Equals plc: The Tide is Turning

Disclaimer. I own shares in Equals Group Plc (AIM: EQLS). This research document contains my personal thoughts/views, and should not be construed/intended as either financial advice &/or a stock recommendation. As always, please do your own research.

Published on 28th September 2020

Making all the right moves

I have huge respect for firms that have the courage to reinvent themselves, particularly when profits are still rolling in. It says a lot about the vision & capability of the leadership team.

Microsoft CEO Satya Nadella did this back in 2014 by shifting to the cloud, and I think fintech challenger brand Equals is about to repeat the feat. Transforming from solely B2C services 2 years ago, into a rapidly expanding ‘one-stop’ e-payments/banking provider for SMEs (50-500 staff).

So what was behind the pivot? Well B2C e-payments was becoming more competitive, especially after the entrance of ‘freemium’ products such as Monzo and Revolut, who were bankrolled by hefty adverting budgets. The good news is that the Board have been proved correct, as illustrated by last week’s resolute H1’20 results.

The future is bright, the future is B2B

Here SMEs are less price sensitive, generate higher retention rates, require complex/value-add support, don’t need heavy promotional spend, & are primarily served by mainstream banks who over-charge them.

Hence providing a bumper $149bn TAM that is expanding globally at c. 4% CAGR, with the SME segment climbing 2-3x faster at between 8%-12% pa.

B2B & international payments were resilient during the pandemic

To me EQLS’s crown jewels are its B2B (65.5% H1’20 revs) & international payments divisions, with the latter delivering H1’20 gross margins of 64.8%.

Together they provide SMEs & HNW individuals with automated self-serve & sophisticated trading desk access to bank grade treasury & overseas settlement functionality. Enabling them to execute secure ‘spot, futures & forward’ forex contracts, alongside cheap & frictionless ‘straight through processing’. A winning formula, since most small firms cannot afford such in-house capability themselves.

FairFX was hit hard during the lockdowns due to fewer overseas holidays

Likewise both B2B & B2C divisions operate off a common state-of-the-art platform, thus driving economies of scale.

So what about the H1’20 numbers?

Well given the extremely challenging backdrop, not surprisingly H1’20 turnover tumbled -21% sequentially to £13.8m (vs £17.4m H2’19), albeit impressively gross margins remained broadly stable at 63.4% (64.9%). B2B now represents 65.5% of the group vs 60.1% H2’19 & 50.5% H1’19 (see below).

Nonetheless even after aggressive cost cutting, furloughing 73 staff, a 20% Q2 salary reduction & utilising government support schemes (£324k), much of this revenue shortfall fell to the bottom line. Thus, pushing adjusted EBITDA lower to +£672k vs £3.67m in H2’19.

Elsewhere net cash closed June at a healthy £7.55m (worth 3.8p/diluted share), reflecting tight working capital control and deferred PAYE (£1.5m, Sept’20 £1.8m). The latter being more than compensated by expected future R&D tax credits from HMRC (£2.3m).

Plus as a positive sign of things to come, it appears net cash has only declined by c. £300k Q3’TD, with the Board expecting to reach cash flow breakeven in Q4 - despite absorbing c. £400k of redundancy payments – and be self-funding from Q1’21 onwards.

Going forward, improving consumer & business confidence could also lift spend as soon as a Covid vaccine is approved (re light at the end of tunnel), which might even be this side of Christmas. Meaning that operational gearing (see below) would then work to the organisation’s advantage – offset by a slight gross margin compression to 62% because of volume discounts.

However this is not just an exciting growth story

Instead as Equals finishes off its technology refresh, alongside focusing on B2B (as opposed to consumer marketing), overheads are set to drop further. For instance at the end of June, headcount had reduced to 280 from a peak of 337, and should decrease further by year-end as systems work is completed on the Wirecard migration.

Ok, how much is the stock worth?

Assuming momentum can be maintained, there is no reason why EQLS can’t eventually command a sum-of-the-parts valuation of 60p (see below), equivalent to an implied 3.1x 2021 EV/sales. Which frankly is still cheap compared to the broader fintech/payment space on 5-10x.

In fact from my calculations, the international payments division alone is worth far more than the entire marketcap (£47.3m) of the group. Moreover, I’m not the only one who thinks so, with professional smallcap investor JO Hambro bumping up their stake from 4% to 5% on 1 September at c.29p.

Business has reached a tipping point

Finally there are numerous catalysts that could drive the share price materially higher from current levels, namely:

1. Strong organic growth from B2B, augmented by a rebound in B2C over the next two years as holidaymakers are allowed to travel abroad. In particular, both of these divisions should further benefit from new big data & CRM initiatives, aimed at cutting customer acquisition costs whilst sharpening service quality.
2. Elsewhere there are even some white label opportunities (ie B2B2B) in the corporate space, considering the quality of the bank grade technology that has been developed.
3. New product launches eg more self-serve forex.
4. Continuing to up/x-sell within the corporate base.
5. Ongoing cost reductions, with the target to reduce payroll (ex NI) to an annual run rate of £12m vs £16m in H1’20.
6. At 26.5p, EQLS appears materially undervalued compared to my 60p valuation and peers.
7.  Possible M&A, given e-payments is a rapidly consolidating space.

Management prepared to take bold decisions if required

Ian Strafford-Taylor, CEO commenting: “Turnover has held up well YTD with the inevitable Covid-19 related fall in April and May. Revenue per working day was £126k in Q1, £82k in April-May, £112k June, & £114k Q3’TD.

House funds of £7.6m as at 18 Sept’20 vs £7.9m as at 29 Jun’20. The Group has some outstanding redundancy/leaver costs [est £400k] to cover in Q4’20, but operationally, management expects that the Group will be cash break-even in Q4’20, and then move into positive territory in Q1’21.

Our revenues continue to grow and we have not yet completed our exercise of cost savings which will benefit H2’20. With a stable cash position, we remain positive about our future prospects and although we are conscious of the potential for further disruption as a result of Covid-19, and indeed Brexit, we remain confident about the outlook for the Group.”

Lastly I am interviewing the company on Wednesday, with the video set to be published on Thursday morning. Watch this space.

Key risks

1. Coronavirus induced problems at some SMEs, which could lead to reduced spend, late payments and/or doubtful debts.
2. Substantial slowdown in UK (re Brexit)/global GDP which could impact the e-payments & travel sectors.
3. Anticipated growth/profitability may take longer than envisaged, cost more or not be fully realised.
4. Regulatory and tax changes. Generic risks of retention/recruitment of key staff, etc.
5. Competition may intensify due to new/existing players. Indeed being relatively small, Equals could get squeezed by larger rivals, partners and customers.
6. As with many small cap AIM stocks, daily trading volumes can occasionally decline, particularly during seasonally quieter periods and/or between newsflow.

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