Description

Background description

Avanza was written up well by Par03 in August 2021. The share price is down 42% since then and is 50% off its November 2021 peak but the business remains attractively positioned. The risk reward is better today.

Avanza is a Swedish direct-to-consumer investment platform (D2C platform). For those more familiar with the UK or US markets, some might draw comparisons with Hargreaves Lansdown and Charles Schwab. Principally, Avanza allows Swedish consumers to invest in securities and funds via pension schemes, tax-efficient investment accounts or general personal trading accounts. As a sideline, Avanza provides cash savings products, corporate finance, and facilitates or directly provides lending for mortgages and margin loans.

There is a total capital of SEK715bn on Avanza’s platform across 1.87m clients. This means an impressive 18% of the total Swedish population – including babies, children and seniors – are customers. The business was founded as online broker in 1999 by Sven Hagströmer. Hagströmer, remains as Chair today with an effective economic stake of 20%. Avanza has broadened its offer over time and today is the leading D2C platform in Sweden. Current CEO, Rikard Josefson, has been in situ for 6 years and will be stepping down in early November 2023 to be replaced by incomer, Knut Frängsmyr, who joins from BNPL lender Klarna, where he was Deputy CEO.

In the 4 years to 2022, the average share of revenue from brokerage is 44%, 19% from fund commissions, 15% from net interest income, 14% from currency commissions, and 8% from other sources.

Market size and share

There are different ways of defining Avanza’s market position. There is comprehensive national statistics reporting on total savings capital. Avanza has a total share of 6.6% up from 2.2% in 2013 and 4.5% in 2019. Avanza is gaining share over time and has captured 10-20% of incremental net Swedish savings capital in recent years. A part of this market is not really addressable by Avanza as it relates to collectively-managed occupational pensions schemes. Another metric is Avanza’s share of transactions in the Swedish stock market. Most recently this was 20% by number of transactions and 8% by value. It is the largest broker by a factor of 3x in number of transactions and almost 2x in value of transactions. We may also look to the proportion of Swedes who are customers. The 18% share of the total population will naturally translate to a higher share of addressable adults. To give a sense of the possible upper limits of this, Avanza claims 31.5% of 20-29 year olds as customers and 43% of men in the Stockholm region.

The majority of the savings and investments market is captured by the 4 incumbent banks – SEB, Swedbank, Nordea, and Handelsbanken – and Avanza and its closest competitor Nordnet. Avanza and Nordnet have been taking share from the banks for many years by offering a superior, technology-enabled user experience with a focus on savings and investments. We have seen estimates that the 4 banks have c.2/3 of the market. Nordnet operates across 4 Nordic countries and is similar in size in aggregate to Avanza. In Sweden, Avanza has always been significantly larger and as of Q3 2023 had 4x as many customers and 2.5x as much Savings Capital as Nordnet. The gap between them in Sweden is widening over time.

Moat

Avanza’s moat stems from having great technology that drives a high quality user experience at the front end and cost efficiency at the back end. Alongside this, Avanza has a scale advantage as the largest pure play D2C platform, with efficiencies in marketing, technology development and general overheads. Also, they enjoy a large and very sticky customer base with churn most recently reported at 0.8% annualised.

The discussions on earnings calls sound familiarly like those of a Financial Services business. But the vibes and culture at Avanza are more like a tech business. Out of a total of c.650 employees, half are in technology and there are over 150 engineers. Avanza’s in-house development is divided into about 30 cross-functional teams, each focussed on an area within the 4 main categories of: customer journey, products, business platform and technology platform. It is worth watching the video ‘Avanza Tech – Story’ linked here where the company talks through their approach. Technologists are empowered and held in high regard. We find it interesting that there have been instances of the CIO joining earnings calls.

Avanza’s technology prowess drives customer satisfaction. Avanza has been the recipient of the Sweden Quality Award for most satisfied savers for 13 years in a row. Customers enjoy a broad selection of products – the company claim 80,000 investment opportunities across securities, funds, savings, mortgages and margin lending – delivered seamlessly. Customers also benefit from lots of tools and educational services such as portfolio generators, news sites, blogs and podcasts. Sven Hagströmer is well know in Sweden and his association with Avanza is not unhelpful in lending credibility. Due to Avanza’s brand recognition in a small country with lots of word of mouth recommendations, they spend very little on marketing. In 2022, the marketing expense was only SEK28m. Average customer acquisition costs in the last 4 years works out as SEK99 per customer. With customer churn extremely low, as noted above, the ROI on this stacks up favourably.

Avanza is the most cost efficient D2C platform in Europe. The best way to measure this is the expense ratio: operating costs / average savings capital. This has been on a downwards trajectory over time and reached a low of 13bps in 2021. It has since increased a little to 15bps as savings capital was reduced by a downturn in stock markets. Management target 12bps or lower in due course. By comparison, Nordnet is at 17bps and Hargreaves Lansdown in the UK is at 24bps. Avanza can offer keenly priced products and generate operating profit margins consistently north of 60%. Trading commissions charged average only 10bps of the total value of trades and are as low as 3bps for Pro Traders. This is superior pricing than many institutional investors encounter.

Growth

There are solid long term growth tailwinds for most D2C platforms. Increasingly, people are cognisant that they need to take responsibility to save for their retirement and are less likely to rely on, or benefit from, defined benefit or generous state pensions. Avanza’s new customers skew quite young at an average of 35 years old. The typical profile is that a customer builds up capital over time starting small and benefitting from accumulated savings and the compounding of investment returns. Avanza should grow its savings capital as its customer base matures and accumulates value.

In addition to this, it should see further growth in customer numbers. The stats cited earlier regarding the penetration of some higher propensity groups such as young, metropolitan investors are suggestive of the levels to which general penetration could trend. There remains lots of capital to be addressed in taking share from the banks who serve their customers poorly. The company provides no hard targets on customers but recently the outgoing CEO has suggested he sees no reason why Avanza could not get to 3m customers. This may seem high in a population of 10.4m. We are told management received the same pushback on aspiring to 2m customers when they had 1m customers, and recent additions, when nearing 2m, are not indicative of having maxed out yet.

Risks

The share price decline from the peak in November 2021 partly follows the pattern of the general market but there are stock-specific concerns. Avanza’s ability to make money is essentially a function of how much savings capital there is on the platform and how much trading its customers are doing. The share price came down with the savings capital as markets declined and as customers traded less often. Ceteris paribus, a market-led decline in savings capital and trading when there had been clear exuberance, should imply a reduction in intrinsic value if one’s estimation had been that prior peak levels were steady state. However, the disappointment reflected in the share price makes us wonder whether there had been a naïve extrapolation of market values and trading activity during Covid baked into expectations. We had always assumed some mean reversion.

Putting aside the level of the stock market, which we don’t have much to say about, we are paying close attention to levels of trading intensity: how many times a customer turns over their portfolio and so generates brokerage commission. This is declining over time. Over and above the normalisation of behaviour after Covid, this downwards trend may be expected to continue. Marginal customers are less likely to be active pro traders and so will engage in less trading activity. These customers can be monetised in other ways such as fund commissions. In 2022 the average revenue margin (revenue/average savings capital) for capital held in funds was higher at 28bps than the brokerage revenue margin of 26bps. However, a material segment of savings capital will always be used for equities, bonds and derivatives and we concede it is difficult to know where trading intensity ends up in the long term.

The sell side places quite a bit of scrutiny on expenses. Avanza has been criticised in 2022 and 2023 for allowing expenses to grow whilst revenue has been suppressed for the reasons discussed (stock market levels & trading intensity) such that the expense margin has increased. Critics cite that in that period Nordnet has seen slower cost growth allowing them to narrow the gap in cost efficiency, and suggest they are more nimble or attuned to market conditions. Management’s response is that they are building the business for the long term and so won’t flex annual budgets according to the whims of the market. Moreover, they have frozen employee numbers for 2023 and suggest that if markets weakened further they would re-appraise the cost structure. For the time being we give them the benefit of the doubt on this point and suspect that some of the sell side is being too short term in their thinking.

There are theoretical regulatory risks that cannot be entirely dismissed. In Sweden, the norm is for D2C platforms to charge retrocession fees to fund managers, typically 50% of the AMC levied to the end customer. In 2013 the Retail Distribution Review ended this practice in the UK so platforms flexed to charging platform fees directly to their customers. Avanza argue they would do the same thing and this ought not to harm their economic model. Indeed, that is what Nordnet already does in some of the other Nordic markets they cover. Another possible risk is a change to the tax system that reduces the incentive to save and invest. The ISK (Individual Savings Account) is a simple and attractive tax wrapper in Sweden that allows investing free of capital gains tax without limit with a tax levied at a rate applied to the asset base annually. The tax rate formulaically varies with interest rates and has generally been modest (c0.5-1.0%) albeit it has moved a little above this recently to something like 1.2-1.3%. If this became fettered or more heavily taxed, this may impede net inflows.

A final risk worth flagging is that contemporaneous with the decline in brokerage income was a mitigating increase in net interest income. In the period before the GFC when interest rates were higher, Avanza used to earn a NIM% of over 2%. This declined to <1% as interest rates remained low, or in Sweden’s case became negative briefly. As the Riksbank raised interest rates, Avanza has seen the NIM% increase again above 2% and this is now an important part of the P&L. It is not our base case, but it is not out of the realms of possibility that there could be regulatory, or other, pressure to pass on more of the interest income to consumers. As such, we think the long term NIM% should be modelled conservatively.

Summary

In summary, Avanza is a the clear and dominant D2C savings and investment platform winner in Sweden. Clever deployment of technology has created happy, sticky customers and a cost efficient business model. There are robust long term growth drivers from further customer growth and accumulation of capital. The share price has halved since the Nov-21 peak.  This decline is largely the result of forward PE compression from over 30x to 15x today.  For a business which dominates its market and has strong long-term growth tailwinds, we believe that this is a very attractive price.

Catalyst

This idea is not predicated specifically on catalysts. However, if some of the following occured, they may be helpful to market perceptions of the stock: increased trading activity, expense ratio reduced from operational leverage, continued strong net inflows and customer growth, new CEO impresses, stock market goes up pusing up savings capital etc