Published: 22 April 2020 – 15:20

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In the halcyon days before Covid-19, when corporates were awash with credit, margins were fat, and valuations were high, issuers could run their balance sheets thinner than the tiniest of little thin wafer-thin mints. Surplus cash generation (or as was all too often proceeds of debt) could be directed either towards management pay-outs, M&A, chunky dividends, share buy backs, or all four. These days, economic activity runs cold. If you’re not in isolation under house arrest then you’re likely one of the valiant members of our society, working in healthcare to save the sick, or providing vital services such as delivering goods to those that need it.

Figure 1: Christian Horz, Alamy Stock Photo

How long this will continue, no one really knows. Yet, management of some companies have, in our view, taken the principled and probably sensible decision to plan for a long siege. Take for example, Hays Plc (HAS LN), the global specialist recruitment firm. Hays has been in business for as long as we can remember. Its management has decided they want that to continue. They’ve seen recessions before. They understand how devastating economic downturns can be to the top line. In recessions almost no one hires, and so recruiters’ profits generally collapse. Even if companies wanted to hire, who could when the central office is boarded up?

At the start of April, Hays took the long term – and we believe honourable – view to be straight with its investors. It decisively acted to batten down the hatches and shore up its balance sheet for what could be turbulent times ahead. It doesn’t know how long such disorderly times will last; all it knows is it wants to come out the other side.

Hays announced:

Over recent years Hays has consistently operated with a net cash balance sheet, and strongly believes this gives valuable confidence to both our clients and investors.To ensure that we have a strong balance sheet and can continue with minimal or no debt once our end markets stabilise, the Board has concluded that it is prudent to now raise equity.

This will both provide the Group with a further liquidity buffer and importantly best allow us to pursue organic growth opportunities with new and existing blue-chip clients. We are already seeing such opportunities begin to emerge and expect further vendor consolidation from our clients when markets stabilise.

Accordingly, Hays has separately announced today its intention to conduct a non-pre-emptive placing of new ordinary shares of the Company targeting gross proceeds of approximately £200 million.

Through an accelerated book build (ABB), Hays raised gross proceeds of £200 million at 95p per share. The day before the ABB its shares closed at 109.4p per share and the ABB was completed at a 13.2% discount. At the time of writing, Hays trades at 106p per share, 12% higher than the ABB price and 3% below the prior ABB close.

Another company to take the long-term view is Aviva Plc (AV/ LN), the insurance provider, in which the ShadowFall Fund holds a long position. On 8 April 2020, Aviva paid heed to the restraint urged by its regulatory authorities on dividend payments by insurers to shareholders. Aviva’s Board of Directors decided to withdraw the recommendation to pay the 2019 final dividend, which was due to be paid in June 2020.

The upshot of this was announced by Aviva as:

Aviva remains well capitalised with strong liquidity. By retaining the final dividend, the estimated group capital ratio will increase by c. 7% to approximately 182% (as of March 13, previously disclosed date.)


ShadowFall Fund is short St James’s Place (STJ LN).

Capitalised at £4.1bn, STJ is a financial services provider, offering products in life insurance, unit trusts, pensions, and mortgage advisory.

As it happens, the ShadowFall Fund was already short STJ prior to the societal disruption caused by the spread of Covid-19. We believed that STJ was approaching a ‘pinch point’, where its management would have to choose to either use its balance sheet to prioritise the growth of its FuM or continue to provide a growing dividend. We had other concerns, but this was the most pressing. And now, in the light of the significant market moves over the past month, we believe that the risk to future dividends is the highest it has been in recent history.


STJ highlight 2 key solvency metrics: The Solvency II free assets as well as the excess of free assets over the management solvency buffer.

As with all businesses, dividends are paid from the retained earnings generated in prior periods. Typically, the only other constraint to the dividend would be the cash available to the company. However, with Solvency II companies there is an additional constraint on the business: The Solvency II Capital Requirement (SCR). Solvency II uses a market-based approach in valuing assets, and as a result Solvency II free assets (excess assets over the SCR) can be prone to fluctuation. As such, for prudence, excess free assets are normally held over and above the minimum capital requirement.

On top of this, given that the assets on the balance sheet contribute to returns for the firm, and thus the ability to pay future dividends, management aim to extract cash in the least intrusive way on the balance sheet, so as to not cannibalise potential future growth.

When looking at the group accounts, we look at the Solvency II free assets of the group both pre and post the cash effects of dividends paid for that financial year. We believe this gives a clearer picture of the assets from which management is able to pay a dividend and normalises for seasonality between the 1H and FY payment.

We note that during the period FY15 to FY19 the trailing twelve-month (ttm) dividend has doubled to £265m, from £130m, an attractive growth rate. Over the same time period, the Solvency II free assets adding back the dividend have not really moved despite the company growing. The effect of this is that:

  1. The dividend as a percentage of the free assets pre dividend in 2015 was 14%, implying 7x coverage, whereas this has now risen to 24% and is now just 4x coverage.
  2. Meanwhile, the Solvency ratio in excess of the group solvency capital requirement has deteriorated from having 45% headroom in 2015 to 20% at FY19. We believe this leaves the group more exposed to solvency risk, and the dividend’s rate of growth is currently unsustainable.
Figure 2: Group balance sheet for Solvency II and proposed dividends. Source: Company Filings, ShadowFall Calculations.
Figure 3: Group balance sheet for Solvency II. Source: Company Filings, ShadowFall Calculations.
Figure 4: DPA Picture Alliance Archive, Alamy Stock Photo

At the 2019 full year results, STJ’s management stated that Solvency II free assets (own funds less the Solvency Capital Requirement) stood at £999m and that the excess of free assets over the management solvency buffer (the Solvency II net assets less a management solvency buffer) stood at £580.6m. Both of these figures are taken pre the payment of the final dividend, which totalled a cash cost of £167m.

If we use the Solvency II sensitivity provided by management at full-year results and mark to market both of these measures for key moves in the market that we have seen year to date, we observe a significant reduction in the liquidity available to management.

Figure 5: STJ Solvency II free assets sensitivity to assumption changes. Source: St James’s Place 2019 Results.

STJ state that the largest equity exposures are to UK and European Equities, if we use the EURO STOXX 600 index (in GBP) as a proxy, which has fallen c. 18% YTD (as of the time of writing). The provided sensitivity implies that this would correspond to a c. -£174m drag on the Solvency II free assets, all else equal. On top of this STJ state that the risk-free rate it uses is the reference yield on ten-year gilts, YTD this has declined from 82bps to 31bps. We believe that the provided sensitivity implies that this would correspond to a c. -£52m drag on the Solvency II free assets, all else equal.

In our view, the effect of these two marks to market are a combined c. -£225m drag on the Solvency II free assets. If we adjust to include the payment of the final dividend, we calculate that it results in a total drag on Solvency II free assets since 2019-year end of c. -£392m; a reduction of c. -39%. If we assume these sensitivities also hold true for the Solvency II net asset calculation, then we calculate this puts the marked to market post-dividend excess of free assets over the management solvency buffer at just £188m; a 68% reduction since year-end 2019.

Figure 6: STJ Solvency II free assets sensitivity to assumption changes. Source: St James’s Place 2019 Results, ShadowFall calculations.

Since 2014, STJ has embarked upon a generous dividend policy paying out dividends totalling £1.07bn, against this the business has generated a “cash result” of £1.14bn. This is equivalent to an average pay-out of 94%. When it comes to the 2019 dividend, we note this pay-out rose to 116%. Management seem to us to justify the pay-out through reference to its “material flow of cash to come from our stock of gestation FUM over the medium term” (2019 financial results call). STJ’s gestation FUM refers to the FUM which STJ manages that will generate fee income in the future as and when it matures. In paying a 2019 dividend which is 16% above its cash result, we believe STJ is drawing on future cash flows to pay to shareholders today. In our view, this is a less than cautious policy. In the context of recent market moves, we question whether both STJ’s current fee earning FUM and its future FUM in gestation, will generate the fees that management had factored when it determined its dividend pre-Covid-19.

In these days of increased uncertainty, we believe it is positive when management teams make principled decisions to de-risk their respective balance sheets in order to protect the future for their stakeholders, such as in the case of Hays and Aviva. In our view these strengthening measures provide greater certainty in such turbulent times. By contrast, if companies such as STJ, in our view, flirt with Solvency II headroom in order to make generous payments to shareholders, we believe that this could store up risk issues down the road as we continue through these unprecedented times.

Matthew Earl

Matthew Earl

Matthew is the Director of ShadowFall Publications Ltd and Managing Partner of ShadowFall Capital & Research LLP.

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