Description

SUMMARY

Equals Group (EQLS) is seemingly another example of the UK AIM’s illiquidity and inefficiency leading to what I think is a mispricing. The summary is EQLS is a ~£80M MC / ~£70M EV predominantly B2B payments business organically growing topline ~20%, with a high likelihood of meaningful topline acceleration in the next 12-18 months (and a long runway to grow thereafter), which generates ~65% GMs and is currently cash flow breakeven, trading at ~2x revenues / ~3x GPs versus comparable B2B payment businesses globally which tend to trade anywhere from 4x through to mid-teens type revenue multiples.

Moreover, there’s an interesting “special sits” angle as EQLS’ largest (~22%) holder is a listed fund (Crystal Amber) that has recently been forced into runoff / liquidation, meaning its ~22% stake will potentially trade to a strategic buyer.

BRIEF BACKGROUND

Formerly known as FairFx, the business up until 2017 was focused on the B2C forex space via (i) prepaid currency cards, and (ii) international payments. While their B2C business was growing, management recognized the threats posed by increasing competition from larger and better funded competitors (such as Transferwise) and realized they didn’t have the scale / balance sheet to pursue a high CAC, capital intensive B2C landgrab.

With that realization, the business in 2017 pivoted toward B2B (particularly SMEs), which has a larger TAM and was earlier in its transition away from the incumbent banks than the B2C space. LTV/CAC is generally lower in B2B given the take rates earned for international payment providers are comparable to B2C, but businesses tend to make international payments at far higher scale and volume, and tend to be stickier, than consumers.

Over the ensuing three years, the B2B platform was built out organically (~£15M capitalized software from 2018-2020) and via bolt-on acquisitions – in total about ~£33M was run through as investing CFs over the 2018-2020 period.

WHY DOES EQLS TRADE POORLY?

This is a pretty key question so needs to be addressed early, given seemingly every decent & growing challenger payments biz trades at least mid-single digit revenue multiples (if not high single digit or even double digit multiples). Why is EQLS sitting there at ~2x sales despite its (accelerating) topline growth? Well, a variety of self-inflicted and COVID-inflicted issues have smacked them over the last 2-3 years:

-          Management overpromised and under-delivered in 2019 – on 1-25-19 they announced FY18 EBITDA of ~£7.5M and expected FY19 would be a year of “significant growth”, but instead they delivered tepid organic growth and did a £16M secondary midway through the year. Despite the headline revenue EBITDA growth, investors focused on the high cash burn associated with building out the B2B biz and the stock got cut in half;

-          COVID decimated the ~30% of their revenue associated with travel (largely FX cards from the old FairFX B2C biz, but also hurt their B2B expense management biz);

-          Wirecard was the issuer of EQLS’ FX cards and disappeared overnight, creating a ~£700k writeoff in 2020 and necessitating EQLS insource the function; and

-          EQLS’ largest holder, Crystal Amber, has been a bit of a ‘carcass swinging in the breeze’ for the last ~18 months, potentially creating an overhang (which is now coming to a head – see below).

As a result, the business today trades for about half the market cap it had two years ago despite the business now generating record revenues & having achieved cashflow breakeven.

WHAT EQLS IS TODAY

EQLS today – following ~3 years of stitching together its B2B strategy, but still with its B2C business intact – is a diversified payments business with services across international payments (both spots and forwards, for B2B), banking & expense management, and FX cards & cash. I’ve snipped below two slides from their 2021 capital markets day which summarize this:

They typically target SMEs and are taking share aware from incumbent banks by offering better tech (e.g. superior UX, richer in features e.g. expense management, more flexible currency options) and more responsive customer service. Management is clear that they don’t compete solely on price – customer service is important particularly within the SME space where, practically speaking, EQLS is interfacing with finance & treasury professionals who are perhaps time poor and for whom execution of international payments and treasury & cash management services is important to doing their job, as compared to B2C where price is the key.

EQLS’ self-confessed most visible competitor is Transferwise (or Wise, as it’s now known), which makes sense as both compete in international payments and ~60% of EQLS’ revenue is its international payments biz. With that said, EQLS offers forwards (Wise doesn’t) and EQLS is more focused on B2B whereas Wise is ~80% B2C / ~20% B2B.

EQLS held its inaugural (virtual) capital markets day in May and for anyone wanting to do more work on this name to understand its various products, tech, sales strategy, governance and operations, risk management etc., I’d recommend the ~2-hour time investment (is available on their website). Frankly, I found the depth and coherence of the management team to be pleasantly surprising for an £80M MC business.

MANAGEMENT AND MAJOR SHAREHOLDERS (AND WHY EQLS IS EFFECTIVELY IN PLAY)

CEO Ian Strafford-Taylor is a founder and has been with the group since 2007. He owns 1.2% (2.2M) of SOI but also has 6.3M long-dated options expiring 2022-2030 with strikes between £0.22-£0.36 (i.e. all heavily in the money) so on a fully diluted basis his ownership is ~4.5%. He understands basic capital allocation (e.g. best use for EQLS currently is investment in tech and sales functions buildout, followed by self-funding (i.e. deferred & performance-contingent) bolt-on acquisitions), earns ~£500k per year (i.e. his equity is more important than the comp), is well aware of what he needs to deliver to see shareholder value creation (i.e. high organic growth + positive cash flow / scale benefits), and is also well aware that transaction and trading comp multiples are a long way in excess of where EQLS is today.

In recognition of the business’ growing scale and complexity as it underwent its B2B strategy pivot, and following the 2019 SNAFU (to which underwhelming financial controls, coupled with an acquisitive growth strategy, I suspect contributed to the forecasting miss & the market losing trust), the BoD and finance function has been heavily refreshed and beefed up over 2019-20:

-          CFO Richard Cooper joined in October 2019 and his impact has been visible in the company’s far more detailed and rigorous financial reporting (compare 2018/19 reporting to 2020/21), and is less aggressive insofar as intangible cost capitalization goes.

-          Chairman Alan Hughes – a vet HSBC banker – joined in 2020. Good hire as he was directly involved in HSBC’s digital bank business so knows the incumbent landscape well.

-          NED Sian Herbert also joined in 2020 and is a vet financial services auditor. Again, good hire to support Richard getting the risk & financial controls & reporting functions up to par (which I believe they now are).

-          Chris Bones joined as a NED in 2021.

-          Hughes, Herbert and Bones replaced directors Chowdhury, Pearson and Head, who had been with the group since 2014, 2014, and 2016, respectively, and who (i.m.o) have less directly relevant experience to their replacements.

All 5 directors (CEO, CFO & 3 NEDs) have bought stock on market over the last ~9 months – in total about 239k units worth £86k has been purchased, with the most recent buying being Cooper & Bones as recently as a few weeks ago post the group’s most recent trading update (see “recent performance” below).

The largest holder (~22%) is Crystal Amber (“CA”), an AIM-listed activist small / nanocap fund, which acquired most of its EQLS stake via a 2016 £5M placement (at 20p) that also came with 7.5M warrants exercisable at 27p (subsequently exercised in March 2019). CA was sitting on a 4-5 bagger with its EQLS investment until things went awry in 2H19, and at 6-30-19 it was 20% of CA’s NAV. Today, EQLS represents ~15% of CA’s NAV (second largest investment).

CA’s 22% EQLS stake is now effectively in play because CA itself is in de facto wind-down – as announced on 6-25-21, Saba Capital Management (which owns >25% of CA stock) sent a letter to CA management to the effect that Saba would be voting its >25% against the continuation of the CA fund at the upcoming AGM (scheduled for November). As such (and assuming Saba votes as per its letter to wind up the fund), CA is now obligated to “formulate proposals to be put to the shareholders to reorganise, reconstruct, or wind up the Company following the Continuation Vote not being passed at the next Annual General Meeting of the Fund”.

With CA’s ~22% interest in EQLS thus clearly “for sale” due to CA being forced into runoff, there exists the possibility that M&A catalyzes the EQLS re-rate. There are likely many potential buyers for EQLS – competitor fintechs, maybe a financial buyer, or potentially an incumbent bank that would see value in plugging the EQLS tech into its larger customer base (as Santander did with Ebury in 2019 – see below).

RECENT PERFORMANCE AND WHERE IT’S GOING

As above, EQLS today trades for about half the market cap it had two years ago even though revenues are at record levels, cash burn has ceased (now breakeven), and the inevitable post-COVID travel snapback should generate £3-5M additional gross profit dollars with high dropdown rates. Snipped below are two key slides from the FY20 results pres showing how the business has performed over the last few years (the first being transaction volumes, and the second being revenue by vertical):

The collapse in travel-related revenue (26% FY19 revenue) starting Q1-20 is obviously COVID driven, but other verticals were also impacted in Q1-Q3 FY20 as general business conditions were difficult.

Q2-FY21’s trading update (released 7-8-21 and snipped below) was particularly bullish. It shows the non-travel business lines picking up significant steam (~10% sequential growth over Q1), and the language accompanying this trading update made clear that June was particularly strong driven by record banking deposits (up ~60% y-o-y), growth in spend platform revenue (“June 2021 being an all-time high”), and the Equals B2B solutions business (“the Group saw strong demand for its ‘own-name multi-currency IBAN’ capability combined with its settlement and clearance capabilities and user-friendly platforms – Equals Solutions. This resulted in £0.3 million of revenues in Q2-2021 as clients came on stream in June 2021, and the pipeline for H2-2021 looks strong.).

In addition to the positive revenue growth signs across the board (outside of travel-related products), management also called out exceptionally strong growth within the forwards products of the international payments vertical: “The strategic push to direct sales towards more sophisticated B2B customers is starting to bear fruit for the Group with an increase in dealing in forward contracts, which typically yield a higher margin.  The number of forward transactions rose by over 200% and the average order size rose from £90k to £114k.  Revenues from forward contracts now represents 45% of the total International Payments’ revenue stream.” With international payments being 60% total 2H-20 revenue, the math implies that forwards are now (45% * 60%) = ~27% of total revenue.

While some of the growth in forwards is likely attributable to a bolt-on they did in October 2020 (Effective FX), the growth in forwards volume is important because forwards are higher gross margin than spot driven by a higher take rate (typically ~100bps vs. ~70bps for spot). Alpha FX (see below) – which generates ~60% of revenue from high margin forwards and options – generates about 80% GMs whereas Wise (spot only) is ~62%.

THOUGHTS ON VALUATION AND POTENTIAL RETURNS

EQLS is a bit tricky to value precisely as its suite of products spans international payments, banking services, travel money and expense management; with that said its largest, fastest-growing, and best business line is its international payments business (~60% revenues). Some data points for consideration:

-          Wise recently IPO’d and sports a £13bn market cap, and its FY22 revenues will probably be in the region of £550-600M. Obviously Wise is many times larger than EQLS and its valuation makes no sense to me nor, I suspect, any rational person …but it trades at ~20x revenues (and ~70-80x EBITDA).

-          A good transaction comp is Santander’s Nov-2019 acquisition of 50% of Ebury, a direct competitor to EQLS (Ebury targets SMEs), for £350M (i.e. £700M TEV). Ebury was private prior to Santander buying it so we don’t have perfect figures, but we do have their 12 months to 4-30-18 figures here (https://uploads5.craft.co/uploads/pnl_source/document/557415/ea675acc8951214f.pdf) which show (on adjusted basis excluding swap costs) £52M revenue, £39M GP, and a small EBITDA loss. Rolling forward Ebury’s 40% growth rate (disclosed as being Ebury’s 3yr revenue CAGR in acquisition press release) for 2 years gives £102M for FY20(f) revenue, which would imply Santander acquired Ebury for ~7x forward revenue and ~10x GP.

-          Alpha FX – an LSE-listed provider of payment and treasury services (mainly forwards and options) to high volume clients (e.g. hedge funds and other financial instos) – trades at 8-9x revenue and >20x EBITDA. It is structurally a higher margin business than EQLS (for now) given AFX’s payment business does more forwards/options forwards (~80% GMs vs. ~65% spot) and the fact its headcount is about half EQLS’ as Alpha exclusively services larger, high volume accounts. AFX CAGR’d revenue 2017-2020 at ~47% so that combined with its structurally high margins is why the market seems happy rewarding it with its 8-9x revenue multiple.

-          Before the market sent EQLS to the penalty box in late 2019, it traded at 4-5x EV/S multiples.

Intuitively, we all know the sales multiple is (or should be) a function of growth rates and expected margin at maturity – to that end:

-          Getting to scale and cash flow positive is clearly key to the EQLS multiple re-rate, and the good news is these businesses do seem to scale nicely. Wise – for example – grew revenue from £178M to £421M, GP (at a ~61-62% margin) from £110M to £261M over FY2019-2021, and over the same period EBITDA grew from £26M to £109M – i.e. (83/151) = over half of incremental gross profits (and about 34% of incremental revenues) dropped through to EBITDA.

-          Similarly, Alpha FX from 2017-2020 grew revenues from £13.5M to £46.2M and PBT from £6.7M to £17.5M – i.e. approximately 33% of incremental revenue dollars dropped through to operating profits.

Based on the above, I think there’s a clear path to EQLS’ current ~2x revenue multiple pushing up at least 1-2x turns over the next ~18-24 months via:

-          Inflecting B2B growth (as is clear from the most recent trading update);

-          Slight gross margin uptick from forwards (within international payments segment) being the fastest growing (and highest margin) subsegment;

-          Return of its predominantly consumer travel-related revenues (26% FY19 revenues, currently running ~5% of total); and

-          After having run the business at CF breakeven since Q4-20, and with significant cost investments having been made since 2017, the business going forward should be able to enjoy strong incremental EBITDA margins (~30%) roughly consistent with Wise and Alpha FX.

I have set out below some indicative, 2yr scenarios, with “TODAY” representing where EQLS is today adjusted for a return to travel-related revenues. I don’t consider the “base” assumptions particularly aggressive, especially given (i) the most recent trading update, (ii) the fact I’m assuming no M&A (whereas EQLS has proven it can hoover up small, private international payment providers for 1-1.5x revenue, as they’ve done historically with Hermex FX, Casco, and Effective FX), and (iii) the fact that their capital markets day made clear there’s some low-hanging fruit to pick (e.g. consolidating their 4 x FCA-reporting entities, getting better at cross-selling products between clients etc.).

RISKS

Major risks are: (i) capital misallocation, (ii) inability to demonstrate scale benefits & positive cash flow, and (iii) CA indiscriminately dumping its 22% stake on market.

Catalyst

- Crystal Amber either disposes its stake to a strategic which can grow EQLS (e.g. Ebury / Santander), or the entire company is sold.

- Accelerating revenue growth & proving out ability to generate positive cash flow.

- Accretive bolt-on M&A (e.g. buying private international payment providers at ~1x revenue)