Description

Investment Viewpoint: Plus500 (PLUS) is a London Stock Exchange listed small cap “Magic Formula” stock, operating in a segment of the on-line brokerage business. The Company has a high return (68% EBITDA margins and ROIC of +100%), rich cash flow business model (with a +50% revenue-to-cash conversion ratio), strong and sustainable competitive barriers, healthy growth prospects, and is run by a owner-operator management team (36% ownership) whose interests are aligned with shareholders. The Company pays out a minimum of 50% of earnings to shareholders, with a dividend yield currently at 5.9%. Despite having the highest returns among competitors/peers, the shares carry the lowest valuation; selling on a trailing 12-month basis at an EV/EBITDA multiple of 5.3x, a P/E of 7.8x and a FCF/EV yield of about 15%. This opportunity exists as a result of: 1) comments from a retail oriented short seller, who freely admits his view is based on a “hunch” and has no evidence to back up his claims and 2) a moderation in the Company’s torrid growth in its recently reported Q2 results, as a result of industry-wide low volatility (which drives trading volume). As both of these issues weighting on the shares are temporary, I believe “Mr. Market” is giving investors an opportunity to purchase shares at very attractive levels, with the potential for the shares to about double in the next 18-24 months, as some of these concerns dissipate. Longer-term, I believe that due to the size of the tangible addressable market and potential growth runway, PLUS has the characteristics to be a multi-year growth compounder with even greater upside possible.

Business Profile and History:  Plus500 is an on-line broker based inIsrael that trades in the UK. Plus 500 operates in the global contract for difference (CFD) industry. CFDs are essentially a highly levered option used for currency and stock trading in most countries in the world (with the major exception being theUS). CFDs are a contract between two people that mirrors the trading a security without actually buying or selling that security. The company’s proprietary trading platform allows its retail customers to trade over 1,700 different financial instruments, including equities, ETFs, indices, foreign exchange, and commodities in more than 50 countries. Plus500’s customers are very similar to gamblers. As such, the right way to look at this business is to compare it to an online casino. There are some professional traders who do make money, but over 90% of traders lose money. This is very similar to online card game sites, where the professionals consistently take money from the “patsies” that play casually for the fun of it. Importantly, the company only accepts retail clients, which eliminates any sort of customer concentration risk like some other brokerage firms face. This benefit is reflected in the company’s daily income statement as it reduces large downward fluctuations and allows for very consistent profitability:

PLUS was founded in 2008 with a view toward enabling clients to trade on movements in the prices of stocks, indexes, commodities, and forex without having to buy or sell the underlying instrument. The company’s first trading platform was released that year as a PC-based product, and the next year the company expanded it to offer commission-free contract for difference (CFD) trades. In 2010 the company launched a web-based version of its platform, thereby allowing Mac/Linux/smartphone users to trade as well, and also began offering ETFs in its trading portfolio. In 2011, the company followed on by releasing iOS app for iPhone and iPad (which quickly became the highest-rated CFD apps), with Android apps released the following year.

PLUS focuses on the retail CFD market. The Company differentiates itself with the lowest cost commission-free trading platform in the industry with the most friendly user interface. PLUS has three sources of revenues; 73% from spread dealing, 24% from overnight margin loans and 3% from proprietary trading.Mobileis the fastest growing platform for the Company, currently accounting for 51% of revenues. The Company has a broad geographical revenue mix (unlike some of its competitors, which have a large percent of revenues from the UK), with UK being its largest country at only 15% of revenues and no one customer accounting for a meaningful percent of revenues.

In July of 2013 PLUS had its IPO, in which it raised $75 million and began trading on the LSE. The shareholder base consists of 45% institutions, 36% insiders and 19% retail investors. PLUS is covered on the sell-side by only two Londonbrokers. For more detail on the Company and to access its regulatory filings, the following is a links to PLUS’s website for investors and its latest investment presentation:

http://www.plus500.com/Investors/Investors.aspx

http://cdn.plus500.com/media/Investors/Reports/Plus500_Investor_Presentation_1H14.pdf

The following are some key investment points supporting my investment thesis on the stock:

A disruptive and highly profitable, cash generative business model: PLUS has a unique low cost, high return business model that matches the Company’s target market focus. While the CFD market has been growing, it has bifurcated in the last few years. Some of the traditional players like IG Group, CMC, and FXCM have been shifting their focus towards more institutional and other high value/ARPU clients. These competitors have offered these customer more sophisticated and complex products and technologies to trade CFDs and related products. Some of the companies have also raised minimum equity requirements in an attempt to purge some of their lower value customers.  The reason for doing this is that these lower value customers tend to have lower ARPU and higher churn rates on average than large and more institutional customers and are looking for a different type of trading platform.

Conversely PLUS focuses exclusively on retail customers, which eliminates customer concentration risk and minimizes daily fluctuations on its income statement. The moves by some of PLUS’s competitors to abdicate this part of the market has been a benefit to the Company. This factor, coupled with some unique marketing programs targeted at unlocking a large number of these type of traders, has helped the Company grow its base of active users and revenues at a very healthy rate since mid-2013. What enables PLUS to profitably target these customers is the Company’s unique technology enabled, low cost operating structure (which I will describe below), which was designed from the ground up to match its target market focus. The combination of PLUS’s proprietary trading platform, user interface, and “marketing machine”, gives the Company by far the lowest cost structure in the industry.

This technology enabled business model is a disruptive force in the industry and in my opinion is one reason why some of PLUS’s major competitors are abdicating the low end of the CFD market. This is another example of a company effectively using technology to create a discontinuity gap relative to incumbent players by changing the business model within an existing industry. History shows that companies that are the disruptive force in bringing a new low cost business model to an established industry (i.e. Dell in PCs and Uber in the taxi market) tend to grow and do well over an extended period. As a comparison, I think it is fair to Compare PLUS with Interactive Brokers. Similar to how Interactive Brokers has created a unique technology platform that has given it a competitive advantage relative to established brokers (TD Ameritrade, Charles Schwab and Fidelity) and enabled it to offer the lowest cost in the industry, PLUS has done the same in the CFD sector of the market. Thus as I will describe below, I believe investors should view PLUS as more of a technology company than a broker. Additionally this technology advantage could in the future be extended to other established tangential markets.

PLUS’s technology enabled business model translates in to financial model with low fixed costs and high margins. Note in FY 21013, total payroll cost comprised only about 6% of overall operating expenses, while advertising spending (which varies with market conditions), comprised roughly 68% of costs. Such a variable operating cost model gives PLUS a lot of financial flexibility to prosper in challenging times in the volatility cycle and the opportunity to grow its user base during healthy times in the cycle. The Company’s low cost structure also translates into outstanding profitability and returns. Recently EBITDA has been running at approximately 68%. PLUS’s high margins coupled with the company’s asset-light business, with minimal PP&E and cap-ex requirements, translates into an outstanding ROIC of +100% and significant free cash flow (FCF) dynamics. In the last 12 months, PLUS has generated FCF of $89 million (net income + D&A - cap-ex), on a base of revenues of $186 million. Thus, PLUS converts about half of every dollar of revenues into cash; I don’t know too many other companies that can compare to this, and certainly none of these companies are selling at a valuation even close to that of PLUS. Given the Company’s policy of returning a minimum of 50% of that cash back to shareholders, this is a business model that is definitely shareholder friendly.

Proprietary technologies and brand provide sustainable competitive advantages and a strong moat: PLUS’s unique technology enabled business model was designed from the ground up by the Company’s founders to be low cost, easy to use, flexible to adding new features, scalable to grow rapidly, and secure. There are three key elements that are at the heart of its technology: its trading platform, user interface, and “marketing machine”.

Most CFD competitors (i.e. IG Group and FXCM) use multiple trading platforms or license 3rd party platforms like Meta Trader 4. While these 3rd party platforms are feature rich and appeals to higher end traders, these companies must pay a meaningful license fee to offer the platform to their customers. Conversely, the founders of PLUS leveraged their technology background and experience in developing an on-line backgammon product to design a platform and other products for trading CFDs. The platform was designed to be robust, secure, flexible, and scalable to handle future growth. Indeed, the platform has proven itself to be robust enough to handle PLUS’s triple digit growth in the recent past without requiring additional headcount or infrastructure, thus allowing the Company to show margin expansion during this time. In addition it is flexible enough to offer PLUS a time to market advantage with new trading CFDs tied to hot IPOs or other financial instruments. For example, PLUS was first to market with a CFD following the Facebook and Alibaba IPOs and a CFD on BitCoin. The importance is that these events cause bubbles of trading activity in the first few days that PLUS can capture ahead of its competitors. Underscoring the significance of this advantage, management indicated that in the in the first two days of trading after the Facebook IPO, they did as much business as they did in about two months on average in the past.

The Company’s proprietary trading platform gives PLUS both a key competitive advantage as well as a strong moat. Any new competitor looking to enter this market would either have to pay significant licensing fees to use Meta Trader 4 or a similar product (which would provide them little differentiation) or spend years and a large amount of money to develop a competing product (if they had the technology knowledge).

A key design element of PLUS’s platform was designing a user interface that stressed simplicity and ease of use. Given that its user target market contains many novices, it was important to keep them engaged in trading activities and reducing support costs. The user interface is available on all major platforms including the web, PC, iOS, Android, and soon the Windows phone. As illustrated in the table below, PLUS has the highest rated apps in the CFD market on Google Play and the Apple iOS store.

The ease of use of PLUS’s trading platform and user interface enables it to offer a highly automated product with little support personnel. While some competitors have tried to play up their superior customer service (such as the ability to speak with a live person), this also adds to their cost structure and makes them less competitive. Thus for PLUS’s clients who value lower transaction costs over better support, this strategy fits well.

Designing a competitive, easy to use, high rated user interface that is platform agnostic takes time, money, and expertise, all of which a new entrant will likely lack. Accordingly this also adds to PLUS competitive advantage and moat. Additionally, these technology enabled cost advantages, allow the Company to focus a greater percent of its cost on its marketing activities, which drives new account and revenue growth. 

On the marketing side of things, the Company does most of its advertising on-line in a very cost effective manor. PLUS draws traffic in three ways: organically (direct to its website), affiliate marketing (PLUS pays a commission to other for directing traffic to its site), and through its online marketing programs. The following table highlights the channel trends in the last couple of years.

PLUS’s online “marketing machine” is a flexible and very effective proprietary tool that gives the Company a competitive advantage in adding new users in a very capital efficient manner and with a high ROI. The “marketing machine” is a tool allows the Company to effectively search and bid on key words across multiple search engines (Google, Yahoo, Bing, etc.) for pricing inefficiencies. Depending on the level of volatility in the market, the Company then spends a variable amount of marketing dollars to capture users. The Company is flexible in adjusting the level of marketing dollars it spends to ensure it fishes only when the fish are biting. Management believes this method has consistently yielded returns of about 100% relative to the lifetime value of these new customers. This technology is PLUS’s “special sauce” in that it allows the Company to help offset the higher churn among lower end customers. This gives PLUS another competitive advantage to effectively participate in this segment of this market that most competitors cannot profitably service.

The technology behind PLUS’s “marketing machine” is very robust and complex, and is built upon numerous proprietary algorithms. It is the result of 14 years of online marketing experience by the founders. Needless to say, this technology will be difficult for competitors to duplicate and adds another very significant layer to PLUS’s already strong technology enabled moat.

As illustrated in the previous table, the Company’s growing brand awareness has driven an increased percent of high margin (no commission) traffic directly to its web site. Relative to its brand, management estimates that the Company has spent ~$150 million over the last few years (including $10 million in the last quarter) on various brand expansion programs. PLUS has seen a correlation inEuropebetween increased brand awareness and improved customer retention (i.e. lower churn). Lower churn has a significant impact on improving the Company’s financials/returns in that it increases revenues per customer as well as the lifetime value of a customer. Management notes a positive trend in this area, where about 20% of PLUS’s core customers generate roughly 80% of revenues and continue to trade with the company for multiple years, providing greater financial stability. Establishing a brand within the CFD business (with a significant number of active customers) does not happen overnight, and will likely cost any new entrant a substantial amount of money (in addition to their spending in other areas, such as technology), which again adds to PLUS’s moat.

PLUS’s group of technology-driven advantages give the Company the lowest cost structure in the industry, which is passed directly on to clients. As a result PLUS offers the lowest trading rates in the industry across all major asset classes. This is illustrated in the following table. 

As more novice and lower end customers are attracted by lower trading costs (as opposed to advanced features), this gives PLUS a competitive advantage in reaching these sectors of the market and fuels its ability to continue to grow its active customer base in areas its competitors are abandoning.

Skilled owner-operator management team, aligned with shareholders: PLUS has a highly talented management with an excellent combination of technology expertise and business acumen. They bring to the Company a computer programming background and were educated at Technion University - Israel Institute of Technology; the equivalent of MIT in Israel. They started their careers in the on-line gambling business, successfully building and selling an online backgammon business. Realizing the similarities between online gaming and CFD trading, they decided to apply their know-how to a new industry. In addition to having the expertise to design and build PLUS’s technology platform and “marketing machine”, their technology background is helpful in shifting through all the available candidates to hire only the smartest programmers in Israel. This is a key reason why the Company can generate industry leading revenue per employee and maintain a time to market advantage in making new CFDs available before other CFD companies. In addition to the technology expertise of the management team, I was struck by the high quality of their general business acumen, which likely came from their experience in running a previous company. This combination of IT and business knowledge is rare in technology companies and has been a cornerstone in PLUS’s success to date.

Importantly, the entire management team’s interests are closely aligned with shareholders. Insiders own 36% of the shares with CEO Gal Huber owning 6%. The majority of the net worth of all the management team members are in Plus500 stock. Additionally, as the management team has modest compensation, dividends are important to their own cash flow. Thus they have a personal interest in the continued success of PLUS and in support of the Company’s goal of a minimum 50% dividend payout ratio.

Large total addressable market (TAM) and long growth runway: There are a number of factors that should position PLUS for healthy growth over the next few years. In addition to volatility reverting closer to the norm (which was previously discussed) these factors include geographic expansion, increased penetration of existing markets, and wider acceptance of CFD products.

While CFDs are currently not available for trading theUS, they are a relatively common financial instrument that has experienced healthy growth and is gaining in popularity in many regions of the word. Though influenced by recent weak volatility trends, the CFD market continues to grow at a healthy rate. According to market research firm Investment Trends, the industry growth from 2007-2011 - during a period of more normal volatility - was estimated at 20% (Investment Trends 2013 survey). In 2013, the overall market declined (while PLUS recorded significant growth) as a result of the record low volatility in the industry. While 2014 could also be a year of somewhat flat industry growth (again while PLUS continues to grow), it should pick up in the future if industry forecasters are correct in calling for an increase in volatility tied to the ending of QE3 and rising interest  rates. 

Relative to PLUS’s TAM, the potential for CFDs to become a more widely utilized product is an underappreciated opportunity. For example, the current penetration rate in continentalEuropeis 0.12%. If the CFD European market can match the 0.25% rate possessed in the UK (still very low), the number of traders inEuropewould more than double and contracts traded would grow exponentially. Increases in the company’s most developed markets (such as the UK, Western Europe and Australia) would stand to drive further upside. From a market share perspective, PLUS still has a relatively small share in some major Western European markets, which gives it room for future share gains. The following comment from a Numis analyst report from May 14, 2014 underscores the potential growth in PLUS’s TAM:

“Combined with our estimate for the number of CFD traders in Australia (c.50k), there is the potential for Plus500’s core addressable market to grow from our current estimate of 450k traders up to potentially 900k traders over the medium term.”

Additional growth opportunities are available for PLUS tied to geographic expansion, especially in Asia, China, Japan and North America. This geographic expansion could take the form of either a “green fields” approach (i.e. after getting the necessary government approvals and establishing a subsidiary) or using some of the Company’s cash flow to purchase an existing operation and client base. For example, in FY13, PLUS began to offer a on-line retail CFD product in Australia. Management believes this new market is a key growth opportunity for the Company.

The bottom line is that the combination of depth and breadth of customer penetration opportunities leaves PLUS poised for robust growth in its customer base and sales over the next few years.

Why are the shares mis-priced?: I believe the current opportunity in the share price has been caused by 1) a campaign from a retail oriented short seller, who freely admits his view is based on a “hunch” and has no evidence to back up his claims and 2) a moderation in the Company’s torrid growth in its recently reported Q2 results as a result of industry-wide low volatility (which drives trading volume).

The short case lacks substance: The first noteworthy fact is that the short case on PLUS is promulgated by a UK-based retail oriented investor who offers a tip service to subscribers and has a social media following. His message has been circulated on various websites, retail investor forums, and even discussed in the general press. His initial posting in June was only a few sentences long and contained no supporting information. Following this posting the stock dropped by over 10% the following day, and lacking any other news, the shares declined +30% in the following three weeks, clearly indicating the short story has had an impact on the stock price.

After speaking with this individual, I came away unimpressed and with the realization that his short thesis is built on “hunches” and lacks any substance. At the heart of the theory, the shorts believe PLUS is a “fraud” because it had been growing much more rapidly than other more established competitors (IG Group) and it is “massively overvalued”. However, he readily admits that this belief is based upon a “hunch” and he has no evidence to back it up. His view is that because the Company is clearly a “fraud”, you don’t have to do any research. The following is a link to an article outlining the original short thesis and admitting his lack of any evidence:

http://forexmagnates.com/is-an-infamous-uk-short-seller-behind-plus500-stock-drop-calling-it-a-scam/

In attempting to understand the short thesis in greater detail, in further discussions I learned that this individual had never spoke with management or had done any research to understand PLUS’s cost structure. Moreover, he had no knowledge of some of the major competitors (for example, FXCM), the business models of internet based companies, or the importance of volatility as a key driver of trading volume.

Recently this individual was featured in a press article which suggests PLUS is under review by UK regulators (the Financial Conduct Authority or FCA) regarding in-bound ID verification compliance issues. After researching this issue and reviewing the Company’s compliance protocols with management, I find this accusation equally baseless.

Despite the lack of evidence put out by the shorts (and while I feel like I am shadow boxing to some extent), I offer the following rebuttal comments for investors to digest. First, most frauds, especially ones the size of PLUS, are not that obvious where one does not need to do any research to spot. Frauds don’t pay out half of their dividends over an extended period (which PLUS does) to shareholders. This is impossible unless a company is raising capital, which PLUS is not doing. With management/insiders owning 36% of the Company, and having very modest compensation, they would be taking money out of their own pockets. Additionally, my research indicates that PLUS has by far the highest search volumes according to Google, another data point which would be hard to fake. Finally, in its 2013 survey of over 13,000 traders and investors, market research firm Investment Trends positioned PLUS as tied for the #4 market share position in the UK (versus not being ranked in 2012). Obviously, a healthy amount of UK based CFD traders know and use the Company’s products, which would again be difficult to fake. A link to this report is: http://www.iggroup.com/content/files/leveraged_trading_report_nov13.pdf

Regarding the recent suggestions in the press regarding the ID compliance issues, I offer the following points to dispel these claims. As an FCA regulated entity, the Company’s UK subsidiary is constantly undergoing monitoring and review. Management states that there have not been any recent inquiries by the FCA and they strongly believe the Company is compliant with regulations. For ID verification, PLUS uses such companies such as Experian and GB Group, which are authorized by regulators as well as used by other competitors. Management also notes that at sign up, PLUS does sanction list monitoring with World-Checks (a Thompson Reuters company). Moreover, PLUS has a very diverse geographic customer base, with the UK only representing about 15% of PLUS’s revenues- which is significantly below other major competitors.

With the announcement of Q2 earnings, which showed a moderation in PLUS’s growth (which ran counter to the shorts original thesis), the short argument changed 180 degrees. The new thesis is that PLUS’s business is in a freefall based on the declining growth in revenues, active customers, and profits. Thus it appears the shorts want to have it both ways.

Low industry volatility, which has also pressured the stock, is likely a temporary issue and could be set for a favorable turn: The shift in the most recent short argument brings up the issue of low volatility in the industry, which is the second factor that has driven the shares down. It is important to understand that the level of trading volume for such instruments as CFDs and foreign exchange is heavily influenced by volatility. Coming away from another discussion with one of the leaders of the shorts, it was quickly realized that he did not know that volatility was an important catalyst for driving trading volumes or that in Q2, volatility was at an all time low. The following link is to a Yahoo Finance chart of the CBOE VIX index, which highlights the decline in overall volatility during Q2:

http://finance.yahoo.com/echarts?s=%5EVIX+Interactive#symbol=%5EVIX;range=1y

While low industry volatility in Q2 did negatively impact PLUS’s rate of growth, it still remained healthy, with revenues rising 83%, active accounts increasing 8%, and as per management (like other LSE based companies PLUS only reports full results twice a year), profit margins remaining healthy. Moreover, PLUS’s growth in some key metrics compares very well relative to other competitors/peers. As illustrated in the table below both IG Group and FXCM reported revenue declines, while FXCM showed a profit loss in the period.

One of the key takeaways from this data is that while low industry volatility has an impact on all the major participants, it appears that PLUS is best positioned to prosper in such an environment relative to both growth and profitability.

Conversely, in an environment of increased volatility, the Company’s low cost business model (to be discussed later) would translate into a significant amount of financial leverage. Increased volatility provides a healthy stimulus for growth in revenues and new accounts at PLUS. While I am not an expert in this area, there are a number of forecasters that expect with the upcoming winding down of QE3 by the Fed, volatility levels will increase. The following quote is from a June 2014 Morgan Stanley Global Currency Research Team report titled “FX Pulse: Positioning for Volatility”: 

“Preparing for higher volatility”…..“We continue to see rising US yields – leading to higher global funding costs – as the major risk to the current low-volatility environment”….. “The message is clear. Rising US bond yields driving global funding costs higher should push up volatility”.

Source: http://www.morganstanley.com/institutional/research/pdf/FXPulse_20140612.pdf

As highlighted in the VIX chart, Q3 volatility levels appear to have bounced off the bottom and are trending up. Additionally, there has been a fair amount of excitement from the Alibaba IPO (note Facebook was the biggest short term revenue event for PLUS in its history) and the Apple new product introductions as well as increased movement in the currency markets. Thus, the monthly operating metrics data from FXCM, another firm heavily impacted by changes in volatility, appears to show a positive trend developing in such things as trading volume, trading volume/day, and trades/day. This data can be accessed on FXCM’s web site at:

http://files.shareholder.com/downloads/AMDA-13JM9E/3233011069x0x611677/a666323d-6ee7-4e6c-baae-76a540b82544/FXCM_Operating_Metrics.pdf

Thus Q3 is looking to be a more favorable environment for PLUS. With sell-side projections low (based on managements guidance and the recent declining industry volatility), and given the Company’s history of intentionally under-promising and over delivering, it is possible that PLUS could overachieve relative to expectations in Q3 and 2H FY2014. With the decline in the share price and the new comments from the shorts following the Company’s Q2 results, any good news in Q3 should have a sharply favorable impact on the share price and leave the shorts to dream up another issue.

Valuation: A “Magic Formula” stock with the highest returns and dividend yield and by far the lowest valuation relative to both CFD and on-line gaming peers: While volatility has been absent from the financial markets, the stock of PLUS itself has seen quite a bit of volatility since its IPO in June of last year. The following is a link to a Yahoo Finance stock chart of PLUS:

http://finance.yahoo.com/echarts?s=PLUS.L+Interactive#symbol=PLUS.L;range=1y

As illustrated in the chart, the stock exhibited a huge gain tied to the triple digit growth rates posted in revenues and even faster gains in profitability. Since peaking in April of this year, the shares have dropped about 45% in response to the accusations spread by the shorts and in response to the Q2 results. It’s worth noting that a relatively large percentage of the shares are held by individual investors (though this is declining), some of which have the same trigger-ready trading mentality as PLUS’s customers and have likely been a contributing factor to the volatility in the share price and in creating the opportunity presented at current levels.

I think it is very rare to find a company, like PLUS, with the following characteristics…

• very healthy growth (+138% y/y in 1H 2014),
• margin expansion (EBITDA +228% y/y in 1H 2014)
• +60% EBITDA/revenue margin,
• triple digit ROIC,
• strong cash generation (a revenue-to-cash conversion ratio of +50%),
• dividend yield of 3.5% (with a minimum 50% payout ratio),
• exceeding guidance, without a profit warning;

… especially one that is selling (all on a trailing 12 month basis) at a:

• EBITDA multiple of 5.5x,
• P/E of 8.4x and
• FCF/EV yield of 15.2%.

This is truly a unique “Magic Formula” quality stock.

Also, as illustrated in the following chart, when compared against other CFD competitors and on-line gaming peers PLUS is the fastest growing, most profitable, and has the highest dividend yield. Normally a company exhibiting such outstanding fundamental and growth characteristics would sell well in excess of its peers. However, as illustrated in the table, PLUS is valued at roughly one-half the average of its peers on just about every metric:

I believe this is a truly outstanding opportunity for investors to own a company with the following characteristics:

• high growth
• superior margin/returns/FCF business model
• a disruptive force in the industry
• sustainable competitive barriers
• a large TAM and long growth runway
• talented owner operator management team, aligned with shareholders
• mispriced for temporary and identifiable reasons
• a very attractive valuation (on both an absolute and relative basis) on just about every metric that provides downside protection.

Given all this, I believe the stock offers investors significant appreciation potential over the next 12-24 months, and for long-term investors is a likely a growth compounder over the next 3-5 years (with even greater upside) if management continues to execute well.

So what are the shares worth? The short answer is a lot more than the current price. However, to try to be more precise I think the best way to answer the question is to triangulate a range using a number of different measurements. I believe that within 12 months it is likely that the near term issues that have pressured the stock will have dissipated. As this occurs, I believe the shares will rerate (which may occur in a short period) to more properly reflect the true value of the business.

Using a relative valuation approach with the peer comps in the preceding table and applying the average multiple for each metric (excluding dividend yield, which is more subjective), one can estimate the price that the shares of PLUS would be valued at in US dollar equivalent prices:

• EV/EBITDA average of 11.7x: $13.84
• P/E (TTM) average of 19.8x: $15.92
• P/E (NTM) average of 14.7x: $12.80
• Dividend yield of 3.4x: $14.63

This yields a price range of $12.80-$15.92, representing potential upside of 96%-144%. Using the average of these produces a price of about $14.30, which given the US dollar equivalent $6.52 stock price, represents upside of 119%. Note that this valuation exercise uses the average for the group. However given the superior returns of PLUS relative to these peers it should actually sell at a premium to the rest.

As someone attracted to investment opportunities in companies with highly generative cash flow dynamics, PLUS’s 50% revenue-to-cash conversion business model is very appealing to me. Doing a little research, I found there are not too many companies able to generate this level of cash on every dollar of revenues. A search using the S&P CapIQ database of ~30,000 non-financial, operating structure (excluding MLP’s, trusts, nano-caps, etc.) companies in English speaking countries revealed that only 43 such companies met this standard and shows the rarity of PLUS’s business model. As you can imagine these companies carry high valuations, with an average EV/EBIT multiple of 13.8x and an EV/FCF multiple of 18.7x. Applying these valuations to PLUS, yields a US dollar stock price equivalent of $16.64 and $18.91 respectively, representing potential upside of +155% and +190% respectively.

In addition to being mispriced because of temporary issues, I believe that due to the size of the TAM and potential growth runway PLUS has the characteristics to be a multi-year growth compounder. With a return of normal volatility in the financial markets, I believe the Company has the capability to compound EPS at a rate of at least 15% over the next 3-5 years. Note that this growth rate would still be below the 20% industry growth rate in the 2017-2011 during a period of more normalized volatility in the financial markets. Under this scenario, PLUS’s EPS power could grow to about $1.44 per share (in US dollars) over the five year period (see table below), from about $0.79 on a trailing 12 month basis. Using a PEG ratio of 1.2x (or a P/E of 18x), which I believe is reasonable for a high margin/growth business like PLUS, would yield a stock price of ~$26, representing an IRR of ~30%.

The company’s historic P&L and my forecasts are contained in the table below:

I believe that even in a bear case scenario - no growth and lower margins - the downside is protected. Assuming revenues stabilize in the $180 million (US dollar) range and EBITDA margins decline from 67% on a trailing 12-month basis, to the mid-50% range, this would translate into EPS of roughly $0.65 per share. Even applying a P/E of 12x, or around one-half of the 20-25x of its peers, would translate into a +20% higher stock price.

As a result I believe the shares offer investors one of the best ways to play a return to more normal volatility in the financial markets, one with very asymmetrical risk/reward ratio and the characteristics needed to be a long-term growth compounder.

Risks:

As is the case with any investment, there are some potential risks. Aside from possible “blacks swans”, I believe the following are the most realistic:

• Continued low industry volatility: While industry volatility is at the low end of its historic range and many experts believe volatility will increase with the ending of QE3 and rates rising, there can be no assurance this will occur. In any case, even in such an unfavorable environment PLUS has proven that it can earn high returns and generate healthy cash flow.
• Government regulation: In most of the major countries where the Company operates, it is subject to various government regulatory agencies. Given the low percent of traders that make profitable trades, there is a risk that additional restrictions may be imposed on the CFD industry, such as caps on leverage. While some changes could have a temporary disruptive impact on PLUS’s business (and likely the overall industry), the Company could adjust its business practices to comply with most new requirements. Also keep in mind that while there has been a lot of general discussion regarding overall “gambling type entities”, they have continued to prosper and grow due to healthy customer appeal. Finally, given PLUS’s graphical diversification, with the UK being its largest country at about 15% of revenues (well below other competitors), the risk of new governmental actions in any one country is mitigated.
• Increased  competition: While I believe  and have outlined PLUS’s strong competitive barriers previously, the CFD industry remains very competitive. New or existing competitors could announce new technologies or pricing policies that could make them more competitive and pressure the Company’s returns. For example, FXCM has discussed plans to expand its CFD product offering in Europe. However, PLUS’s low cost structure has had the impact of moving much of the competitive pressure toward participants in the higher ARPU segment (the more seasoned CFD traders) and away from PLUS’s core market of more novice traders. Additionally the Company’s high margins allow for a fair amount of pricing flexibility to stave off any direct competitive threat.
• Cyber threats: Given the stream of news related to companies’ IT systems and hacker attacks, one can’t rule out this risk. However, PLUS’s trading platform and IT systems were designed from the ground up by some very advanced programmers (with security being one of the key design features) that we think means the company is better protected than most.

Catalyst

• In increase in volatility as PLUS may be the best investment vehicle to play a return to more normal volatility in the financial markets.
• Improved Q3 financial results to dispel the concerns raised by the shorts in regard to the moderation in PLUS's Q2 growth.
• continued dividend payments, an increase in the 50% payout ratio or possible special dividends (in addition to returning cash to shareholders, it will also help to dispel concerns raised by the shorts).
• an acceleration in growth in revenue and profits in the 2H of FY 2014 above current sell-side forecasts.
• increased visibility and interest from US based investors and analysts and increased coverage by some of the major UK brokers.