Morses Club: A misunderstood subprime lender about to thrive in a post-pandemic world

 Disclaimer: We are shareholders of Morses Club Plc

If Card Factory didn’t repel you last time, we bet this one will. But if you are like us, you know that it is precisely what opportunity smells and looks like. Take a deep breath and let us introduce you to Morses Club, you won’t be disappointed.

Elevator pitch:

Morses Club is the UK’s second largest provider of home-collected credit (“HCC”) with a market capitalization of £98m. It issues loans from £200 to £1,500 for a duration of 35 to 52 weeks at 75% to 95% interest rates to customers that typically have no fixed jobs, earn less than £15k per year (mostly from government assistance) and therefore have no access to mainstream lending. Key motives for taking out a loan include Christmas, holidays and unexpected household expenditures when an appliance/car/good breaks down. Having spent a significant amount of time working on the industry, we believe that HCC is profoundly misunderstood by investors and incorrectly assimilated to payday lenders and loan sharks. The cold truth is that, while unfortunate, HCC is a necessity for many households and most of them, as the regulator says in its High Cost Credit Review, “would be significantly worse-off if this line of credit was unavailable”. In addition, while headline interest rates look high, they must be compared to the impairment rate (c.23%) as well as the commission paid to agents (c.21%). All in all, well-run HCC providers earn c.20% return on capital, which, while good is hardly a sign of price gouging. This mismatch between investor expectations and reality therefore provides an extraordinary opportunity to buy a company that i) is cheap on pre-COVID metrics (6x P/E for the core HCC business, excluding the digital division), ii) will be a beneficiary of the post-pandemic rise in unemployment and iii) will see its #1 competitor Provident (44% market share) shut-down, creating a credible path for Net Income to more than double within 2-3 years. Morses is trading at less than 3.0x our “pro forma” 2023 earnings, which paves the way for a 3-bagger in the next 2 to 3 years (historical range since IPO was 9x - 12x). Keep in mind that these numbers do not include the optionality from the digital division (breakeven targeted in 2021) where Morses has a clear path to cross sell its existing HCC customer base and the potential to expand its addressable market by a wide margin. Lastly, insider ownership stands at 39.2%, providing for a good alignment of incentives (36.0% come from Morses’ reference shareholder – the Hay Wain Group – who has one seat on the board and 3.2% from the Executive Team). Also, Morses’ COO purchased £150k of shares four weeks ago, a clear sign of the things to come in our view. Obviously, such a valuation disconnect would not happen if there wasn’t material concerns around the industry/company. We take a look at both of the market’s biggest perceived risks (regulation and rising refund claims) and show why we think they’re overblown. Even if we are wrong and these risks materialize (highly unlikely in our view), we think that a permanent loss of capital would be very limited. 

Litigation Capital Management : Pioneering a new, high yielding asset class

Disclaimer: We are shareholders of Litigation Capital Management.

NB: Litigation Capital Management (“LCM”, ticker: LIT-LN) is listed in the UK while its financial reporting is in AUD, as the company was previously listed in Australia. All figures are expressed in AUD and the GBP/AUD exchange rate used in this write-up is 1.71.

Elevator pitch:

With valuations at or near all-time highs, what if we told you that there is an alternative asset class, litigation finance, where some players have been and will be able to double their capital every 3 years? Let us introduce you to Litigation Capital Management (“LCM”, ticker: LIT-LN), a 15-year-old litigation funder operating in Australia and the UK with a market capitalization of A$170m and a net cash position of A$25m. The company is not only a brilliant capital allocator, averaging 2.35x return on capital every 27 months over the last decade, but it is also on the verge of a significant inflection point, shifting its business from investing its own money to managing over A$700m for institutional investors in the next 2 years. Because of a lack of broker coverage and/or because it is unfamiliar with the industry, we believe that the market is asleep at the wheel, simultaneously undervaluing LCM’s legacy business and giving no credit to LCM’s asset management unit. This provides the perfect set-up for a multi-bagger as LCM keep on delivering impressive returns and signals more clearly to the market the financial implications of its push into asset management. Applying an 8% FCF to EV yield target to LCM’s legacy business would mean a valuation for the entire company of A$376m, or 122% above today’s level. Adding the asset management unit would push the valuation up to A$1,090m, 545% above the current market capitalization. Additionally, we believe there is significant upside to AUMs in the asset management division as institutional investors increasingly look for high, uncorrelated asset classes. We would not be surprised to see more funds or an upsizing of the currently announced funds in the coming months. Finally, LCM’s management is first-class, with the CEO and the non-executive chairman being two of the most highly respected figures in the industry. They own c.12% of the company.

Card Factory: Be Greedy When Others Are Fearful

Disclaimer: We are shareholders of Card Factory.

How would you like to invest in a UK greeting cards retailer with its entire store base closed because of COVID? Yes, you have read that sentence correctly. And no, we have not gone mad. Pinch your nose and let us introduce you to Card Factory.

Elevator Pitch

Card Factory is Britain’s leading specialist retailer of greeting cards, dressings and gifts, with an estate of over 1,000 operated stores. It was set-up in 1997 to provide a lower cost, higher quality card  alternative to incumbent chains. Key to this formula was to vertically integrate the supply chain in order to lower production costs, shorten lead times and get more relevant card designs. These efficiencies were then passed onto the customer and allowed Card Factory to undercut competitors on prices by 50% to 70%. The business model was successfully rolled-out across the UK and the company went on to capture 33% of the market by volume (20% by value) in less than 25 years. Speaking of the market, it is important to understand that there is an ingrained culture of sending cards in the UK, with approximately 87% of adults purchasing cards and each person sending on average 20 of them per  year[1]. It is a macro-resilient industry, as demonstrated by its growth throughout the GFC[2], and volumes have been rather stable despite increased online communications (down only 5% since 2012). Online penetration so far is low at 14% and is essentially focused on categories unavailable in stores. Given the highly experiential component of a card purchase (touching and comparing) as well as the c.£5 average basket value, we expect it to stay low in the longer-term. We therefore believe that Card Factory’s business should come back to near historical levels post-COVID and potentially better (two of its biggest competitors are in administration and plan to significantly reduce their footprints). Do not mistake us, Card Factory is far from being a good business, it has flat to slightly negative like-for-like sales while costs creep up by 2-3% per year, meaning constant margin pressure. On the other hand, everything has a price and despite its challenges, the company should generate c.£45-£50m of free cash flow in the medium-term (for a £110m market capitalization). Mr. Market however hates uncertainty and is so focused on the group’s near-term cash burn and debt load that no matter the price, it is simply unwilling to buy the business. Unsurprisingly, Card Factory trades at 2x normalized earnings. Our work on cash burn indicates that the business has enough liquidity to last until end of May with its stores closed while our analysis of COVID new cases, hospital ventilator beds occupancy and vaccinations indicates that the UK lockdown should be lifted by early/mid-April (an announcement is expected in the week of the 22^nd of February). We believe that this is a typical case of ‘time-horizon arbitrage’, where high uncertainty is mistaken for high risk. This set-up provides one of the best risk/reward we have ever seen, with immediate and tangible catalysts that could propel the shares significantly higher: If we are right, we believe the stock can quadruple and trade at 8x normalized earnings (Card Factory traded at 11x-12x earnings in 2018 and 2019) for a 12% free cash flow yield. If we are wrong, the business will need to raise up to £40m (c.35% dilution at current prices) to make it to the other side of the lockdown. At a similar 8x P/E, the shares would still end up being a 2.5 bagger.

Argentex: a low-cost high-service FX provider ready to take on high-cost low-service banks

Disclaimer: We are shareholders of Argentex. 

Elevator pitch:

Argentex delivers tailored foreign exchange (“FX”) advisory and execution services to UK corporates engaging in non-speculative, commercial currency transactions. As a riskless principal broker, the company only acts as an intermediary and makes money on the spread between the rate it executes the trade at and the one passed on to the client. It has a market capitalization of GBP140m and generates GBP29m of revenues from spot, forwards and options. Banks have 85%+ of the market today but this is eroding fast: FX is a marginal vertical for them – most of their money is made on equity/debt raise and M&A – and therefore client service is poor (FX desks are cut every year) and pricing uncompetitive (150 bps for a spot trade vs. 20bps at Argentex). As one of the best capitalized independent FX broker in the UK (GBP20m net cash as of Sept-20) and with a large, highly incentivized salesforce, we think Argentex can disproportionately benefit from this market share shift and grow at 25%+ p.a. for at least the next 5 years. Argentex’s economics are excellent, with 40%+ EBIT margins and 90%+ ROIC (adjusted for cash required for collateral purposes during the year). With little need for capital reinvestment, we think the company has a clear path to a 29% FCF CAGR, reaching GBP 38.8m by March 2026. Applying an 8% FCF to EV yield leads to an intrinsic value of GBPx 510 per share, or a 33.1% IRR on capital invested from current levels (GBPx 122 per share). Additionally, the company has just entered the European and Australian markets, providing for material upside optionality if it can replicate its model successfully. Finally, insider ownership is high with the three Founding Partners owning 25% of the company. They have significant knowledge and experience in FX markets and are all involved in the day-to-day operations of the business (2 co-CEOs and 1 Managing director).  

2MX Organic: A "free look" at a transaction carried out by France's best retail operator in the organic food space (Disclosure: Yes, it's a SPAC!)

Disclaimer: We are shareholders of 2MX Organic. 

At DK Value we like a good old low risk, high reward set-up. Usually, it takes the form of high-quality companies with good growth potential trading at significant discount to intrinsic value. However, when we have lots of cash sitting around, it can look like 2MX Organic, a French SPAC listed in December 2020 with the purpose of acquiring a leading distributor or a consumer goods player benefiting from the shift to more organic and sustainable food.

Yes, we know that between dilution, bad incentives and record-high business valuations, SPACs are a usually a terrible value proposition. However, when the SPAC’s CEO, Moez-Alexandre Zouari, in addition to its founder shares, buys 10% of the company for EUR30m at the IPO price (EUR 10), we take notice and dig deeper. 

Enlabs: Why shares are worth at least SEK60, 50% above Entain’s public offer

Disclaimer: We own 0.1% of Enlabs’ capital. You can find our initial investment case (28 July 2020) on this blog as well. 

We originally intended to use this platform to 1) share our point-by-point rebuttal to the 6 arguments laid out by Enlabs’ Independent Bid Committee’s (“IBC”) in favor of Entain’s SEK40 public offer [1] and 2) ask Enlabs’ shareholders not to tender their shares during the acceptance period (21 January – 18 February 2021). Then news came out yesterday that Hans Isoz, Enlabs’ 6^th biggest shareholder, had rallied enough shareholders to block the transaction, which is conditional to a 90% acceptance rate [2]. This is a very welcomed development, and we commend Mr. Isoz for stepping up for all Enlabs’ shareholders.

We hope with the following to provide a framework as to the extent to which Entain’s offer undervalues Enlabs. Importantly, we show why Enlabs is worth at least SEK60 per share (50% higher that Entain’s bid), even under the IBC’s flawed valuation methodology.

Enlabs - high tech, high growth, low price

Disclaimer: We are shareholders of Enlabs AB.

NB: Enlabs is listed in Sweden while its financial reporting is in Euro and under IFRS 16. All operational figures are therefore stated in Euros (EUR) and share prices are stated in Swedish Krona (SEK). The same applies for Global Gaming 555, mentioned later. The EUR/SEK exchange rate used in this write-up is 10.31.

Summary

Enlabs is the biggest gambling operator in the Baltics with a market capitalization of SEK1.39bn. It derives 94% of its EUR40m revenues from online operations where it has a 25%+ regional market share. Online penetration in the region is still low, in the high-teens range (vs. 40%+ in some Western European countries) but growing +15% per year thanks to excellent broadband and 4G coverage. We believe the company can disproportionately benefit from this secular tailwind thanks to its unique proprietary technological platform and the local restrictions on gambling advertising favoring incumbents’ brands. This moat currently translates into 30% EBITDA margins, little need for capital reinvestment and therefore a 90% ROIC ex-goodwill. 

A true asset light compounder, we think the company has a clear path to an 18% FCF CAGR, reaching EUR19m in 2024. Applying an 8% FCF to EV yield in 2024 leads to an intrinsic value of SEK48 per share, or a 21.5% IRR on capital invested from current levels (SEK22 per share). This does not include the optionality of entering neighboring markets (such as Finland, Belarus or Sweden), where we think the company is very well positioned. This could add north of SEK10 of intrinsic value per share. Lastly, insider ownership is high with the Chairman owning 21% of the company. He has significant knowledge and experience growing gambling operations in the Baltics and is involved in the day to day operations of the business.