tag:blogger.com,1999:blog-33730144695432021762024-03-05T21:42:18.088-08:00The DK Value BlogTwo value investors leaving no stones unturned: great companies, workouts, special sits...DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.comBlogger7125tag:blogger.com,1999:blog-3373014469543202176.post-64709826630526397512021-06-15T04:24:00.003-07:002021-06-15T04:32:17.281-07:00Morses Club: A misunderstood subprime lender about to thrive in a post-pandemic world<p> <i style="text-align: justify;"><span style="color: #cc0000;">Disclaimer: We are shareholders of Morses Club Plc</span></i></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">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. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Elevator pitch:<o:p></o:p></span></u></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">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. <b>This mismatch between investor expectations and reality therefore
provides an extraordinary opportunity to buy a company that i) is cheap on
pre-COVID metrics</b> (6x P/E for the core HCC
business, excluding the digital division), <b>ii) will be a beneficiary of the
post-pandemic rise in unemployment and iii) will see its #1 competitor Provident
(44% market share)<span style="color: red;"> </span>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)</b>.
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<span style="mso-spacerun: yes;"> </span>a permanent
loss of capital would be very limited.<span style="mso-spacerun: yes;"> <span></span></span></span></p><a name='more'></a> <o:p></o:p><p></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">1-<span style="font: 7pt "Times New Roman";"> </span></span></span></b><!--[endif]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB;">HCC
Market & Company Description <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">As you may not be familiar with the market,
let’s take a step back and go through an overview of the HCC industry and its
customers. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">What is it and how does it work? <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The way HCC works is rather simple. A new
customer will start by completing an online application on Morses’ website. If it
passes the first screening, its local Morses Club’s agent will be in touch to
finalise the details directly at its home (hence the name of the industry). This
agent model is key to HCC providers as agents typically live in the community
they serve, which helps create accountability and improves a lender’s knowledge
of its customer base. <span style="mso-spacerun: yes;"> </span>The prospective
customer will then have to fill with the agent a lengthy questionnaire
detailing its financial condition and weekly income/expenses. Morses will
typically cross check the information given to its agent on a central credit
database, but also crunch its own internal data in order to check for
discrepancies (for instance comparing the weekly electricity bill / rent of a
prospect to all its existing customers in the same area). If a loan is approved
(approval rate is only 30% at Morses), the agent will deliver the loan to the
customer either in cash or directly into its bank account. A loan’s duration
can typically range anywhere from 14 to 52 weeks at interest rates of between
40% and 100%. Repayment is made weekly (both principal and interest is repaid) either
to the agent in person at home or digitally. Contrary to other form of
unsecured high-cost credit, there’s no hidden fee for rearrangements or if
payments are missed. Customers value this weekly repayment system as it helps
them navigate their finances more easily and mitigate the risk of bad surprises
at the end of a loan.<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Market Overview</span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Home collected credit is part of the broader non-standard finance market
which is home to 10-12m consumers (20-25% of UK adults) who have difficulty
getting credit from traditional financial institutions due to their damaged or
sometimes non-existent credit history. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The HCC market in particular is a very
established market in the UK, having existed for over a hundred years. It
caters mainly to the unemployed and underemployed (working part-time while
looking for a job or on zero-hour contracts) who have low and
fluctuating-income streams. HCC customers typically take out small, unsecured,
short-term loans to finance events such as birthdays or Christmas, or
unexpected expenditures. The average loan value in the HCC market in 2020 was c.£770.
<b>The market is mature and has been rather stable in recent years at c.£1.1bn,
despite increased regulation and an employment rate (pre-COVID) at all-time
highs. <o:p></o:p></b></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
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<p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Source: Morses AR<o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The industry has consolidated around 3 national
players</span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> <b>who
represent c.80% of the market in 2020</b> as smaller firms have struggled to
keep pace with the FCA demands on technology and auditability. In addition,
these firms lacked the resources to invest in their digital offerings, which
made them highly uncompetitive in the marketplace. Provident is currently #1
with a 44% market share, followed by Morses at 28% and Loans at Home at 10%.<span style="color: red;"> </span><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">(See the last section for our comments
regarding investors’ concerns over sustainability and recent challenges with
CMCs, which we think are overdone)<o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;"><br /></span></b></p><p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;">Customers Snapshot<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The following snapshot is mostly derived from
the </span><span lang="FR-CH"><a href="https://www.fca.org.uk/publication/research/relending-high-cost-credit-market-narrative-report.pdf"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">PwC review</span></a></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">, which was requested by the FCA
(the HCC regulator) as part of its 2018 High Cost Credit Review. While this
study is based on 156 re-borrowers (whose profile might differ from a typical
customer), our discussions with industry participants lead us to consider it as
a good proxy for the overall HCC customer base.</span></p><p class="MsoNormal" style="text-align: justify;"><!--[endif]--><span lang="EN-GB" style="mso-ansi-language: EN-GB;">As shown by the demographical profile below, the typical HCC customer is
more likely to be a female, over 55 with annual income of less than £12k (most
of which coming from government benefits).<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKW136rbtvK_7pw65h1JIqU3JuFGZ8UTvuK1cccfXX0kauP_w8N7b8-y6mYbQDjv1yGYwzfc_WyU7Ozm-2UL0Xrd4MDMlDyDN51BhjGYCn6BmFxDwuTOSInkkjCMa-WxmW41EvcsKiWbtC/s859/Image+2.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="565" data-original-width="859" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKW136rbtvK_7pw65h1JIqU3JuFGZ8UTvuK1cccfXX0kauP_w8N7b8-y6mYbQDjv1yGYwzfc_WyU7Ozm-2UL0Xrd4MDMlDyDN51BhjGYCn6BmFxDwuTOSInkkjCMa-WxmW41EvcsKiWbtC/s320/Image+2.png" width="320" /></a></div><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> <br /></o:p></span><p></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The purpose of its borrowing was either to
purchase a specific item or fund a specific event (55% of the time) or to cover
different kind of daily expenses (25% of the time).</span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRvweUqsvKY-txYer8tjmlA84BXwhNbH-1rLimytSPqoycxSWS61wclf08RThdFNbnDk-R7XZKuVvROGg50LslU0TKpC_R-APwZwWeDWueaIITOBbDNT_UkCTd0H3_t-PTqqoQOIaEIix5/s660/Image+3.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="333" data-original-width="660" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRvweUqsvKY-txYer8tjmlA84BXwhNbH-1rLimytSPqoycxSWS61wclf08RThdFNbnDk-R7XZKuVvROGg50LslU0TKpC_R-APwZwWeDWueaIITOBbDNT_UkCTd0H3_t-PTqqoQOIaEIix5/s320/Image+3.png" width="320" /></a></div><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p><br /></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p><br /></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p><br /></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p><br /></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p><p class="MsoNormal" style="text-align: justify;">There are two main reasons why customers choose
HCC:</p>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="font-family: Symbol; mso-ansi-language: EN-GB; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">They
have a limited access to alternative products and traditional high-street
banks. Indeed, only 28% of HCC re-borrowers have a credit card and less than
20% have an agreed overdraft <i>(see below)</i> resulting in around ¾ of them considering
no other options for a loan. Of the small number that had considered
alternatives, the main options mentioned in the study were borrowing from
friends or family, selling something or getting a bank loan. “<b><i>Most were
confident that mainstream credit wasn’t an option and they either didn’t have
friends or family in a position to lend to them or were not comfortable asking</i>”</b>;<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="font-family: Symbol; mso-ansi-language: EN-GB; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The
other reason is “<i>because it was known in their community, often people knew
either an agent or someone borrowing from them, and most had been referred by a
friend or family member</i>”. Also cited was the “<i>convenience of applying in
home – or completing in home if starting the application over the phone –
receiving the loan in cash on the spot and having flexibility on repayments
when needed</i>”.<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5-Cv7q96zGlFlvnNsDfBnHtOk9dyajSHPMDx5PUkCKni4AHY6QcOsEBkLBYY1kvFFLi2wfVOwEPLcnQqBviQepWBCpyXYZ_guOE9YrrcE2lkayV5xNGwCxKl17SBhqqt3GXaXcjEtELh7/s661/Image+4.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="661" data-original-width="611" height="233" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5-Cv7q96zGlFlvnNsDfBnHtOk9dyajSHPMDx5PUkCKni4AHY6QcOsEBkLBYY1kvFFLi2wfVOwEPLcnQqBviQepWBCpyXYZ_guOE9YrrcE2lkayV5xNGwCxKl17SBhqqt3GXaXcjEtELh7/w215-h233/Image+4.png" width="215" /></a></div><br /><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Despite high interest rates, customers are very
loyal and do not really consider the cost of the loan, which help explains the
high amount of recurring business in the industry:<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l0 level1 lfo4; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="font-family: Symbol; mso-ansi-language: EN-GB; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The
cost of the loan is not their main concern: “<b><i>There was little to no
evidence in the qualitative interviews of customers shopping around</i></b>”
and “<i>little thought was given to the overall cost of each loan or the longer
term cost of repeat borrowing</i>”;<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo4; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="font-family: Symbol; mso-ansi-language: EN-GB; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">They
often use the same provider and for a long time: “<i>Customers described how
once they had started borrowing it soon became a habit as they found it
convenient, valued using a known provider and could get the money quickly</i>”.
“<b><i>60% of those in the quantitative research had been with the provider of
their most recent loan for 3 years or more</i></b>”.<o:p></o:p></span></p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo4; text-align: justify; text-indent: -18pt;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Company description<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Morses Club derives 90% of its GBP133m revenues
from its Home Collection Credit (HCC) division, where it provides small (£200
to £1,500) short term loans (35 or 52 weeks) to 220,000 customers at interest
rates of 75% or 95%. The impairment rate as a % of revenue is c.23% and
commissions paid to its self-employed agents is c.10%<span style="color: red;"> </span>of
customer repayments (21% of revenues), which incentivize agents to loan only to
customers they know will repay. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">On top of that, the group established an online
division in 2020 after acquiring Dot Dot Loans (digital short-term instalment
loans) and U Holdings (e-money current account). The idea behind this move was
to widen the company’s addressable market by targeting customers that needed
different types of loans. It has a customer base of c.30k people across the UK
to whom it offers loans of up to £5,000 on a maximum duration of 48 months.
Impairment rates are close to 50% online and accordingly, the company charges
higher rates at more than 100% (which both reflects the longer duration of the
loan book).<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Below</span><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> is a financial snapshot of Morses’ HCC and digital divisions that will
serve as the basis for the next section. The FY2018 appears twice as it is
restated for IFRS9 changes.</span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhZJUFGcltXVT_ka1Wpi0t00J339y4uT_ybFB1UVQK29TfWLC5W6rY5dgqWg1B-b21twCNGUFkmMaeHR58HINR2yp5pXKY6aIoLuEY-YcvV3Ga0_yILuft9FX-LjRcOivZNyTYdwfsoDPA7/s1234/Image+5.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="1191" data-original-width="1234" height="585" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhZJUFGcltXVT_ka1Wpi0t00J339y4uT_ybFB1UVQK29TfWLC5W6rY5dgqWg1B-b21twCNGUFkmMaeHR58HINR2yp5pXKY6aIoLuEY-YcvV3Ga0_yILuft9FX-LjRcOivZNyTYdwfsoDPA7/w605-h585/Image+5.png" width="605" /></a></div><br /><div class="separator" style="clear: both; text-align: center;"><br /></div><div class="separator" style="clear: both; text-align: center;"><br /></div><p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p></o:p></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiquwcIxEweuiRvYWlGOVyeFHx-Mf7ACMkepVIii00mv2nQSw0g1WdE4UHy8pDhTlhmKCqxeeHS0Tk7yU5jmnbqcZaYGVrBp12jd5mJitoUVDVIc-qRvwUY1KfDBE6CLnCyg6dK1_k_TTBT/s1125/Image+6.png" imageanchor="1" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="1125" data-original-width="679" height="679" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiquwcIxEweuiRvYWlGOVyeFHx-Mf7ACMkepVIii00mv2nQSw0g1WdE4UHy8pDhTlhmKCqxeeHS0Tk7yU5jmnbqcZaYGVrBp12jd5mJitoUVDVIc-qRvwUY1KfDBE6CLnCyg6dK1_k_TTBT/w409-h679/Image+6.png" width="409" /></a></div><br /><div class="separator" style="clear: both; text-align: center;"><br /></div><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">2-<span style="font: 7pt "Times New Roman";"> </span></span></span></b><!--[endif]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB;">Operational
set-up and valuation<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">A hidden/delayed COVID beneficiary<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Morses is set to fire on all cylinders in a
post-pandemic world. While COVID-19 has impacted customer numbers in the
short-term (they had nothing to spend their money on!), its long-term impact
has materially increased the company’s earning power in three ways:<o:p></o:p></span></p>
<p class="MsoListParagraph" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="mso-ansi-language: EN-GB; mso-bidi-font-weight: bold; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">As
the pandemic ends and the UK government cuts business support, rate reliefs
etc., unemployment should rise and <b>demand for Morses’ products, which are
counter-cyclical, will go through the roof; <o:p></o:p></b></span></p>
<p class="MsoNormal" style="text-align: justify;"><br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwcELiyx2rx5df0ngPIbGn6ly6Azv46c6Zx9BBtqHq8bMkNN6MmojvWEQimijivIj0r1gQRm4QQhK2WZGDNSQbfBqbZD2n9DGKWW-5gzcwSQZv1s2UDiZfrPnlJRkQAUSXI_Kn0ee3r5en/s771/Image+7.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="646" data-original-width="771" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwcELiyx2rx5df0ngPIbGn6ly6Azv46c6Zx9BBtqHq8bMkNN6MmojvWEQimijivIj0r1gQRm4QQhK2WZGDNSQbfBqbZD2n9DGKWW-5gzcwSQZv1s2UDiZfrPnlJRkQAUSXI_Kn0ee3r5en/s320/Image+7.png" width="320" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="mso-ansi-language: EN-GB; mso-bidi-font-weight: bold; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The
community of small, family-owned HCC businesses has been badly hit by the
pandemic and <b>the</b> <b>number of companies registered with the Consumer
Credit Association as HCC providers declined from 400 to 262 in 2020.</b> As
the last standing man, Morses is ideally positioned to capture a
disproportionate amount of market share from these businesses;<b><o:p></o:p></b></span></p>
<p class="MsoListParagraphCxSpMiddle" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-GB" style="mso-ansi-language: EN-GB; mso-bidi-font-weight: bold; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7pt "Times New Roman";">
</span></span></span><!--[endif]--><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Adoption
of remote payment options has been significant, going from 39% of collections
to 80% last year, with no impact on collection rates. This has led Morses to
rethink its operational structure as this shift to digital means agents are not
required to visit customers on a weekly basis but could rather visit them on a
bi-weekly basis or even once a month. As a result, the company managed to shed 30%
of its agents (c.600), lower their commission rate from 10% to 8.5% while increasing
the absolute commission per agent <i>(see below)</i>. <b>This change will</b> <b>enable
the group to save c.£4.4m, or 20% of HCC’s pre-pandemic profit before tax.</b></span></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><b><br /></b></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbIC7qRdrTCtFSoLdAAzC4MRu2MtiU3e7K4mKnLHhNxjlAcXcvK-XRFYWYAXS14pMiylyc-SKv82ufdjIFPwNcDB6Y_yFsYWqNwd7g7A-d81hYDLb8840JZqVfW5Z1gzdp1EEZbNWbQIVz/s356/Image+8.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="206" data-original-width="356" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbIC7qRdrTCtFSoLdAAzC4MRu2MtiU3e7K4mKnLHhNxjlAcXcvK-XRFYWYAXS14pMiylyc-SKv82ufdjIFPwNcDB6Y_yFsYWqNwd7g7A-d81hYDLb8840JZqVfW5Z1gzdp1EEZbNWbQIVz/s320/Image+8.png" width="320" /></a></div><br /><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The #1 HCC lender is exiting the industry<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Provident, HCC’s #1 player, announced three
weeks ago that it would wind-down its HCC business after years of losses
following a botched operational overhaul in 2017 (it tried to shift from an
agent-led model to an employee model) and an unsustainable level of refund
claims from past customers (Provident was a notoriously “aggressive”
underwriter of loans in the HCC space, which came back to haunt them - <span style="mso-spacerun: yes;"> </span>more on this later). Here is a recap of HCC customer
numbers (excluding digital customers) and market share among the top 3 HCC
players (which represent c.80% of the industry).</span></p><div><br /></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmIjVGY530TXyFZuCQAR8tXjvM5PU4n12YzDrdcnIXEBP3hkSF1yaTAk3qqh7YLzHsBvNfPb8bjBuxjHtLUzH9cfXarVpRG_mU5QDOFzkdJLFzC6dnhxd4smUQ6r_VCW2ClNuNVZnzs6lt/s572/Image+9.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="217" data-original-width="572" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmIjVGY530TXyFZuCQAR8tXjvM5PU4n12YzDrdcnIXEBP3hkSF1yaTAk3qqh7YLzHsBvNfPb8bjBuxjHtLUzH9cfXarVpRG_mU5QDOFzkdJLFzC6dnhxd4smUQ6r_VCW2ClNuNVZnzs6lt/s320/Image+9.png" width="320" /></a></div><br /><div><br /></div><div><br /></div><div><br /></div><div><br /></div><div><br /></div><div><br /></div><div><br /></div>
<p class="MsoNormal" style="text-align: justify;">It is important to mention here that while Provident lost c.400k
customers between 2016 and 2019, it did not flow to other players in the
industry as i) most of them were low quality and would not fit into their lending
criterias and ii) the industry shed many customers following some regulatory
changes. The situation is quite different today and Provident indicated in its
2019 results that its customer base had started to stabilize and indicated higher
customer quality.</p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">We expect that Morses, as the new largest
player will capture a disproportionate number of Provident customers in the aftermath
of its exit. We apply a 50% haircut to Provident’s 386k customer number to
reflect Morses tighter lending standards as well as Provident falling customer
base in recent years (although as we mentioned it had started to stabilize
pre-COVID). The following table shows how much additional Net Income Morses can
generate depending on what % of Provident customers post-haircut it acquires.<b>
It is our opinion that Morses can reasonably capture 40% to 60% of Provident
customers post-haircut and therefore add between £13m and £20m to its pre-COVID
£18m Net Income</b>. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyQrCSEnC4YMXG_FQ-n3fa8O2eQgatvmhLi30-XaWMZPTWIAN5ahbQX5E4VkLrmjzkbgLEkCQVrEOBCC4QER6t75If6lrJOUc3O2yRNZFKsIuv79UxN-9DgFWuZpnFKrGavxwXxrXmQV09/s1151/Image+10.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="327" data-original-width="1151" height="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyQrCSEnC4YMXG_FQ-n3fa8O2eQgatvmhLi30-XaWMZPTWIAN5ahbQX5E4VkLrmjzkbgLEkCQVrEOBCC4QER6t75If6lrJOUc3O2yRNZFKsIuv79UxN-9DgFWuZpnFKrGavxwXxrXmQV09/w623-h177/Image+10.png" width="623" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></b></p><p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Valuation <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Below is a table that sums up most of the
moving parts highlighted above in order to arrive at our estimate of the
business’ earning power for FY23 (ending March 2023). <o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiSmhFlH02L3u0cw1hhaVy2DX16VV_lxaocXG-qaXzd101HcWOnog_iVZQFgdpmDLH_CaPrfUC0K41cqy1lz3PLviYT3jpNn8-OgIPo9-zBVirGfJK_vkCCJVsJEJvvP2wOgJsCCdYkU3eW/s671/Image+11.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="479" data-original-width="671" height="397" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiSmhFlH02L3u0cw1hhaVy2DX16VV_lxaocXG-qaXzd101HcWOnog_iVZQFgdpmDLH_CaPrfUC0K41cqy1lz3PLviYT3jpNn8-OgIPo9-zBVirGfJK_vkCCJVsJEJvvP2wOgJsCCdYkU3eW/w557-h397/Image+11.png" width="557" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">As you can easily see, while Morses is on the
cusp of a significant inflection point in terms of customer and loan book growth,
this is far from being reflected in the current share price. </span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The company trades at 6x its
pre-COVID earnings and <b>c.3x our pro forma earnings estimate (c.30%+ free
cash flow yield)</b>. <b>As the catalysts we identified above become clearer to
the market, we expect shares to quickly recover to pre-pandemic levels. If
reality is anywhere near our base case expectations, we think that the share
price can triple in the next two years. <o:p></o:p></b></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Bear in mind that all of this excludes the
digital division, which has been losing c.£7m per year since it was acquired.
The business is now rightsized, and management expects breakeven for the end of
this year which<span style="color: red;"> </span>is highly realistic given the
fixed nature of the cost base and the customer growth numbers seen so far. <b>We
think that this division provides significant upside optionality</b> <b>if
management executes well.</b> Indeed, Morses online offering targets a wider
part of the 12m person UK non-standard credit market, which would significantly
increase the company’s addressable market. It is ideally positioned and can
jumpstart its growth by cross selling its HCC user base into digital products.
Indeed, Morses’ internal research shows that over 50% of its existing customers
want to use its e-money current account services and online banking services. <b>However,
until we see tangible proof of execution going the right way, we value the
digital division at £0.</b></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="font-size: 14pt; line-height: 107%; mso-ansi-language: EN-GB;"><o:p> </o:p></span></b></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB; mso-fareast-font-family: Calibri;"><span style="mso-list: Ignore;">3-<span style="font: 7pt "Times New Roman";"> </span></span></span></b><!--[endif]--><b><span lang="EN-GB" style="font-size: 14pt; line-height: 115%; mso-ansi-language: EN-GB;">Why
is it cheap? Regulatory and other risks<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">By now you must be thinking this is too good to
be true. And you are right, it is! <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">There are two main concerns in the market at
the moment and they pertain to i) the sustainability of the industry and ii) the
sharp increase in refund claims in the past year. We have done a lot of work on
these and think they are way too overblown. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Sustainability of HCC <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><!--[if gte vml 1]><v:shape id="Picture_x0020_1"
o:spid="_x0000_s1026" type="#_x0000_t75" style='position:absolute;left:0;
text-align:left;margin-left:3pt;margin-top:105.75pt;width:596.95pt;height:194.25pt;
z-index:251658245;visibility:visible;mso-wrap-style:square;
mso-width-percent:0;mso-height-percent:0;mso-wrap-distance-left:9pt;
mso-wrap-distance-top:0;mso-wrap-distance-right:9pt;
mso-wrap-distance-bottom:0;mso-position-horizontal:absolute;
mso-position-horizontal-relative:page;mso-position-vertical:absolute;
mso-position-vertical-relative:text;mso-width-percent:0;mso-height-percent:0;
mso-width-relative:page;mso-height-relative:page'>
<v:imagedata src="file:///C:/Users/CHRIST~1/AppData/Local/Temp/msohtmlclip1/01/clip_image025.png"
o:title=""/>
<w:wrap anchorx="page"/>
</v:shape><![endif]--><!--[if !vml]--><span style="height: 324px; left: 0px; margin-left: 12px; margin-top: 2667px; mso-ignore: vglayout; position: absolute; width: 995px; z-index: 251658245;"><br /></span><!--[endif]--><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Investors often mix up HCC with payday loans/ loan sharks or the wider
high cost credit industry and therefore consider the former as an industry at
risk of being wiped out by the regulator. Nothing could be further from the
truth. In its study of the UK’s High Cost Credit industry made on behalf of the
FCA (the high cost credit regulator), PwC studied the 6 most popular unsecured
high-cost lending products and concluded that <i>“<b>home collected credit
customers had the lowest indicators of harm of the 6 high cost credit products
covered in the study</b></i>”. You will find below the results of the PwC
survey comparing HCC and Payday Loan customers.</span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyNgJfew4P5gEYnX_MksH_ztOXU36mvoO_5FHjGXgzITaktmJcJNbg8vB9JOedrR9jRBKOCOpzHGJA1_41SIeMCd3wZu_cURwRRYu6MLb5gMjZWWrk7J2hrdKxsW73Uj0UkTRU-2_xWwqP/s1257/Image+12.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="409" data-original-width="1257" height="194" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyNgJfew4P5gEYnX_MksH_ztOXU36mvoO_5FHjGXgzITaktmJcJNbg8vB9JOedrR9jRBKOCOpzHGJA1_41SIeMCd3wZu_cURwRRYu6MLb5gMjZWWrk7J2hrdKxsW73Uj0UkTRU-2_xWwqP/w597-h194/Image+12.png" width="597" /></a></div><br /><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span><p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">DK View on regulation<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">In its </span><span lang="FR-CH"><a href="https://www.fca.org.uk/publication/consultation/cp18-12.pdf"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">2018 High-cost Credit Review</span></a></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> (which we highly recommend to any
prospective investor), the FCA highlights a few interesting points about its
perception of the HCC industry. Its concerns are mainly related to the risks of
repeat borrowing, rather than the price of a single loan: <o:p></o:p></span></p>
<p class="MsoNormal" style="margin-left: 35.4pt; text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">“<i>A number of comparisons have
been made during our study between home</i></span><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit and HCSTC, with calls to extend the HCSTC price cap to
home</span></i><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit. Such
considerations need to take into account the specific characteristics of the
particular products and <b>there are significant differences between HCSTC and
home</b></span></i><b><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i></b><b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit products</span></i></b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">. Home</span></i><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit loans will typically have more, and more frequent,
repayments than HCSTC, with few if any contingent charges and no balloon
payments at the end of the loan to clear the debt. <b>While the costs for some
home</b></span></i><b><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i></b><b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit consumers can
accumulate, this is the result of how some firms refinance consumers’ loans,
rather than the pricing of individual loans.</span></i></b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> Our proposals aim to address this source of
harm directly and we would expect to see reductions in the cumulative cost paid
by consumers<b>. We are therefore not currently planning to develop proposals
for a price cap for home</b></span></i><b><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i></b><b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected
credit but will revisit this issue when we assess the effectiveness of the
changes we are now proposing</span></i></b><u><span lang="EN-GB" style="mso-ansi-language: EN-GB;">”</span></u><span lang="EN-GB" style="mso-ansi-language: EN-GB;">.<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Relending is the FCA’s major point of contention,
arguing that some customers may be using HCC as a “revolving line of credit”
throughout the year, which quickly traps them into a circle of debt, given the
interest rate charged. However, it also stressed that “<b>repeat borrowing and
multiple borrowing is clearly a prevalent feature of home</b></span><b><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></b><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit use. We do not consider that this in itself is harmful.
Providing creditworthiness assessments are carried out effectively, weekly repayments
should be affordable and sustainable. Repeat borrowing can be a useful means of
managing cyclical income shortfalls</span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">”. Multiple loans arise for the need of families
to finance in a single year vacations, Christmas and the back-to-school period
for the kids, as well as other unscheduled expenses throughout the year.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Interestingly, the FCA found out that “<b><i>generally,
consumers are mainly positive about using home</i></b></span><b><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i></b><b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">collected credit</span></i></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">” and that “<b><i>many said that
they would be significantly worse</i></b></span><b><i><span lang="EN-GB" style="font-family: "Cambria Math",serif; mso-ansi-language: EN-GB; mso-bidi-font-family: "Cambria Math";">‑</span></i></b><b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">off if this line of credit were unavailable to
them</span></i></b><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">”. <o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The FCA highlights a few alternatives to HCC,
among which credit unions and local authorities but quickly points out several
barriers such as low appetite to finance riskier customers from and caps on
rates that credit unions can charge, which limit their participation in the
subprime market. In addition, the sector has seen a very low rate of market
entry since, as the Woolard Report points out, “<i>without economies of scale,
the higher costs of lending to sub-prime consumers, especially where relatively
small sums are being lent, is not profitable enough to encourage entry from
commercial firms without interest rates comparable to high cost credit.”<o:p></o:p></i></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">From our work on the industry, we do not think that
the FCA will impose material changes on relending in the coming years. But let’s
say we are wrong and the FCA regulates repeat borrowing: What would happen to
our numbers? The following chart shows the distribution of HCC loans
origination per borrower:<o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFaxsUMD3RJOiESd_zGvTCoP6i_Z_wLV6fniNKJzHv8socM-1rspaLMkX6fxEPiJH4gc_CbHg0xoGEccV_KDD0ntjErKbWfp8K78xHROjEsANpSaNYeURY9ruEa4nb4PrARXuCEmQu1DVL/s1018/Image+13.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="690" data-original-width="1018" height="274" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhFaxsUMD3RJOiESd_zGvTCoP6i_Z_wLV6fniNKJzHv8socM-1rspaLMkX6fxEPiJH4gc_CbHg0xoGEccV_KDD0ntjErKbWfp8K78xHROjEsANpSaNYeURY9ruEa4nb4PrARXuCEmQu1DVL/w404-h274/Image+13.png" width="404" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">We assume anything above 3 loans per customer
per year is considered excessive by the FCA (in line with our perception) and
forbidden outright. As most reputable HCC firms do affordability assessments
for every single additional loan they issue to customers, we would expect a
regulation – if there ever is one – to be less rule-based and leave more room
to HCC providers. Anyway, the following table shows that based on our
calculations, such a regulation would reduce loans issued by c.21.5%.<span style="color: red;"> </span>This include a mitigation factor from all customers
above the 3 loans per year threshold shifting to only 3 loans per year. <o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxHbs5wBgZcuePoNdCdKm048_mnNCkbrUU9g1-tJ1v4mwekRPGpE2Wm7LQtPY56vAr67767e7C9I4zP8Td1-WylepLDrAVWGqPSq86dr7Qh8amY9fwBfkFwUg-b39zc8o6pY4URTEJN1mL/s419/Image+14.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="342" data-original-width="419" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxHbs5wBgZcuePoNdCdKm048_mnNCkbrUU9g1-tJ1v4mwekRPGpE2Wm7LQtPY56vAr67767e7C9I4zP8Td1-WylepLDrAVWGqPSq86dr7Qh8amY9fwBfkFwUg-b39zc8o6pY4URTEJN1mL/s320/Image+14.png" width="320" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">We then apply this 21.5% haircut to our base
case amount of loan issued. We increase the interest charged to consumer from
67% to 70% as we believe that Morses would use its “pricing power” in order to offset
part of these regulatory changes. Overall, we estimate that while the regulation
would reduce Net Income by c.40% compared to our base case, it would still be
20% above 2019 levels.<b> Shares would then trade at 4.4x our Net Income
estimate, which would simply be way too cheap once regulatory concerns are
“de-risked”.</b></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfvdLw2H46KYfMW-gslWenDAlrOhBQawbwUbdqstyE3MjQA3cAI9z3LPffGm8kiuJNJMTzSf8aFtl51CfA4tnFNTMKCu-3y5Wtq__mriLqmsmImOCAKYCWLRQiBDODTPM9mFEDz4v6lJxE/s671/Image+15.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="530" data-original-width="671" height="374" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfvdLw2H46KYfMW-gslWenDAlrOhBQawbwUbdqstyE3MjQA3cAI9z3LPffGm8kiuJNJMTzSf8aFtl51CfA4tnFNTMKCu-3y5Wtq__mriLqmsmImOCAKYCWLRQiBDODTPM9mFEDz4v6lJxE/w473-h374/Image+15.png" width="473" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;">NB: the Net Income from Provident customers
acquired has been adjusted to reflect a similar customer number adjustment. <o:p></o:p></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The flood of refund claims</span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Because of the FCA’s lack of clarity regarding
what constitutes “problematic” repeat borrowing, there has been in 2020 a significant
step up in claims for refund by Claims Management Companies (“CMCs”) <span style="mso-spacerun: yes;"> </span>on behalf of past HCC customers. For instance,
Morses went on from paying £0.4m in FY20 to £4m in FY21. Usually the claim process
carries two steps: i) claims are brought to the attention of the company, which
then rejects it or negotiates a settlement; ii) if both parties are unable to
resolve the issue, then the claim is referred to the financial ombudsman
service (“FOS”). Successful claims generally require the reimbursement of
interests paid by the customer and an 8% interest penalty. CMCs then take a cut
of the amount paid to the customer by lenders (typically a percentage). <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Importantly, the way CMCs gather all these claims
in a cost-effective way is through online ads directed to past HCC customers (“Ever
took out a doorstep loan? You could get a refund! Fill in our form to see if
you are eligible”). This is very similar to what happened to airlines in Europe
a couple of years ago with EU 261. The tables below gives an overview of all
the complaints that have been reported to the FCA by the companies. It is
important to keep in mind that this data includes all kind of complaints
received (like somebody not having been able to access its online account
etc.). Nonetheless, we think that the data is directionally correct.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><o:p> </o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_sCaOomf39ADhSXBl_a1etre2ZCmYggrv4tSP4zBVFXTKPemmUVA57MPvd3ZnT-gJTzMk25E9bftCH4q1ahUM8J13eS83-ZyOk4YITIKDo4DxT1Fr6G8cQfcI-2bG8l49IyL5uksP-shI/s597/Image+16.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="597" data-original-width="475" height="359" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh_sCaOomf39ADhSXBl_a1etre2ZCmYggrv4tSP4zBVFXTKPemmUVA57MPvd3ZnT-gJTzMk25E9bftCH4q1ahUM8J13eS83-ZyOk4YITIKDo4DxT1Fr6G8cQfcI-2bG8l49IyL5uksP-shI/w286-h359/Image+16.png" width="286" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="color: #595959; mso-ansi-language: EN-GB; mso-themecolor: text1; mso-themetint: 166;"><br /></span></i></p><p class="MsoNormal" style="text-align: justify;"><i><span lang="EN-GB" style="color: #595959; mso-ansi-language: EN-GB; mso-themecolor: text1; mso-themetint: 166;">As an aside, it is interesting to note that Morses’ upheld rate is the
lowest among major players (while Provident has the highest), which indicates
better underwriting standards – at least compared to peers. This is further
confirmed by the upheld claim per customer rate of Morses being the lowest
among HCC participants. Also, bear in mind that current refund claims stem from
past customers, which means that i) the 2020 upheld per customer ratio is
artificially boosted by the COVID-linked temporary loss of customers and ii)
Provident’s ratio is overestimated to some degree because it lost more than
half of its customers in recent years.<o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">As you can easily see, 95%+ of claims have
centered around two companies</span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">: <b>The first is Provident</b>, because of the sheer size it had in the
past (its HCC division had in 2015 c.800k customers, 4x the size of Morses) and
also because it had notoriously been “aggressive” in its underwriting process. <b>The
second is Amigo</b>, a provider of guarantor loans (a subsegment of the high
cost credit market, similar to HCC). These loans are offered to borrowers with
weak credit histories if they have friends or family willing to bear the risk
of default. This would typically reduce the interest rate paid from 70/90% in
HCC to c.40/50%. The sector was ripe for abuse (a “guarantor” signature is
easily forged) and Amigo’s <span style="mso-spacerun: yes;"> </span>poor
compliance/KYC systems led it to carry a significant amount of irresponsible
lending over the years. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">Why does it matter? <b>Well,</b> <b>these two
companies both</b> <b>happen to have entered schemes of arrangement this year (21<sup>st</sup>
January for Amigo and 15<sup>th</sup> March for Provident)</b>. The general
purpose of such a scheme is to put an absolute cap on certain creditors’ claims
(in this case the CMCs’) – generally at a discount to their face value – in
order to avoid bankruptcy. So far only Amigo’s scheme terms have been made
public: they intend to contribute £15 to £35 million to the scheme and 15% of
profits over the next four years. This will effectively cap the claims at c.10%
of face value. Despite the magnitude of the haircut, 95.09% of creditors voted
in favour of the scheme (the alternative being receiving £0 as the Amigo goes
bust!). While the court didn’t sanction these terms (the </span><span lang="FR-CH"><a href="https://www.amigoscheme.co.uk/docs/AllSchemeltdJudgement.pdf"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">judgment</span></a></span><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> is a fascinating read), we expect a
revised deal to c.20%/30% of claims to be approved. Provident’s scheme should
be very similar to Amigo’s, although the details have not been published yet. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-GB" style="mso-ansi-language: EN-GB;">The bottom line is, even if the deal ends up
being a 50% recovery for creditors,</span></b><span lang="EN-GB" style="mso-ansi-language: EN-GB;"> <b>the incentives for CMCs to bring in new
clients have effectively disappeared. </b>Indeed, from now on, whether CMCs
bring in 0 new clients or 1m new clients, the absolute amount set aside by
Provident and Amigo in their respective schemes of arrangement will be
unchanged. It would make no sense for CMCs to spend money on online ads to make
0 incremental revenue (since their fees are a % of repayments). <b>Because
Amigo and Provident represented such a large amount of the profit pool (90%+ if
the FCA statistics are a good proxy), we would expect the biggest CMCs to
retreat from the market as i) the unit economics of an ad will considerably
worsen (since 90% of customers acquired in the past will not be revenue
generator anymore) and ii) it becomes a marginal revenue driver.</b> <b><span style="mso-spacerun: yes;"> </span></b>Of course, smaller firms may still make a
living going after Morses and Loans at Home, but the retreat from bigger firms will
nonetheless materially decrease the amounts paid by these companies longer
term. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">What if we are wrong? The following table shows
the impact adding the previous section and a pessimistic scenario for claims
(tripling to £12m). NB: we assume the company increases its interest rate
charged to clients to 75% to partially offset the claim impact.</span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5UhLP0hVaaicXQ-Fp0WMptffGJK99y-ty9RuRvHWEsU826UagGiR2CyLaV1_3tukrLHM3iWxfQLfLHxd8UQJVHOHtC02w41ZQXXzNuMx3TsFrm4Maa6ZWyDeXVvqDeV4DSHRBXTGMFHxB/s693/Image+17.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="530" data-original-width="693" height="323" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5UhLP0hVaaicXQ-Fp0WMptffGJK99y-ty9RuRvHWEsU826UagGiR2CyLaV1_3tukrLHM3iWxfQLfLHxd8UQJVHOHtC02w41ZQXXzNuMx3TsFrm4Maa6ZWyDeXVvqDeV4DSHRBXTGMFHxB/w422-h323/Image+17.png" width="422" /></a></div><br /><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="mso-ansi-language: EN-GB;">While this scenario would completely erase the upside,
<b>the fact that shares would still be worth a small 20% premium to the current
share price at 10x PE is indicative of the significant asymmetrical
risk/reward.</b> <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-GB" style="color: #4472c4; mso-ansi-language: EN-GB; mso-themecolor: accent1;"><o:p> </o:p></span></p><div class="separator" style="clear: both; text-align: center;"><br /></div><br />DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com14tag:blogger.com,1999:blog-3373014469543202176.post-11686439032885610882021-03-15T04:26:00.009-07:002021-03-15T06:28:55.445-07:00Litigation Capital Management : Pioneering a new, high yielding asset class<p><i style="text-align: justify;"><span style="color: #c00000;">Disclaimer:
We are shareholders of Litigation Capital Management.</span></i></p><p class="Body" style="text-align: justify;"><i><span style="color: #c00000;">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.</span></i><i><span style="color: #c00000;"><o:p></o:p></span></i></p>
<p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"><b><u>Elevator pitch:<o:p></o:p></u></b></p>
<p class="Body" style="text-align: justify;">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. <b>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</b>. 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. <o:p></o:p></p>
<p class="Body" style="text-align: justify;"><o:p><span></span></o:p></p><a name='more'></a> <p></p><p class="Body" style="text-align: justify;"><o:p><br /></o:p></p>
<p class="ListParagraph" style="margin-left: 34.5pt; mso-list: l0 level1 lfo2; tab-stops: list 34.5pt; text-align: justify; text-indent: -16.5pt;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-xDrYN0RojmWnprS1WvGVM3Ecy4ujNm2edhlYuRKuqUp5N73odQXwoGJtxU8fNBvgTzMwPIj2uO6ZPfe6uAcm1DGPZfWU0pUAnjuV7o0V8Sd6_u7-_bmwVioYzR2tw4DS8KZAcQGKYhyk/s325/LCM+1.PNG" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="218" data-original-width="325" height="132" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-xDrYN0RojmWnprS1WvGVM3Ecy4ujNm2edhlYuRKuqUp5N73odQXwoGJtxU8fNBvgTzMwPIj2uO6ZPfe6uAcm1DGPZfWU0pUAnjuV7o0V8Sd6_u7-_bmwVioYzR2tw4DS8KZAcQGKYhyk/w195-h132/LCM+1.PNG" width="195" /></a></div><!--[if !supportLists]--><b><span lang="FR" style="line-height: 107%;">1.<span style="font-family: "Times New Roman"; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; font-variant: normal; font-weight: normal; line-height: normal;">
</span></span></b><b><span style="line-height: 107%;">Company
description</span></b><b><span lang="FR" style="font-size: 12pt; line-height: 107%;"><o:p></o:p></span></b><p></p>
<p class="Body" style="text-align: justify;"></p>LCM is a UK-listed alternative asset
manager specializing in disputes financing solutions with offices in the UK,
Australia, Singapore and Hong-Kong. It has a market capitalization of A$170m
and generates revenues (A$38.4m in 2020) from direct investments made with its
own capital. The company recently launched an asset management arm, with a
first fund of A$225m, and will start collecting performance fees in the coming
years. <div>Its current,
own balance sheet portfolio of A$171m (both amount funded and committed) is
made up of commercial disputes (32%), class actions (33%), insolvency claims
(12%) and international arbitration cases (23%).<o:p></o:p><p></p>
<p class="Body" style="text-align: justify;">Being originally focused on the
Australian market, the addition of a UK team in 2018 presented the company with
a significant opportunity to enter Europe with a strong and immediate presence
to the point that the EMEA region now accounts for c.50% of revenues.<span style="mso-spacerun: yes;"> </span><o:p></o:p></p>
<p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"><b><u style="text-underline: #2F5496;"><span style="color: #2f5496;">A primer on litigation funding<o:p></o:p></span></u></b></p>
<p class="Body" style="text-align: justify;"><span style="color: #2f5496;">Litigation
funding is the practice whereby a third-party funds the legal expenses of a
plaintiff in exchange for a cut of any proceeds that result from the dispute.
The cut is determined either as a percentage of the proceeds or as a multiple
of capital deployed. The typical investment cycle of a claim can be illustrated
by the following:</span><span style="color: #2f5496;"><o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDIwFW8_qyalxRObG1r8LiZuLu3fFurNo4ODn-yxnNiwpZHBFm05orP7dH1xgmTnOT5_OxZzajWz-RPL9JHxO9jbd7qSazyffDQ6Vb3Ln7RpJ80BPrpOKUThToFSePf77Ne5SX6bLMKcCd/s551/LCM+2.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="540" data-original-width="551" height="201" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDIwFW8_qyalxRObG1r8LiZuLu3fFurNo4ODn-yxnNiwpZHBFm05orP7dH1xgmTnOT5_OxZzajWz-RPL9JHxO9jbd7qSazyffDQ6Vb3Ln7RpJ80BPrpOKUThToFSePf77Ne5SX6bLMKcCd/w205-h201/LCM+2.PNG" width="205" /></a></div>
<p class="Body" style="text-align: justify;"><span style="color: #2f5496;">This type
of financing originally appeared in Australia 20 years ago but is increasingly
going mainstream as (i) it helps equalize access to the legal system and (ii)
it frees-up valuable working capital for companies engaged in disputes. </span><b><span style="color: #2f5496;">Despite its growing popularity,</span></b><span style="color: #2f5496;"> </span><b><span style="color: #2f5496;">penetration of
litigation funding is still low, at c.5% of total legal expenses in countries
where it is the most developed</span></b><span style="color: #2f5496;"> (UK, US
and Australia). Among the main listed players, we find Burford Capital (Mkt
Cap: £1.35bn) and Omni Bridgeway (Market Cap: £515m).</span><span style="color: #2f5496;"><o:p></o:p></span></p>
<p class="Body" style="text-align: justify;"><span style="color: #2f5496;">While
initially focused on insolvency claims, the past 10 years have seen a
significant expansion of the industry to commercial claims, class actions and
international arbitration in an increasing number of countries. Key drivers of
this growth have been the prohibitive cost for client of large-scale
litigation, the desire to avoid the uncertainties of litigation as well as the
recognition of the value of litigation funders as an accounting and working
capital tool (no need to expense on the P&L and see cash outflows for legal
bills). One specific segment of the industry currently experiencing significant
growth is the corporate portfolios, where litigation funders provide capital to
multiple disputes of a single corporate. This allows funders to take on
multiple cases and minimize risk as their capital is now collateralized against
an entire pool of disputes (reducing the risk of a binary outcome from a single
case). </span><span style="color: #2f5496;"><o:p></o:p></span></p>
<p class="Body" style="text-align: justify;"><span style="color: #2f5496;">Interestingly,
institutional investors are becoming more and more acquainted with litigation
funding as an asset class and its non-correlated, high return nature. </span><span style="color: #2f5496;"><o:p></o:p></span></p>
<p class="Body" style="text-align: justify;">The company had an outstanding track
record over the last decade, with an average return on capital of 2.38x (Money
on Invested Capital “MOIC” or Money on Money multiple, “MoM”) over 27 months.
The company’s hit ratio has been even more impressive, with 226 cases financed
since its inception in 1998 and only 11 losses suffered (of which just 6 were
adjudicated by a court or tribunal unfavorably), implying a loss ratio below
5%.<o:p></o:p></p>
<p class="Body" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3xsTUzbMU_YsrbejenT31BEjKwkTcsuhvhay076mm7OnS4BhYTy2zAEONd_9cexNOITM4BGAy4TBWyaptQQdpavS4PJqcaqUG9VxQc3UVCjbE80k1xu_6nIr6oPcHZtnaHTala8sojt35/s891/LCM+3.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="204" data-original-width="891" height="139" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3xsTUzbMU_YsrbejenT31BEjKwkTcsuhvhay076mm7OnS4BhYTy2zAEONd_9cexNOITM4BGAy4TBWyaptQQdpavS4PJqcaqUG9VxQc3UVCjbE80k1xu_6nIr6oPcHZtnaHTala8sojt35/w609-h139/LCM+3.PNG" width="609" /></a></div><o:p> </o:p><span style="text-align: justify;">Lastly, unlike its listed peers
Burford and Omni Bridgeway, LCM adopts a conservative accounting standard which
recognizes revenue only when it is earned in contrast to ascribing a fair value
to its book of investments from time to time (which, in essence, would give
management the opportunity to “mark-to-model” its investment portfolio and
recognize non-cash earnings – this issue was made abundantly clear by Muddy
Waters’ </span><span class="Hyperlink0" style="text-align: justify;"><span style="color: black;"><a href="https://www.muddywatersresearch.com/research/bur/mw-is-short/">report</a><span face="Calibri, sans-serif"><span style="font-size: 14.6667px;"> </span></span></span></span><span style="text-align: justify;">on Burford). This certainly makes
LCM’s results more lumpy and harder to forecast, but for investors willing to
put in the work, this should not matter and on the contrary be welcomed.</span></div><div><p class="Body" style="text-align: justify;"><o:p></o:p></p>
<p class="Body" style="text-align: justify;"><o:p> </o:p></p>
<p class="ListParagraph" style="mso-list: l0 level1 lfo3; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span style="line-height: 107%;"><span style="font-size: 12pt;"> </span> 2.<span style="font-family: "Times New Roman"; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; font-variant: normal; font-weight: normal; line-height: normal;"> </span></span></b><!--[endif]--><b><span style="line-height: 107%;">Moat and
Investment Process<span style="font-size: 12pt;"><o:p></o:p></span></span></b></p>
<p class="Body" style="text-align: justify;">The nature of capitalism is that
excess returns will eventually be competed out by new entrants. It was
therefore key for us to assess whether LCM has an enduring moat that will
protect its returns in the coming years. Let us go through why we think it is
the case. <o:p></o:p></p>
<p class="Body" style="text-align: justify;"><o:p> </o:p></p>
<p class="Body" style="text-align: justify;"><u>A strong, mostly proprietary,
origination network<o:p></o:p></u></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">Litigation
finance is a very relationship-driven industry, with most cases being brought
to a funders’ attention by referral. LCM benefits strongly from its
long-standing reputation and relationships with lawyers, accountants, and
insolvency practitioners. Law firms for instance, which represent the bulk of
new cases, typically work with only one or two litigation funders that they
know they can work with well. <o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">This can
be seen in the numbers: In the southern hemisphere, where LCM has spent the
last two decades building an extensive network of relationships, it is the sole
litigation funder recommended to the client in 65%-70% of cases while in the
UK, it is closer to 60%. <o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">In
addition, we would expect law firms to be very picky about which litigation
funder they endorse as the consequences of recommending to a client a new
funder that fails to honor its funding commitment mid-case or that does not
work well with them could prove fatal to their relationship. <o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">We think
this will result in an industry where new cases are increasingly locked up by a
small amount of well-known global litigation funders, which should prevent new
entrants and be supportive for the industry returns over the mid to long term. <o:p></o:p></span></p>
<p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"><u>A disciplined project selection and
an active case involvement<o:p></o:p></u></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">Given the
specific skills required to identify the most promising litigation cases, LCM
assembled a team of investment managers that are all ex-practitioners with
experience in their respective fields and know it from the inside. <o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">LCM
considers applications for financing against the following 5 key criteria: 1)
there must be proportionality between the size of the claim and the funding
commitment; 2) the claim must be based on clear legal principles and not any
novel points of law; 3) there should be written evidence supporting the claim;
4) the defendant must have the capacity to meet the expected amount of the
claim and 5) the law firm pursuing the claim must have relevant expertise in
the concerned field.<o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">Its due
diligence generally takes the form of a multi-stage approval process, involving
a minimum of three investment managers and the partners that will stress-test
and bring as many views as possible. LCM will also sometime call specialists
for peer-review. As a result, only 3-5% of cases end-up being approved.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">We believe
that the incentives of the investment managers support a collaborative
environment and foster proper capital allocation over the long term. Indeed,
the main criteria include the number of quality applications they originated,
the financial performance of their investments as well as the financial
performance of the group’s investments. Only 35%<span style="mso-spacerun: yes;"> </span>of the annual bonus is cash, with the balance
being received in stock options vesting over 3 years.<o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l2 level1 lfo5; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">On top of
that, LCM takes an active role in managing its projects which generally involves
maintaining a close working relationship with the funded party and its legal
team. It also ensures that the solicitors and barristers engaged by the
claimant are proficient and will perform the work on time, and cost
effectively. <o:p></o:p></span></p>
<p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"><u>An experienced team of litigation
lawyers<o:p></o:p></u></p>
<p class="Body" style="text-align: justify;">LCM is led by a high-caliber pair of
lawyers who are considered pioneers of litigation finance and boast more than
40 years of cumulative experience:<u><o:p></o:p></u></p>
<p class="ListParagraph" style="mso-list: l4 level1 lfo7; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">LCM’s CEO,
Patrick Moloney, started practicing law in 1996 and established his own
litigation firm in 2003, at the early stages of the industry. He became
Director of LCM the same year and acted in more than 200 commercial cases since
then, mostly in Australia. <o:p></o:p></span></p>
<p class="ListParagraph" style="mso-list: l4 level1 lfo7; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">Nick
Rowles-Davis, the Non-Executive Chairman leading the UK team, is among the most
respected practitioner in the industry. He most notably created and refined the
concept of corporate portfolios in litigation finance. He was previously
Managing Director at Burford Capital, before founding Chancery Capital with a
clear focus on corporate client portfolios. He is also the Director of the
Association of Litigation Funders of England & Wales. <o:p></o:p></span></p>
<p class="Body" style="text-align: justify;">This impressive duo holds a
substantial stake in the company as Patrick Moloney owns 7.76% of the company
and Nick has been granted stock options to the extent of 4.25% of the capital
when he joined in 2018. <u><o:p></o:p></u></p>
<p class="ListParagraph" style="text-align: justify;"><br /></p>
<p class="ListParagraph" style="mso-list: l0 level1 lfo8; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span style="line-height: 107%;"> 3.<span style="font-family: "Times New Roman"; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-variant-east-asian: normal; font-variant-ligatures: normal; font-variant-position: normal; font-variant: normal; font-weight: normal; line-height: normal;"> </span></span></b><!--[endif]--><b><span style="line-height: 107%;">Where is the
opportunity and why does it exist?<span style="font-size: 12pt;"><o:p></o:p></span></span></b></p>
<p class="Body" style="text-align: justify;">The opportunity is twofold and to a
large extent explained by both LCM’s conservative cash accounting, which
creates earnings lumpiness and its relisting in 2018 in the UK (from
Australia), where investors are less familiar and/or wary of the industry (cf
Muddy Water’s short report on Burford). <o:p></o:p></p>
<p class="Body" style="text-align: justify;">First, we think that the market is
significantly underestimating LCM’s ability to put its own capital to work at
high MOIC rates. Indeed, if we take a 2.35x multiple (in line with the
company’s historical track record) and keep legal investments flat at A$40m per
year, the company should be able to generate free cash flow of A$30.1m per
annum.<o:p></o:p></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVCGDXQ0Xi6H8dUgXirspM5F28LtnWTfEsRLPxffbSFerbZhbJnmYioIt1kf_4eFRbvtqMm6c-dXbMoKj-xfsb6B4FdEwHaBl0RruCTYLxpD6whzCbsBoeEFJFzMggNsVPqvjBFzPE-bEh/s758/LCM+4.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="752" data-original-width="758" height="574" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjVCGDXQ0Xi6H8dUgXirspM5F28LtnWTfEsRLPxffbSFerbZhbJnmYioIt1kf_4eFRbvtqMm6c-dXbMoKj-xfsb6B4FdEwHaBl0RruCTYLxpD6whzCbsBoeEFJFzMggNsVPqvjBFzPE-bEh/w578-h574/LCM+4.PNG" width="578" /></a></div><div><br /></div>
<p class="Body" style="text-align: justify;"><!--[if gte vml 1]><v:roundrect id="_x0000_s1033"
alt="Rectangle : coins arrondis 14" style='position:absolute;left:0;
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</v:roundrect><![endif]--><!--[if !vml]--><span style="height: 20px; left: 0px; margin-left: 133px; margin-top: 3268px; mso-ignore: vglayout; position: absolute; width: 771px; z-index: 251659264;"><br /></span><!--[endif]--><b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><p class="Body" style="text-align: justify;"><b><b><br /></b></b></p><b>At
an 8% free cash flow yield target, LCM’s market cap should reach A$376.3m in
2025, 122% above today’s level</b>. Put another way, and as shown by the FCF
sensitivity table below, the market is currently pricing return on capital of
1.80x, i.e. a 25% reduction over historical levels. <o:p></o:p><p></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKbjP9g9PDBpV9wjKyb5LtDuZwIOs3bgbSIDlYQRjzRtIJqAAXm8ZwzIaATO3JPQR2qYFXJgCLxhxJziRhcMbMzr5wgDrpJEe_2gKgITu1J1HqPmofMzqWxi8JWCXJPzhva_svEnNaaH2J/s762/LCM+5.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="131" data-original-width="762" height="103" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKbjP9g9PDBpV9wjKyb5LtDuZwIOs3bgbSIDlYQRjzRtIJqAAXm8ZwzIaATO3JPQR2qYFXJgCLxhxJziRhcMbMzr5wgDrpJEe_2gKgITu1J1HqPmofMzqWxi8JWCXJPzhva_svEnNaaH2J/w599-h103/LCM+5.PNG" width="599" /></a></div><div class="separator" style="clear: both; text-align: center;"><br /></div>
<p class="Body" style="text-align: justify;"><i>Note: Because capital investment
each year relates to starting, ongoing and ending cases, we expect a phasing of
total proceeds as follow: 25% collected in the first year, 45% in the second
year and 30% in the third year. See below a theoretical example. <o:p></o:p></i></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2do1K498mrJ9CIgsoYjKftxBEKHPPR4bVoWP8-OQfX9X9As4IEAKx7RF62rwHcoHsPkL-lksge61K2AZ5_VIWNJAC8q_p9c20-fAHnPDDh10BTo3C639auZKvJThUtjAT-Ux7RoAqZIEh/s800/LCM+6.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="148" data-original-width="800" height="110" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2do1K498mrJ9CIgsoYjKftxBEKHPPR4bVoWP8-OQfX9X9As4IEAKx7RF62rwHcoHsPkL-lksge61K2AZ5_VIWNJAC8q_p9c20-fAHnPDDh10BTo3C639auZKvJThUtjAT-Ux7RoAqZIEh/w596-h110/LCM+6.PNG" width="596" /></a></div><p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"><br /></p><p class="Body" style="text-align: justify;"><br /></p><p class="Body" style="text-align: justify;">The second leg of the opportunity,
however, is what could make the stock a multi-bagger: <b><u>LCM is shifting its
business form the current capital intensive, own balance sheet investments, to
an asset light, highly scalable asset management business. <o:p></o:p></u></b></p>
<p class="Body" style="text-align: justify;">The company has so far raised a A$225m
fund (US$150m) and is planning to launch a second fund of A$450m-500m
(US$300m-350m), when the former is 75% committed. This should happen fairly
soon since in September 2020 the company said it was already 60% committed
(only 6 months after its official launch in March 2020). The company will get a
35% performance fee if the invested capital’s IRR is superior to 20% (25% if
IRR is below 20%). Based on what management is seeing in its pipeline of cases,
it is confident that it can invest this capital at a similar MOIC rate as it
did in the past and has done so on the fund’s invested capital so far.</p>
<p class="Body" style="text-align: justify;">If the company manages to raise this second
fund successfully, total AUMs will reach A$700m. Assuming a 2.0x MoM over 3
years would yield an IRR above 20% and therefore a 35% performance fee. In that
case, LCM will generate total fees of A$245m, or 1.45x the company’s market
cap. If LCM manages to keep AUMs constant in the future at A$700m<span style="mso-spacerun: yes;"> </span>(which we think is highly conservative in an
environment of low returns), these would add A$81.6m (A$245m fees smoothed over
3 years) of proceeds to the company’s existing, own balance sheet investment
business.<span style="mso-spacerun: yes;"> </span>While the company said it has
the capacity to handle these two funds with its current investment manager
team, we expect further investments (quantified here at A$5m) in new investment
managers to source ideas in other parts of the world and in other areas of the
law.<o:p></o:p></p>
<p class="Body" style="text-align: justify;"><br /></p>
<p class="Body" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqdT7GsrPM1iZv96FqZJroGocmyiOG5c4xT_drNORAnlt-3QeNaQ_ffd27apqmqulo6V761bKlELRZDIV__qNecOO3S282VZHkjJ7BBt4Iz4JFW7YoE7UNwnZMSlnh6vgJZliWUY93v0LW/s716/LCM+7.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="377" data-original-width="716" height="334" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqdT7GsrPM1iZv96FqZJroGocmyiOG5c4xT_drNORAnlt-3QeNaQ_ffd27apqmqulo6V761bKlELRZDIV__qNecOO3S282VZHkjJ7BBt4Iz4JFW7YoE7UNwnZMSlnh6vgJZliWUY93v0LW/w636-h334/LCM+7.PNG" width="636" /></a></div><b><o:p> </o:p></b><p class="Body" style="text-align: justify;"><b>Given the high operating leverage of
the asset management business, free cash flow would nearly quadruple and lead
to a target market cap of A$1,095m in 2025, or 6.3x today’s market cap. <o:p></o:p></b></p>
<p class="Body" style="text-align: justify;">We think that these two funds are only
the beginning as an increasing amount of pension and endowment funds will be
looking at the litigation funding asset class to diversify their holdings and
get uncorrelated, high returns. Two of the current LPs (a US university
endowment and the asset management division of a global investment bank) have
secured entrenched rights to participate in future funds raised by LCM and
given the broader enthusiasm of institutional investors for the sector, we
would not be surprised to see more funds announced in the coming months or an
upsizing of these two funds. <o:p></o:p></p>
<p class="Body" style="text-align: justify;"><o:p> </o:p></p>
<p class="Body" style="text-align: justify;"><o:p> </o:p><b style="text-indent: -16.5pt;">4.<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; font-weight: normal; line-height: normal;">
</span></b><b style="text-indent: -16.5pt;">Risk</b></p>
<p class="Body" style="text-align: justify;">The main risk is obviously the
inability of the team to keep generating impressive returns while deploying a
significant amount of capital. Here are our thoughts on that:<o:p></o:p></p>
<p class="ListParagraph" style="mso-list: l6 level1 lfo11; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">With more
capital getting deployed into litigation funding, one would worry returns would
be reduced due to pricing pressure. However, it is our belief that LCM’s strong
relationships with law firms confer the company a significant competitive
advantage to source good deals. We also think that a potential supply/demand
imbalance (capital inflows vs opportunities to finance) is unlikely to be
reached before two full investment cycles are completed (at the very least). On
top of that, the total size of the legal market in the developed countries
mentioned is huge and funding penetration still very tiny (between 1% and 5%).
Oversupply of capital should therefore not be reached at least in the medium
term considering the growth prospects of the industry. <o:p></o:p></span></p>
<p class="Body" style="margin-left: 18pt; text-align: justify;"><i>Ex: There is
c.£40bn of litigation spend in the UK per year of which c.5% is funded,
implying a current addressable market of c.£2bn p.a. In the US, numbers are
starker as legal expenses represent $400bn per year with less than 1% financed
($4bn addressable market).<span style="mso-spacerun: yes;"> </span><o:p></o:p></i></p>
<p class="ListParagraph" style="mso-list: l6 level1 lfo11; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">The
Corporate Portfolio strategy will allow LCM to keep pace with its commitment
plans as these multi-cases projects require more capital but also spread the
risk of losses among a higher number of cases, therefore cancelling the risk of
a binary outcome of one single dispute. We are consequently confident that the
capital raised from external investors will be deployed without difficulty even
with a strict project selection of 3-5%.<o:p></o:p></span></p>
<p class="Body" style="text-align: justify;">In most countries the litigation
funding industry is either unregulated (US), self-regulated through an industry
body (UK) or slightly regulated (Hong-Kong, Singapore and Australia). While
further regulatory touch is hard to anticipate at this time, we believe that
LCM’s long lasting stance on the market and its strong network among industry
bodies will be a strong asset to anticipate and deal with further regulatory
announcements. <o:p></o:p></p>
<p class="Body" style="margin-left: 18pt; text-align: justify;"><i>Ex: In Australia
in particular, the parliament introduced in 2020 a new rule requiring
litigation financiers wanting to fund class action lawsuits to get an
Australian Financial Service License (AFSL). LCM anticipated this coming
regulation and got its license early on and was, as a result,<span style="mso-spacerun: yes;"> </span>the only industry compliant player at the
time of implementation. <o:p></o:p></i></p>
<p class="ListParagraph" style="mso-list: l8 level1 lfo13; tab-stops: list 36.0pt; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Symbol; mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-family: "Times New Roman"; font-size: 7pt; font-stretch: normal; font-style: normal; font-variant-caps: normal; font-weight: normal; font: 7pt "Times New Roman"; line-height: normal;"> </span></span></span><span style="mso-ansi-language: EN-US;">We
ultimately believe that regulation will be a tailwind rather than a headwind
for LCM as higher regulatory burdens will impact smaller funders. <o:p></o:p></span></p><div class="separator" style="clear: both; text-align: center;"><br /></div><br /><br /></div>DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com13tag:blogger.com,1999:blog-3373014469543202176.post-50755088517124105882021-02-22T05:33:00.009-08:002021-02-22T05:54:32.899-08:00Card Factory: Be Greedy When Others Are Fearful<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="color: #990000;"><i>Disclaimer: We are shareholders of Card Factory.</i></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">How would you like to invest in a UK greeting
cards retailer with its entire store base closed because of COVID? </span>Yes,
you have read that sentence correctly. <span lang="EN-US">And no, we have not gone mad. Pinch your nose and let us introduce you
to Card Factory. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-US">Elevator Pitch<o:p></o:p></span></u></b></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">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<a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftn1" name="_ftnref1" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></a>.
It is a macro-resilient industry, as demonstrated by its growth throughout the GFC<a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftn2" name="_ftnref2" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[2]</span></span><!--[endif]--></span></a>,
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<sup>nd</sup>
of February). <b>We believe</b> <b>that</b><b><span style="color: red;"> </span>this is a
typical case of <i>‘time-horizon arbitrage’</i>, 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. </b><o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-US"><span></span></span></u></b></p><a name='more'></a><b><u><span lang="EN-US">Business Description & Supply Chain<o:p></o:p></span></u></b><p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Sales reached £451.5m in FY’20 (ended Jan- 2020)
and are split between greeting cards (54%) and a complementary range of items such
as gift wrap/bows, helium balloons and other soft toys (46%). The proportion of
the latter increased in recent years (it used to be 38.5% at the IPO in 2013) as
the company improved its merchandising and cross-selling abilities. By channels,
stores represent 95% of revenue while online and partnerships with other
retailers account for 4 and 1%, respectively. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyy_iuZNV_b_Yk4uew76C6DBA1ntmoKH7n-c7xo64nRtEgUeDLn_hl_itFQSkyhLV-ZEgqXP4nVy6aHEuPqp0I6L-6KyXPxp2xz6J4vY5VU9JjZJfXDsHW8U2sEbtNlLLb2yZt6j6fcPzd/s366/1Picture1.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="331" data-original-width="366" height="240" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyy_iuZNV_b_Yk4uew76C6DBA1ntmoKH7n-c7xo64nRtEgUeDLn_hl_itFQSkyhLV-ZEgqXP4nVy6aHEuPqp0I6L-6KyXPxp2xz6J4vY5VU9JjZJfXDsHW8U2sEbtNlLLb2yZt6j6fcPzd/w266-h240/1Picture1.png" width="266" /></a></div><br /><div class="separator" style="clear: both; text-align: left;"><span style="text-align: justify;"><br /></span></div><div class="separator" style="clear: both; text-align: left;"><span style="text-align: justify;">The company has 1,015 stores as of H1’21 and a plan to reach 1,100 by FY’25. The pricing range goes from £29p to £179p with most of the volumes being in the £89p and £99p range and around 20% coming from the lower-end prices (£29p and £59p). The average basket value is £5 (online is slightly higher). The seasonal breakdown of sales is as follows: 15/20% for Christmas, 10/15% spring seasonal occasions such as Mother’s Day, Father’s Day, Valentine’s Day and Easter and 65/70% for everyday occasions such as birthdays and weddings.</span></div><p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Card Factory’s competitive edge lies in its
vertically integrated supply chain. It prints nearly all of its non-handcrafted
‘everyday’ and seasonal cards (60% of volumes) at its internal facility called
Printcraft. The rest, mainly handcrafted
cards and the non-card merchandise, comes from third party suppliers in the Far
East. Additionally, Card Factory designs 98% of its greeting cards thanks to
its in-house design team, allowing for faster lead times and greater agility
regarding changing customer tastes. This unique set up in the industry has
allowed the company to generate mid-60% gross margins, while providing
customers with more relevant content at prices 2 to 3 times below competition. To
put it into context, Clinton, Card Factory’s biggest competitor, reported gross
margins of 53.4% and 54.2% in FY’17 and FY’18. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">In recent years, the company has been pressured
by subdued like for like growth (-0.5% and -0.1% in FY’20 and FY’19) and an ever-increasing
cost base. There were two significant drivers for the latter: the pound
devaluation following Brexit (50% of COGS are paid in US$) and the rise of the UK
minimum wage. This drove gross margin from 68-69% five years ago to 66% in
FY’20 while EBITDA margin (adjusted for IFRS16) fell from 25% to 19% in the
same period. Despite these challenges, Card Factory did not raise prices for
the last 5 years. However, since 2018 and the rollout of an EPOS system across
its store base, Card Factory has experimented with price increases in test
stores. What it found was that raising prices on the £39p, £59p and £149p range
(to £49p, £69p and £179p respectively) would lead to only slight declines in
volume that would be largely offset by the price increase. The company therefore
implemented the new pricing strategy for these ranges in FY’21 across the
entire estate. Going forward, it also plans to increase the contribution
margins of the £89p and £99p range. Given the £1 psychological barrier, the company
intends to “disguise” the price increase as a slight reduction in the card
quality (and hence COGS), which should boost gross margins. Cutting card costs
by 10% while keeping prices constant would be akin to a price increase of c.3%
(see below). <o:p></o:p></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl-9vlHxGaQB_TnZxM8KU8uYwvKbcRX_JdUNncjegWXDWTEjlCX93-8eUpJP4x6CXL3T-fC0xO5RQJRGaLYWlVCGTvGz21gvzocDskul9cDdJ5mZJvQ3B8ncnPPJ7TQYHC3vsSLOhKdTYG/s305/2.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="95" data-original-width="305" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl-9vlHxGaQB_TnZxM8KU8uYwvKbcRX_JdUNncjegWXDWTEjlCX93-8eUpJP4x6CXL3T-fC0xO5RQJRGaLYWlVCGTvGz21gvzocDskul9cDdJ5mZJvQ3B8ncnPPJ7TQYHC3vsSLOhKdTYG/s0/2.png" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span>The result of these pricing initiatives would
enable the company to raise its sales per store by c.6% (see below), enough to
maintain margins for the next 3 years and sustain £50m annual free cash flow.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhslpu2ENWj3peW7nlmCET_Y6yBvU8nXt6cz3hQvAcPkTrCtl8_HnxbsNTqNgEkLBvvCbZNOy_eCgPJtrHIfptbYIhpZ25_nyGA9RpNi_3Rwq5mMwfqgSAxdYspcXFVK984MAkrFwKyv9_i/s485/3.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="131" data-original-width="485" height="105" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhslpu2ENWj3peW7nlmCET_Y6yBvU8nXt6cz3hQvAcPkTrCtl8_HnxbsNTqNgEkLBvvCbZNOy_eCgPJtrHIfptbYIhpZ25_nyGA9RpNi_3Rwq5mMwfqgSAxdYspcXFVK984MAkrFwKyv9_i/w391-h105/3.png" width="391" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span><b><u><span lang="EN-US">Market & Online
Threat</span></u></b></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">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<span class="MsoFootnoteReference"> <a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftn3" name="_ftnref3" title=""><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[3]</span></span><!--[endif]--></a></span>.
The market has been rather stable since 2004, going from £1.5bn in 2004 to £1.35bn
in 2020, a CAGR of -0.7%. Excluding online sales from 2020 numbers would point
to a CAGR of -1.6%. Overall, this is a macro-resilient industry, as demonstrated
by its growth throughout the GFC<a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftn4" name="_ftnref4" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[4]</span></span><!--[endif]--></span></a>,
and volumes have been rather stable despite increased online communications (down
only 5% since 2012). We continue to expect a downward trend in the coming
years. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span><span lang="EN-US"> </span><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhH9tqnYh0Wz-F6f2oVROgBpKX9WEC8yDU_Pnc_4s1gX-jKfmtu4gQFq4ESwEV-4fjWXnujpmfHRTBwbbQI8PeFrDRCyua_dPxsYabnQHzxqdr4VwJJxW_8I9XrGf8mfMvnYcVLgE166_WP/s826/4.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="380" data-original-width="826" height="262" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhH9tqnYh0Wz-F6f2oVROgBpKX9WEC8yDU_Pnc_4s1gX-jKfmtu4gQFq4ESwEV-4fjWXnujpmfHRTBwbbQI8PeFrDRCyua_dPxsYabnQHzxqdr4VwJJxW_8I9XrGf8mfMvnYcVLgE166_WP/w571-h262/4.png" width="571" /></a></p><p class="MsoNormal" style="text-align: justify;">Card Factory is the market leader, with c.20%
of the market by value, followed by Clinton Cards and Paperchase at c.9% and
2%, respectively. The remaining players are grocers (40% of the market), other
high street retailers (25%) and then online specialists (7%). As we mentioned
in the introduction, the company’s competitive positioning is extremely
differentiated from peers with its low cost, high quality business model (see
below on the right).</p><div class="separator" style="clear: both; text-align: center;"><br /></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQjXUUDbiMf1fgAoAvutofVKmqsYYduEfj4uYk7BBjKYJPXWCdZcskuM0iE5I7PocoUXZn5mNZBxrBuyOzEPh7C4Yzn2x0ySjAqYze-ieyiExXIkAkH-QYC8pbDvThac-NsOD_u23xhGWP/s375/6.png" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em; text-align: center;"><img border="0" data-original-height="239" data-original-width="375" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQjXUUDbiMf1fgAoAvutofVKmqsYYduEfj4uYk7BBjKYJPXWCdZcskuM0iE5I7PocoUXZn5mNZBxrBuyOzEPh7C4Yzn2x0ySjAqYze-ieyiExXIkAkH-QYC8pbDvThac-NsOD_u23xhGWP/w298-h190/6.png" width="298" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8JU49AIPVNbsInXxcxiPOf6X32qgbyGJtDG55_NtzteC945yiheiUJcHqwFyB6u5A1nEzbu7F3Q4jHWZWk2heT3Dgy_k_ZO_ej0POG4wclwefRHeqsh-IvxKEmL4iRkXwfx24Rqz4fjZ0/s312/5.png" style="clear: left; margin-bottom: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="312" data-original-width="222" height="315" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8JU49AIPVNbsInXxcxiPOf6X32qgbyGJtDG55_NtzteC945yiheiUJcHqwFyB6u5A1nEzbu7F3Q4jHWZWk2heT3Dgy_k_ZO_ej0POG4wclwefRHeqsh-IvxKEmL4iRkXwfx24Rqz4fjZ0/w224-h315/5.png" width="224" /></a></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;">As is easily observable, Card Factory has been
able to take significant market share and its like-for-like performance has
therefore significantly outperformed the market (see below).</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCw8vUIoLIUHbkL6H8l_AIJCwqx220OBeP_3lqrTNZNs_vZMoVUlfv_5-kgibCMOpN63Us5D180-5YB_qFDl-IRFhnWFvSGcpZ19e9Ztcn8TX8zrlF40FI44665VohCoznX2YCN0QO4Fy5/s629/7.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="245" data-original-width="629" height="157" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhCw8vUIoLIUHbkL6H8l_AIJCwqx220OBeP_3lqrTNZNs_vZMoVUlfv_5-kgibCMOpN63Us5D180-5YB_qFDl-IRFhnWFvSGcpZ19e9Ztcn8TX8zrlF40FI44665VohCoznX2YCN0QO4Fy5/w402-h157/7.png" width="402" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span>In addition, we believe that Card Factory like
for like sales could materially improve in 2021 and 2022 since its 2 main
competitors are currently in administration. Clinton entered administration in
December 2019 (for the second time since 2012) and has since reduced its estate
from c.350 stores to 270. It was still heavily loss making after its previous restructuring
and given its low gross margin, we do not see a path to profitability going
forward. However, the owners (the Weiss family) also own Clinton biggest
supplier, which creates strong incentives to keep the business going for as
long as possible. We expect that the lockdown will be the last nail on the
company’s coffin. Paperchase, the #3 specialty card retailer, also entered
administration in January 2021 and plans to reduce its store base from 127 to
90. The group is EBITDA positive for both FY’18 and FY’19 and while its
leverage is unsustainable at 6/7x, we believe this is a capital structure issue
rather than a business issue and the company should stay in business in the
near-term.</p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Regarding the online penetration of the market,
it stood at 14% in 2019 and we expect it to stay low in the longer-term given
the immediate and experiential nature of a card purchase. Customers want to touch
the product, compare the quality across the price points and do not want to
wait (85% of store visits are planned in advance). In addition, the
complimentary range provides customers with a one-stop-shop for special
occasions where they can buy both a card and party items (like helium balloons,
card wrap/bows etc..). We think this is why online players predominantly cater (65%
of sales) to the personalized card market (think printing a card for your
parents with their grandkids on it), a category unavailable in stores. We think
personalized cards have a low overlap with traditional cards and are largely
used for different life events.</span></p><p class="MsoNormal" style="text-align: justify;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvKCrpp1WSWQmXJu69Nu1dWabRXjSIwry8mlznupCIOh5HzqHxCzNiQuXg8zfPy7O8DbqzXe0infwPcHQ-1xqJwA_CNKy7gBypxhAHHgsuBo0T5E0UU0H7Qf9aFG0xJ14TM4SWq7fAX_vL/s257/9.png" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em; text-align: center;"><img border="0" data-original-height="257" data-original-width="171" height="331" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvKCrpp1WSWQmXJu69Nu1dWabRXjSIwry8mlznupCIOh5HzqHxCzNiQuXg8zfPy7O8DbqzXe0infwPcHQ-1xqJwA_CNKy7gBypxhAHHgsuBo0T5E0UU0H7Qf9aFG0xJ14TM4SWq7fAX_vL/w220-h331/9.png" width="220" /></a><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifZT6AlgZNqQUyfPotPjKnzUxxOsrAovo5p_SaqlQQYDcQrIR5d-GQGSl-sM36h-1tWWseKCwBti55JvUBQxostpJRCofnajl-28-l03X3WhQHge5gGEVzF8Rwi57yI6q3Qn2CKbOeJhTo/s260/8.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="260" data-original-width="258" height="312" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifZT6AlgZNqQUyfPotPjKnzUxxOsrAovo5p_SaqlQQYDcQrIR5d-GQGSl-sM36h-1tWWseKCwBti55JvUBQxostpJRCofnajl-28-l03X3WhQHge5gGEVzF8Rwi57yI6q3Qn2CKbOeJhTo/w310-h312/8.png" width="310" /></a><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-US"><br /></span></u></b></p><p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-US">Liquidity, Debt Load & COVID reopening<o:p></o:p></span></u></b></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Having done significant work on Card Factory’s
cash burn, debt load and covenant breaches, we do not share the market concern and
consider them heavily overblown. <b><u><o:p></o:p></u></b></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">First, we <b>estimate the company monthly cash
burn to be £7.4m per month</b> from end of January onward. See below the
numbers and related assumptions.<o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhF_MpHiWLZx1sXi9UWURRpQp9YcXkLFzLZN1QhbHYCjKH5lAEN7wMl1GkkjSKxw1WmKOKOZ4v-3R7bsQcOiWCMZzkXOIM9SlCXemXBffyIb09_Vi3xDNE5fn28_zA4SyP4GMSU7eeq_35-/s1574/10.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="297" data-original-width="1574" height="191" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhF_MpHiWLZx1sXi9UWURRpQp9YcXkLFzLZN1QhbHYCjKH5lAEN7wMl1GkkjSKxw1WmKOKOZ4v-3R7bsQcOiWCMZzkXOIM9SlCXemXBffyIb09_Vi3xDNE5fn28_zA4SyP4GMSU7eeq_35-/w1020-h191/10.png" width="1020" /></a></div><br /><span lang="EN-US"><br /> </span>Second, Card Factory reported in its January trading
update net debt of £90m as of end of December (down from £142.5m at the half
year results). This is the result of both a seasonal low in working capital in
December (see below on the left in green) and aggressive cash management (rent
and taxes have been deferred). We assume net debt for FY’21 (end January ‘21)
to be 121.5m (below on the right in green). This figure is derived by adding to
the £90m end of December net debt our estimated cash burn for January as well
as a working capital adjustment similar to last year’s differential between
December and January net debt position.<p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_0L49oaaVUsOe2CTGvXiHKuink_5Veq67W5LT7q2w5xawJQauY7ChuRQ8v17uinlAxw2p0TQf_3XTd67K6hcTxC3i01rKqk30iFy-7FckIYhYFnYTsDNKkrGwaMN3gHw9e_ZWaAZFqqbq/s475/11.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="347" data-original-width="475" height="282" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj_0L49oaaVUsOe2CTGvXiHKuink_5Veq67W5LT7q2w5xawJQauY7ChuRQ8v17uinlAxw2p0TQf_3XTd67K6hcTxC3i01rKqk30iFy-7FckIYhYFnYTsDNKkrGwaMN3gHw9e_ZWaAZFqqbq/w385-h282/11.png" width="385" /></a><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtDUvPRdlUtTiCuvpkDgQn6oJXM8GwmB64cy6qcCuxTqnAtf3aWjwOH2CQADdQlQwnML528QlxxlBsyJgFgsg0ZQcou_ojY4tOnRoDvs4ffSgl9vs2GcnizZGwLkEqeFdUS8_MQ62bFBpN/s177/12.png" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em; text-align: center;"></a><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtDUvPRdlUtTiCuvpkDgQn6oJXM8GwmB64cy6qcCuxTqnAtf3aWjwOH2CQADdQlQwnML528QlxxlBsyJgFgsg0ZQcou_ojY4tOnRoDvs4ffSgl9vs2GcnizZGwLkEqeFdUS8_MQ62bFBpN/s177/12.png" style="clear: right; display: inline; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="62" data-original-width="177" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgtDUvPRdlUtTiCuvpkDgQn6oJXM8GwmB64cy6qcCuxTqnAtf3aWjwOH2CQADdQlQwnML528QlxxlBsyJgFgsg0ZQcou_ojY4tOnRoDvs4ffSgl9vs2GcnizZGwLkEqeFdUS8_MQ62bFBpN/s0/12.png" /></a><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"><br /></span></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-US">Putting the above estimates together indicate
that Card Factory has enough liquidity to withstand the closure of its stores
until at the very least the end of May (see below).</span></b></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEGuLoKmtf6ruXMksm5XBTBnDUK6C5WFEVtdwPlANCS48pyNm2p4ht_dYfI23JK4yZ_PFRRNPgxJvftWxLlj2XECn_sG1A54vXGkNkryOqqhqr6wFdA996S2BdyVIibOtuB2PXEfc2s11a/s373/13.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="165" data-original-width="373" height="163" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEGuLoKmtf6ruXMksm5XBTBnDUK6C5WFEVtdwPlANCS48pyNm2p4ht_dYfI23JK4yZ_PFRRNPgxJvftWxLlj2XECn_sG1A54vXGkNkryOqqhqr6wFdA996S2BdyVIibOtuB2PXEfc2s11a/w366-h163/13.png" width="366" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;">Our base case is a reopening of non-essential
shops in the UK by mid-April. Indeed, as of the 14<sup>th</sup> of February, NHS
weekly data showed that 95% of the >70 years old population received
its first vaccine injection (see below).</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpGWVQTSfQV2QalIfBvX_yNDqadfx_MdZFa2N5asrNp2SMDIZNl6EjCpW__VIRV1mYLdD_ddPpAcz8NWC8U5gkbDA_YGzdDvfuD5NDpZQfaOimiLtUwZvJ3SrUH9Mv3dphla7Hb2KyQEcn/s330/14.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="79" data-original-width="330" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpGWVQTSfQV2QalIfBvX_yNDqadfx_MdZFa2N5asrNp2SMDIZNl6EjCpW__VIRV1mYLdD_ddPpAcz8NWC8U5gkbDA_YGzdDvfuD5NDpZQfaOimiLtUwZvJ3SrUH9Mv3dphla7Hb2KyQEcn/s320/14.png" width="320" /></a></div><p class="MsoNormal" style="text-align: justify;">Given the current trends and the daily incremental
vaccinations, we would expect 100% of the >50 years old population to have
received their first vaccine shot by early March. This milestone would pave the
way for a reopening of non-essential shops by early April.</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi04vAjLx4gDNLF9l6Q-SRFxe46z571cuSxy3M94CeprKorimjz-GyhC_NePF7xgVrT10C1j06dWpLD4YjW5py-DGunT6GIV5FMIkigA0536ldWkk4wRzlBob225yqe06X46SSzmesZTlRm/s612/15.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="340" data-original-width="612" height="245" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi04vAjLx4gDNLF9l6Q-SRFxe46z571cuSxy3M94CeprKorimjz-GyhC_NePF7xgVrT10C1j06dWpLD4YjW5py-DGunT6GIV5FMIkigA0536ldWkk4wRzlBob225yqe06X46SSzmesZTlRm/w440-h245/15.png" width="440" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">In addition, a key indicator in whether a
reopening is possible or not is the number of COVID patients in mechanical
ventilation beds (MVB). The figure currently stands at 2535. Back in April 2020,
it took c.50 days for MVB occupancy to go form this number to less than 400
(when the UK reopened on the 15<sup>th</sup> of June). Assuming a similar 50-day
timeline would point to a MVB occupancy reaching levels consistent with a
reopening by the 12<sup>th</sup> of April. This is in line with our above assumption.</span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwWMCqnN_y4yDy1maq6O2_uGpKIXqJhJ_zvGuUeEzARkwP0YG8STmK-TGJIwYk2xiDgQERMiu4j-7i1cvRJFg5QwW_weJqqPsZuUAg753LW7xH60N53K7M56DpakSclUEoY03V5tWKvFfq/s774/16.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="381" data-original-width="774" height="235" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwWMCqnN_y4yDy1maq6O2_uGpKIXqJhJ_zvGuUeEzARkwP0YG8STmK-TGJIwYk2xiDgQERMiu4j-7i1cvRJFg5QwW_weJqqPsZuUAg753LW7xH60N53K7M56DpakSclUEoY03V5tWKvFfq/w476-h235/16.png" width="476" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Based on our forecasts for a reopening of
stores by April and because of the highly cash generative nature of the
business, we expect Card Factory to quickly bring down net debt to 1.6x by FY’23
(on a profit before tax basis). This would be at the lower end of the company’s
target range of between 1.2x and 2.6x, allowing for a return of dividend
payments as soon as 2022. As a reminder, the company last ordinary distribution
to shareholder in 2019 was £48.9m, a 42% dividend yield based on today’s
prices.</span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXWsPFjWqplVjl-GyjoPf34SHiVxTXgkNQIOfC6MJNJBTbP8ULDB20uqmxuptyNoJ0wS1KviYNa4b-uuixHQkEud1byFn6Dk43C6H1oruYsP3Z7fqg5zhCYAMUsIvNzdqGLsAkq5ZGsVLu/s336/17.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="144" data-original-width="336" height="164" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXWsPFjWqplVjl-GyjoPf34SHiVxTXgkNQIOfC6MJNJBTbP8ULDB20uqmxuptyNoJ0wS1KviYNa4b-uuixHQkEud1byFn6Dk43C6H1oruYsP3Z7fqg5zhCYAMUsIvNzdqGLsAkq5ZGsVLu/w383-h164/17.png" width="383" /></a></div><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">Lastly, we believe concerns around the covenant
breaches are highly exaggerated. Indeed, looking at the situation from a bank
perspective, we see little logic in recording a loan loss provision in this
environment and forcing an otherwise solvent business into administration for
short-term liquidity issues. We expect
the loan officers to be heavily incentivized to avoid such an outcome and, like
in January, provide the company waivers for as long as the lockdown last. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><b><u><span lang="EN-US">Valuation <o:p></o:p></span></u></b></p><p class="MsoNormal"><span lang="EN-US">Our model
here is pretty straightforward. We assume a progressive return to normal by FY’23
(end January 2023), with sales per store reaching 96% of the FY’20 levels. We think
this is quite conservative given the company’s historical like for like performance
and the FY’21 c.6% price increases. We expect the company to continue its store
rollout plans and add 35 stores (2.8% growth vs FY’20) by FY’23, while online sales
should stabilize at FY’21 levels (COVID effect being offset by the rollout of
the new website in FY’21). Retail partnerships should expand as the company closes
new customers. We expect costs to grow at a 2% clip for the period, with the
increase in minimum wage being partly offset by cost initiatives at the supply
chain level (distribution, warehouse and printing). See below our model for
more details.<o:p></o:p></span></p><p class="MsoNormal" style="tab-stops: 352.55pt; text-align: justify;"><span lang="EN-US"><br /></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhN1KdhrTtZcNd2x-M8mpYMRBox2sqaWw7MpOMdzl2u8KUFyPzi6vqycR7_U-sRO1i7VyHUJSTH3jCAt5wscIIOdteeEz2R7pyvyU7KMYzaAqEfAHsZ4BS0rNh3N8_Cz31b0xgX2M3QKpxJ/s784/18.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="616" data-original-width="784" height="526" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhN1KdhrTtZcNd2x-M8mpYMRBox2sqaWw7MpOMdzl2u8KUFyPzi6vqycR7_U-sRO1i7VyHUJSTH3jCAt5wscIIOdteeEz2R7pyvyU7KMYzaAqEfAHsZ4BS0rNh3N8_Cz31b0xgX2M3QKpxJ/w670-h526/18.png" width="670" /></a></div><br /><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheQ5n6ANADgQX8bTcMXqi25Cl15PfpbG043A2UOHQIjSGlIaTsfKb2mOhJAi53RxKhKTvO4fnbpAAGuDIEiVVqTbqQG8Wn1lHEUZMhhfDvFgdTzkaqIj9Hrxrav3y4qUW4f0sdIlzS5vUa/s724/19.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="198" data-original-width="724" height="170" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheQ5n6ANADgQX8bTcMXqi25Cl15PfpbG043A2UOHQIjSGlIaTsfKb2mOhJAi53RxKhKTvO4fnbpAAGuDIEiVVqTbqQG8Wn1lHEUZMhhfDvFgdTzkaqIj9Hrxrav3y4qUW4f0sdIlzS5vUa/w618-h170/19.PNG" width="618" /></a></div><br /> <p></p><p class="MsoNormal" style="tab-stops: 352.55pt; text-align: justify;"><span lang="EN-US"><br /></span></p><p class="MsoNormal" style="tab-stops: 352.55pt; text-align: justify;"><span lang="EN-US"> </span> </p><p class="MsoNormal" style="tab-stops: 352.55pt; text-align: justify;">As can be seen, the company currently trades at
2.1x earnings and 48% free cash flow yield pre growth investments. In the past
3 years, the stock traded at c.10% free
cash flow yield pre-growth and c.9x earnings, multiples we would expect the
company to reach again once it puts COVID behind it.</p><p class="MsoNormal" style="text-align: justify;"><b><span lang="EN-US">Conclusion<o:p></o:p></span></b></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US">We believe that<span style="color: red;"> </span>this
is a typical case of <i>‘time-horizon arbitrage’</i>, 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 conservative 8x normalized earnings for a 12.5% free cash flow
yield. Even if we are wrong, and assuming a worst-case capital increase of £40m
(c.35% dilution at current prices and more than enough to survive 5 additional months
of lockdown), we expect the shares to more or less triple. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US"> </span></p><p class="MsoNormal" style="text-align: justify;">
</p><div><!--[if !supportFootnotes]--><br clear="all" />
<hr align="left" size="1" width="33%" />
<!--[endif]-->
<div id="ftn1">
<p class="MsoFootnoteText"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftnref1" name="_ftn1" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="font-size: 10pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></a><span lang="EN-US"> Mooping IPO prospectus<o:p></o:p></span></p>
</div>
<div id="ftn2">
<p class="MsoFootnoteText"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftnref2" name="_ftn2" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="font-size: 10pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[2]</span></span><!--[endif]--></span></a><span lang="EN-US"> Ibid<o:p></o:p></span></p>
</div>
<div id="ftn3">
<p class="MsoFootnoteText"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftnref3" name="_ftn3" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="font-size: 10pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[3]</span></span><!--[endif]--></span></a><span lang="EN-US"> Ibid<o:p></o:p></span></p>
</div>
<div id="ftn4">
<p class="MsoFootnoteText"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Card%20Factory/Write%20Up/Write%20Up%20NO%20PHJOTO.docx#_ftnref4" name="_ftn4" title=""><span class="MsoFootnoteReference"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="font-size: 10pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: Arial; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[4]</span></span><!--[endif]--></span></a><span lang="EN-US"> Ibid<o:p></o:p></span></p>
</div>
</div><div><div id="ftn2">
</div>
</div><div><div id="ftn4">
</div>
</div><div style="mso-element: footnote-list;"><div id="ftn2" style="mso-element: footnote;">
</div>
</div>DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com10tag:blogger.com,1999:blog-3373014469543202176.post-35721237481921546522021-02-15T13:49:00.002-08:002021-02-15T13:52:13.646-08:00Argentex: a low-cost high-service FX provider ready to take on high-cost low-service banks<p><i><span style="color: #990000;">Disclaimer: We are shareholders of Argentex.</span></i><span style="color: red;"> </span></p><p class="MsoNormal" style="text-align: justify;"><b><u><span style="mso-ansi-language: EN-US;">Elevator pitch:<o:p></o:p></span></u></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">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. <b>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). </b>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). <span style="mso-spacerun: yes;"> </span></span></p><p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;"><span></span></span></p><a name='more'></a><span style="mso-ansi-language: EN-US;"><span style="mso-spacerun: yes;"><br /></span></span><p></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">1- <span style="font: 7pt "Times New Roman";"> </span></span></span></b><b><u><span style="mso-ansi-language: EN-US;">Company Description & Addressable Market</span></u></b></p><span style="mso-ansi-language: EN-US;"><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwU-nIzpJ70wWmyF7g05ZeYWzctDhQwzgCfW-YJJkmj5ogGIDQr3dsuqKXWxtw2LG2C3jWW6MvEqGF6e32OlUCNijw4S60VUgJ9tJxbfoTyB5_FmjQ3bAWozEHhSqY-Qsr4kFaUZaR73ak/s376/Image+1.png" style="clear: right; float: right; margin-bottom: 1em; margin-left: 1em;"><img border="0" data-original-height="257" data-original-width="376" height="121" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwU-nIzpJ70wWmyF7g05ZeYWzctDhQwzgCfW-YJJkmj5ogGIDQr3dsuqKXWxtw2LG2C3jWW6MvEqGF6e32OlUCNijw4S60VUgJ9tJxbfoTyB5_FmjQ3bAWozEHhSqY-Qsr4kFaUZaR73ak/w162-h121/Image+1.png" width="162" /></a></div>Argentex traded in 2019 a notional FX
amount of GBP12bn (95% was EUR, USD or GBP) </span><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: "Times New Roman"; mso-fareast-language: FR; mso-hansi-font-family: Calibri;">with
1,200 corporates active in the broad array of the economy <i>(see on the right)</i>.
The typical client has an annual requirement to convert </span><span style="mso-ansi-language: EN-US;">between GBP1m and GBP500m of currencies. Importantly,
sales are predominantly recurring since importers/exporters have an almost
constant need to exchange currencies throughout the year every time they
ship/receive products/raw materials. <o:p></o:p></span><p></p><div class="separator" style="clear: both; text-align: center;"><br /></div><p></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">While 64% of notional FX traded was spot and 36% was forwards, the
latter carries higher spreads (c.30 bps vs. spot at c.17bps) and therefore sales
are more balanced with a split between spot, forwards and options at 46%, 48%
and 6%, respectively. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Additionally, it is important to understand that <b>Argentex only acts
as a pure intermediary for its clients and therefore does not actively trade on
the market nor make directional bets on currencies. </b>It only makes money
from the spread between the rate it executes the trade at its institutional
counterparty and the rate it passes on to the client.<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><br /></p>
<p class="MsoNormal" style="text-align: justify;"><b><i><u><span style="color: #2f5496; mso-ansi-language: EN-US; mso-themecolor: accent1; mso-themeshade: 191;">How big is
the UK FX market and what is the relevant TAM for Argentex?<o:p></o:p></span></u></i></b></p>
<p class="MsoNormal" style="text-align: justify;"><i><span style="color: #2f5496; mso-ansi-language: EN-US; mso-themecolor: accent1; mso-themeshade: 191;">Establishing
an accurate addressable market is difficult as the company targets a subset of
the UK corporate world. However, the following sets of numbers directionally show
how big the market is and highlight the large runaway of market share gains
Argentex enjoys. <s><span style="mso-spacerun: yes;"> </span></s><o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><i><span style="color: #2f5496; mso-ansi-language: EN-US; mso-themecolor: accent1; mso-themeshade: 191;">A recent
survey from the Bank of England<a href="https://d.docs.live.net/201d3af060700e4e/D%5E0K%20Partners/Stocks/Argentex/Write-up/Write%20Up%20Final.docx#_ftn1" name="_ftnref1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><b style="mso-bidi-font-weight: normal;"><span face=""Calibri",sans-serif" style="color: #2f5496; font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin; mso-themecolor: accent1; mso-themeshade: 191;">[1]</span></b></span><!--[endif]--></span></span></a>
stated that the average daily volume of FX traded through London is over GBP2.0
trillion of which c.GBP670m is non-interbank spot and forward trades.<span style="mso-spacerun: yes;"> </span>This same survey estimates that <b>c.85% of
UK SME and corporate clients continue to use clearing banks</b> as their main
provider of foreign exchange services. As Argentex’s average daily trading
volume is GBP46m, this would represent a global market share of 0.007% or
0.046% of the non-bank sub-segment. <o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><i><span style="color: #2f5496; mso-ansi-language: EN-US; mso-themecolor: accent1; mso-themeshade: 191;">However, the
ONS estimates that the total value of goods and services imported and exported
to and from the UK in 2019 was c.GBP1.4tn, implying a daily volume of GBP5.4bn.
We believe that the ONS statistic represents a better proxy of Argentex’s TAM
as the Company only deals with clients that engage in commercial FX
transactions. As a result, we estimate that <b>Argentex’s market share is
c.0.9%</b> (GBP46m of average daily trading volume in 2019).<o:p></o:p></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><i><span style="color: #2f5496; mso-ansi-language: EN-US; mso-themecolor: accent1; mso-themeshade: 191;"><o:p> </o:p></span></i></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">2-<span style="font: 7pt "Times New Roman";">
</span></span></span></b><!--[endif]--><b><u><span style="mso-ansi-language: EN-US;">Moat
and Financial Snapshot<o:p></o:p></span></u></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">We believe that Argentex has 5 key attractions for clients, which put
together will allow the company to disproportionately benefit from the shift
away from banks and retain its clients.<s> <o:p></o:p></s></span></p>
<p class="MsoListParagraph" style="mso-list: l5 level1 lfo6; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Wingdings; mso-ansi-language: EN-US; mso-bidi-font-family: Wingdings; mso-bidi-font-weight: bold; mso-fareast-font-family: Wingdings;"><span style="mso-list: Ignore;">Ø<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><b><span style="mso-ansi-language: EN-US;">Unmatched Service and Proactivity <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">The typical Argentex client or prospect does not have a treasury
department and its CFO/treasurer is actively looking for service or advice. Simply
put, they like to speak to someone before putting on a GBP10m trade. Banks do
not fit the bill as they typically offer poor service (FX desks are
understaffed and the first victim of cost cutting initiatives) and cannot provide
advisory services (banking regulations). On the other hand, <b>Argentex only
has 1,200 clients and can therefore approach them on a case-by-case basis and provides
a degree of service and proactivity that is unmatched<a href="https://d.docs.live.net/201d3af060700e4e/D%5E0K%20Partners/Stocks/Argentex/Write-up/Write%20Up%20Final.docx#_ftn2" name="_ftnref2" style="mso-footnote-id: ftn2;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><b style="mso-bidi-font-weight: normal;"><span face=""Calibri",sans-serif" style="font-size: 11pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[2]</span></b></span><!--[endif]--></span></span></a>.</b>
This high-level service results in many clients using Argentex as their sole FX
providers. We expect that for clients using multiple providers, this will
result in wallet share gains over the long-term. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">To this end, Argentex decided not to operate a 360 model (like most alternative
FX providers). Instead, the salesforce is only focused on new customer
acquisition while traders oversee the day-to-day relationship with existing
clients. Also, we very much appreciate Argentex’s remuneration policy in that
regard and think it fosters both a strong sense of loyalty as well as
client-centricity among its employees:</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;"><span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> - </span></span><span style="text-indent: -18pt;">The
salesforce is paid 10% to 17% (depending on new business acquisition targets)
of the revenues generated by an acquired client over the lifetime of the business
relationship;</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;"><span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span><span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> - </span></span><span style="text-indent: -18pt;">Traders
are paid 10% of the revenues generated by a client.</span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Overall, Argentex attracts clients that predominantly value the
company’s advisory services and proactivity. For this reason, we believe that
pricing pressure is unlikely as the client perceives the spread as compensation
for the advisory service, not only for the execution. Additionally, this
protects Argentex from fintech FX startups, who propose a do-it-yourself
approach to SMEs. We do not believe that “unsophisticated” clients will want to
trade forward contracts by themselves or trade even a couple of millions worth
of GBP/EUR/USD in spot contracts without getting some advice first. <o:p></o:p></span></p>
<p class="MsoListParagraph" style="mso-list: l4 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Wingdings; mso-ansi-language: EN-US; mso-bidi-font-family: Wingdings; mso-bidi-font-weight: bold; mso-fareast-font-family: Wingdings;"><span style="mso-list: Ignore;">Ø<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><b><span style="mso-ansi-language: EN-US;">Low Prices <o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">We estimate that <b>on top of a better service, customers switching to
Argentex can cut their FX costs 5 to 10-fold.</b> Indeed, banks generally
charge between 100bps and 200bps on spot transactions whereas Argentex only charges
c.20bps. A similar difference holds true for forwards. Interestingly,
prospective clients generally do not know the extent of banks’ spreads since
pricing is very opaque and this is a key element of the sales pitch. For them, <b>switching
to alternative FX providers such as Argentex can yield significant and
immediate improvement in margins</b>. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><i><u><span style="mso-ansi-language: EN-US;">Case Study (1/2):</span></u></i><i><span style="mso-ansi-language: EN-US;">
Let us take a UK corporate with a 15% EBIT margin that exports 50% of its goods
and imports 50% of its raw materials from Europe. Assuming all FX transactions
are made with spot contracts, the following table shows that switching from
banks charging 100bps and 200bps to Argentex’s 20bps will improve margins by 74bps
to 165bps and increase EBIT between 5% and 12%. <o:p></o:p></span></i></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOVvfnXnpyDrxowCwAMNEbmh0C8KvP6iIPMPBc5RPWrlMi61pewd1RtOOmmfjBkToxSNBOeRenj_oPRPjBQ-kHUz8hR8czBzWtytyrnLiho9gk4n3DjBFgOHYJBvJTbFJEkkaIGdY0jT53/s667/Image+2.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="174" data-original-width="667" height="141" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOVvfnXnpyDrxowCwAMNEbmh0C8KvP6iIPMPBc5RPWrlMi61pewd1RtOOmmfjBkToxSNBOeRenj_oPRPjBQ-kHUz8hR8czBzWtytyrnLiho9gk4n3DjBFgOHYJBvJTbFJEkkaIGdY0jT53/w544-h141/Image+2.PNG" width="544" /></a></div>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Trust is key in this business given the critical nature of the service
provided and while the significant savings entailed by the first switch to an
alternative FX provider more than justify the “risk”, we believe that the
rewards from switching to a cheaper alternative, once pricing is already at
20bps, is immaterial and clients are therefore extremely sticky. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><i><u><span style="mso-ansi-language: EN-US;">Case Study (2/2):</span></u></i><i><span style="mso-ansi-language: EN-US;">
The following table shows the impact on margin and EBIT of a switch from Argentex
to another alternative FX provider charging only 10bps. <o:p></o:p></span></i></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZjYdAt4bPf62D6bG0y4tZ8eUnVoekAzaeiReoQvtTfGfldmp7XT1u0KdAbUo7mDS_IfQ6Nl-9axpwSS1gGCsKQwBv0xfit96S4j2WLC4yPOWv9Tq2P9bcS2BwAPPnIoy7isP0RzlPipfC/s593/Image+3.PNG" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="170" data-original-width="593" height="155" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZjYdAt4bPf62D6bG0y4tZ8eUnVoekAzaeiReoQvtTfGfldmp7XT1u0KdAbUo7mDS_IfQ6Nl-9axpwSS1gGCsKQwBv0xfit96S4j2WLC4yPOWv9Tq2P9bcS2BwAPPnIoy7isP0RzlPipfC/w548-h155/Image+3.PNG" width="548" /></a></div><div class="separator" style="clear: both; text-align: center;"><br /></div>
<p class="MsoListParagraphCxSpLast" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Wingdings; mso-ansi-language: EN-US; mso-bidi-font-family: Wingdings; mso-bidi-font-weight: bold; mso-fareast-font-family: Wingdings;"><span style="mso-list: Ignore;">Ø<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><b><span style="mso-ansi-language: EN-US;">Strong reputation and highly engaged salesforce
<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">As we mentioned previously, trust is key and Argentex benefits from a
strong reputation and a long-standing track-record of operations. In addition, we
believe that its listing (IPO in June 2019) significantly improved awareness
among prospective clients and that it makes them more inclined to deal with Argentex
since they can check the company’s financial health. Interestingly, Argentex’s
institutional counterparties decreased their initial collateral requirements
following the IPO as they gained more confidence in the company’s financial
position.</span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Moreover, Argentex puts a big emphasis on the quality of its sales force
because while lower prices and good service are part of the client’s acquisition
equation, the real tipping point always comes down to the salesman. For this
reason, the company hires 10 new graduates every 6 months that it tightly integrates
within its experienced sales force. This allows best practice sharing among the
new hires and a training from the ground up to the Argentex-way. Indeed, co-CEO
Carl Jani stresses the need to “be genuine” and to take pride in the value the
product brings to the client. As a result, the company strongly discourages “product-pushing”
and will only sell to the client what it needs, and not more exotic (and higher
spread!) products. <o:p></o:p></span></p>
<p class="MsoListParagraph" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Wingdings; mso-ansi-language: EN-US; mso-bidi-font-family: Wingdings; mso-bidi-font-weight: bold; mso-fareast-font-family: Wingdings;"><span style="mso-list: Ignore;">Ø<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><b><span style="mso-ansi-language: EN-US;">Fortress Balance Sheet<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">The company was GBP13m net cash at H1’21 (Sept-2020), excluding our
estimate of the cash required for collateral purposes. We believe this is a
strong attraction to clients wanting to avoid FX providers that could go under
pressure while they have outstanding contracts with them. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Additionally, FX trading requires cash on the balance sheet for
collateral purposes and this acts as a significant barrier to entry. It takes
around GBP2m of cash to trade GBP3bn of FX (our estimate following conversation
with management). Replicating Argentex current GBP12bn footprint would therefore
require at least GBP8m of cash on the balance sheet. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Importantly, the comfortable cash position allows the company to take
advantage of volatile market activities when other providers retreat. Argentex
can then step up to underwrite more transactions and therefore gain market
share. <i>Case in point:<span style="mso-spacerun: yes;"> </span>March was the
best performing month of 2020 when Argentex collected GBP5m of revenues versus
GBP1.5m in August (GBP29m for the entire year).</i><o:p></o:p></span></p>
<p class="MsoListParagraph" style="mso-list: l2 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="font-family: Wingdings; mso-ansi-language: EN-US; mso-bidi-font-family: Wingdings; mso-bidi-font-weight: bold; mso-fareast-font-family: Wingdings;"><span style="mso-list: Ignore;">Ø<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><b><span style="mso-ansi-language: EN-US;">Regulation<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">While the industry is not heavily regulated, getting certifications is
still an additional barrier to entry (time and energy consuming). Alternative FX
providers need to be approved by the FCA in the UK as well as comply with MIFID
2. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;">To recap, these 5 key attractions constitute a powerful cocktail that
translated into 30%+ p.a. top line growth over the past 5 years, 40%+ EBIT
margins and triple digit returns on capital employed (adjusted for the cash
required for collateral purposes). <o:p></o:p></span></b></p>
<p class="MsoListParagraphCxSpFirst" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></b></p>
<p class="MsoListParagraphCxSpLast" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">3-<span style="font: 7pt "Times New Roman";">
</span></span></span></b><!--[endif]--><b><u><span style="mso-ansi-language: EN-US;">A
Management Team with Skin in The Game<o:p></o:p></span></u></b></p>
<p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;">The three founding partners own 25% of the company</span></b><span style="mso-ansi-language: EN-US;">, representing GBP34.0m at GBX 122 per share.
They are involved in the day-to-day operations of the business and have
extensive experience of FX markets. Additionally, Sir John Beckwith’s<b>
Pacific Investments Group owns 12.5% of the capital</b>, after having funded
and backed the group since its creation in 2012. The company is currently chaired
by Sir Digby Jones, a British businessman and politician who has served as
Minister of<span style="mso-spacerun: yes;"> </span>State for Trade and
Investment between 2007 and 2008.<s> </s><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Management has gone through the Euro crisis, Brexit and now COVID so it understands
very well that the FX business can be volatile in the short-term. It therefore <b>prefers
to spend its time focusing on how to best position Argentex for the next 5-10 years</b>.
This focus is rather evident from two main decisions taken this year: <o:p></o:p></span></p>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l0 level1 lfo4; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Management
decided to move into a bigger office and to keep hiring its salesforce cohort
last summer, even if it puts profitability under pressure for the year; <o:p></o:p></span></p>
<p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo4; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Management
rejected many trades from prospects and clients that were not considered strong
enough to withstand COVID. Doing so would have helped increase sales (and the
share price) in the short term but at the cost of putting Argentex in jeopardy
in the longer-term if the client went under. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;">In an industry where risk management and discipline are paramount, we therefore
feel in particularly good hands with Argentex’s owner-operator founders.</span></b><i><s><span style="mso-ansi-language: EN-US;"> <o:p></o:p></span></s></i></p>
<p class="MsoNormal" style="text-align: justify;"><b><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></b></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">4-<span style="font: 7pt "Times New Roman";">
</span></span></span></b><!--[endif]--><b><u><span style="mso-ansi-language: EN-US;">Valuation</span></u></b><b><span style="mso-ansi-language: EN-US;"><o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">We expect the company to keep taking market share from banks in the
years to come, which should largely support the company’s ambition of c.25-30%
top line growth per year. This leads us to sales of GBP102m revenues in 2026
(23.4% CAGR) on FX volumes of GBP45.7bn. This would imply a 3.3% market share
based on the ONS numbers assuming no growth in the economy by 2026. The cost
base is almost entirely variable (commissions account for 65% of total OPEX)
and we therefore expect EBITDA margins to grow from 48.0% to 49.6% during the
period and absolute EBITDA to reach GBP50.7m <i>(the margin declines in 2021 as
the activity temporarily retreats while Argentex continues to recruit new salespeople
and moves its HQ to a bigger location). </i><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Argentex owns its technological IT platform and does not capitalize much
R&D OPEX so we expect CAPEX to stay at around GBP2.5m per year. At the
Company’s 19% tax rate, this leads to a free cash flow pre and post-interest
(there is no debt) of GBP38.8m (28.7% CAGR).<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span style="mso-ansi-language: EN-US;">Applying a conservative 8% FCF to Enterprise Value gives us a target
Enterprise Value of GBP485m in 2026. Due to its high cash conversion profile,
we expect Argentex’s net cash position to reach GBP139m by 2026, of which GBP94m
will be available to shareholders (we consider the other GBP45m as restricted
cash used to fund potential collateral payments). This leads to a <b>target
Market Capitalization of GBP578m, or GBPx510 per share. We therefore expect an
investment at current prices of GBPx122 to generate a 33.1% IRR over the next 5
years. <o:p></o:p></b></span></p>
<p class="MsoNormal" style="text-align: justify;"><!--[if gte vml 1]><v:shape id="Image_x0020_2"
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<p class="MsoNormal" style="text-align: justify;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigNGbgltmk8czXdUrupMlGTydOzNzZLA2_kBk35d-d5MLM20BOEQqgYdyXr4xZYkIIu_-wGgLhg_TxAiKG7cQJvHVZLzhh5GVMWBRRSPduMJasABEz7gkanpiKAnF09t9z_BscrZ2wYphl/s838/Image+4.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="469" data-original-width="838" height="362" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigNGbgltmk8czXdUrupMlGTydOzNzZLA2_kBk35d-d5MLM20BOEQqgYdyXr4xZYkIIu_-wGgLhg_TxAiKG7cQJvHVZLzhh5GVMWBRRSPduMJasABEz7gkanpiKAnF09t9z_BscrZ2wYphl/w647-h362/Image+4.PNG" width="647" /></a><b></b><b><span style="font-size: 16pt; line-height: 107%; mso-ansi-language: EN-US;"><o:p> </o:p></span></b></p>
<p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">5- </span></span></b><b style="text-indent: -18pt;"><span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; font-weight: normal; line-height: normal;"> </span></b><b style="text-indent: -18pt;"><u>Risks</u></b></p><p class="MsoNormal" style="text-align: justify;">Given the highly concentrated nature of our portfolio, we focus a lot on
what could go wrong and how it could lead to permanent loss of capital, which
is why we spent a significant amount of time considering the key risks related
to this investment.<o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><b>Bankruptcies of top end-customers<o:p></o:p></b></p><p class="MsoListParagraph" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->As a
riskless principal broker, the company is not exposed to customer bankruptcy
per se, but to the following scenario: <b>a big customer going bankrupt with an
ongoing forward trade and at the same time an adverse move in the underlying currency</b>.
If this happened, Argentex would immediately ‘cancel’ the trade by booking an
equal and opposite trade with its institutional counterparties. Argentex would however
be on the hook for the losses created by the adverse currency move. <o:p></o:p></p><p class="MsoNormal" style="margin-left: 18pt; text-align: justify;"><i>Ex: A client with a GBP100m forward contract goes
bankrupt. The underlying currency moves against the client by 10% on the same
day. Argentex ‘cancels” the trade as described above and limits further damage.
However, the company is on the hook for c.GBP10m, i.e. the GBP100m notional
times the adverse currency move (10%). <o:p></o:p></i></p><p class="MsoListParagraph" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span><b>Risk
management is therefore at the core of what the company does</b>. This starts pre-trade, with not chasing what
Carl Jani refers to as “dirty revenues” and be willing to sacrifice short-term
financial performance for the long-term health of the business. Management’s first
question when looking at a deal is “does this have the potential to hurt us?”. Additionally,
a lot of time is spent assessing the creditworthiness of each client and the
company will require up-to-date financials from them when they want to put on a
big trade. The company also has strong risk parameters regarding its exposure
to a limited number of clients or industries.<o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><i>Ex: During the summer of 2020, it could have done a deal with a retailer
and taken £2m for £200m underlying currency, which would have shown stronger H1’20
results. It did not and the retailer is now bankrupt. The company would have
been in a more precarious situation if it accepted the deal.<o:p></o:p></i></p><p class="MsoListParagraph" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>Post
trade, Argentex will do daily sensitivity analysis on the top 20 “most at risk”
clients and simulate diverse currency scenarios. It will also look at its
overall currency exposure to see where traders can be more lenient on
collateral requirement or on the contrary where they need to be strict. <o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><b>Damage of reputation due to poor client services or KYC procedures <o:p></o:p></b></p><p class="MsoListParagraphCxSpFirst" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>As
explained previously, reputation is paramount in this industry and one of the
competitive advantages of independent FX providers is better client service
compared to institutional banks;<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>Poor
client services arising from incorrect trade execution, human error, trader’s
unavailability to answer queries on time could have a severe negative effect on
the company’s reputation and on its activity. Indeed, as the famous saying goes
“it takes 20 years to build a reputation and five minutes to ruin it”;<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>Argentex
is still a nascent company in this industry and sometimes gets referenced to
other clients by word of mouth. Even a tiny portion of clients being
unsatisfied can have a snowball effect and therefore impact the growth of the
company;<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpLast" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>In
parallel, poor KYC procedures leading to some client bankruptcies, while
limited, can spread negative sentiments (even unjustified) around the solidity
of the business.<b><o:p></o:p></b></p><p class="MsoNormal" style="text-align: justify;"><b> </b></p><p class="MsoNormal" style="text-align: justify;"><b></b></p><div class="separator" style="clear: both; text-align: center;"></div><b><b><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgE29ZWazJIHHx55VeiX3J8baAoPwDEDnimRqAsfhvO1BE5uVAYTosoz6FVfIWTM8JWRYiGZrUcHjvqLuaOt4DOEGGzaE50srHQ7x-Y8w8tN9_djEirUkaeYTWHJWIrBsOs8Fy2FpE5aCL3/s401/Image+5.PNG" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="401" data-original-width="170" height="341" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgE29ZWazJIHHx55VeiX3J8baAoPwDEDnimRqAsfhvO1BE5uVAYTosoz6FVfIWTM8JWRYiGZrUcHjvqLuaOt4DOEGGzaE50srHQ7x-Y8w8tN9_djEirUkaeYTWHJWIrBsOs8Fy2FpE5aCL3/w136-h341/Image+5.PNG" width="136" /></a></b><br />Poor integration of new recruits<o:p></o:p></b><p></p><p class="MsoListParagraphCxSpFirst" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->Because the
salesforce is key in bringing in new clients, recruits need to be trained and reach
the skill level of the experienced salesforce for the business to achieve its
growth targets. Indeed, as the following charts shows, as recruits gain
experience, they become better at acquiring clients;<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->However,
training from scratch a new batch of recruits every 6 months (a work done by
the co-CEO and the experienced salesforce) requires time, energy, patience, and
salary expenses without the guarantee of success. As a result, it can disturb
the work organization of experienced team members as they need to allocate time
between training and sourcing new prospects;<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l1 level1 lfo3; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->While we
welcome the quasi-constant arrival of fresh and motivated young graduates, we
also consider it as a risk that Argentex will need to take into account if it
wants to optimize its growth prospects without impacting the current solidity
of its team.<b><o:p></o:p></b></p><p class="MsoListParagraphCxSpLast" style="text-align: justify;"><b> </b></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><b><u>Appendix 1 <o:p></o:p></u></b></p><p class="MsoNormal" style="text-align: justify;">Some examples from our research: <o:p></o:p></p><p class="MsoListParagraphCxSpFirst" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->Traders
usually find out the rates at which clients are interested in or the day
clients like to trade and call them before they have to;<o:p></o:p></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>Argentex
will sometimes charge less than it could on a specific trade to keep a good
relationship (whereas bank pricing is largely based on mechanical grid prices);<o:p></o:p></p><p class="MsoListParagraphCxSpMiddle" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">
</span><!--[endif]-->Flexibility
over settlement payment: bank will charge corporates a lot if they do not pay
at settlement whereas Argentex will be more flexible;<o:p></o:p></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;">
</p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]-->-<span style="font-size: 7pt; font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span>Argentex
will also be more flexible around the corporate structure: SPV for instance are
rejected by banks for FX services although they are backed by massive PE firms. <o:p></o:p></p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><br /></p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><br /></p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;"><br /></p><p class="MsoFootnoteText"><span lang="FR"><span face="Calibri, sans-serif" style="font-size: 14.6667px; text-align: justify; text-indent: -24px;">[1]</span> </span>Link to the press release: <span lang="FR"><a href="https://www.bankofengland.co.uk/markets/london-foreign-exchange-joint-standing-committee/results-of-the-semi-annual-fx-turnover-survey-october-2018"><span lang="EN-US">https://www.bankofengland.co.uk/markets/london-foreign-exchange-joint-standing-committee/results-of-the-semi-annual-fx-turnover-survey-october-2018</span></a></span><o:p></o:p></p><p class="MsoFootnoteText"><o:p> </o:p></p><p class="MsoListParagraphCxSpLast" style="mso-list: l0 level1 lfo2; text-align: justify; text-indent: -18pt;">
<span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="FR" style="font-size: 11pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="FR" style="font-size: 11pt; line-height: 107%;"> [2]</span></span><!--[endif]--></span></span><span face=""Calibri",sans-serif" lang="FR" style="font-size: 11pt; line-height: 107%; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"> See Appendix 1</span></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><p class="MsoListParagraph" style="mso-list: l3 level1 lfo1; text-align: justify; text-indent: -18pt;"><b><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;"><br /></span></span></b></p><div style="mso-element: footnote-list;"><div id="ftn2" style="mso-element: footnote;">
</div>
</div>DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com9tag:blogger.com,1999:blog-3373014469543202176.post-49333722618437057762021-01-17T11:32:00.003-08:002021-01-18T09:26:36.739-08:002MX 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!)<p></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><i style="color: #990000; font-family: inherit;">Disclaimer: We are shareholders of 2MX Organic. </i></span></p><p class="MsoNormal" style="text-align: justify;">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 <b>2MX
Organic</b>, 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.</p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;">Yes, we know that between dilution, bad
incentives and record-high business valuations, SPACs are a usually a terrible
value proposition. <b>However, when the SPAC’s CEO, Moez-Alexandre Zouari, in addition to its founder shares, </b></span><b>buys </b><b>10% of the company for EUR30m at the IPO price (EUR 10), we take notice and
dig deeper.<span style="mso-spacerun: yes;"> </span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><span></span></span></p><a name='more'></a><span lang="EN-US" style="mso-ansi-language: EN-US;">The investment case is rather simple: 2MX
Organic’s listed shares are in reality “class B preferred shares” that can be
redeemed by shareholders at EUR10 when the company announces an acquisition.
With shares trading at EUR10.35 as of last Friday, the maximum downside is capped
at 3% while the upside could prove meaningful if the market likes the deal (after
all “organic” and “sustainability” are nice buzzwords to ride the ESG trend!). <b>The
current share price therefore allows investors to get a “free look” at a transaction
carried out by one of France best retail operator with significant skin in the
game.</b> Interestingly, shares traded for as much as EUR13 on the day of the IPO and
provide a blueprint on what could happen when an acquisition is announced. <o:p></o:p></span><p></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;">A bit more background is in order to explain our bullishness: the company is the brainchild of an experienced trio who is expert at maximizing shareholder
value. Moez-Alexandre Zouari, the CEO, has significant retail experience and
owns c.1500 stores in France under well-known brands such as Franprix,
Monoprix, Casino and Picard. He is a best-in-class operator and has helped Casino turnaround several hundred underperforming units. He also recently acquired
a 44.5% stake in Picard, France’s leading frozen food retailer, for EUR156m. We
believe his extensive knowledge of the retail space as well as his access to proprietary
data from its store base will allow 2MX Organic to target the companies best positioned
to thrive under customers’ changing tastes. Importantly, <b>this is</b> <b>not
all talk: not only did <span style="mso-spacerun: yes;"> </span>Mr. Zouari buy EUR30m worth of B shares at IPO, but he undertook not to request the redemption
of the market shares that he will hold</b>. On the other hand, Xavier Niel (the
billionaire founder of Iliad, France’s fourth largest telecom operator) and Matthieu
Pigasse (Partner at investment bank Centerview) already teamed up in 2016,
IPOing Mediawan, a SPAC designed to create a pan-European content creator for
VOD platforms. In the interest of full disclosure, Mediawan languished around
EUR10 even after its first acquisition so this might happen to 2MX. But given
the odds, we are more than happy to take the bet!<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;">Before we wrap it up, here are some<span style="mso-spacerun: yes;"> </span>interesting figures from the company’s website you might be interested in:<o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-Gw5dnYyKYlSJrGkg422RWdFvptQ-OWxhyphenhyphenn0rNjy7-9IhStJYHVOfPZIf6jsoWz0yyd70_43gjbg-3Z884UInlgEfue3BVPIQ6BMhX9iYXHtmEUSseN8ai8pkynDd-SkcaW7_FBIXdSZ4/s503/Picture1.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="374" data-original-width="503" height="383" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-Gw5dnYyKYlSJrGkg422RWdFvptQ-OWxhyphenhyphenn0rNjy7-9IhStJYHVOfPZIf6jsoWz0yyd70_43gjbg-3Z884UInlgEfue3BVPIQ6BMhX9iYXHtmEUSseN8ai8pkynDd-SkcaW7_FBIXdSZ4/w515-h383/Picture1.png" width="515" /></a></div><p align="right" class="MsoNormal" style="text-align: right;"><b><span lang="EN-US" style="mso-ansi-language: EN-US;">DK Value<o:p></o:p></span></b></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;">For those interesting in the fine print
regarding the redemption of the Market Shares (although we argue it does not
matter as if shares fall below EUR10, arbitragers will buy them and bid<span style="mso-spacerun: yes;"> </span>up the share price back up to EUR10), here
are the critical details you can find in the 300-page prospectus. In order to
redeem your shares the following conditions must be met:</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;">- The
Chairman of the Board of Directors must have convened, prior to the Initial
Business Combination Deadline, the members of the Board of Directors at a
special meeting to (i) appoint the Financial Expert and, following the issuance
of its report (ii) to approve a proposed Initial Business Combination that it
has selected.</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;">- The
special meeting of the members of the Board of Directors thus convened must
have approved the proposed Initial Business Combination submitted by the Chief
Executive Officer on the basis of the Financial Expert’s report certifying that
the Company has sufficient financial means in the form of equity capital and
authorization of credit lines to carry out the Initial Business Combination</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><b>- Following an affirmative vote of the members of the Board of Directors
adopted at the Required Majority, the Company must publish a notice (the “IBC
Notice”)</b></span></span><span lang="EN-US" style="mso-ansi-language: EN-US; text-indent: -18pt;"> previously
communicated to the Autorité des Marchés Financiers, describing the Initial
Business Combination to the shareholders and the market and indicating that
following its approval by the Board of Directors, the Initial Business
Combination will be implemented</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;"><span lang="EN-US" style="mso-ansi-language: EN-US;">- <b>Following the publication of the IBC Notice, the Company will provide
Market Shareholders with the opportunity to redeem all of their Market Shares.</b></span></span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;"><b>- </b>The
redemption price of a Market Share is equal to €10.00. All the Market Shares
redeemed by the Company as described above will be cancelled immediately after
their redemption</span></p><p class="MsoNormal" style="text-align: justify;"><span style="text-indent: -18pt;">- The
redemption of the Market Shares is completed by the Company no later than the 30</span><sup style="text-indent: -18pt;">th</sup><span style="text-indent: -18pt;">
calendar day following the completion date of the Initial Business Combination
approved by the Board of Directors (the “Initial Business Combination
Completion Date”), or on the following business day if such date is not a
business day.</span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri; text-indent: -18pt;"><span style="mso-list: Ignore;"><span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;">- </span></span></span><span lang="EN-US" style="mso-ansi-language: EN-US; text-indent: -18pt;">Other
requirements for redemption:</span></p>
<p class="MsoListParagraphCxSpMiddle" style="margin-left: 72pt; mso-add-space: auto; mso-list: l0 level2 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-US" style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-US" style="mso-ansi-language: EN-US;">Notify
the Company, by registered letter with return receipt requested sent to the
registered office to the attention of the Board of Directors’ Chairman and copy
to the Chief Executive Officer or by electronic telecommunication to the
address specified in the notice, no later than the thirtieth (30th) calendar
day following the IBC Notice, his/her/its intention to have his/her/its Markets
Shares redeemed;<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="margin-left: 72pt; mso-add-space: auto; mso-list: l0 level2 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-US" style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><span lang="EN-US" style="mso-ansi-language: EN-US;">Have
had full and entire ownership, on the thirtieth (30th) calendar day following
the IBC Notice, of his/her/its Market Shares held in pure or administrative
registered form;<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="margin-left: 72pt; mso-add-space: auto; mso-list: l0 level2 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-US" style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7pt "Times New Roman";"> </span></span></span><span lang="EN-US" style="mso-ansi-language: EN-US;">Have
put his/her/its Market Shares exclusively into pure registered form (forme nominative pure) no later than two business days before the Initial Business
Combination Completion Date, and have kept such Market Shares under such form
until the date of redemption of the Market Shares by the Company; and<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="margin-left: 72pt; mso-add-space: auto; mso-list: l0 level2 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-US" style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><span lang="EN-US" style="mso-ansi-language: EN-US;">Not
have transferred, on the redemption date of the Market Shares by the Company,
the full ownership of his/her/its Market Shares;<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpLast" style="margin-left: 72pt; mso-add-space: auto; mso-list: l0 level2 lfo1; text-align: justify; text-indent: -18pt;"><!--[if !supportLists]--><span lang="EN-US" style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7pt "Times New Roman";"> </span></span></span><!--[endif]--><span lang="EN-US" style="mso-ansi-language: EN-US;">Not
have informed the Company of his/her/its irrevocable undertaking not to request
the redemption of his/her/its Market Shares by the Company prior to the meeting
of the Board of Directors having approved the IBC and this in accordance with
the provisions of the Articles of Association;<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p><br /><p></p>DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com0tag:blogger.com,1999:blog-3373014469543202176.post-69014682678074360842021-01-13T05:32:00.024-08:002021-01-14T04:42:18.279-08:00Enlabs: Why shares are worth at least SEK60, 50% above Entain’s public offer<p><i style="color: #990000; font-family: inherit; text-align: justify;">Disclaimer: We own 0.1% of Enlabs’
capital. You can find our initial investment case (28 July 2020) on this blog as well. </i></p><p class="MsoNormal" style="line-height: normal; mso-margin-bottom-alt: auto; mso-margin-top-alt: auto; text-align: justify;"><span style="font-family: inherit;">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 <span style="color: #3d85c6;">[1]</span> 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<sup>th</sup> biggest shareholder,
had rallied enough shareholders to block the transaction, which is conditional
to a 90% acceptance rate <span style="color: #3d85c6;">[2]</span>. This is a very welcomed
development, and we commend Mr. Isoz for stepping up for all Enlabs’
shareholders.</span><span style="font-family: "Times New Roman", serif; font-size: 13.5pt;"><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">We hope with the following to provide a
framework as to the extent to which Entain’s offer undervalues Enlabs. <b>Importantly,</b>
<b>we show why Enlabs is worth <u>at least SEK60 per share</u> (50% higher that
Entain’s bid), even under the IBC’s flawed valuation methodology.</b></span></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span><b><span style="font-family: inherit;"></span></b></span></span></i></p><a name='more'></a><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><b><u>1. Considerations regarding bid premium</u></b></span></span></i><p></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">2020 has been eventful for Enlabs and its value
accordingly increased throughout the year, whether it is with Global Gaming’s
acquisition (high cost and sales synergies + possible relaunch of Ninjacasino
in Sweden), with Ukraine and Belarus legalizing online gambling or with Enlabs’
impressive organic performance. When facts change, so does the value of a
business. But sometimes the market is slow to react and therefore relying on
premium to the share price of the previous 180 days or to the share price on 22
February 2020, is highly misleading (After all Q4’20 EBITDA was a whopping 30%
above market expectations). <b>The only things that matter is</b> <b>how the public
offer price compares to the intrinsic value of the company – not to the
previous day, week or even month share price.</b></span></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><b><u>2. Market valuation of Enlabs</u></b></span></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">In that regard, the IBC failed Enlabs’
shareholders spectacularly. Indeed, it mentions in its press release that
Enlabs is “currently trading at approximately 12x 2021E EBITDA on market
consensus <span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[3]</span></span></span><!--[endif]--></span></span>”,
implying that 12x EV/EBITDA is a fair multiple. We think Enlabs’ competitive
positioning in jurisdictions where marketing is heavily restrained and online
penetration low deserves a far higher multiple but for the sake of the argument
let us assume 12x EV/EBITDA is the right metric.<o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">First, we are stunned that the IBC relied on
market consensus rather than their own estimates during the sale process. <b>This
is highly problematic since the Q4’20 EBITDA figure was 30% above expectations and
clearly imply that the market consensus is some 15% to 20% below what the
company can realistically achieve in 2021. </b>We believe market consensus will
likely need to raise its EUR23.0m EBITDA estimate for 2021 to at least EUR27.0m (<i>see
below</i>). <s><o:p></o:p></s></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZ_Proa3xZxmcoS_dgYOyl8a4AmRUVN30oBZrSTiU_KNWd2-TPYHor2KhP_tt5lJuIqCvbZdHgZGqSHpeLnVWCi3tuTZPOsYmPKB0GLCIzMgv-09nEhQzRDjjzrIMEp-t5V4E8Ve7bh1As/s291/1.png" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" data-original-height="247" data-original-width="291" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZ_Proa3xZxmcoS_dgYOyl8a4AmRUVN30oBZrSTiU_KNWd2-TPYHor2KhP_tt5lJuIqCvbZdHgZGqSHpeLnVWCi3tuTZPOsYmPKB0GLCIzMgv-09nEhQzRDjjzrIMEp-t5V4E8Ve7bh1As/s0/1.png" /></span></a></div><span style="font-family: inherit;"><br /></span><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit;"><span>Another way to look at 2021E EBITDA is to
annualize the Q4’20 EBITDA (which includes both Enlabs and Global Gaming for
the entire period), adjust it 20% downward for some Q4 revenue cyclicality (highly
conservative), add the synergies from the Global Gaming’s acquisition which
should kick in in 2021 (deducted from our conversations with the management) and
lastly add 2021E’s organic growth of c.15% (assumes 0% at Global Gaming and 25%
at Enlabs and no operating leverage). This leads to an EBITDA figure of EUR28.1m
for 2021, roughly in line with what we think the newly adjusted market
expectations should be (</span><i>see below</i><span>).</span></span></p>
<div class="separator" style="clear: both; text-align: center;"><span style="font-family: inherit; margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="113" data-original-width="311" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh4fdQ4zEZAn712P_AFPFj7cUbOLcuA2C7qp9OAhMcPJsl6TAB16QXT_ZWBVWw_PaAOj69Pumny_S5d0m70Ut0UCXX-PYg5xM0PO3VF9NmmQJZ7rSOVesJnFND5SkgTgn6VKYqoBi9xcjYr/s0/2.png" /></span></div><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit;"><b><span lang="EN-US" style="mso-ansi-language: EN-US;"><br /></span></b></span></p><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit;"><b><span lang="EN-US" style="mso-ansi-language: EN-US;">Taking both new estimates and keeping the IBC’s
12x EV/EBITDA multiple would lead to a fair value of Enlabs of <u>SEK49–51 per
share</u>, 23 to 28% above Entain’s offer </span></b><span lang="EN-US" style="mso-ansi-language: EN-US;">(<i>see below</i>).</span></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM4VG2ZqJgJ16Eq7DhANjQ3KuyI_dZXce4a4oGn3ikmZdIsiefSss9GbsNQTfy8FmcqJpZewPpygGOitI69qE8MJ_zhTBCyBLeHxtungSSk6BOsVDfo2a17u9bW1p_KfH4PvOO0tRnhgTX/s518/3.png" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" data-original-height="176" data-original-width="518" height="162" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM4VG2ZqJgJ16Eq7DhANjQ3KuyI_dZXce4a4oGn3ikmZdIsiefSss9GbsNQTfy8FmcqJpZewPpygGOitI69qE8MJ_zhTBCyBLeHxtungSSk6BOsVDfo2a17u9bW1p_KfH4PvOO0tRnhgTX/w476-h162/3.png" width="476" /></span></a></div><div class="separator" style="clear: both; text-align: center;"><span style="font-family: inherit; text-align: justify;"><br /></span></div><div class="separator" style="clear: both; text-align: left;"><span style="font-family: inherit; text-align: justify;">And there is more. Enlabs is in prime position
to expand into adjacent markets worth several times its core markets. The
company indeed has plans to enter Ukraine and Sweden during 2021.</span></div>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l1 level1 lfo1; text-align: justify; text-indent: -18pt;"><span style="font-family: inherit;"><span><!--[if !supportLists]--><span lang="EN-US" style="mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-bidi-font-weight: bold; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-stretch: normal; font-style: normal; font-variant: normal; font-weight: normal; line-height: normal;"> 1/ </span></span></span></span><span style="text-indent: -18pt;">Ukraine’s
online market is estimated to be c.EUR300m, or 5.5 times the size of the Latvian
market and 2.5 times the size of the entire core markets of Enlabs </span><span class="MsoFootnoteReference" style="text-indent: -18pt;"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftn4" name="_ftnref4" style="mso-footnote-id: ftn4;" title=""><!--[if !supportFootnotes]--></a><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftn4" name="_ftnref4" style="mso-footnote-id: ftn4;" title="">[</a>4]</span></span></span><!--[endif]--></span></span><span style="text-indent: -18pt;">.
We believe that the company, thanks to its proprietary technological platform
(lauded by none other than Entain’s CEO on his call to shareholders), should
command a high market share in the online casino market. Assuming casino
accounts for 40% of the online market and that Enlabs reaches a 7.5% market
share by 2023, this would mean EUR9.0m of additional revenue.</span></span></p>
<p class="MsoListParagraphCxSpLast" style="mso-list: l1 level1 lfo1; text-align: justify; text-indent: -18pt;"><span style="font-family: inherit;"><!--[if !supportLists]--><span lang="EN-US" style="mso-ansi-language: EN-US; mso-bidi-font-family: Symbol; mso-bidi-font-weight: bold; mso-fareast-font-family: Symbol;"><span style="mso-list: Ignore;">·<span style="font-stretch: normal; font-style: normal; font-variant: normal; font-weight: normal; line-height: normal;"> 2/ </span></span></span><span lang="EN-US" style="mso-ansi-language: EN-US;">In
Sweden, Enlabs is looking to relaunch the Ninjacasino brand after it was banned
by the regulator under the Global Gaming umbrella <span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[5]</span></span></span><!--[endif]--></span></span>.
Ninjacasino did at its peak in 2018 EUR79.0m in revenue <span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[6]</span></span></span><!--[endif]--></span></span>
and given its strong brand name, we would expect the company to get back 30% to
35% of its historical customer base in the case of a successful relaunch by
2023, implying some EUR26.0m additional revenue at the mid-point.</span></span></p><p class="MsoListParagraphCxSpLast" style="mso-list: l1 level1 lfo1; text-align: justify; text-indent: -18pt;"><span style="font-family: inherit;"><span> Put together these new markets would
add 37% to Enlabs’ 2021E sales </span><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[7]</span></span></span><!--[endif]--></span></span><span>.
</span><span><b>Alas, while these new revenue streams will materially increase the long-term
intrinsic value of Enlabs, they do not show up in the market consensus EBITDA
for 2021 </b><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="mso-bidi-font-weight: normal;"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[8<a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftn8" name="_ftnref8" style="mso-footnote-id: ftn8;" title="">]</a></span></span></span></span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftn8" name="_ftnref8" style="mso-footnote-id: ftn8;" title=""><b><!--[endif]--></b></a></span></span><b>.
The significant optionality from these new countries should be reflected in
Entain’s offer given Enlabs’ clear path to market leadership</b></span><span>. Assuming a 20%
EBITDA margin, EBITDA from Sweden and Ukraine should reach c.EUR7.0m by 2023,
or a EUR84m Enterprise Value at the IBC’s 12x EV/EBITDA. We discount this back 2
years at 10%, add it to Enlabs’ “core market” EV and find that Enlabs intrinsic
value rises to </span><b><u>SEK59</u></b><b style="text-indent: 0px;"><span lang="EN-US" style="mso-ansi-language: EN-US;"><u>–</u></span></b><b><u>61</u></b><span><b><u> per share</u></b>, or 47.9% to 52.7% above the
current offer.</span></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdRtRoZUJTWH9ImujSH6aItaMJlegjRKX5SiLknI6NAmNKksFCPDRQLzR0PA9Dj3tX5SuCyTdZkuuTWKTk_G4dsJG34g64AnudnpXiw5rWQkL-JBA0SumkbL1qhLzANPlwjnWahah70nop/s676/4.png" style="margin-left: 1em; margin-right: 1em;"><span style="font-family: inherit;"><img border="0" data-original-height="365" data-original-width="676" height="282" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdRtRoZUJTWH9ImujSH6aItaMJlegjRKX5SiLknI6NAmNKksFCPDRQLzR0PA9Dj3tX5SuCyTdZkuuTWKTk_G4dsJG34g64AnudnpXiw5rWQkL-JBA0SumkbL1qhLzANPlwjnWahah70nop/w520-h282/4.png" width="520" /></span></a></div><span style="font-family: inherit;"><br /></span><div class="separator" style="clear: both; text-align: center;"><span style="font-family: inherit;"><br /></span></div><div class="separator" style="clear: both; text-align: left;"><span style="font-family: inherit;"><b style="text-align: justify;"><span lang="EN-US" style="mso-ansi-language: EN-US;">Lastly, we believe that the bid should include
a strategic premium since Entain plans to use Enlabs and its well-established
brands as a launchpad into Northern and Eastern European markets </span></b><span lang="EN-US" style="mso-ansi-language: EN-US; text-align: justify;">(after all Entain’s CEO spoke at
length about the expansion opportunities Enlabs would provide Entain during his
call with shareholders)<b>.</b></span></span></div><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><b><u>3. Risk assessment</u></b></span></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">We would not agree with the board that there
are “<i>elevated risks associated with Company’s operations in only a few core
markets</i>”. While the online license suspension during COVID-19 (April-May
2020) was no doubt stressful for everybody at Enlabs (and for its shareholders),
we would caution against extrapolating and react emotionally to it. These were
very unusual times and since then the Constitutional Court of Latvia ruled that
the country's ban on online gambling during this period was unconstitutional <span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><span style="color: #3d85c6;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[9]</span></span></span><!--[endif]--></span></span>.
Furthermore, the commitment from authorities to fight against black-market operators
indicate an understanding of the benefits of having a locally licensed and
taxed market. The current closure of Enlabs’ land-based operations is
unfortunate but very marginal in the context of the group, as they represent
less than 6% of sales with low contribution margin compared to online. <o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">We are also confused by the board’s statement that
growth in Enlabs’ core markets will saturate in the mid to long term – of
course it will! But by then the company will likely have tripled in size. See
below the difference in online gaming penetration in core markets compared to
Sweden and the UK. You can find written in red the potential increase in market
size if penetration reaches Sweden’s levels.<span style="mso-spacerun: yes;">
</span>This increase does not include the growth of the total market in the
meantime. <o:p></o:p></span></p>
<span style="font-family: inherit;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmXXAGBvxL0C8JuFSmrL0W1JlnI3M7wTMZBBoKwR6978snpgeJqBiz_CdhhWSri3Iis_BDMMww1fkUe68Hhloj3lK5zBi44NzdjZ1JBwhublPR0yJp_NqPdZwXZ69QmWbp2M7WLE_TtQPd/s2767/5.png" style="margin-left: 1em; margin-right: 1em; text-align: center;"><img border="0" data-original-height="1137" data-original-width="2767" height="211" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmXXAGBvxL0C8JuFSmrL0W1JlnI3M7wTMZBBoKwR6978snpgeJqBiz_CdhhWSri3Iis_BDMMww1fkUe68Hhloj3lK5zBi44NzdjZ1JBwhublPR0yJp_NqPdZwXZ69QmWbp2M7WLE_TtQPd/w515-h211/5.png" width="515" /></a></span><div><span style="text-align: justify; text-indent: -18pt;"><span lang="EN-US" style="font-family: inherit; font-size: x-small; line-height: 107%; mso-ansi-language: EN-US;"><i>Source: H2GC and local regulator estimates</i></span></span></div><div><b><i style="text-align: justify; text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><br /></span></span></i></b></div><div><b><span style="font-family: inherit;"><i style="text-align: justify; text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span><u>4. Views of existing large shareholders</u></span></span></i>
</span></b><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">The fact that Enlabs’ Chairman, (i) will be
employed by Entain after the acquisition to develop the group’s operations in
the Baltics and Nordic regions, and (ii) will be offered a compensation package
consistent with senior executives of the Entain group raises questions as to
whether the offer provides a true level playing field to the remaining
shareholders. Surprisingly, none of these concerns have been addressed by the
IBC. <span style="color: red;"><o:p></o:p></span></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">Additionally, we question how Enlabs’ Independent
Bid Committee was able to review thoroughly the offer and obtain the fairness
opinion from Mangold as it was appointed on 6 January 2021, the day before the
offer announcement. <span style="mso-spacerun: yes;"> </span></span></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><b><u>5. Fairness opinion</u></b></span></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">Mangold’s fairness opinion, as published to
shareholders, has little substance so it is impossible to judge what was
provided to the board. We would be pleased if the IBC was willing to share Mangold’s
financial forecasts (we would be interested to see how they compare to the old
– and new – market consensus and to our estimates) as well as its analysis on
new market developments and how it was taken into consideration when deriving the
SEK40 “fair” value.</span></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="line-height: 107%; mso-ansi-language: EN-US;"><span style="font-family: inherit;"><b><u>6. Impact on the Company and its
employees</u></b></span></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">Nothing to add here. Entain will surely provide
additional resources to Enlabs in its market expansion but the company already has
the technology and the people to get there on its own and therefore these
opportunities should be valued as part of the deal.</span></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="font-family: inherit; line-height: 17.12px; mso-ansi-language: EN-US;"><b><u><br /></u></b></span></i></p><p class="MsoNormal" style="text-align: justify;"><i style="text-indent: -18pt;"><span lang="EN-US" style="font-family: inherit; line-height: 17.12px; mso-ansi-language: EN-US;"><b><u>Conclusion</u></b></span></i></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;"><b>As we hope it is clear by now, Entain’s offer materially
undervalues Enlabs and we will hold on to our shares and wait for
an improved offer by Entain.</b><o:p></o:p></span></p>
<p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">Interestingly, the current setup provides for an
interesting low risk, high reward scenario and we accordingly increased our position from 30% to 40% of our portfolio: the shares trade at SEK42 (a 5%
premium to the offer price) while Mr. Isoz and investors owning more than 10% of
Enlabs could block the transaction and seem determined to seek a higher price
from Entain (Mr. Isoz mentions in the article that the offer would at least have
to start with a 5). Given how Enlabs fits into Entain’s strategic expansion in
Northern and Easter European markets, we feel that the odds of an improved offer is very high. <o:p></o:p></span></p><p class="MsoNormal" style="text-align: justify;"><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">---</span></p><div style="mso-element: footnote-list;"><div id="ftn1" style="mso-element: footnote;"><div style="text-align: justify;"><span style="font-family: inherit;"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref1" name="_ftn1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 12.84px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">Link to the press release: <a href="https://enlabs.com/en/press/pressreleases/2021/3862667-statement-by-the-independent-bid-committee-of-enlabs-ab-in-relation-to-the-public-offer-from-entain">https://enlabs.com/en/press/pressreleases/2021/3862667-statement-by-the-independent-bid-committee-of-enlabs-ab-in-relation-to-the-public-offer-from-entain</a> </span></span></span></div><div style="text-align: justify;"><div><span style="font-family: inherit;"><span><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 12.84px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref2" name="_ftn2" style="mso-footnote-id: ftn2;" title="">[2]</a> </span></span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref2" name="_ftn2" style="mso-footnote-id: ftn2;" title=""><!--[endif]--></a></span></span><span lang="EN-US" style="mso-ansi-language: EN-US;">Mr. Isoz owns 2.7% of the company. <span style="mso-spacerun: yes;"> </span>Link to the article: <a href="https://www.di.se/nyheter/budet-pa-enlabs-moter-mothugg-kan-stoppas-av-agargrupp/">https://www.di.se/nyheter/budet-pa-enlabs-moter-mothugg-kan-stoppas-av-agargrupp/</a></span></span></span></div><div><span style="font-family: inherit;"><span><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p></o:p></span></span><span><span class="MsoFootnoteReference"><span><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 12.84px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;"><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref3" name="_ftn3" style="mso-footnote-id: ftn3;" title="">[3]</a> As per Entain press release, a</span></span></span></span><span lang="EN-US" style="mso-ansi-language: EN-US;">nalyst consensus consists of Redeye (<i>note from 22<sup>nd</sup> November, 2020</i>) with sales of EUR92.7m and EBITDA of EUR25.2m, and ABG Sundal Collier (<i>note from 12<sup>th</sup> November, 2020</i>) with sales of EUR86.0m and EBITDA of EUR22.0m</span></span></span></div><div><span style="font-family: inherit;"><span><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p></o:p></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref4" name="_ftn4" style="mso-footnote-id: ftn4;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[4]</span></span><!--[endif]--></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">H2GC estimates – See Appendix 1</span></span></span></span></div><div><span style="font-family: inherit;"><span><span style="mso-ansi-language: EN-US;"><span lang="EN-US"><o:p></o:p></span></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref5" name="_ftn5" style="mso-footnote-id: ftn5;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[5]</span></span><!--[endif]--></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">NinjaCasino’s Swedish license was revoked by the regulator in June 2019 for social responsibility shortcomings and overly aggressive advertising practices by Global Gaming</span></span></span></span></div><div><span style="font-family: inherit;"><span><span style="mso-ansi-language: EN-US;"><span lang="EN-US"><o:p></o:p></span></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref6" name="_ftn6" style="mso-footnote-id: ftn6;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[6]</span></span><!--[endif]--></span></a><span lang="EN-US" style="mso-ansi-language: EN-US;"> Global Gaming: Annual Report 2018</span></span></span></div><div><span style="font-family: inherit;"><span><span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p></o:p></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref7" name="_ftn7" style="mso-footnote-id: ftn7;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[7]</span></span><!--[endif]--></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">Based on Redeye numbers</span></span></span></span></div><div><span style="font-family: inherit;"><span><span style="mso-ansi-language: EN-US;"><span lang="EN-US"><o:p></o:p></span></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref8" name="_ftn8" style="mso-footnote-id: ftn8;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[8]</span></span><!--[endif]--></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">2021E EBITDA might actually be reduced by them, given<b> </b>the high marketing investments required to launch into new markets</span></span></span></span></div><div><span style="font-family: inherit;"><span><span style="mso-ansi-language: EN-US;"><span lang="EN-US"><o:p></o:p></span></span></span><span><a href="https://d.docs.live.net/201d3af060700e4e/D%5e0K%20Partners/Stocks/Enlabs/Enlabs%20Letter%20Final.docx#_ftnref9" name="_ftn9" style="mso-footnote-id: ftn9;" title=""><span class="MsoFootnoteReference"><span class="MsoFootnoteReference"><span face=""Calibri",sans-serif" style="line-height: 14.2667px; mso-ansi-language: FR; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[9]</span></span><!--[endif]--></span></a><span style="mso-ansi-language: EN-US;"> <span lang="EN-US">Ruling here (in Latvian) </span></span><span lang="EN-US" style="mso-ansi-language: EN-US;"><a href="https://www.satv.tiesa.gov.lv/wp-content/uploads/2020/05/2020-26-0106_Spriedums.pdf">https://www.satv.tiesa.gov.lv/wp-content/uploads/2020/05/2020-26-0106_Spriedums.pdf</a></span></span></span></div></div></div><div id="ftn9" style="mso-element: footnote;"><p class="MsoFootnoteText"><b><u><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;"><br /></span></u></b></p><p class="MsoFootnoteText"><b><u><span lang="EN-US" style="font-family: inherit; mso-ansi-language: EN-US;">Appendix 1</span></u></b></p></div></div><p class="MsoNormal" style="text-align: justify;"><b style="text-align: left;"><span style="font-family: inherit;"><u></u></span></b></p><div class="separator" style="clear: both; text-align: center;"><span style="clear: left; float: left; font-family: inherit; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="202" data-original-width="660" height="156" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpniXdRAs_7pbFDZtwC7LV5mQDF4hraqysBKkUAuTWyrvOJymdkAZnNWBQlMRoXxSn41JiplSM8IKFk2tN840awxedXPHxDIREMQtibIYP1H7y3Kx0amHnE4Heo5YviSe_0nNYZs5aQstn/w555-h156/8.png" width="555" /></span><b style="text-align: left;"><u><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpniXdRAs_7pbFDZtwC7LV5mQDF4hraqysBKkUAuTWyrvOJymdkAZnNWBQlMRoXxSn41JiplSM8IKFk2tN840awxedXPHxDIREMQtibIYP1H7y3Kx0amHnE4Heo5YviSe_0nNYZs5aQstn/s660/8.png" style="margin-left: 1em; margin-right: 1em;"></a></u></b></div><p></p><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit; font-size: x-small;"><i><span><br /></span></i></span></p><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit; font-size: x-small;"><i><span><br /></span></i></span></p><p class="MsoNormal" style="text-align: justify;"><span style="font-family: inherit; font-size: x-small;"><i><span><br /></span></i></span></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><br /></p><p class="MsoNormal" style="text-align: justify;"><i style="font-family: inherit; font-size: small; text-align: left;"><span>So</span><span>urce: H2GC estimates</span></i></p></div>DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com6tag:blogger.com,1999:blog-3373014469543202176.post-81914214625093542472020-07-28T04:02:00.035-07:002021-01-19T00:59:10.897-08:00Enlabs - high tech, high growth, low price<div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span style="color: #990000; font-family: inherit;"><i>Disclaimer: We are shareholders of Enlabs AB.</i></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span style="color: #990000; font-family: inherit;"><i><br /></i></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span style="color: #990000; font-family: inherit;"><i>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.</i></span></div>
<h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b><u><span lang=""><font face="inherit" size="3">Summary</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">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. </span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;">A true asset light compounder, we think the company has a clear path to an 18% FCF CAGR, reaching EUR19m in 2024. <b>Applying an 8% FCF to EV yield in 2024 leads to an <u>intrinsic value of SEK48 per share</u>, or a 21.5% IRR on capital invested from current levels (SEK22 per share)</b>. 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.</span></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify; text-indent: 0px;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit; font-size: small;"><span><a name='more'></a></span>1 - Company Description</span></u></b></h3>
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<span lang="" style="font-family: inherit;">Enlabs’ online business generates almost all of its revenues from the Optibet brand. It launched a secondary brand called Laimz in June 2020 targeting the female customer segment. Revenues are split 66% from Casino, 28% from Sports-Betting and 6% from Poker. Latvia, Estonia/Lithuania and Finland/Other account for 70%, 24% and 6% of revenues respectively.<o:p></o:p></span></div><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0bHUjsepOwwKgZiqRmsmuvWtNVFvG-ySnY4y6epjL1H5hWLIIEAan2ASR-L7jMn3JHHAe74p0daaUiefa80yhPrl7vzccfyU3jk-KjPGIT-y1TZKmbz-Fys_t1-7_UE5rUUO3HB4ddApQ/s364/Picture+1.png" style="margin-left: auto; margin-right: auto;"><span style="font-family: inherit;"><img border="0" data-original-height="343" data-original-width="364" height="219" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0bHUjsepOwwKgZiqRmsmuvWtNVFvG-ySnY4y6epjL1H5hWLIIEAan2ASR-L7jMn3JHHAe74p0daaUiefa80yhPrl7vzccfyU3jk-KjPGIT-y1TZKmbz-Fys_t1-7_UE5rUUO3HB4ddApQ/w233-h219/Picture+1.png" width="233" /></span></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><i><font face="inherit">Company Reports</font></i></td></tr></tbody></table>
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<span lang="" style="font-family: inherit;"><br />The company also operates land-based sports-betting bars in Latvia and Lithuania, representing 6% of revenues.<o:p></o:p></span></div>
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<b><i><u><span lang=""><font color="#0b5394" face="inherit">Primer on Gambling Economics (skip if you are already familiar with gambling operations)<o:p></o:p></font></span></u></i></b></div>
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<i><span lang=""><font color="#0b5394" face="inherit">Revenues are derived from a take-rate on the volume wagered by customers.<o:p></o:p></font></span></i></div>
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<font color="#0b5394" face="inherit"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><i><span lang="">In casino the take-rate is fixed on a per game basis (c.3/4% of wagers) and has a rather low variance quarter on quarter.<o:p></o:p></span></i></font></div>
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<font color="#0b5394" face="inherit"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><i><span lang="">The take-rate in poker is a percentage of the pot levied at the end of each hand, called the rake(c.5% of the pot). <o:p></o:p></span></i></font></div>
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<font color="#0b5394" face="inherit"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><i><span lang="">In sports betting the operator uses an overround system (the fact that odds add to more than100%) which translates into a built-in edge for the house (c.8/9% of wagers). Adverse game results can however result in a high variance of the take-rate quarter on quarter.<o:p></o:p></span></i></font></div>
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<i><span lang=""><font color="#0b5394" face="inherit">The unit economics of online gambling are excellent:<o:p></o:p></font></span></i></div>
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<font color="#0b5394" face="inherit"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><i><span lang="">On average, customer lifetime value is around 3x the customer acquisition cost.</span></i><b><u><span lang=""><o:p></o:p></span></u></b></font></div>
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<font color="#0b5394" face="inherit"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><i><span lang="">The business generates 80%+ of its revenues from a very sticky 15% of customers (called VIPs).</span></i><b><u><span lang=""><o:p></o:p></span></u></b></font></div>
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<i><span lang=""><font color="#0b5394" face="inherit">These metrics translate into businesses that generally have >60% contribution margins, >25% EBITDA margins and >30% Return on Capital employed.</font></span></i></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit;"><br /></span></u></b></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">2 - Moat and Financial Snapshot</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">Enlabs’ moat is built on three pillars:<o:p></o:p></span></div>
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<b><span lang="" style="font-family: inherit;">Industry regulation, which keeps competition low and incumbents’ brands strong<o:p></o:p></span></b></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">The Baltic market is regulated on a country by country basis and operators need to apply for a license from the regulator. There is a relatively high share capital requirement to be eligible for a license, varying from EUR1m (Estonia and Lithuania) to EUR1.5m (Latvia).<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">More importantly, advertising of gambling products is heavily restricted in both Estonia and Lithuania, while it is banned in Latvia. This strongly benefits incumbents like Enlabs who already have a slice of the customer’s share of mind. Enlabs ‘cornered’ the sponsorship market in Latvia in the last few years (where it owns the naming rights for Football and Hockey national leagues and federations, two of the country’s most popular sports) and is replicating this strategy in Estonia and Lithuania to gain market share.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Additionally, the Baltic market is very niche and not of interest to the biggest industry operators. For instance, if GVC Holdings (Europe’s leading gambling operator) was to reach a 50% online market share in Latvia, it would increase its online sales by a meager 1.4%.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">In Latvia Enlabs sees almost <b>no revenue churn from cohorts going as far back as 2007</b>, a testament to the competitive positioning of the company in the country. </span><span face="calibri, sans-serif">It is therefore an extremely profitable market for Enlabs with more than 90% contribution margin.</span></span></div><p class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><o:p></o:p></span></p><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span style="font-family: inherit;"><br /></span><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigdrgwqxa6iQZ_mdIAQckZTkgLriMcjgGas6P6ZU4J-bY-2Yl_ZaYK1UKDEoD813TZovlD3Io4RTbHGz3neoeLOOjDDZWqvw34Z_-EFZMbk79orXky2gB0-vp0xYSAYqloB-IscCdW_NYf/s522/Picture+2.png" style="margin-left: auto; margin-right: auto;"><span style="font-family: inherit;"><img border="0" data-original-height="197" data-original-width="522" height="126" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigdrgwqxa6iQZ_mdIAQckZTkgLriMcjgGas6P6ZU4J-bY-2Yl_ZaYK1UKDEoD813TZovlD3Io4RTbHGz3neoeLOOjDDZWqvw34Z_-EFZMbk79orXky2gB0-vp0xYSAYqloB-IscCdW_NYf/w334-h126/Picture+2.png" width="334" /></span></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><span style="font-family: inherit;"><font><i>DK Value estimates</i></font><br /></span></td></tr></tbody></table><span style="font-family: inherit;"><br /></span></div>
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<b><span lang="" style="font-family: inherit;">Enlabs leading technological platform<o:p></o:p></span></b></div>
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<span lang="" style="font-family: inherit;">The company spent the last three years building a new proprietary technological platform.<o:p></o:p></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">This is a significant competitive advantage as it means greater operating leverage and reduced third party variable costs on incremental sale.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">It also means an improved user experience thanks to a faster go-to-market route with new products/games and full flexibility when making adjustments to the app’s front end. This in turns leads to less churn, improves engagement and extends the customer lifetime value.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">It makes market entry quicker and easier as the platform can easily be adapted to local market requirements. For instance, in Belarus, Enlabs was one of the first operators to submit a compliant platform to the regulator.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><b><span lang="">The scale of Enlabs’ operations, which benefits the company in three ways:</span></b><span lang=""><o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">First, and in relation to the above-mentioned naming rights, Enlabs can significantly overspend its competitors during the bidding process because it can spread the cost over more users.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Second, as a multi country operator, it can leverage its dominant position in Latvia (#1 operator with >50% market share and >90% contribution margins) to finance its market share grab in Estonia and Latvia where it is only in the top 5.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Third, Enlabs can afford bigger and bolder IT investments than competitors. We mentioned the proprietary platform in the last section. Enlabs will in this regard be the only gambling operator in the region not relying on third-party technology.<o:p></o:p></span></span></div>
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<span lang="" style="font-family: inherit;">The truth however lies in the numbers: <b>this moat, coupled with the asset light nature of the business translates into 30% EBITDA margins and a ROIC ex-goodwill of 90% in the last 5 years and a ROIC including goodwill of c.30%</b> (the goodwill is linked to a 2008 acquisition and has been grossed-up for any impairment).</span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit;"><br /></span></u></b></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">3 - Market</font></span></u></b></h3>
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<b><span lang="" style="font-family: inherit;">Latvia:<o:p></o:p></span></b></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">According to the regulator, total market size is EUR310m, of which EUR55m is online. This represents a 17.8% online penetration rate in 2019, up from 5.7% in 2015.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Enlabs has a 50% market share of the online market and is the #1 operator. Enlabs also has a 60% market share of the EUR3.2m land-based betting shop market.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">We forecast a flat offline market and annual increase of online sales in the EUR11m range per year (EUR13m in 2019 and 2018), meaning a 2.3% increase in yearly online penetration. This would lead to a 28.4% penetration rate in 2024.<o:p></o:p></span></span></div>
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<b><span lang="" style="font-family: inherit;">Estonia:<o:p></o:p></span></b></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">The Estonian regulator doesn’t publish market data, but it has been estimated by H2GC at around EUR170m, of which EUR31m is online. This represents an online penetration rate of 18.3%, quite similar to Latvia.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Enlabs has a 20% online market share in Estonia, making it the #2 biggest operator in the country. The company is targeting the top 1 position by replicating its Latvian strategy (especially regarding sponsorship).<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">We forecast a 2.5% increase in penetration, close to Latvia’s numbers which has similar online penetration levels. This would lead to a 30.8% penetration rate by 2024.<b><o:p></o:p></b></span></span></div>
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<b><span lang="" style="font-family: inherit;"> Lithuania<o:p></o:p></span></b></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">The Lithuanian regulator’s 2019 data shows a market size of EUR112.6m but effective total market is closer to EUR400m (adjusted for offline illegal activities). Online revenues of EUR40m represents a 10% penetration in the country.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Enlabs entered the market in Q4 2018 and therefore only has the #4 spot in the market with 3% online market share. The company is however gaining market share due to its superior Casino offering.<o:p></o:p></span></span></div>
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<b><span lang="" style="font-family: inherit;">In summary, Enlabs is generating c.EUR40m of revenues in a c.EUR150m Baltics online market which we expect to grow at 13% p.a. until 2024, reaching EUR270m.</span></b></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit;"><br /></span></u></b></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">4 - Market expansion</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">In addition to the company’s core markets, there are three significant opportunities where Enlabs could leverage its strengths in the medium term:<o:p></o:p></span></div>
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<span style="font-family: inherit;"><b><span lang="">Belarus:</span></b><span lang=""> This is a EUR500m market, of which EUR50m is currently online, representing a 10% penetration rate (on par with the size of the Latvian online market). The country liberalized its online gambling market in 2019 and therefore the licensing process is ongoing (with only one license awarded so far). Enlabs applied early and should be among the first 3 operators to enter the market.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><b><span lang="">Finland/Sweden: </span></b><span lang="">The company has started to target users in Finland in 2018 where it is seeing very interesting unit economics and allocating more marketing (albeit from a low base). This is a EUR800m online market (15x the Latvian online market). Enlabs also has a Swedish license (EUR1bn online market) but so far, the company has not entered the country.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><b><span lang="">Ukraine: </span></b><span lang="">Ukraine is set to legalize online gambling in 2020 following an order by the President to reform the industry in 2019. Ukraine has a large market despite it being illegal. According to unofficial statistics, online gaming market should alone be worth EUR300m.<o:p></o:p></span></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><br /></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRE77qxKpzTYzLt6JKW7BG2ZxxITcavC4X2XyrjDKUE5btS_QZ_6RDhvZxAzYOzJ38YfJcjvViXc-y4_xHb-0Wr27S0h1MWXVbwoJH3qFUqDOHupvgNFeTw-3QIQRAigyytSEl2S8UR0LZ/s824/Picture+4.png" style="margin-left: auto; margin-right: auto;"><span style="font-family: inherit;"><img border="0" data-original-height="254" data-original-width="824" height="158" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRE77qxKpzTYzLt6JKW7BG2ZxxITcavC4X2XyrjDKUE5btS_QZ_6RDhvZxAzYOzJ38YfJcjvViXc-y4_xHb-0Wr27S0h1MWXVbwoJH3qFUqDOHupvgNFeTw-3QIQRAigyytSEl2S8UR0LZ/w512-h158/Picture+4.png" width="512" /></span></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><span style="font-family: inherit;"><font><i>H2GC & DK Value estimates</i></font><br /></span></td></tr></tbody></table><div class="separator" style="clear: both; text-align: center;"><span style="font-family: inherit;"><br /></span></div></div>
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<span lang="" style="font-family: inherit;">Obviously, the company doesn’t have the manpower to execute on all fronts, but it is testament to the many opportunities that Enlabs is currently considering.</span></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><font face="inherit" size="3"><b style="text-indent: -18pt;"><u><span lang=""><br /></span></u></b><b style="text-indent: -18pt;"><u><span lang="">5 - Global Gaming 555 Acquisition</span></u></b></font></h3>
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<span lang="" style="font-family: inherit;">The company announced in June 2020 that it acquired 29.9% of a Swedish online gaming operator, at SEK8 per share. (<i>Implied EV of EUR20m – 1x Sales’20E</i>). This represents a EUR10m outlay and was financed half in cash and half in Enlabs’ shares (a 3.5% dilution at current prices). A full takeover has not been announced but we believe it will be Enlabs endgame with the company.<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">Global Gaming will generate around EUR20m of revenues in 2020 in Finland and Estonia from its ninjacasino.com brand. It used to operate the brand in Sweden (where it generated c.EUR60m in revenue two years ago), but the Swedish regulator took its license away in 2019 due to poor KYC compliance systems.<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">Assuming a takeover for the remaining shares at SEK8 a share, it will cost Enlabs a total of EUR30m. However, Global Gaming has a net cash position of EUR10m so the EV price paid is EUR20m. While generating breakeven EBIT for the moment, we estimate the synergies at around EUR5.5m at the EBITDA level or 20% of projected sales. These would come from a migration onto Enlabs technological platform (c.5% of sales estimated impact by cutting third party suppliers), contract renegotiations with casino games provider (c.2-3% of sales) as well as downsizing the cost base in the countries where Enlabs already has a footprint (c.10-12% of sales). <b>On a post-tax basis, this transaction would therefore represent a c.20% return on capital spent. <o:p></o:p></b></span></div>
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<span lang="" style="font-family: inherit;">In a best-case scenario, we believe Enlabs could be relaunching the ninjacasino.com brand in Sweden with its own Swedish license and its own KYC compliance systems. If this is the case and if Enlabs manages to reactivate 30% of ninjacasino.com old Swedish customer base, it could generate an estimated additional EUR4m of EBIT. The return on capital would then hover around 40%.<o:p></o:p></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><br /></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjl3jHopH4ovoIER0C4PMlBbVapjk9ow95ODsj2O-_e1OZn9baqrRPr2ru6W-ZHt1RfUcfGwY4bidkB5FV7HpgZCV30Y_zGipsbNSka9xjTwtuJppN6oy4juwXxB9a1OeKyHOJnMUDur8_A/s756/Picture+5.png" style="margin-left: auto; margin-right: auto;"><span style="font-family: inherit;"><img border="0" data-original-height="187" data-original-width="756" height="126" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjl3jHopH4ovoIER0C4PMlBbVapjk9ow95ODsj2O-_e1OZn9baqrRPr2ru6W-ZHt1RfUcfGwY4bidkB5FV7HpgZCV30Y_zGipsbNSka9xjTwtuJppN6oy4juwXxB9a1OeKyHOJnMUDur8_A/w512-h126/Picture+5.png" width="512" /></span></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><font face="inherit"><i><font>DK Value estimates<br /></font><br /></i></font></td></tr></tbody></table></div>
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<span lang="" style="font-family: inherit;">We believe Enlabs will finance the remaining of the transaction in the same way it financed the first tranche, i.e. 50% in shares and 50% in cash. At current prices (SEK22 per share) and assuming an SEK10 takeover price for the remaining shares, the entire deal will increase the share count from 62.8m in 2019 to 68.9m, or 9.7%. We are fervent supporters of the transaction, which we believe will allow Enlabs to boost its scale in Estonia and more importantly accelerate its growth strategy in Finland with a strong brand. We are further encouraged by the optionality of the Swedish relaunch, which could generate significant shareholder value: At 10x EV/EBIT, this additional EUR4m in EBIT corresponds to c. 30% of the current Enlabs’ market capitalization (at SEK22 per share).</span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit;"><br /></span></u></b></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">6 - Balance Sheet and Financial Health</font></span></u></b></h3>
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<span style="font-family: inherit;"><b><span lang="">The company is EUR20m net cash with no debt (15% of the current market capitalization).</span></b><span lang=""> We believe Enlabs’ cash position has materially increased in ‘value’ during the Covid-19 with weaker peers struggling throughout the crisis. This will most likely mean two things: distressed sellers of assets and cash strapped competitors shrinking both marketing and technological/product investments. Either way it will significantly benefit Enlabs operations.</span></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><br /></span></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">7 - Ownership</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">T<b>he chairman, Niklas Braathen, owns 21% of the company, representing EUR28m at SEK22 per share. </b>He is involved in the company’s strategy and talks daily to the CEO. He sold the Optibet brand to the company back in 2008 and has extensive knowledge in building and growing a gambling brand in the Nordic/Baltics market.<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">Christian Haupt, another board member owns 9% of the company, representing EUR12m at SEK22 per share.</span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang="" style="font-family: inherit;"><br /></span></u></b></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">8 - Valuation</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">Taking 2019 revenues (EUR39.6m) and adding 5 years of increased online penetration in the Baltics takes us to EUR72.2m revenues in 2024 (12.8% CAGR). We expect gross margin to decrease from 70.6% to 69.6% because of higher content costs. Marketing expenses are expected to increase to 18% vs 17% in 2019 because of new sponsorship deals. Meanwhile, we expect fixed costs to grow at a 5.7% CAGR from 2019 to 2024, reflecting 1/3 of costs (rent, utility & central costs) growing at 5% and the rest growing at half of the sales rate. This would bring Enlabs organic 2024 EBITDA to a 31.5% margin, or EUR22.7m in absolute amount.<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">As previously mentioned, we believe Enlabs will take over Global Gaming in the coming months. This would add a EUR5.6m EBITDA in 2024 post-synergies. Adding Enlabs’ organic EBITDA to Global Gaming’s leads to a combined EUR28.3m EBITDA in 2024.<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">As Enlabs owns its technological platform and doesn’t capitalize much R&D opex, we expect capital expenditures to stay at around EUR3m per year. At the company’s 20% tax rate, this leads to a free cash flow pre and post interest (as there is no debt) of EUR19.6m (a 18.5% CAGR over 5 years).<o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">Applying a conservative 8% Free Cash Flow to Enterprise Value gives us a target Enterprise Value of EUR245m in 2024. Due to its high cash conversion, we expect Enlabs net cash position to reach EUR76m by 2024, leading to a <b>target Market Capitalization of EUR322m or SEK3.32bn, i.e. <u>SEK48 per share</u>. An investment at current prices of SEK22 per share would therefore generate a <u>21.5% IRR over 4 years</u>.</b><o:p></o:p></span></div>
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<span lang="" style="font-family: inherit;">This IRR is solely based on Enlabs’ s expansion in its current geographical footprint. It does not include any upside from the adjacent market opportunities mentioned above. Of these opportunities, we consider two of them as very likely to materialize by 2024: an entry in Belarus and a relaunch of the ninjacasino.com brand in Sweden. As an example, if Enlabs were to capture 10% of the Belarus’ online market as well as get 30% of its old customer back in Sweden, this would increase Enlabs revenues by EUR22m in 2024 and FCF will increase to EUR24.6m (a 24% CAGR over 5 years). Using the same valuation methodology, we derive a target price of <b><u>SEK58 per share, or a </u></b><b><u>27.4% IRR over 4 years</u> at current prices.<o:p></o:p></b></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><b><br /></b></span></div><div class="MsoNormal" style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><span lang="" style="font-family: inherit;"><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRrGOVZgHmf3LYtvkubw4TUa7Ym26y8tdq6oeIbAmr8rYXabKJJ8Jt9Om-rww4ZzQK56kY8JmhvBjYoIHDiSWlHF-QHJvSsv-6vG5yQl6mEt5iVpMPKd3L9k1YwfO-P4mTWYVHwPCq04Se/s760/Picture+6+png.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="454" data-original-width="760" height="306" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRrGOVZgHmf3LYtvkubw4TUa7Ym26y8tdq6oeIbAmr8rYXabKJJ8Jt9Om-rww4ZzQK56kY8JmhvBjYoIHDiSWlHF-QHJvSsv-6vG5yQl6mEt5iVpMPKd3L9k1YwfO-P4mTWYVHwPCq04Se/w513-h306/Picture+6+png.png" width="513" /></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><font><i><font>DK Value model</font><br /></i></font><b style="text-align: justify; text-indent: -18pt;"><u><span lang=""><br /></span></u></b></td></tr></tbody></table></span></div><h3 style="line-height: 15.6933px; margin: 0cm 0cm 8pt; text-align: justify;"><b style="text-indent: -18pt;"><u><span lang=""><font face="inherit" size="3">9 - Risks</font></span></u></b></h3>
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<span lang="" style="font-family: inherit;">We focus a lot on what could go wrong and how could it lead to permanent loss of capital, which is why we spent a lot of time considering and quantifying the key risks related to this investment:<o:p></o:p></span></div>
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<b><span lang="" style="font-family: inherit;">Money laundering in gambling and in the Baltics:<o:p></o:p></span></b></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Put simply, money laundering is the process of depositing cash proceeds from illegal activities into legitimate financial institutions. One can only do so if it appears to come from legitimate sources.<b></b><o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">It is a very simple process offline: People can walk into casinos with large amounts of cash which they trade for chips without facing the questions they would face if they were trying to deposit the same amount of cash with a bank. Gambling winnings are considered a legal form of income, therefore any money that is taken out as winnings is "clean" money that can be deposited in any bank. There are two reasons why we are not overly concerned with this risk with Enlabs retail operations. First, they operate only sports betting shops which are less appropriate for money laundering as the operator margin is higher (c.8%) than casinos (c.3%) and the matches outcomes can result in high variance of win/losses. Second, sports betting shops are a very limited market (In Latvia and Lithuania it represents less than 1% and 5% of the total market). This makes it less attractive to money launderers as they can find bigger markets where their wagers will be lost in the overall volumes.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">After careful research we came to the conclusion that investors do a system 1 association of money laundering in offline to the online segment. However, in the Baltics, the regulator only allows deposits throughs banks or a few PSPs providers. None of them allow cash to be converted directly digitally and therefore the money used to deposit on the gambling website is already in the system. There is no need to launder it as it is already ‘clean’. Furthermore, online operators must ascertain the identity of every user through national ID checks. In Latvia use of e-wallets/PSPs are altogether banned and customers are allowed to deposit money online only through their personal bank account. Additionally, they can only cash-out their winnings through the account used to initially deposit the money. This therefore makes it not fit for money laundering purposes.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">We went deeper and compared the Revenue to Deposit ratio of Enlabs and some peers that disclose these metrics and found no discrepancy in the numbers: While Enlabs stands at 30% (for every euro deposited over a quarter, Enlabs generates 30cts in revenues), Leovegas (a Swedish online casino operator) is at 31% and Mister Green’s (a German and Nordic online casino operator) at 32%. A very low revenue to deposit number would have indicated money laundering risks (since criminals laundering money generally deposit a lot of cash, only play with a little portion and then cash-out)<o:p></o:p></span></span></div>
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<i><span lang="" style="font-family: inherit;">As an aside, money laundering in online operations is very much possible and present. It however predominantly concerns black market operators which do not abide by the regulators rules and allow PSPs that transfer physical cash directly into digital money or tokens used on the black operator website.<o:p></o:p></span></i></div>
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<span style="font-family: inherit;"><b><span lang="">Gaming tax increase:</span></b><span lang=""><o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Gaming taxes on revenues are currently set at 10% in both Latvia and Lithuania and 5% in Estonia. In most European markets the gaming taxes are around 20% of revenues with the UK at 21%, 20% in Spain and 24% in Italy for instance. It is important to note that taxes are levied on revenues which means that regulated operators are at a disadvantage compared to black (unregulated) operators because they need a higher handle on wagers to reach the same profitability.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">While we do not dismiss such an increase, the UK, Spain and Italy all have a very high customer channelization rate, so the black-market size is low. In the Baltics, black markets represent around 40% of the legal market which is unheard of in Europe. The governments are trying hard to fight this, but they have overall poor domain ban enforcement. Increasing taxes would therefore only push more people onto the black markets because regulated operators would need to increase prices (i.e the handle) in order to keep their profitability levels.<b><o:p></o:p></b></span></span></div>
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<span style="font-family: inherit;"><b><span lang="">Higher marketing intensity for offline sponsorships: </span></b><span lang=""><o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Enlabs has almost all of its sponsorships coming for renewal in 2021 and we believe these are a must have for every operator. We would therefore expect some price increase as the markets have gotten bigger since the last auctions (two to three years ago).<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">In Latvia, we expect rationale behavior from peers as they are not overly well capitalized and can seldom afford marketing commitments as big as Enlabs which has a 50% market share. Latvia’s marketing budget is 30% of Enlabs total marketing spend and we expect an increase of 30% for the offline sponsorship’s costs, which are 70% of the overall marketing budget.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">In Estonia and Lithuania, we expect Enlabs’ s push into the sponsorship market to result in 30% higher prices. These countries represent 70% of the total marketing budget and sponsorships costs are 50% of the overall marketing spend.<o:p></o:p></span></span></div>
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<span style="font-family: inherit;"><span lang="">-<span style="font-stretch: normal; font-variant-east-asian: normal; font-variant-numeric: normal; line-height: normal;"> </span></span><span lang="">Put together we expect marketing costs to increase from 17% to 19.5% of sales. However, these costs will allow for higher sales levels and the impact will therefore be closer 18.5%, which is the number we use in our forecasting.<o:p></o:p></span></span></div>
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<span lang="" style="font-family: inherit;">To quantify those risks, we modelled a scenario where gaming taxes would increase in the Baltics to 20% as well as a loss of market share in each country in the 20% range (for instance in Latvia the company markets share would go from 50% to 40%). Enlabs ‘s free-cash flow would only increase to EUR13.6m (10% CAGR over 5 years). Using the same valuation methodology, we derive a target price <b>of <u>SEK30 per share</u></b>, or an <b><u>8.0% IRR over 4 years</u></b> at current prices. We therefore think that permanent loss of capital is extremely low even in a worst-case scenario.<o:p></o:p></span></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKxvX4l99gJLCvZDapX0Idv0cPmSpUpU_0PBOlU7j6YWzpzUyepbWXce-MofEkIV_djdw4zczhIIIDg504aHSdgshLz-ZxSrH1oWSntBCbp-mG6ooia_4_LwSv5DsL8euCt89bHfxIh_ME/s583/Picture+7.png" style="margin-left: auto; margin-right: auto;"><span style="font-family: inherit;"><img border="0" data-original-height="460" data-original-width="583" height="294" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKxvX4l99gJLCvZDapX0Idv0cPmSpUpU_0PBOlU7j6YWzpzUyepbWXce-MofEkIV_djdw4zczhIIIDg504aHSdgshLz-ZxSrH1oWSntBCbp-mG6ooia_4_LwSv5DsL8euCt89bHfxIh_ME/w373-h294/Picture+7.png" width="373" /></span></a></td></tr><tr><td class="tr-caption" style="text-align: left;"><i><font face="inherit">DK Value model</font></i></td></tr></tbody></table>
DK Valuehttp://www.blogger.com/profile/17241518838101157355noreply@blogger.com0