UK-based Hargreaves Lansdown (LSE:HL.) operates the country's largest direct to investor investment service, administering over £85 billion British Pounds (approximately $111 billion USD) of investments for 1,136,000 active clients.
Peter Hargreaves and Stephen Lansdown founded the company in a spare bedroom in Clifton in 1981 and oversaw its development into a financially secure, profitable FTSE-100 entity. Although no longer involved with day-to-day management, both founders remain as significant shareholders of the company, with an aggregate 41% ownership. Meanwhile, the current management accounts for less than 1% insider ownership.
Hargreaves Lansdown generates most of its sales from platform fees (43% of fiscal 2019 total sales), interest (15%) and fund charges (14%), all of which are predictable and recurring. It also receives more unpredictable revenue from stockbroking, which has repeatable transactions but is a bit cyclical.
Per the chart below, Hargreaves Lansdown delivered superior returns on assets every year for more than a decade now. This critical metric outperformed the likes of not only the company's direct competitors in the UK, such as AJ Bell (LSE:AJB) and IG Group (LSE:IGG), but also its American counterparts like TD Ameritrade (AMTD) and Charles Schwab (SCHW). At the same time, we also notice that AJ Bell has been a rising star here, with steady and consecutive improvement in its returns for four years now.
A consistently high return on capital is a strong sign of the management's skillful capital allocation as well as the existence of an economic moat that fends off competition. In our view, Hargreaves Lansdown possesses its enduring competitive edges mainly through scale advantage and dominating market position. The company has the largest do-it-yourself investment platform in the country, with a more than 40% market share (which is still growing) in the direct-to-customer space. Its closest followers, Interactive Investor and Barclays Smart Investor (LSE:BARC), each share a bit over 10% of the relevant market.
We also believe that Hargreaves should, at least for the medium term, continue to benefit from many favorable trends, including an aging population, rising dependence on personal savings to retire, increasing digitization in the investment management space and growing awareness of the UK savings gap.
In the meantime, we have our concern regarding the longer-term uncertainties facing the business as the industry-wide "race to zero" goes on. Theoretically, Hargreaves Lansdown's revenue success is built upon dragging down investors' returns. Three of the company's four most significant revenue contributors, namely platform fees, stockbroking income and fund charges, could suffer from the secular headwind in case UK investors get increasingly cost-conscious. We already saw the game-changing impact of the widely-spread zero commission scheme on online brokers in the U.S.
Of course, Hargreaves has always argued that customers pay for a premium service and even compared the company to John Lewis or Waitrose in this regard, citing its reputed customer service, quality investor tools, user-friendly platform and superior research content. Yet, it has not convinced us that these factors would be enough.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We own shares of Hargreaves Lansdown.
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