Description

Ferratum Writeup

Market cap: e569M HQ: Helsinki, Finland
Net Debt: e176M
TEV: e745M
PE 2018: 18.5x

Ferratum (“FRU”) is a fast growing and profitable technology-based lender. It is in our opinion the best-in-class pure online loan provider in Europe today, and possibly globally. The company is rapidly expanding its competitive advantage over peers but also morphing into a full-service digital bank with an expanding addressable market.

Led by a successful and aligned founder-CEO, we expect FRU to grow the topline at 28% year-over-year into 2023, compound EPS at 40% per year and expand ROE to 30% from 20% today.  Because of limited sell-side coverage (only one analyst) and free-float of just 44%, investors can own FRU at 18.5x forward 2018 PE.

We base our bullish view of FRU on the following pillars:

1. Record of rapid and profitable growth with a proven ability to adapt to change

2. Best in class combination of EBT margins, growth rates and ROE

3. Low regulatory risk thanks to uniquely diversified geographic mix

4. Competitive advantage gained through (a) massive and diversified dataset that allows modeling of customer behavior through cycles, products and regions (b) a full European banking license that lowers FRU's cost of funding relative peers and (3) a mobile banking platform that lowers the cost of customer acquisition

5. Positive shift away from microloans into longer duration products, that reduces customer acquisition costs, impairment rates and drives EBIT margins expansion

6. Benefit from large past investments to build an online bank platform which support revenue growth acceleration and should yield operating leverage on fixed costs

7. Improving tax basis that drives rates from 14-15% in 2018 to below 10% by 2023

8. A motivated and aligned Founder-CEO, who owns 55% of the company, doesn’t want to sell below his current position and is passionate about building a long-lasting franchise

9. Limited sell-side coverage and float that will resolve on its own as value expands at 40% per year and FRU's forward PE drops to 13.2x on 2019e

Record of rapid and profitable growth with proven ability to change

Founded in Helsinki in 2005, FRU began its journey as a provider of microloans with short term, single-pay, high APR products targeted at underbanked Nordic retail customers. In the early years FRU focused on rapid growth of the Microloan product into new regions in Europe, eventually operating at the peak in 34 countries. While Micorloans are highly profitable and an excellent means to improve the company’s data-driven lending algorithm, it was limited in scope and eventually made it hard for FRU to manage a wide geographical footprint; regulatory change was an additional risk. As a result, the company initiated a strategic plan in 2012 to achieve the following goals:

1. Shift the revenue base away from highly regulated short-term microloans

2. Reduce dependency on geographical expansion and focus on higher value products

3. Build a low-cost funding base through a pan-European banking license

4. Develop a mobile-banking platform that serves as both a funding channel to attract deposits and as a marketing tool to upsell higher value products

Overall, from 2004 to 2017, FRU grew profitably each year by serving close to 2mm customers. From 2011 to 2017 FRU’s revenues expanded at a 37% CAGR, EPS at 48% CAGR and ROE averaged 23%. Free Cash Flow generation exceeded Net Income by a factor of close to 2X thanks to conservative impairment charges that far exceeded actual cash flow write-offs. FRU’s growth came from a combination of regional expansion and new product introductions.  Yet, the company still has a very long way to go before it fully penetrates its addressable market:

High margins, best in class growth rates and peer leading ROE

Looking at online lending peers, we find that FRU outgrew and outperformed its competitors in almost every metric:  while most public competitors grew at high-single-digit rates at best, and exhibited decelerating trends, FRU sales expanded at 37% CAGR. FRU sustained these high growth rates without sacrificing margins and yielded 20% after-tax ROE, as opposed to the contracting margins of the peers:

Low regulatory risk thanks to diversified geographic mix

FRU operates in 25 different markets with Finland the biggest country, accounting for 18.6% of total revenues. The company’s largest region (The Nordics) account for 40% of total sales (Finland, Sweden, Denmark and Norway). We believe regional diversification is crucial to investing in lending providers and impacts the valuation multiples they deserve.

Looking at the US centric lenders ELVT, CURO and ENOVA, we see outsized risk of regulatory change at the federal level potentially impairing these businesses quickly and possibly unexpectedly. This risk explains in part why these comps trade at a PE multiple range of 7.5x – 11x.  In FRU’s case we take comfort in the fragmentation of the European financial system and the fact that APR caps and loan values are set solely at country regulator levels. This dynamic allows us time as investors to react. With 25 different countries, multiplied by 3 to 4 products in each country, we think the likelihood of rapid and material impairment to FRU’s franchise is much smaller than its public US peers. Coupled with higher growth rates, this explains why FRU trades at 18.5x forward earnings.

Competitive advantages

As mentioned above, FRU is currently present in 25 markets. The broad geographic span allows FRU to improve its credit scoring algorithm by experimenting in different regulatory and macro environments. It has formed a DNA of agility and the ability to react to change through rapid product development within the organization. We believe this cultural aspect is crucial to online digital players who compete in an environment of frequent change, where it is vital to be able to bring new features tailored specifically to unique customer segments.

FRU holds a banking license which covers 12 counties and an additional five counties will be brought under the bank umbrella in the medium-term. The Banking license allows FRU to take in deposits at very low rates (currently shy of 1%). Competitors on the other hand lack this advantage and raise capital at corporate lending terms, with blended interest rates ranging between 8%-13% interest. While attaining a banking license is not an insurmountable barrier, it does take time to receive regulatory approval. Moving each country under the same banking license is a 12 to 15 month endeavor so a new entrant would require several years to build a similar footprint to FRU’s current pan-EU bank umbrella.

FRU’s investment to build a modern and agile digital mobile bank platform further expands its lead over peers. FRU has begun to offer its mobile bank on a white-label model to partners. This model of ’Banking-as-a-Service’ means any company, irrespective of sector, can introduce banking services to its customers. The launch of FRU’s first Banking-as-a-Service (“BaaS”) venture, in partnership with Thomas Cook Money, the financial services division of Thomas Cook, enables FRU to cheaply access 1mm new potential customers. This strategy lowers FRU’s marketing spend materially as its partner foots the bill of pushing the service to the customer base, while leaving FRU the option to offer or reject loans at its discretion. We believe this strategy will allow FRU to accelerate its growth going forward at better economics.

Positive and rapid mix shift

Early in its history FRU started by providing short term, single-pay, high APR loans to the underbanked (a product FRU calls “Microloans”). As the company initiated its strategic transformation, the share of Microloans dropped from 75% in 2014 to less than 20% in 2017:

The company continues to leverage Microloans as a marketing tool to attract new customers, who are then upsold into high lifetime value. The shift in the product base into longer duration loans benefits FRU by lowering the impairment rate by around 700bps on an individual product basis. Customers who take revolving credit loans (“Credit Limit”) also have higher retention rates thereby lowering the effective cost of acquisition over their lifetime. As can be seen by the number of countries where FRU introduced the long duration products, the company is in the early inning of this positive shift.  

Expected benefit from large past investments to build an online bank platform

FRU’s launched its mobile bank in 2016 and introduced the product in five European markets, including in France and Spain, two of Europe’s largest retail banking markets.  The investment in the mobile bank cost FRU e7mm in 2017, or 3.1% of EBIT margin. Management expects the mobile bank to break even by 2020 and from there to expand margins and drive revenue growth acceleration. The Mobile Bank facilitates cross-selling of products within FRU’s existing customer base but also replicate white-labeling JVs similar to the Thomas Cook case. We estimate that the online bank will attain the same margin as the corporate average.

Improving tax basis that drives rates from 14-15% in 2018 to below 10% by 2023

As FRU brings in more countries under its European bank license, it will be able to funnel profits at a lower tax rate over time. FRU structured its banking license in Malta were it benefits from favorable tax terms. We expect the tax rate to come down to below 10% by 2023 yielding additional EPS compounding of 1.5%.

A motivated Founder who is also the CEO, which owns 51% of the company

Jorma Jokela, the CEO and Founder of FRU holds approximately 55% of FRU. He is an experienced entrepreneur who started and sold companies before launching FRU. Jorma’s vision is to build a low-cost digital bank with best in class user experience, while leveraging FRU’s data driven lending algorithm to deploy capital into high yielding bank products. Jorma has also indicated several times that he does not want to sell his stake further. We view him as a capable CEO aligned with long-term shareholders.

The challenge from limited sell-side coverage and float

We expect this issue to resolve on its own as value expands at 40% per year and FRU's forward PE drops to 13.2x on 2019e and 9x by 2020e. Eventually either the market will recognize the material upside in owning FRU or the company will be taken out by a strategic buyer or by private-equity. We also won’t be surprised if Jorma takes FRU private.

Risks

Regulation – In recent years the regulatory environment has been restrictive towards short-term lenders, with interest rate caps present or negotiated in most regions. FRU has seen the writing on the wall and was early in shifting its mix into longer-term loans with larger principals, which aren’t subject to the same regulation. FRU’s banking license is also crucial in its ability to fend off further changes since it will allow it to offer native credit card products and other high APR instruments as a means to maintain its revenue sources. We see FRU growing EPS at 40% cagr even with its mix shifting to 75% of products with APR’s of 25% to 30% (as opposed to over 100% today).

Recession – in periods of economic slowdown or recession the number of potential customers spike as the need for short term lending increases significantly. This tends to offset the impact of higher impairments on existing loans, as it lowers marketing acquisition spend and enables FRU to be more selective on a higher pool of applicants. In this sense we also note that FRU has proven its staying power through the 2008 recession, when it was a far younger and less diversified business.

Model

We see FRU growing revenues at a CAGR of 28% from 2018 to 2023, below management’s aspiration to grow 40% per year. As the product mix shifts more into recurring loans and longer duration products, we expect impairments to trend down. Combined with operating leverage and maturation of the investment in the mobile banking platform we expect margins to mature at 30% by our end year. This drives an EBIT CAGR of 48% in our projection period. We expect the funding mix to be 75% bank deposits versus corporate debt, and assume base interest rates expand, which will drive blended interest rates to 4.0%.  As a result, EBT should grow at 39% CAGR, as the blended tax rate improves, EPS CAGR tops 40% from 2018 to 2023, while ROE reaches 30%.

Catalyst

Compounding of earnings

take private / take-out