FreeAgent cashes out to RBS for £53 million, net-net, the right outcome

Another SaaS vendor in the accounting space falls. In this case, FreeAgent, founded in 2007 and which IPO'd in 2016 at a valuation of 84p per share has today been made an all-cash offer of 120p per share by RBS.

The deal, which is set to close in the second quarter of 2018 - subject to regulatory hurdles - represents an 84% premium on last night's closing price and an enterprise value of £53 million or 5x revenues.

A rollercoaster ride

FreeAgent's journey in the public markets has been a rollercoaster. After it initially priced, the shares enjoyed a steady rise to a peak of 142p per share in January 2017 but thereafter it has been a story of steady and relentless decline to a point where the shares were trading at 64p yesterday, after flatlining at 75p in the period November 2017 to February 2018.

The HMRC factor

Part of the reason for the decline was that HMRC's recent win in a case involving contractors working at the BBC being reclassified as employees put a natural question mark over FreeAgent's ability to continue growing at the rates it had enjoyed in the past. FreeAgent's main appeal is to micro-businesses and contractors in particular.

It is this latter group which is under HMRC's spotlight. Recently, HMRC said that all government departments making use of contractors will have to treat them as employees in cases where there has been a simple swap in tax status, rather than a genuine independent contractor environment.

While most analysts think that HMRC will focus on bringing large organizations into compliance with the so-called IR 35 regime, the pall hanging over this whole segment cannot be underestimated.

The RBS connection

For its part, FreeAgent had contracted with RBS to provide integrations between FreeAgent's accounting system and the bank's systems. This is not a new idea but did provide FreeAgent with the potential to earn fees drawn from a much larger pool of potential customers. In the last reported accounting period, FreeAgent noted it had billed some £250,000 for integration work.

For my part, I was dubious about the rationale behind this move because it was hard to see how FreeAgent could leverage the SaaS model in a situation where it was effectively a captive operator on behalf of a third party. The fact RBS has seen value in this model and decided to acquire FreeAgent suggests the partnership is reaping significant opportunity, adding to the installed base at a steady clip.

Opportunities and challenges

In a statement that talks about both challenges and the upside, the company said:

These challenges include HMRC's timetable for MTD, which has seen two-year delays to the original timetable for implementation, and changes to IR35 legislation which have tempered near-term growth prospects in the accountancy practice channel. Furthermore, whilst the FreeAgent Directors believe that FreeAgent's SaaS solutions include a comprehensive list of features which are tailored to address the specific needs of the micro-business community and therefore provide FreeAgent with a competitive advantage, FreeAgent's principal competitors are, in the main, much larger and better capitalised entities which can compete for new customers both by spending heavily on customer acquisition and by adopting aggressive pricing strategies. 

CEO Ed Molyneux said:

Today's announcement represents the beginning of a new and exciting chapter for FreeAgent.  Our vision is 'making businesses happier and more successful by putting them in control of their finances' and this moves us closer to that vision. Having developed a strong strategic partnership with RBS and with over 10,000 of their business banking customers having already signed up to use FreeAgent's accounting solution, we look ahead to the next chapter, where we will accelerate and further extend our technology capabilities as part of a bigger group. Our working together represents a really compelling opportunity and hence the Board is intending to recommend the offer which we believe makes both good strategic and financial sense.

In a short phone conversation, Molyneux told me that:

When you look across the UK banking market in the context of MTD and the rapid changes occurring in customer requirements, bringing the accounting capability together with banking services opens up many more opportunities than currently exist when the two pieces are kept separate from one another.

My take

This is a good exit for FreeAgent that makes sense for every stakeholder.

RBS gets the expertise of 11 years developing a robust accounting system geared to the needs of microbusinesses while at the same time gaining significant opportunities around business intelligence inside that customer base that would otherwise be impossible to achieve. Remember what I said about Intuit and its banking aspirations?

RBS has been wise to state that it will keep FreeAgent in a ring-fenced environment, operating out of the existing Edinburgh offices. Past efforts by other vendors have failed to take this critical step which ensures that the culture which gets a vendor to this point isn't destroyed by a pre-existing culture that is often fundamentally different. The net impact is that the very things that made the acquired business successful evaporate over time.

Shareholders that have 'kept the faith' with FreeAgent get a handsome reward for their loyalty, while customers should now see accelerated features that help manage MTD (when it emerges) while also getting access to improved services.

I wish Ed, Roan, Olly and the team all the very best for what sounds like a bright and interesting future.