2022 | 2023 | ||||||
Price: | 6.22 | EPS | 0 | 0 | |||
Shares Out. (in M): | 110 | P/E | 0 | 0 | |||
Market Cap (in $M): | 684 | P/FCF | 0 | 0 | |||
Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
TEV (in $M): | 684 | TEV/EBIT | 0 | 0 |
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I will not count this write-up for my annual contribution requirement as I published it also on my blog. But given that nobody reads it, it seemed a waste not to share this one. Also, I'm hoping for some pushback to see if I've missed something substantial.
FlatexDeGiro (FTK, ~€ 680m market cap) is one of the largest pan-European online discount brokers focussed on retail trading. The company in its current form is the result of after a merger between Dutch online broker DeGiro and Germany’s Flatex (completed in July 2020). As can be expected from an online broker, FTK’s share price performance over 2020 and 2021 was amazing, as people confined at home picked up trading (a.o. things). In addition, the meme-stock frenzy (e.g. Gamestop, BBBY) attracted many retail investors into speculating with stocks. All this led to great results.
2022 is looking different however, and the share price is down ~70% for the year. After a few years with surging numbers of new users and user transactions, KPIs slowed down and even turned negative in the case of the number of transactions. Combining negative comps with a rise in interest rates, Europe’s energy related woes, pressure on consumers wallets from inflation, a looming recession and a listing on a German stock exchange, and we have a perfect cocktail for a lower valuation.
In addition, earlier this week FTK released a profit warning, cutting its FY outlook to € 380m revenues and ~37% ebitda margin as the expected improvements in 4Q did not materialise, resulting in c. -15% ebitda estimated for 2022 vs consensus. On top of this, German regulator Bafin slapped FTK on the wrist, citing improvements needed on governance and (temporarily) increasing regulatory requirements. FTK is not ‘small and non-complex’ anymore and requires some structural and organisational changes. The company acted swiftly, reorganising some managerial positions and increasing capital buffers with € 50m + fully retaining 2022 net profit. All in all, the market got scared, sell-side analysts downgraded the stock and shares dropped >40%. The profit warning itself wasn’t the biggest driver of the decline. Sure, a worse than expected 4Q is not good news, but it was the combination of a warning from Bafin and comments on capital allocation that scared markets the most; the first gave German investors a nice Wirecard déjà vu, while the latter was a 180 degree turn from recent management commentary. FTK is projecting very strong cash flow generation and prepared markets for some form of sustainable capital return policy; this is now pushed to next year.
Why my interest in FTK, given that high(er) interest rates, pressure on consumer spending, etc. are probably not going away anytime soon? A few reasons. One is that, notwithstanding the slowdown in transactions this year, the company’s profitability has continued to grow strongly, and I expect it to continue to grow given increased penetration, scale effects and monetisation initiatives. FTK’s ebitda margin is now in the high 30s % and I see no reason why it could not catch up to more mature peers (>60%). Another reason is that FTK is now trading at a single-digit forward p/e, compared to ~18x historically (5y) and ~20x currently for peers. And even if multiples would stay the same, with earnings growing >25% p.a., FTK’s share price should perform quite nicely over the next years. Let’s look at the story in more detail.
Background
FTK operates in ca 20 countries in Europe. Activities are split between Core Markets (Austria, Germany, the Netherlands), which account for ~2/3 of revenues, and Growth Markets (mainly France, Spain, Portugal, Italy, Switzerland, UK, Ireland), which take the rest. The company has ~2.4m clients (98% retention rate) and ~€ 38bn assets under custody, of which € 3.5bn cash. FTK has a banking licence, which is a competitive advantage as most peers outsource their banking activities. Roughly 1/3 of the shares are owned by insiders (management and/or co-founders of FTK and DeGiro).
Revenues are generated from three different sources:
Strategy
FTK’s focus and main strategy has always been to be the cheapest online retail broker, have a large offering, provide user-friendly interfaces (desktop and smartphone app) and consequently attract a large user base. This has worked well over the last years, as users flocked to the broker. And as the user count increased, so did FTK’s earnings: group ebitda increased from ~€ 30m in 2017 to ~€ 110m in 2021.
FTK’s race to the bottom continues today. For that purpose, about a year ago FTK introduced its new ‘DeGiro goes zero’ model. As the name implies, this offering is based on a commission-free model. In short, this new offering consists of: 1. no trading commissions for a variety of exchanges (NYSE and NASDAQ, Euronext Paris and Lisbon, Bolsa de Madrid, Borsa Italiana, NASDAQ Stockholm and Copenhagen). Important to note that for the previously mentioned Core Markets, transaction charges remain for transaction on the local exchanges; combined with 2. higher handling fees and FX charges (now € 1.00, from € 0.50, ~60% of transactions are subject to handling fees; charges for FX transactions have risen to 0.25%, from 0.10%).
The idea behind the changes was partly window dressing, as marketing a ‘zero commissions’ model is clearly beneficial, but it also increased transparency, which is something European markets lacked given the many different brokers. Customers have now a much clearer overview of overall costs given the ability to trade in many different markets on the same platform. Overall, average revenue per user increased after the introduction of the new model, from € 4.59 on average in 2021, to € 5.30 on average for the first 9 months of 2022.
As mentioned, FTK’s strategy has always been based on being the first in the ‘race to zero’ on commissions, i.e. to have a very broad offering, the lowest commissions and consequently the highest growth rate. With the new model, FTK takes another step down the cost curve and remains on average one of the cheapest online broker. This will continue to be beneficial for FTK’s growth and maturation.
Competition and competitive advantage
One possible threat is the growth in Europe of zero-commission models, similar to Robinhood in the US. These models dragged down commissions given the adoption of ‘payment for order flow’ (PFOF), where brokers earn income from market makers by routing client orders to said market makers. This threat is however relatively mitigated in Europe. PFOF is deemed controversial as it might give rise to conflicts of interests by creating the incentive to route orders to the market maker that pays the highest commissions instead of the market maker that provides the best execution. PFOF appears to be in breach of (or might cause to breach) existing MIFID regulations. PFOF has already been banned in the UK and the Netherlands and the European Commission is currently aiming for a Europe-wide ban.
FTK is not the only broker to offer zero-commission models. There have been plenty of other competitors offering zero-commissions (e.g. eToro, Trading212), though all earn income via ‘hidden charges’ such as high FX charges, ‘maintenance’ / inactivity charges, etc. These competitors tend to be less transparent than FTK. Regulations has increased for such ‘hidden charges’-models and will probably continue to become stricter.
To be clear: FTK is definitely not the best online broker. There is plenty of room for improvement. There are several other brokers with better platforms and offerings, but all cater to a different market (segment). eToro is one of the largest and is perhaps more suited for large(r) accounts. It’s desktop web interface and mobile app are good, but a bit less intuitive than FTK’s. They also have some added costs, such as withdrawal fess, which are burdensome if you target retail consumers. AvaTrade and Interactive Brokers are also good brokers, though AvaTrade is focussed and CFDs and one large complaint from retail clients regarding IB is that its trading platform is ‘too complicated’. In addition, both are not the cheapest. I could continue, but the point is clear (I hope); FTK’s target market (so far) has been retail clients, so the user experience has to be good and intuitive, its offering has to be broad and – most importantly – the product and service have to be cheap. Given these targets, FTK is generally deemed to be one of the best online brokers to trade with.
An interesting development which might eventually lead to serious competition is the entrance of online banks into brokerage services. Companies such as Revolut provide a wide variety of services to many millions of clients (credit, payments, insurance, international transfers, etc.). Offering brokerage services is a natural extension. Though these companies will probably not have the scale (and as such competitive pricing) to match FTK anytime soon, the potential combination of an overall broad banking and insurance related offering on an efficient platform might eventually attract a large client base.
While I certainly acknowledge the threat from competition, I remain confident in FTK’s future growth potential. The main reason for this is FTK’s focus on scale and efficiency since inception. FTK clearly understood that in a continuously integrating and consolidating market such as Europe, where online trading penetration has long-term tailwinds, overall brokerage commissions have been too high for too long. The market was ripe for disruption and badly in need of commoditisation; in a market where the product is a commodity, the lowest cost ‘producer’ wins. And that is exactly how FTK was build, i.c. to be the most efficient player. Sure, there will always be (new) competition, but it’s a large market and many incumbents will struggle to attain proper efficiency.
FTK distinguishes itself from its competitors given its proprietary IT system. FTK has been able to offer very attractive fees thanks to its improving cost profile. All infrastructure is integrated in-house. In addition to fully automated execution, settlement and clearing of orders, the system allows for efficient onboarding (AML/ KYC, fiscal / regulatory reporting, etc.). Thanks to its banking licence and easily scalable infrastructure, FTK can swiftly incorporate new (banking) products and services (insurance, mortgage, etc.). Most online brokers have outsourced a large part of their IT system and offering, notably banking services, and have less ability to pressure costs. FTK can achieve significant economies of scale as it continues to efficiently expand its offering and user base. The company has so far been able to drastically reduce its overall cost per transaction (from c. € 1.40 in 2019 to c. € 0.70 in 2021) and should be able to continue to do so.
Financials
Once the headwinds of high yoy comps subside, FTK should be able to continue to grow revenues for the foreseeable future:
In terms of margins, 2022 will see a jump in profit margins, mainly from synergies resulting from the combination with DeGiro, some operating leverage, higher interest income as well as lower variable compensation (which fluctuates with FTK’s share price). Overall, this is the picture:
This is rather a conservative forecast in my opinion:
Valuation
Looking at it a few different ways:
FTK has grown very rapidly over the past few years, and the relatively recent acquisition of DeGiro was transformational. My (rather simplistic) take on the special audit from the German regulator is that the rapid growth and current size of FTK warranted increased regulatory scrutiny. FTK is not a small company anymore. News that the regulator performs an audit is never taken as positive, but an audit was performed and some shortcomings were identified. We don’t know the exact details, but these shortcomings appear relatively easy to address. Perhaps too optimistic, but this looks like growth pains to me.
I believe the main risk to the thesis to be a prolonged period of market and economic uncertainty. Strong pressure on (European) consumer spending would certainly have an impact. In that case, there’s no reason why forward multiples couldn’t go down another 30%, or more.
I might be too early here. 2023 will be another relatively tough year from a consumer sentiment point of view. Also, Bloomberg consensus still seems too high. Nonetheless, I remain optimistic. FTK has been sold off aggressively this year, partially for good reasons, though its performance during this difficult year has been resilient and gives me confidence on the growth story. I believe that investors oversold FTK and that the stock should rerate back at some point to a more reasonable multiple, reflective of its growth potential. For what it’s worth, management has been rather actively acquiring shares over the past few days. Looking out a few years, the share price could double or more as the valuation becomes less reflective of sentiment and more of FTK’s growth.
Continued user growth and operating leverage
Improving consumer sentiment
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