the mighty quin

28
22 October 2013 www.progressive-research.com Quindell Portfolio is a research client of Progressive. Please refer to important disclosures at the end of the document. QPP.L 17.0p Market Cap: £749m SHARE PRICE PERFORMANCE 12m high/low 17.5/6p Source: LSE Data KEY INFORMATION Enterprise value £731m Index/market FTSE AIM Next news FY13 update – Jan ‘14 Gearing 5% Interest cover >50x INITIATION OF COVERAGE Insurance transformation and beyond Quindell is changing the face of the UK insurance industry. The group brings consulting expertise, software platforms and outsourcing infrastructure to a world historically not known for flexibility and pace. We describe how regulatory change has added to the confusion – and the opportunity. Quindell has its detractors, and clearly the high-growth strategy is not without risk, but the group is attempting to alter, and thereby profit from, a number of extremely large and lucrative markets. These strategies could generate, over time, material shareholder value. The biggest barrier to investors being able to make informed decisions, in our view, is a lack of understanding. Quindell has commissioned this research, which will comprise a number of reports, to help explain various aspects of the group’s operations. We believe that Quindell’s strategy is clear : to provide insurers with a technology-enabled outsourcing partner, unafraid of challenging the status quo, and willing to accept risk and promote change. Quindell is not an easy business to understand – it is necessarily complex, the markets within which it operates are vast but opaque, and the acquisitive history has almost left investors behind. We therefore include sections on the core parts of the business: consulting & software, and outsourcing. We also briefly describe two of the key differentiators : the so-called Collaboration Protocol (p19) and the group’s rapid moves to use telematics in motor insurance (p21). Recent newsflow has been exceptional : over £300m of organic new business including a deal with Direct Line; extended reach into Canada; additional Board appointments, a stake in the UK’s largest motor repairer, and increased exposure to telematics through ingenie. Yesterday’s Q3 trading update confirms the positive progress, describes positive operating cash generation and indicates that market consensus expectations for 2014 are too low. Shares in Quindell arguably carry a higher-than-average degree of risk, due to the complexity and rapid pace of growth, but avoiding a stock simply based on ignorance of its operations feels like an unintelligent decision. Hopefully this document, and others in the future, can give readers the detail they need in order to at least make informed choices. 0 5 10 15 20 Nov-12 Feb-13 May-13 Aug-13 QUINDELL PORTFOLIO PLC SOFTWARE AND COMPUTER SERVICES ANALYSTS Gareth Evans +44 (0)20 7349 5156 [email protected] Ian Poulter [email protected] FYE DECEMBER 2011 2012 2013E 2014E 2015E Revenue 13.7 137.6 429.3 695.2 757.4 Adjusted EBITDA 6.7 52.2 135.2 206.4 221.2 Adjusted PBT 6.3 49.2 131.3 203.1 216.9 Adjusted EPS (p) 0.7 1.4 2.5 3.5 3.9 EV/Sales 55.4x 5.5x 1.8x 1.1x 1.0x EV/ Adj. EBITDA 113.4x 14.5x 5.6x 3.7x 3.4x P/E 25.6x 12.2x 6.7x 4.9x 4.4x Source: Company Information and Progressive Equity Research estimates

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Page 1: The Mighty Quin

22 October 2013

www.progressive-research.com Quindell Portfolio is a research client of Progressive. Please refer to important disclosures at the end of the document.

QPP.L 17.0p

Market Cap: £749m

SHARE PRICE PERFORMANCE

12m high/low 17.5/6p

Source: LSE Data

KEY INFORMATION

Enterprise value £731m

Index/market FTSE AIM

Next news FY13 update – Jan ‘14

Gearing 5%

Interest cover >50x

INITIATION OF COVERAGE

Insurance transformation and beyond Quindell is changing the face of the UK insurance industry. The group brings consulting expertise, software platforms and outsourcing infrastructure to a world historically not known for flexibility and pace. We describe how regulatory change has added to the confusion – and the opportunity. Quindell has its detractors, and clearly the high-growth strategy is not without risk, but the group is attempting to alter, and thereby profit from, a number of extremely large and lucrative markets. These strategies could generate, over time, material shareholder value.

The biggest barrier to investors being able to make informed decisions, in our view, is a lack of understanding. Quindell has commissioned this research, which will comprise a number of reports, to help explain various aspects of the group’s operations.

§ We believe that Quindell’s strategy is clear : to provide insurers with a technology-enabled outsourcing partner, unafraid of challenging the status quo, and willing to accept risk and promote change.

§ Quindell is not an easy business to understand – it is necessarily complex, the markets within which it operates are vast but opaque, and the acquisitive history has almost left investors behind.

§ We therefore include sections on the core parts of the business: consulting & software, and outsourcing. We also briefly describe two of the key differentiators : the so-called Collaboration Protocol (p19) and the group’s rapid moves to use telematics in motor insurance (p21).

§ Recent newsflow has been exceptional : over £300m of organic new business including a deal with Direct Line; extended reach into Canada; additional Board appointments, a stake in the UK’s largest motor repairer, and increased exposure to telematics through ingenie. Yesterday’s Q3 trading update confirms the positive progress, describes positive operating cash generation and indicates that market consensus expectations for 2014 are too low.

Shares in Quindell arguably carry a higher-than-average degree of risk, due to the complexity and rapid pace of growth, but avoiding a stock simply based on ignorance of its operations feels like an unintelligent decision. Hopefully this document, and others in the future, can give readers the detail they need in order to at least make informed choices.

0

5

10

15

20

Nov-12 Feb-13 May-13 Aug-13

QUINDELL PORTFOLIO PLC SOFTWARE AND COMPUTER SERVICES

ANALYSTS

Gareth Evans

+44 (0)20 7349 5156

[email protected]

Ian Poulter

[email protected]

FYE DECEMBER 2011 2012 2013E 2014E 2015E

Revenue 13.7 137.6 429.3 695.2 757.4

Adjusted EBITDA 6.7 52.2 135.2 206.4 221.2

Adjusted PBT 6.3 49.2 131.3 203.1 216.9

Adjusted EPS (p) 0.7 1.4 2.5 3.5 3.9

EV/Sales 55.4x 5.5x 1.8x 1.1x 1.0x

EV/ Adj. EBITDA 113.4x 14.5x 5.6x 3.7x 3.4x

P/E 25.6x 12.2x 6.7x 4.9x 4.4x

Source: Company Information and Progressive Equity Research estimates

Page 2: The Mighty Quin

22 October 2013

2

Table of contents

   

EXECUTIVE  SUMMARY  .................................................................................  3  

SIGNIFICANT  RECENT  NEWSFLOW  ................................................................  6  

OVERALL  STRATEGY  .....................................................................................  9  

REVENUE,  PROFIT  AND  CASH  FLOW  ...........................................................  10  

EXPLAINING  THE  EXTRAORDINARY  GROWTH  .............................................  12  PROFITING  FROM  THE  REFERRAL  FEE  BAN  ...............................................................  13  

THE  BUILDING  BLOCKS  ...............................................................................  17  CONSULTING,  SOFTWARE  AND  OUTSOURCING  .......................................................  17  

GAME  CHANGER  1  :    THE  COLLABORATION  PROTOCOL  ..............................  19  COLLABORATION  EXTENDED  :  “HIRE  CAR  OR  CASH?”  ................................................  20  

GAME  CHANGER  2  :  TELEMATICS  ...............................................................  21  QUINDELL  AND  THE  TELEMATICS  OPPORTUNITY  ......................................................  22  

FINANCIAL  FORECAST  COMMENTARY  ........................................................  23  

FINANCIAL  FORECASTS  ..............................................................................  27  

Page 3: The Mighty Quin

22 October 2013

3

EXECUTIVE SUMMARY As described on the front page, this document is intended to help educate the reader who wishes to learn more about Quindell, but who is perhaps confused by some of the industry jargon, or who has been unable to keep pace with the many acquisitions, or contract win announcements.

Strategy

Quindell aims to profit by offering insurers technology-enabled outsourcing partnerships that drive revenue and profit. The group is unafraid of challenging the status quo, is prepared to accept risk and actively promotes change across the industry. This change is aimed at benefiting insurers in general, and Quindell in the process.

In essence, the group is aiming to benefit from the somewhat sluggish and change-averse nature of the insurance industry and a number of existing providers. In particular, Quindell has sought to gain from the market turmoil created during the recent regulatory change. The most important recent regulation has followed the review by Lord Jackson which effectively banned (with effect from April 2013) referral fees. Historically, law firms and other providers of services would pay insurers to “refer” policyholders to them at the time of a claim, in the hope of selling legal or other services – such practices are now illegal if client data is passed by the insurer.

Quindell’s strategy : profiting from the referral fee ban

One of Quindell’s most innovative aspects relates to the way it has negotiated effectively “around” the referral ban, arguably in a more intelligent and rapid manner than many of the competitors. Technically, the ban only covers insurers being paid for passing the personal details of potential claimants to service providers. Quindell has structured itself and its relationships with insurers and other parties to meet the requirements of a “not prohibited referral” (see page 14). Essentially, Quindell offers to act for the insurer as their outsourced provider of call-answering services. These calls come, mainly, from policy holders wishing to notify their insurers of an accident. Because the Quindell representative answers the call, and because of the scripts they use when dealing with the customer, it is deemed to be the customer (rather then their insurer) who authorises the release of personal details. These details are then available, as they would have been prior to the referral ban, to other parts of the Quindell group. Services (legal, medical etc) can be offered to the potential claimant, and the group earns revenue from a number of these areas. Quindell is already being written in to insurers’ policies with end customers, a sign that this new structure is rapidly taking hold in the marketplace.

Depending on the attribution of blame for the accident, the caller is classified as either “at fault” or “non-fault”. In an “at fault” situation, Quindell works with the insured party to manage the claim efficiently and in a low-cost manner. Quindell can also approach the other party, offering to repair the vehicle cheaply and manage any personal injury or other claim.

When a caller is deemed “non-fault”, Quindell can itself begin the process of repairing the vehicle and managing any medical or other claims; Quindell thereby generates revenue for its own business units, and seeks to claim off the “at fault” insurer in due course.

It should be noted that, although the margins for some of the work can be highly attractive, especially in “non-fault” cases, the working capital cycle can be extremely long (c. 6 months), such that a fast-growing business will therefore be highly cash consuming as contracts and volumes are added.

Page 4: The Mighty Quin

22 October 2013

4

The Building Blocks

Given the group’s strategy as outlined above, and given its innovative structure to work around the referral ban, we next examine how the group has in fact been built up. The business has been established largely around the three pillars of Consulting, Software and Outsourcing. The Building Blocks section of the note briefly describes the history of the various acquisitions, how they are planned to fit together, and what has been created in terms of group critical mass. The following sections focus on each of the three areas.

Consulting

Consulting provides high-level advisory services into the insurance (and related) industries. Quindell has a team of highly knowledgeable experts in various fields, who are active at the highest levels in terms of customer contacts. They work to drive change and allow Quindell’s customers to achieve their business goals. The focus of Consulting is sometimes claims management and claims handling, but equally consultants can work on helping insurers drive new business areas and implement major change unrelated to claims.

Software

Software platforms have been assembled and can be brought to bear either in a customer setting (as a licence or SaaS fee), or within the Outsourcing units described below. The Quindell Solutions portfolio of products includes a range of software for insurers to manage all core areas of their operations; this section of the note highlights the types of platforms available.

Outsourcing

The Outsourcing aspects of Quindell are many and varied, and they currently account for the lion’s share of H1 EBITDA. Essentially, these business units provide a number of services that may be required by someone involved in an insurance claim. Legal services, medical assessment, medical recuperation, costs analysis and other services are all component parts of the group’s offering to insurers (and claimants).

Game changer : The Collaboration Protocol

The group, having established itself as a material component of the UK insurance industry, is now well placed to start changing the way claims are handled. In particular, Quindell management have identified an aspect of the UK motor claims market which appears highly amenable to improvement : the car hire costs.

This section describes the current market structure, with agreed “standard” costs charged between insurers for vehicles of certain types, and industry-accepted numbers of days’ hire which tend to accompany vehicle repair work of different degrees of severity. The two “collaboration models” are then described.

Collaboration model 1 : “Simple Collaboration” – here, Quindell establishes a structure with an insurer which allows the two parties to work together, even when Quindell is working with a “non-fault” consumer, and the insurer has insured the “at fault” road-user. Quindell, working with its consumer, is incentivised under an over-arching agreement “above” this particular claim to ensure a rapid and low-cost claim resolution, and in particular is incentivised to keep car hire duration as low as possible. Quindell shares in the insurer’s benefit of lower claims cost.

Page 5: The Mighty Quin

22 October 2013

5

Collaboration model 2 : “Cash or hire car?” – in this variant, Quindell operates under a framework agreement to offer a “cash alternative” to a consumer prepared to forego their right to a rental vehicle. Rather than “just take” the hire car offered, the victim of an accident could elect to receive a cash payment to compensate them for loss of use of the vehicle. A consumer with access to alternative transport, or not needing the vehicle frequently, might be happy to take such an offer. The insurer saves significant amounts of money when this offer is taken (as, clearly, no car hire is needed), and again Quindell is able to take a share of the saving. The model is already being extended into the Legal Services area of the market, with Quindell’s most recent comments suggesting that some 50% of this segment could adopt the model during 2014.

Telematics – “a major contribution to road safety”

In addition to the other aspects of its business, Quindell has been active in the arena of telematics : the provision of “black box” devices to allow insurers to monitor driver behaviour. These devices, in the opinion of the author, offer huge benefits and are likely to transform the way that insurers interact with consumers. Quindell’s experience of consulting to the telecoms market gives it a strong combination of insurance and mobility knowhow, perfect for the telematics space.

The early adopters of telematics are young drivers – their insurance premiums are highest, their driving is often poor but they are capable of changing habits, and often their parents are involved in both the purchase and the insurance of their first vehicle. Quindell has a c.43% stake in ingenie, an early telematics market entrant. The opportunities for Quindell are significant – ingenie could turn out to be a highly valuable investment, the group could sell telematics technology and offerings to a range of other and larger insurers, and Quindell could evolve a range of outsourcing and support services to address the growing telematics opportunity.

Financial model

We initiate coverage in this note with a set of forecasts which demonstrate both the rapid growth achieved to date, and the opportunities for 2014 and beyond. It is clear that the group has achieved a great deal in terms of revenue expansion over recent periods.

Much of the expansion in late 2013 and 2014 is already “contracted” in terms of deals won, and outsourcing structures being put into place. Clearly the group is at the mercy of claims volumes and, to a degree, implementation pace, but the trajectory is clear, and the levels of revenue and profit growth, both historic and forecast, speak for themselves.

We also include in this section, as is our policy, some comment around the risks and challenges that the group faces. All businesses carry a degree of risk, and for Quindell the main perceived risks relate to the pace of acquisition (and the lack of transparency that flows from this) and the cash-consumptive nature of the growth to date (acquiring blocks of “old-style” claims volume with multi-month working capital requirements). It appears that the pace of acquisitive growth may be slackening, which will address the former concern, and the cash generation from already-won contracts will soon begin to compensate for the cash requirements of the new. This will be accelerated as volumes move to the Collaboration Model, with much faster working capital cycles.

Summary and conclusion

We will publish further documents in due course highlighting specific aspects of the operations, but for now we are pleased to initiate coverage on this extremely exciting group. We strongly suggest that potential investors meet with management and learn about the ongoing opportunities, and the potential for applying Quindell’s strategy and tactics to new and emerging markets.

Page 6: The Mighty Quin

22 October 2013

6

SIGNIFICANT RECENT NEWSFLOW Recent weeks have seen a material level of newsflow from the group, with announcements on a range of fronts. We highlight a number of these items below, with a short analysis of impact on the group and its prospects.

19 September : Additional investments in ingenie group

Quindell extended its ownership of ingenie Limited from 19% to c.43% through the issue of Quindell shares (71m shares). The announcement describes an agreed valuation of ingenie of £50m, which is used to impute a value for the Quindell shares (17.5p). Even applying the actual Quindell share price on 19 September (16.75p), and calculating in the opposite direction, the implied value of ingenie remains close to £50m, so Quindell’s new stake would be worth some £21m. In Quindell’s 2012 accounts, its 19.7% stake was valued at just £3.3m, implying a total value for ingenie of some £17m.

This deal suggests that major value creation has taken place within ingenie across the course of the year, with Quindell expecting further expansion and extension of ingenie over time.

The deal also included investments by Quindell into new ingenie subsidiaries, one in the UK focussing on older (over-25) drivers to whom ingenie’s offering has not previously been available, and another in Canada, to allow ingenie to establish operations in that geography.

19 September : Deal with Insurance Broker Association of Ontario for telematics and outsourcing

The group announced a deal with the Insurance Broker Association of Ontario (“IBAO”). Quindell’s telematics technology will be provided through the IBAO to its 12,000 brokers, who together account for some 6million car insurance policies.

Alongside the telematics agreement, Quindell has also signed a five-year exclusive deal to provide a claims and policy outsourcing platform into the Canadian auto insurance marketplace. The agreement will leverage Quindell’s technology expertise and positioning, and the IBAO broker network and local market knowhow.

This deal, although small to begin with (C$6m by end 2014 based on initial target of 30,000 devices), could expand and extend to C$210m in the event of 30% telematics uptake across the market. Importantly, this relationship could also provide significant insurance relationships for Quindell in the Canadian market, potentially allowing it to replicate its dramatic UK growth profile

Warrants for c.17m share were issued (at a price of 17.5p) to the IBAO and certain key staff, equivalent in value to around £3m.

26 September : Acquisition of PT Healthcare stake

Quindell acquired a 26% stake in PT Healthcare Solutions Corp, the consideration being the issue of 31.6m shares (equivalent to around £5m). The remaining 74% is subject to put and call options in April 2014, with the price set at up to 242m shares (equivalent to c. £39m), the uplift compared to the value already paid presumably being a degree of control premium, and also reflecting the anticipated growth in the business over the intervening time.

PT Healthcare runs over 100 physiotherapy and rehabilitation clinics in Canada. The opportunity is clear : Quindell can leverage its claims volume presence (built in part through the IBAO deal above) and significantly increase utilisation of the PT Healthcare clinics.

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22 October 2013

7

25 and 27 September : Acquisition of >25% stake in Nationwide Accident Repair Services

In two separate announcements, Quindell has revealed that it has built a stake in Nationwide Accident Repair Services plc (NARS), which has now reached over 25%. NARS is a UK-wide provider of accident repair facilities, and the statement describes the clear opportunity for “working in collaboration” given the NARS repair services infrastructure and Quindell’s significant (and growing) levels of claims handling volume.

It is unclear whether Quindell plans to acquire the remainder of NARS, but with a 25%+ stake, Quindell has a degree of control and the ability to block certain other outcomes.

30 September : Board changes (and useful comment around level of ongoing acquisitions)

A number of Board level changes were announced :

Robert Bright as new Independent NED (main board director of HSBC Insurance Brokers Limited, 35 years’ experience in insurance industry, main board of Ageas UK Limited, previously director of Mobile Doctors Group Ltd)

Robert Cooling as new Independent NED (33 years in Royal Navy, culminating in appointment as Vice Admiral, and COO of NATO’s strategic level command covering multi-national staff, civilian and military)

Tony Bowers appointed Independent Non-Executive Vice Chairman

Tony has been senior NED of Quindell since May 2001, and has a background of 23 years as a partner of Deloitte

Jason Cale to retire : Jason’s role was mainly around some of the larger acquisitions

Interestingly, alongside the statement around Jason Cale’s retirement from the Board, Quindell commented that “the board is now focussing on its organic growth strategy with mainly infill acquisitions”. This might in some way appease those who have historically worried that the group’s breakneck acquisition pace both raised risk and reduced transparency. In our view, this pace of growth was necessary to capitalise on the opportunities suddenly apparent in the market, given the regulatory changes and the slowness of competitors to act. Nevertheless, this opportunity has now been seized (with dramatic results in terms of growth), and the group is able to moderate its plans. A transition to a state with fewer and/or smaller acquisitions should allow the group’s organic performance to show through.

9 October : £150m Direct Line contract win

The announcement in early October of a three-year deal with Direct Line included the comment that it was “significant from day one” and is worth over £150m across the three-year period. The contract covers the provision of Quindell’s technology-driven outsourcing model, and includes the technology itself, integrated supply chain and outsourcing of services.

This is, in many ways, the archetypal Quindell contract : a major UK player prepared to outsource claims volume and process management, with Direct Line, its customers, and Quindell all standing to benefit from lower claims costs and more efficient process administration.

Page 8: The Mighty Quin

22 October 2013

8

9 and 21 October – updates on trading and details of achieved organic growth rates

Quindell has given two recent material trading updates, on 9th and 21st October. The group is seeing material organic growth in revenues, with highlights from the trading statement shown below :

§ Direct Line contract (described above) at £50m+ per annum, plus £150m of other new business wins and £100m of previously-announced business wins, totalling organic growth of £300m per annum

§ Collaboration Model ultimately targeting 75% of UK auto insurance market (previously 70%)

§ Adoption of Collaboration Model seen in Legal Services, with expectations of up to 50% of the UK market by end of H1 2014

§ Revenue for Q3 of £92m – compared to revenue of £163m for the whole of H1, clearly showing significant delivered acquired and organic growth

§ Positive operating cash flow of £3.6m – below EBITDA profitability (£34m) but still at least positive, despite the highly significant investment in working capital of new blocks of claims volume

§ Continued discussion of move to London Full List and possible dual listing in Canada in early 2014; appointment of KPMG as group auditor as part of this process

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OVERALL STRATEGY We believe that Quindell’s strategy can be described as below :

“Quindell aims to profit by offering insurers technology-enabled outsourcing partnerships that reduce claims costs. The group is unafraid of challenging the status quo, is prepared to accept risk in return for reward, and is actively promoting change across the industry. These changes are designed to benefit insurers and their customers, and drive revenue and profit for Quindell in the process.“

Essentially, the group’s plan has been driven through three separate processes, which have been running partly in turn, and partly in parallel through the growth of the Quindell portfolio (note lower case “p”) :

§ Consulting sales have been used to deliver rapid presence at the high end of the UK insurance market

§ Acquisitions (especially during a period of industry turmoil during regulatory change) have built significant market share and scale within the UK claims handling marketplace

§ Once present at “top table” due to consulting, and active in the markets on a daily basis due to claims volume acquired, the group has instigated a number of changes to market methodologies. In particular, the Collaboration Model has been developed and is now being utilised.

We believe that the group has timed its entry into the UK marketplace well : insurers are under pressure from ongoing poor combined loss ratios (they are not making money, on the whole) and returns on investments have been unable to compensate for the dire performance of the insurance market itself.

Importantly, the group has also been building its presence during a time when other players have been either unwilling to commit capital, or unprepared to accept risk, due to the regulation changes.

There has been significant press and industry commentary surrounding the various legislative changes, but the most major of these is the effective banning of referral fees. Historically, insurance companies, on receipt of a phonecall from one of their customers involved in a car accident, were able to pass customer details to third parties in return for a fee. For example, medical injury specialist law firms would pay insurers for “leads” in the form of telephone numbers and names of people suffering car crashes. The solicitors would contact the consumer, offer to represent them, and earn revenue and profit. The UK insurance industry became accustomed to receiving such fees – although the net result to the industry was a zero-sum game (or worse), to each individual insurer, the referral fee became a useful part of income.

Post the ban, a number of insurers and professional services firms have established so-called ABSs – Alternative Business Structures to avoid the now-illegal referral fee. Some firms are now part of insurance groups, and other processes have sprung up.

Quindell’s tactics around legislation have involved both creating innovative structures (such as those described in the next section) and also acquiring businesses of various types (as described in the Building Blocks section page 12), hopefully at artificially low prices as others were unprepared to act.

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REVENUE, PROFIT AND CASH FLOW The group has two divisions – selling software and providing outsourced services. The H1 2013 result saw the Software and Consulting unit double revenues y/y, and generate significant EBITDA, with a very strong (73%) EBITDA margin. Assuming that accrued income expansion was nearly all within Outsourcing, then the Software side of the business is likely to have provided significant cash flow to help offset the working capital investment within Outsourcing.

Outsourcing division workflow

Quindell acts as the outsourced provider of call-answering services to the insurer with that relationship clarified in the policy documentation that a customer signs with their insurer. The calls which Quindell’s personnel answer are mainly from policyholders who want to notify their insurers of an accident (the FNOL). Quindell representatives answer the calls and establish their direct relationship with the customer. It is the customer (rather than their insurer) who authorises the release of personal details to the Quindell group.

These details are then available, as they would have been prior to the referral ban, to other parts of the Quindell group. Services (legal, medical etc) can be offered to the potential claimant, and the group earns revenue from a number of these areas.

Motor incident work flow

Source: Progressive Equity Research

The chart above shows the basic work flow associated with the claims process for a motor incident. It also shows the basic funding which Quindell has to undertake as part of the process before it receives payment – this has clear implications for short-term cash flow during a period of significant growth. As described above, we believe the group has been relying on the Software division to fund working capital generation within the Outsourcing units.

Lead generation – various owned platforms / insurer relationships

Event – “First Notice of Loss”

Insured party’s fault ?

SplitNon-fault At fault

Work with insured party to minimisequantum of loss. Offer services to

other party to generate ancillary

revenue.

Offer services to own insured party to minimise impact

of incident and generate revenue for business units. Claim off “liable”

insurer in due course.

Continue to learn about event until liability becomes

clear.

Associated cash flow :

Fund lead generation (no longer “referral

fee” for personal data)

Fund claim management

process & staff

Fund claim costs (car hire, repair,

any health assessments

and/or rehabilitation

Receive payment

Page 11: The Mighty Quin

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11

This second chart shows more detail of the work flow and the elements of the claims process together with the solutions required and the relevant Quindell business provider. We will return in another note to the detail of the savings provided to insurers, and the specifics around working capital and cash flows.

Mapping incident work flow to Quindell’s solutions/businesses

Source: Progressive Equity Research

Rapid fault/non-fault decision making

The speed and accuracy with which decisions are made as to whether an insured driver is at fault or not for a motor incident is crucial to the potential revenue generation from non-fault claims. Firstly, a better level of allocation of FNOL between fault and non-fault widens the pool of potential business. Secondly, the speed with which such a decision is made improves the conversion rate of cases for services related to hire, repair and personal injury. Quindell’s use of a single case manager provides both increased customer satisfaction, and a better “quality” of decision leading to lower risk in terms of repair decision and liability for cost.

QUINDELL PORTFOLIO COMPANY OR

SOLUTION

INTELLIGENT CLAIMS MANAGEMENT

QUINDELL BUSINESS BUSIINESS SERVICES, AI CLAIMS SOLUTIONS

SILVERBECK RYMER, PINTO POTTS, THE COMPENSATION

LAWYER, COMPASS COSTS

MOBILE DOCTORS

OVERLAND HEALTH, ENZYME

INTERNATIONAL

PROCESS

CLAIMS MANAGEMENT

ACCIDENT MANAGEMENT

CREDIT HIRE

EFFICIENT REPAIR

MINIMISES CAR HIRE PERIOD,

REDUCES ‘KEY-TO-KEY’ TIME

LEGAL SERVICES

MEDICO-LEGAL

MULTI-DISCIPLINE

REHABILITATION

REQUIRED SOLUTION, KNOWLEDGE OR SERVICE

ADVANCED DECISION SUPPORT

BESPOKE IT SYSTEMS, INDUSTRY KNOWLEDGE,

CLAIMS EXPERTISE

RELATIONSHIPS WITH AVIS & EUROPECAR

PERSONAL INJURY CLAIMS SERVICE, COST

RECOVERY, LITIGATION SERVICE

EXPERT MEDICO-LEGAL REPORTING

FAST MULTI-DISCIPLINE REHABILITATION SERVICES

FAULT (OR NEGLIGENT PARTY

INSURER

NON-FAULT

QUINDELL PROVIDES

AGREED SERVICE, PREDICTABLE

COSTS….

QUINDELL PROCESSES

CLAIM

….OR HANDS CASE BACK TO BROKER

ROADSIDE ASSISTANCE

NEEDED

CAR HIRE NEEDED?

VEHICLE REPAIRS?

PERSONAL INJURY?

REFERRAL PARTNER OUTSOURCES TO QUINDELL

QUINDELL DETERMINES FAULT OR NON-FAULT

MOTOR ACCIDENT OCCURS

INSURED CALLS INSURANCE COMPANY. FIRST NOTIFICATION

OF LOSS (FNOL)

EVENT

Page 12: The Mighty Quin

22 October 2013

12

EXPLAINING THE EXTRAORDINARY GROWTH Quindell has experienced exceptionally strong growth, across a multi-year period, during a time in which the insurance industry has not itself really excited investors. This has led some to question the validity, scalability and longevity of the growth.

We believe that the growth has come from a combination of two factors : the clear and strong group strategy which we summarise on page 6 above, and the acquisition methodology which we describe below. The bringing-together of a strategic industry perspective with an aggressive acquisition strategy, at just the time when the insurance sector was grappling with legislative change (as highlighted in the section below), has given Quindell the opportunity to exhibit extraordinary growth.

There is one further point we would make : that this growth phase has been exceptionally strong, and may not be repeated in terms of growth rate percentages, but the underlying strategy lends itself to replication and repetition : the group has shown itself to be strategically smart, operationally agile and willing to drive activity through M&A. This is how the growth to date has been achieved, and these attributes can be applied in telematics, in overseas markets, and in other new developments as they impact the insurance sector. The UK regulatory change, and Quindell’s rapid and nimble reaction to it (as described below) is simply one manifestation of industry evolution – we see no reason to doubt that Quindell can repeat the type of strategic gain it has achieved during this period of industry turbulence. Other areas of industry change will no doubt occur over time, leading to new opportunities and potential areas of growth for the group. It is this that could arguably lead to even more significant long-term value creation.

Acquisition intelligence

The group has made a number of acquisitions in the recent past, and we believe that the acquisition strategy could be described as …

“Buy an underperforming or growth-constrained asset when others are reluctant to commit, then flood it post acquisition with insurance workload volumes from sources across the group”

Quindell has acquired a number of businesses in areas of the market pressured by legislative change, and/or bogged down in claims disputes with insurers. The group has been able, by a combination of its growing industry presence and strong negotiation tactics, to both grow revenues across relatively fixed cost bases and work towards “block settlements” with insurers. The net result is better utilisation of resources, and potential recovery of debtor book values not reflected in purchase prices.

The best examples of this would probably be Quindell Legal Services and Quindell Health Services. In both cases, the businesses acquired were either constrained by regulatory confusion or lack of case volume. Quindell Legal Services comprises essentially four businesses (Silverbeck Rymer, Pinto Potts/TCL, Compass Costs and Accident Advice Helpline) whose warranted or historic EBITDA summed to c.£17m per annum. By comparison, following acquisition and significant increases in volumes as Quindell’s caseload is directed internally, the current Q2 run-rate is quoted as being £62m per annum.

Dramatic results can be achieved by combining an opportunistic but aggressive acquisition strategy with a large and commanding market share in insurance claims volumes. It is this, in our view, that really explains Quindell’s phenomenal growth.

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Profiting from the referral fee ban As described above, a significant part of the group’s recent growth has come through its ability to navigate, and profit from, the referral fee ban which left others struggling to justify and defend their positions in the market. Arguably this created a once-in-a-generation opportunity from which Quindell has benefited immensely. In this section, we describe how this has been achieved.

Regulatory change

From the 1 April 2013 the payment or receipt of referral fees for personal injury (PI) cases was banned by the Legal Aid, Sentencing and Punishment of Offenders (LASPO) Act 2012. The ban refers to business involving the provision of legal services, which relate to a claim or potential claim for PI or death - including damages.

A “referral” includes the provision of information to another person (other than by the client) that a provider of legal services would need to make an offer to provide legal services to the client. It includes the name and contact details of a client.

From 1 April 2013 Claims Management Companies (CMCs) have not been able to refer PI claims to a solicitor for a fee. The new legislation also prevents CMCs from referring other claims or potential claims where that claim results from circumstances that involved PI or death.

The ban does not prevent CMCs from undertaking other regulated claims management activities, such as advertising for claims, investigating and advising in relation to claims. Activities such as credit hire, storage, and vehicle recovery and repair are not affected by the ban on referral fees.

The ban prevents insurers being paid for passing the personal details of potential claimants to service providers.

The table overleaf shows a flow chart provided by the Solicitors Regulation Authority (SRA) which outlines the process by which a solicitor may determine whether a referral would be prohibited if a fee was involved.

The SRA view

In its 2012 Discussion Paper on the (then upcoming) LASPO Act, the SRA noted that:

“… there are three main aspects of any arrangement that will determine whether it contravenes the ban (assuming it involves personal injury matters):

(i) whether there is a referral;

(ii) whether there is a payment; and

(iii) whether the payment is for the referral.

We believe that (i) and (ii) are relatively straightforward as both are effectively defined in the Act. The difficulty will be establishing in (iii) whether the payment is for the referral, particularly where the introducer is providing services to the solicitor, such as marketing, vetting of claims or other claims management activities…..

…….It is relatively clear that arrangements in which potential clients are given information to enable them to contact a suitable solicitor will not be caught by the ban. This is because this is not a referral within the terms of the Act (although it would be considered a referral for the purposes of our Code of Conduct and solicitors need to satisfy themselves that the arrangement complies with this). At the other end of the spectrum, any situation in which a third party, such as an insurance company, simply passes on details of someone known to have suffered an accident to a solicitor, in return for a fee, will be caught.”

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When is a referral fee banned under LASPO 2012?

Source: Solicitors Regulation Authority, Progressive Equity Research highlighting

Regulation to the rescue

Although the implications of LASPO could have meant that consumers were unable to receive suggestions regarding legal advice in the event of a claim, another change in regulation has (ironically) allowed many of the practices to continue. The Legal Services Act 2007 introduced the “Alternative Business Structure”, a regime under which non-regulated organisations could own firms of solicitors. It is under this legislation that Quindell has established its businesses.

Solicitor  refers  to  anotherperson

Solicitor  receives  a  referralfrom  another  person

Solicitor  makes  anarrangement  with  a  third  party

Does  the  business  referred  involve  legalservices  relating  to  a  claim  or  potentialclaim  for  personal  injury  or  death?

Is  the  solicitor  providing  legalservices  relating  to  a  claim  orpotential  claim  for  personal  injury  or  death  or  an  ancillary  

claim?

Does  the  business  referred  involve  legalservices  which  relate  to  any  other  claim  orpotential  claim  which  is  connected  to  a  claimfor  personal  injury  or  death  (ancillary  claim)?

Is  the  client  involved  a  claimant  or  a  potential

claimant?

Is  the  third  partyproviding  services  to  the  claimant?

Does  the  information  received  allow  an  offer  to  be  made  to  the  claimant/potential  claimant  to  provide  legal  

services?

Has  the  information  been  provided  by  the  client  instead  of  another  person?

Has  the  solicitor  received  or  made  any  other  consideration  for  the  referral  or  for  making  the  arrangement  (excluding  reasonable  hospitality)?

Not  a  prohibited  referral

YES

YES

YES

YES

YES

YES

YESYES

YES YES

YES

YES

NO

NO

NO

NONO

NO

NO

NO

NO

NONO

Prohibited  referral  fee

NO

Has  the  solicitor  received  a  payment  or  made  a  payment  for  the  referral  or  for  making  the  arrangement?

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Legal opinion

Quindell has structured its businesses and its relationships with insurers and other parties to work within the demands of the new regulatory environment. It has taken legal advice to gain an opinion on its business model within the new legislative framework. It remains happy that the opinion given confirms that it is operating in an appropriate manner. Anyone concerned that the structure may fall foul of regulation can take a degree of comfort from the regular reviews undertaken by both the FCA and the SRA – Quindell is regulated by both organisations, as are many of its clients. Quindell has reported not a single incident of regulatory concern across around 50 referral sources.

Operating the model

Quindell has crafted, in conjunction with a number of insurers, a model that the group believes allows it to comply with the legislation but still glean the required information from the insurer’s customer at the time of a claim.

The model relies on one simple (yet arguably ingenious) idea :

§ If the party giving Quindell the information is the claimant, rather than the insurer, then there is no “passing of information” from insurer to Quindell. The information is passed by the claimant. Thus there can remain a payment by Quindell to the insurer for the claim, but the payment is not in respect of the insurer passing information.

How Quindell side-steps the referral fee ban

Source: Quindell, Progressive Equity Research

The model therefore involves a law firm (Quindell’s) providing a first notice of loss (FNOL) service for an insurer under the law firm’s own name. The insurer then uses (and publishes) the FNOL reporting telephone number provided by Quindell. Consequently, the customers then instigate the initial contact with Quindell within the terms of the already-agreed terms and conditions of the policy.

Ban applies to situations which are : A “referral “ (passing of client information by a third party to a law firm)…

Quindell structure : NO – the client passes their OWN information direct to the Quindell group (which is taking details of the insurance claim on behalf of the insurer)

… in relation to a potential personal injury claim…

YES – many of the accidents can lead to PI claims

… and leading to a fee being paid FOR the referral.

UNCLEAR – but is irrelevant if the passing of information by the client is not a referral in any case

So, Quindell aims to avoid the auspices of the ban completely, since there is no “transfer” of information from the insurer to the Quindell group. Quindell’s role as outsourced provider of call-answering services (including First Notice of Loss calls) gives it the position from which to gather the data direct from the client at the time of the potential claim.

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It is crucial, in our view, that potential investors understand and consider Quindell’s structure within LASPO and the Legal Services Act. This structure is critical to the group’s ongoing ability to garner customer information, and to provide the array of legal, medical and car hire/repair services into the industry.

We highlight a number of reasons why the Quindell structure should be acceptable under the current regulatory structure :

§ The Quindell group (including its legal service arms) is structured as an Alternative Business Structure under the Legal Services Act, and has received approval from the Solicitors Regulation Authority (SRA) in this regard

§ The SRA’s own guidelines (see page 14) around LASPO and the referral fee ban include a specific question : “Has the information been provided by the client instead of another person?” – if the answer is yes, then the ban does not apply

§ Both Quindell and the insurers with whom it contracts are regulated by other industry bodies, who have been conducting audits of the various businesses during the last six months of operation, and would surely have raised any concerns by this time

§ Finally, Quindell has been winning significant volumes of claims business in recent weeks and months; the counterparts to these contracts would surely not have agreed to the structures if they had any concerns as to the validity or acceptability of the platform

Quindell has seen major benefits from the regulatory change

In our opinion, Quindell has been a major beneficiary of the regulatory change. The group has, arguably, moved more rapidly and in a more intelligent manner than many of its competitors and peers. In particular :

§ Quindell has established its news ABS-based structure, using its innovative methods to avoid falling foul of the referral fee ban, and has managed to take significant share of the UK insurance claims market in a staggeringly short period of time

§ The group has been able to acquire a number of assets at potentially “knock-down” prices, as many potential acquirers were unable or unwilling to enter the market at a time of regulatory uncertainty, and some historic business models were rendered unworkable.

§ By combining organic growth (through nimble action) and opportunistic acquisitions, Quindell now commands, on the basis of comments in the Q3 update, something between 20% and 25% of the UK auto claims volume. This now allows the group to negotiate with interested parties from a position of significant strength and “relevance” which others struggle to emulate.

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THE BUILDING BLOCKS

Consulting, Software and Outsourcing Quindell has been built up using three elements :

§ Consulting to provide industry-leading expertise and knowhow

§ Software to generate high margin revenues from insurance customers, and to power the group’s internal processes

§ Outsourcing to offer insurers and brokers a platform for resolution of claims management processes and delivery of the various ancillary services

We will return in future publications to each of these in greater detail, but the snapshots below provide summaries of the major elements of each area, the levels of revenue and EBITDA that can be (and have been) generated, and where we see the major long-term value to the group.

Software and Consulting Total acquisition cost c£60m; Actual EBITDA H1 2013 £16.4m

Consulting

Quindell has assembled a large pool of high-quality industry talent, through the acquisition of a number of relatively small businesses.

These include Enzyme and IT Freedom, which helped the group formalise the “champion and challenger” model, utilised to good effect in the Software division. Further, the group acquired Business Advisory Service and Home Advisory Service to help insurers plan and evolve their go-to-market strategies.

Quindell provides consulting services to a large number of high-end insurers, helping them with business strategies most broadly, with their customer acquisition plans and their approaches to new technologies such as telematics.

Consulting operations provide the group with a range of top-level relationships with major insurers across the market, and give the group a “seat at the table” as the industry deals with changes in regulation, changes in consumer behaviour, and changes in technology.

Software

The group owns a number of software platforms, and sells software and implementations to insurers in a large number of geographies, with a particular focus on the UK, but an increasing presence in North America (particularly Canada).

The software suites involve a number of different aspects of an insurer’s business, but generally focus on the claims management process, and streamlining the process to improve customer service and reduce claims cost to the insurer.

We have seen a demonstration of the software in action, and will provide greater detail in a subsequent note. The process, essentially, involves software managing the claims information-gathering process, through a process of “dynamic dialogue”. The claims handler does not ask for information that is irrelevant, but asks additional questions in areas which will help determine fault/non-fault status, and also areas which may determine a basis upon which an insurer can contest liability even in an at-fault claim.

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The software is managed in a dynamic and fluid way, which provides three key benefits :

§ The claim is handled in a smooth and efficient way, with all relevant data captured, an expert “technical intervention” employee can join the call if the liability decision is not clear-cut, and a rapid decision as to likely liability is made

§ The software can be easily configured by non-technical staff, allowing “champion and challenger” versions of workflow to be established, giving insurers the chance to test new methods of handling claims quickly and easily.

§ Changes in insurance claims trends can be handled easily; for example the recent “flash for cash” scams in which fraudsters flash their lights at other road users to tempt them into driving on, and then deliberately crash into them. Workflow systems using Quindell platforms can be quickly tailored to pay special attention to such claims, allowing the insurer to focus on minimising liability in relation to such potentially fraudulent activity by the supposedly “non-fault” party to the accident.

The major elements of software sales relate to the ICM claims hub system, and the iter8 business in Canada which is having material success in generating leads, both for traditional claims management systems, but also in regard to telematics platforms.

Outsourcing Total acquisition cost £157m; Actual EBITDA H1 2013 £41m

By far the largest part of the group, Quindell’s outsourcing activities are mainly to do with the provision of claims management services, and the actual delivery of various services required to resolve the claim itself (car hire, vehicle repair, personal injury claim services, medical etc).

The group has made a number of acquisitions, and has benefited from the change in the regulatory landscape which made a number of business models significantly less profitable than they had previously been.

We will revisit the outsourcing aspects of the group in another publication, but the main areas relate to :

§ Claims management : Ai Claims and Crusader Assistance

§ Medical : Mobile Doctors and Overland Health

§ Legal : Silverbeck Rymer, Pinto Potts, Compass Costs and Accident Advice Helpline

A number of these acquired businesses also came with significant debtor balances, which effectively represent costs of claims being made against insurers by non-fault parties to accidents.

The group’s strong position in the market, and its ability to offer the Collaboration model (see page 19 below), may now render these outstanding debtor balances more collectable than had historically been the case. Quindell aims to negotiate so-called “block settlements” with insurers against which it has outstanding debtor balances at the same time as it negotiates with that insurer around the Collaboration Protocol.

Early evidence is that this policy is meeting with extraordinary success : the group had previously targeted some 50% of the UK market, but this has recently been upgraded to a 75% target on the basis of conversations already under way. This would lead not just to a hugely successful Collaboration Protocol delivery, but also presumably to very significant cash inflows from block settlements.

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GAME CHANGER 1 : THE COLLABORATION PROTOCOL Quindell has built a major and leading position within the UK insurance claims handling marketplace. The group is, however, determined to improve its margins and cash profile, while at the same time delivering savings to insurers (and thereby, ultimately, consumers). This is possible through a concept known as the “Collaboration Protocol”.

Collaboration Protocol – the basics

The Collaboration Protocol works by changing the dynamic between the insurer and whoever is managing the repair/other elements on behalf of the non-fault consumer.

Large insurers and large repair networks will be working on large numbers of claims together at any one time. Normally, the insurer is continually fighting to bring down the overall repair cost, and the repair network is attempting to maximise profit, which historically has involved ensuring that maximum revenue is obtained for each element of the claim. Some repair networks have been content to see car hire periods drag on, repair costs rise and general procedural and bureaucratic delays allowed to inflate the real cost of the claim.

The Collaboration Protocol firstly acknowledges a number of “realities” that the insurers, in practice, must accept. Then, it implements a shared and common aim, that of minimising the cost of a claim over and above an agreed minimum level. Both Quindell and the insurer then work together to keep the cost of claim low, and Quindell shares in the benefit of achieving this goal.

Rather than the traditional model of conflict between the interests of the insurer and repairer, the Collaboration Model aligns these interests, provides a “fair” but measurable profit to the claim manager (Quindell) but also ensure that Quindell is then working for the benefit of the insurer to keep the overall claim cost as low as possible.

The steps involved are as follows :

1. Agree base-level fixed claims costs

Agree an acceptable level of genuine base costs that Quindell (or any other claim manager) will need to incur and cover during the process of managing a claim. This includes paying a referral fee (or equivalent), running the claim management process and earning a profit margin, and the actual input costs of car hire (with no profit to Quindell).

2. Work together to minimise actual cost over base level

Due to relationship and trust between the parties, the insurer can rely on Quindell to minimise hire durations, repair costs and so on. Quindell can therefore act under “delegated authority”, authorising repair commencement, expediting the process and reducing replacement car hire duration.

3. Share the benefit of reduced overall cost

Once claims have been managed, and costs minimised, there is a “true-ing up” process, under which Quindell earns margin specifically for reducing car hire durations. Below certain levels, Quindell is incentivised at up to 50% of the daily cost of the car hire – the insurer and Quindell effectively share 50/50 the benefits of any savings achieved.

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Collaboration extended : “hire car or cash?” Once the Collaboration Protocol has established a major degree of trust between insurer and claims manager, and has aligned the interests of both (unusually in the industry) then opportunities for additional major savings begin to emerge.

Specifically, there is potential for dramatic savings on the basis that the claims manager is no longer incentivised to maximise (or even begin) the duration of a car hire. Historically, claims management organisations generally owned their own fleets (or leased them) and made significant margin on each day of car hire.

Under the Collaboration Protocol as described above, the claims management organisation (Quindell) is incentivised to minimise the cost of car hire, since Quindell shares in the profit advantage if overall claims cost is below the agreed levels.

Extending this concept still further, the claims management organisation can offer the consumer a choice :

“Either take the hire car to which you are entitled following your non-fault accident, or we can provide a cash alternative to compensate you for loss of mobility”.

This choice has never previously been offered to consumers, because claims management organisations have been (a) trying to maximise margins they earn on each day of car hire, and (b) in no way incentivised to keep claims costs down.

The cost savings to the insurer (which are then shared with Quindell) can be dramatic : the current plan is to offer a £200 cash payment in lieu of a hire car. Given that the cost of car hire can easily run into the thousands of pounds, the saving is clear.

Collaboration Model – cost of claim vs industry and Quindell costs

Source: Quindell, Progressive Equity Research

In a future document, we will return specifically to the Collaboration Protocol, and describe it in more detail, but the benefits to insurers are clear in terms of cost savings, and better alignment of interests through the supply chain.

0"

200"

400"

600"

800"

1,000"

1,200"

1,400"

1,600"

1,800"

Industry"average,"19"days,"GTA"costs"

Quindell,"non>collabora@on"

model"

Quindell"collabora@on"protocol"

Quindell"collabora@on"with"cash"alterna@ve"

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GAME CHANGER 2 : TELEMATICS As with the Collaboration Protocol, we will return to the Telematics market in a future document, but we summarise here some of the key drivers of the marketplace, and the potential impact on the Quindell opportunity.

Telematics – the basics

Telematics, as it applies to the automotive sector, relates to the provision of information from the vehicle directly to a remote third party (the insurer, a membership organisation such as the RAC, or any other provider).

Generally, the systems currently being offered rely on the placement of a small “black box” device in the car, linked to the OBD (on-board diagnostics) port, and containing a communications module to transmit data to the telematics provider.

Telematics can deliver a range of different types of information, depending on the type of system installed, and the data being targeted for the specific purpose :

§ Vehicle location, speed, acceleration, g-force and braking details – these allow insurers to gather accurate data about the way a vehicle is driven

§ Engine and other component readings, including levels of wear of certain parts of the vehicle, tyre pressures and any warning lights / fault indicators – these can provide breakdown organisations with details of faults or failures

§ Airbag inflation or other crash-related signals (such as vehicle shock/vibration measures) – these allow automated alerting of the emergency services and/or commencement of the insurer’s claims process

Telematics and insurers

Insurers have been slow to roll out telematics products, although over the years a number of trials have taken place. The last two or three years have seen a resurgence of interest, driven by ongoing improvements in technology, reduction in costs of both hardware and communications, and a demand driver following a change in regulation. The regulatory change relates to female drivers, who can no longer benefit from gender-specific pricing. They are now charged the same as (more accident-prone) male drivers, and are turning to telematics in an attempt to “earn back” the lower insurance costs they previously enjoyed on the basis of gender.

Telematics has also been, largely, the preserve of younger drivers. Young drivers’ insurance premiums are high, and it was only in this high-premium environment that the cost of telematics could historically be offset by lower premium levels.

Given the reducing costs as described above, the role of telematics is, in our opinion, and on the basis of a large number of early-stage rollouts, beginning to materially impact on the insurance landscape.

Trickle turning to a flood?

Insurers, having been slow to adopt telematics, now face an interesting game-theory problem. “Good” drivers (who are low risk and have fewer accidents) will naturally adopt telematics products to earn lower premium costs as they demonstrate their low-risk characteristics. Insurers who offer telematics-based policies first will therefore tend to gather large numbers of low-risk (and highly attractive) customers. Insurers not offering telematics will be left with the proportionately higher-risk and less profitable pool of drivers who were not keen to accept the scrutiny of telematics. There is, in our opinion, a good chance that the early trickle of insurer interest could turn into a flood, as insurers race to attract high-quality, low-risk drivers.

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Telematics – carmakers’ entry into insurance market?

As well as being able to benefit (especially early-adopting players), insurers are also under significant threat from telematics as car manufacturers could look to use the technology to capture a larger share of the insurance market at the time of new car sales.

Essentially, the danger is this : as telematics becomes more widespread and is eventually built into new vehicles, the vehicle manufacturer will be able to offer an insurance product “free” or bundled with the price of the vehicle for (say) the first year post purchase from new. Since insurance is a hard service in which to differentiate an offering, consumers are likely to just acquiesce to the route of least resistance, and accept the manufacturer-offered insurance. This effectively increases the insurer’s cost of customer acquisition – the insurer will have the cost of advertising to the consumer, and also will be at a disadvantage in terms of information, since the “incumbent” vehicle manufacturer insurance provider will have all the telematics data and will be able to price policies extremely accurately.

Quindell and the telematics opportunity Given the rapid rise of telematics in recent times, and given Quindell’s leading position in the industry, readers will be unsurprised to see a major level of involvement. We summarise below a number of the ways in which Quindell has been involved with the telematics opportunity :

Consulting : providing consulting to a number of players in the industry on how best to benefit from the telematics opportunity; both through the insurance division and also in the mobile arena through the Quindell telecoms businesses

Software : ownership of software IP which allows insurers to implement rapidly, and at low cost, telematics-based insurance policies, and to price them accurately using sophisticated ratings engine methodologies

Outsourcing : working with a number of parties to provide outsourced delivery of cutting-edge telematics solutions

Ownership of ingenie : Quindell has recently increased to c43% its stake in ingenie, an insurance brand offering an early-to-market telematics product. As described on page 6 above, the ingenie business could easily turn into a highly valuable asset for the group. It has already has provided an early reference site for the Quindell telematics technology.

Telematics – a major contribution to road safety

We have attended an ingenie-sponsored industry event describing telematics and the benefits it can provide. Clearly, there are material benefits to the insurance industry in terms of more accurate pricing, better data to manage claims, and improved efficiencies of process.

More far reaching are the benefits to society – if drivers are allowed (or forced) to focus on aspects of their behaviour that increase risk, then they will change their behaviour. Clearly this will take time, and will not remove all instances of careless or reckless driving, but there will be certain individuals whose behaviour can be moderated, and who therefore avoid accidents that would otherwise have happened.

Quindell is helping lead the telematics charge, which fits well with the group’s overall aim to drive down the cost of claims – both by managing them more efficiently, and, in the case of this technology, helping prevent them in the first place.

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FINANCIAL FORECAST COMMENTARY We have included overleaf our financial forecasts for the group. Essentially, we model continued expansion of the group’s software and consulting business, and delivery on a number of contracts already won within outsourcing, alongside a number of additional wins over time.

H1 2013 results

H1 2013 results provide the most up-to-date and comprehensive view of the group’s performance. The highlights were :

§ Revenues grew by a factor of over 2.5x year-on-year, and exceeded the full year 2012 figure in H1 2013

§ EBITDA likewise more than trebled, with H1 EBITDA both pre- and post-exceptional costs exceeding the full year 2012 figure

§ Within the mix, both Software & Consulting and Outsourcing saw dramatic growth in both revenues and EBITDA – so the growth is balanced across all areas of the Quindell portfolio. Importantly, and potentially indicative of future performance, while margins in Software & Consulting declined moderately (but still reached 73%), margins in Outsourcing moved forward dramatically on the back of increased volumes being applied to acquired businesses (see page 12 for details of our view on this strategy) with the division now achieving 29% margins.

§ Cash generated from operations was £2.3m (prior to exceptional costs), which compares well to the guided outflow of £15-20m for H1, and although not a high proportion of EBITDA (c4%) is at least positive. We point to the highly cash-consumptive nature of the working capital cycle, as highlighted in a number of places in this note. There was also a significant increase in accrued income, which we detail in the section below.

§ The group ended June 2013 with net debt of £14.1m, modestly higher than the prior year’s figure of £10.9m, but much smaller when expressed as a percentage of EBITDA : last year net debt/H1 EBITDA was around 70%, this year it is just 26%. In terms of “affordability” of debt, this should provide reassurance.

Other items from H1 results announcement

There were a number of other items of note within the results statement. In particular, long-term EBITDA guidance is now IN EXCESS of 25%, presumably as a result of increasing confidence in the margin potential of the Outsourcing division. Equally, the Software & Consulting margins, although declining, remain at a very healthy 70%+ level.

The specifics around expectations for the Collaboration model were also clarified and upgraded : the group is now aiming to address 75% of the UK market with this protocol, and is already in discussions with providers comprising some 30% of the market – these feel like material steps forward, and again presumably this increase in confidence is driven by the tone and the quality of the discussions under way.

Accrued income – how it stacks up

Within the H1 results, attention has been drawn to the level of accrued income, which rose from £32m to £71m within Quindell Legal Services (and also grew in other areas of the group).

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The expansion of accrued income represents an increase in the level of revenue recognised in advance of invoicing, and is a natural result of increased claims volume. The group, in addition to accrued income by division, has published claims volume by month, allowing us to map claims volume increase against accrued income expansion.

Claims volumes for June were just below 9,000 per month in Quindell Legal Services, up from just below 4,000 per month in December (source : Quindell). This represents a multiple of c.2.2x across the timeframe, almost exactly the same multiple that we apply to the £32m December accrued income to reach the June accrued income level of £71m. To us, therefore, the expansion in accrued income should not, of itself, be a cause for concern – it is a simple and logical corollary of the expanded claims levels, and is in fact a sign of the group’s success in dramatically increasing its market share.

Risks and challenges

As with any business, Quindell faces a number of risks and challenges. In accordance with our standard practice, we provide a table below indicating some of what we consider to be the major risks to the business. We also provide a summary of the management feedback or comment regarding each issue, allowing readers to form a view on each risk item in the context of the group :

Quindell Risks and Challenges, with management responses

Risk or challenge to business Management action or response

Highly cash-consumptive nature of large parts of business (eg PI litigation, motor claims outsourcing) when blocks of claims are won, requiring significant investment in working capital in the first six months

This is why the business has raised capital, is seeking a potential main-market listing, and uses cash flow from software etc to invest in working capital within the outsourcing divisions. Three factors should reduce this over time : (1) as profits are earned from business already “on boarded”, these help cover the cost of new business wins, (2) migrating volumes to the Collaboration Model changes working capital out of all recognition, (3) new business is likely to represent a lesser proportion of total, so Net Debt / EBITDA should fall further

Highly acquisitive track record increases risk and reduces transparency across the group

The group has rushed to take advantage of the regulatory flux, and has built a very large business in a very short space of time. This is now likely to slow in terms of acquisition pace – recent months have seen fewer, generally smaller, deals. The retirement of Jason Cale from the Board was accompanied by comments about future deals being more “infill” for this reason. Fewer, smaller deals should represent less of a risk.

Potential lack of management bandwidth to cater for so many areas of simultaneous rapid growth

An exceptional team of divisional MDs has been assembled, some from industry and some from the acquired businesses. It is their expertise, combined with central group strategy, that is driving the performance being achieved.

Source: Progressive Equity Research, Quindell

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The moral dimension

At this point it is right that we comment on the moral debate surrounding some of the units. In particular, legal and medical claims have attracted criticism, and it is clear that over the years, many fraudulent and unnecessary claims have been made within the industry. We suggest that, simply because some claims are wrongful, that does not remove the right of honest injured parties to claim. Genuinely aggrieved or physically injured parties should be able to seek redress; it merely raises the standards of proof and quality of evidence required. Quindell’s aim is to work in a highly ethical manner, working with insurers as a body to reduce claims costs but still ensuring that legitimate claimants are dealt with fairly and quickly.

Summary

Overall, we believe that the combination of H1 results, the Q3 update, and other recent newsflow suggests that the group is continuing to experience strong growth in revenues and profits, and that its innovative business model is gaining additional material traction.

We will publish an additional document in due course with more detail on the group’s finances and our model assumptions, but for now we are pleased to initiate coverage on this extremely exciting group.

We strongly suggest that potential investors meet with management and learn about the ongoing opportunities, and the potential for applying Quindell’s strategy and tactics to new and emerging markets.

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FINANCIAL FORECASTS FINANCIAL MODEL EXTRACTS

Source: Progressive Equity Research

Year ended December FY-11 FY-12 FY-13 FY-14 FY-15£m £m £m £m £m

Profit & Loss Act Act Est Est EstRevenue 13.7 137.6 429.3 695.2 757.4 Adj EBITDA 6.7 52.2 135.2 206.4 221.2 Adj EBIT 6.4 50.3 132.2 203.1 217.6 Reported PBT 4.1 41.2 121.0 199.1 212.9 PBT before exceptionals and AAG 4.7 43.9 125.0 203.1 216.9 Fully adj PBT 6.3 49.2 131.3 203.1 216.9 NOPAT £ 5.9 37.0 100.0 151.3 162.4 Reported EPS (p) 0.4 1.2 2.3 3.4 3.8 EPS before exceptionals and AAG (p) 0.5 1.2 2.4 3.5 3.9 Fully adj EPS (p) 0.7 1.4 2.5 3.5 3.9 Dividend per share (p) 0.00 0.00 0.05 0.10 0.20 Cash flow & Balance sheetOperating cash flow 4.5 36.7 17.7 76.5 188.0 Free Cash flow £m 3.1 29.9 (11.8) 24.7 129.8 FCF per share p 0.3 1.1 (0.3) 0.6 3.1 Acquisitions (2.7) (58.4) (12.0) (4.5) (2.0)Shares issued 2.4 91.0 0.0 0.0 0.0 Net cash flow 3.1 27.6 (23.8) 20.2 127.8

Overdrafts / borrowings (16.1) (29.6) (32.5) (32.5) (32.5)Cash & equivalents 3.7 47.2 23.5 43.6 171.4 Net cash / (debt) (12.4) 17.6 (9.0) 11.1 138.9

Metrics FY-11 FY-12 FY-13 FY-14 FY-15Adj EBIT growth 683.7% 163.1% 53.6% 7.1%Adj PBT growth 674.9% 167.2% 54.7% 6.8%Adj EPS growth 109.5% 81.5% 38.7% 10.8%Dividend growth N/A N/A N/A N/AAdj EBIT margins N/A N/A N/A N/AOperating cash conversionCAPEX/Depreciation

Valuation FY-11 FY-12 FY-13 FY-14 FY-15EV/Sales 54.4 5.1 1.7 1.0 0.8 EV/EBITDA 111.5 13.4 5.4 3.4 2.6 EV/NOPAT 126.2 19.0 7.3 4.7 3.6 PER 25.6 12.2 6.7 4.9 4.4 Dividend yield n.a. n.a. 0.0 0.0 0.0 FCF yield 1.9% 6.4% -1.7% 3.3% 18.0%

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Disclaimers and Disclosures

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