|Shares Out. (in M):||113||P/E||10.9||8.0|
|Market Cap (in $M):||134||P/FCF||0||0|
|Net Debt (in $M):||-27||EBIT||0||0|
|TEV (in $M):||107||TEV/EBIT||6.0||4.4|
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Argentex is a high service, low-cost FX provider for SMEs. They offer spot, forward and option hedging alternatives for a diverse range of sectors. This is a high growth, high margin, high cash conversion and high returning business with reasonable barriers to entry at scale. There has been considerable change at management level with the departure of a co-founder and a new FD who has rebased expectations. As a result, the shares trade on only 2022e 7x EV/ EBITDA and a FCF yield of 10%, These improve to 4x and 17% two years out, respectively, before taking account of several growth options which are not in consensus numbers. We think the current price is significantly de-risked with plenty of upside opportunity through earnings and rating growth with its closest listed peer trading on >3x premium.
AGFX was founded in 2011 as a joint venture between Pacific Investments and three directors (two of whom remain in the company). It operates as a riskless broker for non-speculative FX transactions across spots, forwards and options, earning revenue from the spread. It was founded as a service/ advice led, voice brokerage, differentiating it from the major banks which are transactional only and higher cost to the client (typically 100-150 bps).
AGFX’s key differentiation in the market vs banks and smaller competitors such as Alpha is advice led approach where decision makers can speak to a dealer at AGFX who will provide an informed view on the trade, combined with expert execution all which should have a pricing and efficiency benefit for the client. AGFX have sales heads who directly responsible for acquiring new client accounts and are paid a commission (10-17.5%) of gross revenue generated by a client for the life of the client. Sales heads are recruited from grass roots and trained by AGFX, there is a high turnover here (c30%) given the fast-paced nature of the role, but significant reward for those that survive with year 3/4 salespeople typically generating £0.7m/ 1.4m growing to £5m in year 7. Clients are then serviced on an ongoing basis by a dedicated member of the dealing team who must have a minimum 10 years FX experience and who provide advice and manage the client’s exposures and execution on every trade. Dealers are paid a flat percentage commission of 10% of revenue. Most of the rest of the cost base is fixed, generating attractive operating leverage.
The market cap at 88p is £100 million, with around £20 million of free cash for an EV of £80 million. In the last year AGFX generated revenues of c£30m and operating profits of £10m with avg shareholder's equity of c£27m.
> Strong quality and growth metrics
AGFX has exceptional historic quality and growth metrics having grown revenue from less than £1 million in 2013, to £29 million in 2020. At the same time operating profits have increased from £0.3 million to £12.4 million. 2021 was a COVID year which saw increased uncertainty from clients and resulted in lower revenues (driven by a lower average spread – more on this later) and increased operating cost investment to drive future growth.
Returns are also impressive having averaged well over 50% normalised return on equity pre COVID. Given the COVID drop in profitability this declined significantly in 2021 but we expect it to recover well above 30% in forecast years.
The business is fundamentally capital light. Cash conversion depends mainly on the spot/ forward mix (typically 50/50 by volume) with spot contracts typically settling for cash within 2 days. Forwards present a more profitable revenue stream (c50bps vs spots at 30bps) but are more cash consumptive with the average duration between three and five months. Regardless, AGFX will typically convert 75% of revenues to cash within three months. Tangible capex is negligible from year to year, the business did invest £2.7m in a new premise fitout in 2021 but this won’t repeat. Intangible capex is invested into developing the platform which to date has received around £5.5m of investment. I think that the impending monetisation of this platform is a key growth option going forward which is currently not in consensus.
The business does require capital to trade – I conservatively estimate c£5m for £12bn of FX turnover. That equates to around £200-250k of collateral capital required to generate £1m of revenue on the current business with 30% operating margins and 65-70% incremental drop trough (see below)
> High operating leverage drives impressive incremental drop-through
Argentex is already generating impressive economics, despite still being a voice only brokerage. I think that 65-70% of every £ in revenue ought to drop through to contribution from here given the largely fixed cost base and known variability in sales and dealer commission rates combined with low fixed salaries.
Ongoing investment in new offices/ locations may dilute this in the shorter term but my understanding is that these new businesses will operate on similar economics.
AGFX are investing in and will begin monetising an online platform (see below) which should facilitate further wallet share growth from existing clients. I expect that there will be little incremental cost beyond the initial build out (albeit much of the investment has already been made) to this given it is intended to leverage on existing clients/ relationships and it should be more profitable than the current voice led brokerage activities.
> Heavily invested management team
Of the 113m shares in issue, management and those close to management own a significant proportion of the equity. Moreover, insiders have been buyers of the equity in August 2021 at 80p as ex-co-CEO Carl Jani’s stake was placed out to the market. I think there was significant scale back in this trade suggesting that management weren’t just picking up the shortfall from institutions, and strong institutional demand. The current share price is only 10% above this level at which >10% of the equity was crossed with high insider participation, thus I think ought to be relatively de-risked. Management and insiders acquired c1m shares out of the 13m sell down. In total, management + Pacific own over 30% of the equity.
> Rebased expectations
A new CFO joined in the middle of COVID and has rebased expectations at the same time. She has an LTIP which is based on EPS growth, so it seems likely she will want to start from a low base. Options vest at 135p (vs 88p today). The board and advisors have experience in public markets, and as significant shareholders, I think it is unlikely that they will chance having to rebase expectations again.
As I discuss in catalysts section, I think there is considerable margin of safety in the current guidance based on historic seasonality.
> Growth options/ structural tailwinds
I think there are several growth options which the market is currently not pricing in:
AGFX have been operating in an extremely low and benign interest rate environment. Given the likelihood that interest rates will increase, I think this ought to generate a reasonable tailwind for the business.
It is difficult to quantify exactly how beneficial this could be but given current mix, with every 1bps increase in spread could be worth c£400k of incremental revenue at high drop through as discussed. I view this as a free option as zero incremental cost attached to a rate increase and I don’t think that there is really any downside from the current environment.
I think this is an exciting growth avenue for AGFX, leveraging existing investment and clients, it ought to be highly accretive to the underlying business. AGFX currently is a voice only broker, adding a tech element similar to other players like Alpha should aid wallet share growth but may also significantly improve AGFXs multiple.
Historically, the business has sunk over £5m in developing it’s own internal systems, with a little further investment c£1.2-1.4m this year (and around the same going forwards) I think this can be launched onto an online platform. This will allow previously on-boarded clients who used AGFX in the past to make a large trade, to continue using their services for smaller ongoing trades where they don’t necessarily require the advice led service offered by the salespeople and dealers. Because they are cutting out the dealers, and because this is leveraging off existing clients (no marketing or customer acquisition cost required) it ought to be more profitable than the existing business.
There may be some cannibalisation/ substitution by clients who move away from voice brokerage to online only but if the profitability is improved this shouldn’t be a significant concern. AGFX think that this platform will improve revenue visibility since it will provide exposure to more repeat, smaller trades. In the best case, they can streamline month end processes and perhaps reduce cost for the client through reduced administrative headcount thus making their proposition much stickier.
Alongside the platform described above, I believe that AGFX are likely to offer a similar Alternative’s Banking product to that which is growing exceptionally quickly at Alpha FX.
“Alternative Investment Managers find that opening overseas bank accounts and completing transactions are often held up by policies and technologies that are mass-market in nature and therefore not designed to efficiently cater for the complexity of investment structures. This in turn means that opening bank accounts and managing transactions is time-consuming, resource intensive and expensive, both for traditional bank providers but also the clients they serve.”
Alpha have spent a couple of years building out this offering which has grown form zero to £6m at December and now £9.5m in June. Peer Equals (written up on VIC recently) have a similar “Equals Solutions” product which has also grown rapidly. While AGFX are lagging in getting their product to market, I think that they have significant embedded growth potential from this due to their heavier weighting to financial services/ alternative investment managers (c40% of revenue vs Alpha at c25%)
AGFX is launching in two new geographies. The Netherlands is already generating revenue. I expect Australia to begin generating revenue in 2022.
Why this mispricing exists?
I think this is a good business, with well incentivised/ invested management, strong margins and returns, and a reasonable runway for growth from initiatives which are not yet in market guidance. Yet it trades at a valuation implying significantly worse economics and/ or a high likelihood of missing guidance.
1) IPOd then missed guidance
AGFX IPOd in June 2019 and initially performed strongly, but one year later was hit by COVID and then twelve months after that earnings were revised downwards.
2) Management changes including CFO
Carl Jani co CEO departed the business and this raised concerns in the retail community around the financial performance of the business.
3) Poorly managed management sell down
When Carl’s stake was sold down it was offered only to institutional investors and at a significant discount to the prevailing market price (cross at 80p, vs 100p in the market). I think that this upset retail investors, and some weaker holders came out following share price decline form c200p.
None of these are fundamental issues with the business. The current price and set up is significantly de-risked with rebased expectations, management investing £800k at 80p and the shares currently trading only 10% above this level.
AGFX should generate c£9-10m of PAT this year, less capex of £1.2-1.3m = FCF in the worst case of £7.7m on an enterprise value at 88p of £79m = 10% FCF yield. I like the risk/ reward from here given the rebased expectations and the growth options outlined above. Two years out, FCF yield improves to 17+% so I think there is a reasonable margin of safety.
200p seems a fair place to start on a FCF yield basis over the short to medium term.
AGFXs closest listed peer in the UK is Alpha FX. Across all valuation metrics, the AGFX discount to AFX of over 70-80% is unreasonable for a business with similar growth prospects (and several which are not in guidance). I think that as AGFX builds out its tech offering more in line with that of Alpha’s, then there ought to be a significant re-rating of the shares.
A 25% discount to AFX on 2023/ 2024 earnings would imply an AGFX share price north of 240/ 300p.
I don’t think that there are any fundamental reasons for Alpha to trade at such a significant premium. Alpha are ahead of the curve in terms of the tech offering. And they haven’t disappointed on guidance. However, they do operate with more risk which has allowed them to grow quickly – last FY they had to provide for a Norwegian client who failed to meet £30m of margin obligations
> Near term
Interim results are due on Monday (8/11/21) and I believe that these will be used to reassure that the business is well on track to meet full year guidance. The market seems concerned about the spread compression (implied between volume of FX turnover and revenue in 11/10 announcement), and that this might lead to a downgrade at the FY. I believe that the reduced implied spread is a function of a higher mix of swaps in the half, which carry a lower yield, rather than underlying spread compression. Again, as interest rates increase, so should the swap yield, if not also driven by a rebalancing of the business mix back to the norm.
However, putting this to one side, I also think that there is sufficient margin of safety in guidance given the typical seasonality in the business, even if swaps continue to have a higher mix.
3y avg H2 weight has been 58%. The company has already announced on 11/10/21 that revenue for H1 expected to be £15.7m vs guidance for the FY at £31.7 implying only a 50% weight to H2.
Given the current rating, I think that any reassurance around the FY will result in some share price appreciation. If the company can beat guidance this year then I expect the business will sustain a considerable rerating from these highly discounted levels.
Medium- and longer-term share price catalysts revolve around the growth and re-rating potential outlined above.
> Further yield compression: a permanent shift in business mix toward lower yielding products
> Governance: the board may be too close to management
> Declining returns: collateral may become more expensive as the business grows into different currencies through different regions and AGFX may be subject to margin calls if underlying clients’ default
> Cash conversion could decline if the business mix changes substantially
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