx. 10% of PBT) which is a bit disappointing given their large holdings and get massive cash dividends.

Is the management motivated to grab the opportunity and grow the business further? The CEO is now 65, has built a successful business (which incidentally was worth about four times as much a few years back). What are his options?

a) Retire – would the business do much worse without him? Probably not – the model is not that easy to replicate because the relationships with clients take time to build and creating an effective, flexible training takes time.

b) Try to take it private? He’s done that before. If so, would the price be favourable to the shareholders? The last time they did it, it was.

c) Allow takeover? There was some talk about this last year - https://www.thisismoney.co.uk/money/markets/article-12398237/MARKET-REPORT-Takeover-speculation-sends-FDM-shares-soaring.html. There is a possible poison pill guarding against hostile takeover.

d) Continue for a bit longer? I’d assume he’d want to cement his legacy and leave once the value has recovered somewhat.

Good investment?

FDM has never been this cheap on EV/EBIT basis (6x), ROCE/CROCI is massive (~40-50%). Divi is huge – they could obviously cut it but even in a downturn I’d expect them to pay some. The dividend provides some level of protection against price falls from now on. It’s currently at 330p.

Why is it cheap?

The UK/global economy is uncertain. Employment could go way down. There is some evidence for it in the FDM’s last results – 20% fewer consultants placed and 60% fewer consultants trained in 2023 compared to 2022.
They dropped out of FTSE 250 recently - https://www.lseg.com/en/media-centre/press-releases/ftse-russell/2024/ftse-uk-index-series-review-march-2024
Other recruiters are also cheap. FDM is probably (partly rightly) bundled with this category in investors’ minds.

Pros:

Biggish internal ownership
Business model – not easy to replicate at scale
Cheap compared to the past – EV/EBIT (~6x). This is a cyclical business so it may still go further down
Long runway both geographically and industry-wise

Cons/Risks:

They are susceptible to the same downturns in hiring like the other body shops – Hays, Robert Walters etc – perhaps more since they still need to feed the pipeline for the upturn whereas the others can just downsize. On the other hand in a down turn employers may be looking for cheaper resources who stick around
There is some anecdotal evidence that some of the banks and other big employers are getting better at creating their own grad/apprentice programmes.

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