Description

Swissquote is a market leader in online trading in Switzerland.  At the current price, we think the stock is trading at a reasonable multiple as-is, with a free option on interest rates in Europe becoming non-negative.  If interest rates in Europe normalize, earnings double. We believe the outlook for European interest rates is likely to look very different a year from now (remember when they were never going to go up in the US?  Swissquote is Schwab or Ameritrade then.) 

The business is founder owned & managed and has a history/culture of being customer-focused and continually innovating to disrupt fat and lazy incumbents.

Background: Swissquote is Switzerland’s leading provider of online financial & trading services and IPOed in 2000. CEO Marc Burki and Chief Technology officer Paolo Buzzi are both founding partners of Swissquote and large shareholders.  The CFO and the Chairman came on around the time of the IPO a short time after the founding.  The same four people have run the company since the tech bubble.  (E*Trade, with similar pedigree, has gone through five or six CEOs over that period.)

Quick history: Swissquote was first created in 2000 as a platform to enable private investors to access real-time prices for securities listed on the Swiss stock exchange with the goal of democratizing banking. Since then they have expanded their capabilities and offerings to include ePrivate banking, become one of the world’s top ten online currency trading providers, and forming various partnerships to help digitize financial products. Their vision is “…to be the world’s most pioneering and intuitive online bank.”

Their primary driver of profit is from trading commissions and fees which currently make up the vast majority of revenue and profit. The other revenue driver of revenue is from investing customer cash (~20% of customer assets – think traders of currency futures, not long-term stock investors) in interest bearing assets where they earn a NIM, similar to E*trade or Schwab. Currently, this part of their business is earning very little due to negative interest rates in Switzerland and Europe.

The business has continued to grow at a very attractive rate on all metrics when we look back over time- double digit growth in accounts, client assets, customer deposits, and trading commissions. 

Valuation: The core business is trading at under 12.5x 2018 EPS and under 10x NTM EPS, which is the historic low.  This includes virtually no contribution from net interest income. It usually trades around 12-14x NTM EPS. 2019E EPS is 4.30. Conservatively, assuming nothing changes, 13x 2019E EPS of 4.30 would get us a price target of 56, 27% upside.

Where we really make money here is if European and Swiss interest rates change (those two should be joined at the hip).  If interest rates go to a mere 150 bps we are talking about a more than doubling of earnings. We do not believe it likely to be linear beyond that – it is the first move off of negative interest rates that matters the most.

If that is not the number you get by a simple calculation, here is why.  The B/S is not all tied to Swiss interest rates. In fact, due to the global nature of the clients and their respective functional currencies, ¼ of the B/S is tied to USD rates, ¼ is tied to EUR rates and the remaining ½ is tied to Swiss rates.  US dollar rates and NIM have already normalized.   

We calculate that normalized rates would lead to $3.30 in incremental earnings. We make the assumption this scenario happens in ~2 years from now and put a 14x multiple on our “pro-forma” earnings we get to a CHF 93 price target, more than a double.  Discount it back two years at 10%, and this scenario is worth 77/share.

Of course this is a probabilistic analysis.  We assign a 70% probability to rates starting to rise by the end of next year.  (You may have a different probability, but as long as its not zero the stock is likely to be attractive still).  What to do with the other 30% probability?  Well, we could go back to the as-is valuation of 56, in which case a weighted average would be 71.  We think that is too conservative as that would be an interest rates never rise valuation which we consider quite unlikely.  Maybe they rise in year 2, 3 or 4.

The Swiss market is still largely dominated by larger banks such as UBS that have defensive online trading platforms. Swissquote charges half of what UBS charges so they are clearly still a disruptor from a pricing perspective.  They are currently 50% of the online space in Switzerland and see more muted growth in this market going forward.  They clearly want to grow internationally.

White label is one way to enter another market where their brand name is less recognizable and they can partner with an existing large player that has clientele and can utilize their digital low cost trading platform with their existing clients for execution. They currently have white label business of 800 mm and 103 mm of this is cash which is not within their custody.

They have a global presence in Forex trading. Right now, ½ of their Forex trading volume is outside of Switzerland with most of their equity trading in Switzerland. They expect their equity trading volume outside Switzerland to be at the level inside Switzerland over the next 5-7 years.

On capital allocation, they are pre-emptively reserving capital for a rising rate environment as their RWA calculation will change as their assets would move from the government bank which has a 0 RWA. Thus, they don’t have much as much excess capital as they appear to have due to their internal 17-18% maximum risk weighted asset ratio they have put on themselves which he described as a “pro forma” calculation for when rates go up. They pay out ~30-40% of net profit to shareholders in the form of a dividend. They have done some opportunistic repurchasing of stock and were actively buying stock from a shareholder last year and subsequently sold the stock back into the market at a higher price. Bought in at $30-40 and sold closer to $70 within a year - not a bad capital allocation decision!

Risk- That they do something stupid to grow outside Switzerland, particularly in Asia and the Middle East.  Their white label strategy where they do execution for larger incumbent players to enter new markets seems smart and lower risk.

Markets they are already in include Hong Kong, Dubai, London and Luxemburg. Apparently the Chinese are big into FX trading. Middle East clients like to trade gold (surprise!). In Hong Kong they are having a problem upgrading their license. They mentioned Singapore as another market they want to enter.

Bitcoin- lots of media hype for what appears to be little risk that they are directly taking on. They get a fee on volumes traded. They had 12 mm of revenue associated with bitcoin in 2017- unusually high due to heightened interest and high prices. Wouldn’t be surprised to see bitcoin revenue decrease.

The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

Catalyst

Change in stock market perception of European interest rates.

Takeover