Shares in small business loan provider Funding Circle Holdings (LON:FCH) fell today by as much as 20% as the company revealed that the planned growth for the full year would be just 20% as opposed to 40% as it tightens lending criteria. Share price is as such:
It’s been a disastrous IPO for investors here, it goes without saying. Starting out at 440p, anyone who invested at the start would be nursing a hefty paper loss which doesn’t look like becoming any better soon. Not so much the founders and members of staff, many of whom earned a windfall. It does seem in retrospect that the need to go public was to provide an out rather than for any of the more traditional means why some firms list.
On a separate note I am also an investor in the public-facing Funding Circle product. I feel on balance this is perhaps quite average: the offering has been massively degraded over the past couple of years (many changes sold as enhancements to users were nothing of the sort), yet its listing does offer a modicum of security. The balance sheet does mean it will not disappear overnight as we have seen with other P2P companies.
At let us give them their dues at least: they have grown to be one of the pioneers of the P2P tech scene. On pure volumes alone they are very established in the market (although other P2P loan providers offer the same). A couple of years ago they exited property development loans which in the light of Lendy going bust is an extremely wise decision. They also have been relatively quick to expand: offering institutional products and putting their brand overseas.
The warning comes in an RNS updating us on H1. First a summary of results:
In advance of interim results to be published on 8 August, headline half year performance compared to H1 2018 was:
● Revenue growth of c.30%
● Segment adjusted EBITDA breakeven with the UK improving
● Adjusted EBITDA loss margin to be c.25%
● Loans under management of £3.5 billion, up 37%
● New loan originations of £1.2 billion, up 14%
Segment adjusted EBITDA is worse off (previous year £7m). Largely this figure is not meaningful as it excludes ‘product development’ and central costs, which there always will be some. The origination figures also show a slowing of growth.
Here comes the warning:
● Current loan performance remains in line with previous projections. Across all geographies, investor returns on a net basis are expected to deliver 4.4-8.4% in 2018 and 5.0-8.5% in 2019.
● The increasing uncertain economic outlook has reduced demand for loans and the Company has proactively further tightened lending to higher risk band businesses. This affects overall origination volumes, but protects net returns for investors on the platform.
● As a result, Funding Circle expects 2019 revenue growth to be c. 20%, versus previous guidance of 40%.
● The Company expects adjusted EBITDA loss margin for 2019 to be better than 2018.
None of this is good news. A wide range of potential returns does not give much clarity. Reduced demand and (presumably) reduced supply means that Funding Circle will have to work a bit harder as the better-rated business may be on the verge of getting mainstream lending (many business that go to Funding Circle cannot access this).
We do not have many figures to go on, as Funding Circle are a relatively new business. Throughout their short life they have shown massive losses, but this is not surprising or even uncommon of the sector: firms spend heavily in their early days to gain market share and profits are not important. Funding Circle have cleared sustained this by issuing equity and then latterly going public. If we look across the P2P universe we can see a few firms at various stages of the journey – perhaps Ratesetter (another loss making company) is the next candidate for the public offering.
With only losses to speak of, many of the traditional metrics lose their meaning. We can see from the losses that there are many adjustments:
We can see that the heaviest investments being made are in people and marketing. If these taps could be turned off somehow, there could be scope for some decent profits, although one wonders if marketing costs are an integral part of acquisition. Remuneration for employees looks very high even considering the London base: with roughly 1,000 employees the average wage comes out to almost £80,000 – considering that most will be at relatively low levels must suggest either that these people are very generously paid or that there is huge pay further up.
The main reason why we can be laissez-faire with losses at present is the huge cash balance on hand. Cash amounted to £333m; mostly as a result of the IPO. Even with levels of losses at £50m a year, this provides for many years before any further action has to be taken.
So the real critical success factor for the business is growing its loan book as this generates the fees which provide for its revenue. On this front, there are two sets of fees: Funding Circle can charge businesses for setting up loans, and it can also charge P2P lenders for servicing their accounts. On both fronts we can see that this has grown quite linearly as the loan book has expanded.
We can see that in some ways that poor performance leading to the desertion of P2P lenders would be a bad thing for Funding Circle, but they have sought to mitigate this by getting in institutional lenders. We can see that from today’s update there are new institutions pledging over $200m, but this isn’t enough to cover all its new loan origination and such, the public remain an important part of the business as regards to funding loans.
This is not the first time that FCH have gone to the institutions, but the first investment trust (FCIF) was dissolved. Across the board there have been diminishing returns, and whilst Funding Circle can afford to blank retail investors and not engage with them, the same cannot be said for the larger institutions. So it will be interesting to see how the new institutional funds pan out.
It is very difficult to value the business, aside from the cash component. A large part of it will be picturing what Funding Circle will be, rather than what it is now. It is fair to say they are investing heavily to protect their position, and it is hard to deny there is a large degree of both scalability in their operations and their large costs now will become more efficient with greater fee generation. For example, developing their platform to facilitate £2bn of loans will not be at double the cost.
If we assume that marketing and people costs will always be high, those days of profits will be long into the future. 2020 will be another loss making year for sure it seems, and broker forecasts seem to indicate that even at £300m, the business will be no more than break-even in real terms and not their adjusted ones. If the business is scalable beyond that, then the price today will be seen to be a bargain. In short, this is driving the high valuations we have seen so far.
Personally I am not sold on this. Funding Circle was once a disruptor, but I can see them being disrupted in future. Banks could offer some real competition on the businesses that are less risky, and I feel there is a better solution in the offing with regard to the more risky loans. So with such a long horizon for payback I have no desire to be invested. 1/5.