Small Cap Value Report (14 Jan 2015) - TUNG, GMD

14th Jan '15 by Paul Scott

44 comments 26590 reads

Good morning! Very busy today, lots to absorb & process!

Tungsten (LON:TUNG)

Share price: 237p
No. shares: 103.5m
Market Cap: £245.3m

Interim results - for the six months to 31 Oct 2014 are out this morning. Turnover rose from £0.8m last time to £10.2m this time. The operating loss rose from £5.5m to £14.5m. It's very rare for me to say this, but these figures are almost irrelevant. I say that because during this period Tungsten has been putting in place the building blocks for what could potentially be a spectacular business in a couple of years' time.

What the company has done to date, is to raise £160m in fresh cash from an IPO at 225p per share in Oct 2013. It then used that money to buy an e-invoicing software company, with many large cap clients. It also bought a small bank (yes, really!), and has developed a new invoice discounting service for the supplier base of its clients, whereby those suppliers can receive instant payment for invoices (once they have been approved online) for a small deduction.

The beauty of this is that it's invoice discounting that is seamlessly integrated within invoicing software - so there are no bits of paper flying around, it's all electronic. If the supplier needs cash, they can just press a button to receive instant payment for some or all of their invoices, providing the customer has approved the invoice. This also means there is effectively no credit risk to Tungsten. Or miniscule risk anyway.

The size of the opportunity is simply vast. Tungsten is already processing about $150bn invoices through its software. The invoice discounting has only recently started, on a small scale. However, they are targeting £1 trillion of invoice flow through the system, and 10% penetration for the invoice discounting. So you can do the maths. Tungsten sit in the middle and make an almost risk-free interest rate margin, for this short term lending, and it's all handled electronically.

I absolutely love this business model, and it's not pie in the sky, it's actually happening. The people are key too - normally this type of blue sky, grand scale project would hit the buffers, but in this case myself and other investors are putting our faith in Edi Truell's track record, and substantial personal investment in Tungsten - note that in Sep 2014…

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Paul Scott

14th Jan '15

woodcutter,

I write about news announcements that interest me the most, which will by definition include a lot of stocks that I hold, which is always disclosed by me. There are also reports on numerous other companies that I don't hold.

If you don't like my reports, then don't read them, simple as that.

I made it abundantly clear that TUNG is high risk.

A lot of people don't understand their business model. It's not really about invoice processing. The profits will come from the bank - it's an invoice discounter that is being built. The e-Invoice processing stuff is just the hook to get the captive supplier base of large organisations, but the real money should (hopefully) be made from selling them invoice discounting services integrated into the software. Thought I had explained all that in the original article, but never mind.

Paul.

boothbym

Tung has the potential to be huge.

150bn invoicing at 5% = 7.5bn finance at 5% profit = 375m in fees just on finance.
If 10% financed its 15bn at 5% profit its 750m in fees and this is on current invoicing.

If they do 1000bn invoicing at 10% finance then 100bn at 5% = 5bn in fees.

So on a pe of 10 for financing fees of between 375m = 3.75bn to 5bn=50bn

so between 15-200 times its current value!

or it could go bust

dpaccount

No offense Paul - really enjoy your articles, but I'm curious as to how you reconcile the two following quotes from this article:

i) "since this type of share can often go wrong, often badly wrong too. So huge risk warnings need to be at the forefront of our minds"

ii) "I've made this about my 2nd or 3rd largest long position in the market"

As Spock would say - illogical, captain. Sure, expected value may be argued to be high based off the [speculative] % assigned, but most *likely* outcome is a poor one. Is not a more punt-sized stake appropriate?

Cheers,
David

monzo

I have no position in #TUNG. I looked into it before Paul started coverage of it in his reports and didn’t really understand the business model enough; that was when it was circa 230p. I looked at it again when the fundraising at 340p took place but again decided it wasn’t for me. It still remains on my watch list and I follow the RNS’s but it really is high risk and not one I’m comfortable to hold at the moment. I almost wouldn’t mind paying a premium if it doubles or triples and there's a proven fundamental basis for the investment.

Getting to the point. I pretty much disregard the revenue figures being banded about. A billion, a trillion. It’s very much like the trainline that’s going to IPO soon. Revenues ARE a barometer but irrelevant in terms of viewing the income of the company. They are merely the ‘middle man’ in processing the transaction and nothing more from what I can see. The relevant financial information is the fee per transaction to the company we’re researching which is minuscule.

Paul states "A lot of people don't understand their business model. It's not really about invoice processing. The profits will come from the bank - it's an invoice discounter that is being built. The e-Invoice processing stuff is just the hook to get the captive supplier base of large organisations, but the real money should (hopefully) be made from selling them invoice discounting services integrated into the software”

From the Insight RNS "Insight, a leading global asset manager responsible for over £318 billion in assets under management, has agreed to purchase approved-to-pay, investment grade receivables originated through the Tungsten Network e-Invoicing platform. Terms of the agreement with Insight, which is subject to certain regulatory approvals, are not disclosed.”

What fundamental basis is there from the above to assume that there’s any real margin to be made for £TUNG? You can quantify invoices processed and the pennies that are made from each one but the bank just seems like a massive grey area where the provider of the finance calls the shots, sets the terms and ultimately comes out the victor.

Am I missing something obvious here?

extrader

Hi billytk,

The terms of TUNG's agreement with Insight may not have been disclosed, but it seems likely that the 'turn' TUNG makes will be more than 'pennies'.

The agreement is not imposed by the provider of finance, but a (consensual) commercial agreement between 2 parties : Insight gets a 'safe' outlet for its surplus cash, TUNG gets an acceptable (to it) return.

On the one hand, yield-hungry investors; on the other hand, cash-strapped SME's, whose banks won't lend for capital requirement reasons. In between, a broker connecting supply in a 'low-risk' way with demand - and who will, therefore, be able to charge an 'appropriate' fee for their services.

I'm not sure what you think is missing ?

ATB

15th Jan '15

You can work out what margins Tungsten (LON:TUNG) is likely to make from invoice discounting, from researching the business model, and then piecing together various bits of information that management talk about in the webinar, and from other articles, and RNSs, etc. It's just a question of doing the work.

I've calculated that TUNG are likely to make an attractive net lending margin. There are also arrangement fees. I don't think people appreciate just how difficult and costly it is for SMEs to obtain financing at the moment, so many suppliers will bite off TUNG's hand at being offered this product.

However, the product may be proven, but it's only at the start of a roll-out, so it remains to be seen whether the exciting volume of discounting transactions comes through, at a good margin. I think there's a strong chance that it will work, but there's an element of educated guesswork in this.

Look, it's a speculative investment. That won't appeal to most people, which is fine. Whatever floats your boat!

Regards, Paul.

woodcutter

Paul apologies if my post was a little abrupt.

However there has been a marked difference recently between the analysis and comment on companies that you hold stock and those that you don't, particularly when there has been a significant drop in the share price, typically BOO and TUNG. The analysis has read more like a justification for your investment rather than a balanced view, you may disagree but that's my opinion, and my assumption is we are encouraged to give opinion.

Indeed i would suggest that in order to perhaps give greater clarity you write a separate blog for the stocks you buy/sell including reasoning and justification and confine this column to stocks you do not have an investment in using the stockopedia metrics as a basis for valuation.

Every morning i scan the investegate site doing my own analysis of company statements and reports. I like to read your analysis as a filter against my own, sometimes i agree sometimes not, that won't change.

WC

Ramridge

Re. Tungsten (LON:TUNG) Here is a link to a research report by CanaccordGenuity dated November 2013.
https://research.canaccordgenuity.com/_layouts/res...

It may be old but still relevant in many ways. In particular have a look at the model and assumptions section at the back of the report. It gives details about lots of financial assumptions including assumed margins, cost of funds, etc for Tungsten Bank, the invoice discounting part of the business.

IMHO the business model fundamentals if anything have become more attractive. The major change is that they are about 6 - 12 months behind their execution plans and tooling-up costs are higher than forecast.

Woodcutter,

Yes it was a bit abrupt, but apology accepted - thank you.

I take your point, but that's just the nature of these reports. It's a real life account of how a value/GARP investor sees individual stocks. And to be fair, I get a helluva lot more right than wrong, if you look back at my views on stocks. That's why several thousand people read this blog every morning.

I'm absolutely not going to go down the route of putting out bland, neutral reporting on news. You can get that anywhere else. My stuff is punchy, and gives reasons why a real world investor likes or dislikes individual stocks. If stocks I like are high risk, I always say so. Also if I hold a share, it is clearly stated at the end of every article.

So whilst I accept your opinion, and it's fine for you to express it, I'm not changing anything in these reports! If you don't like a particular stock & disagree with my opinion, that's fine. Please do put up counter-arguments in the comments section - I don't want positive reinforcement, I want to hear the bear case - that's far more useful to a holder than just mutual back-slapping with fellow bulls!

Regards, Paul.

Tungsten (LON:TUNG) - here's a simple way to value the company's prospects. Assume that e-invoicing will just breakeven, at best. Park that to one side, as it's largely irrelevant to profitability. The business will be all about invoice discounting profits. So take the amount of credit that TUNG will be likely to lend, and then just apply an interest rate margin, and deduct admin costs.

So if say the Insight deal is $3bn (we know it's billions, just not how many). Assume then that TUNG make a lending margin of between 5-10% pa (that is realistic, as I believe they are borrowing at about 3%, and lending on at about 10-12%). That gives an annual lending gross margin of between $150-300m. Less admin costs of say $30-50m, and you get a profit range of $100-270m.

Take off say 20% tax, and that's earnings of $80-216m, convert into sterling and that's £52-141m annual earnings.
Put that on a PER of 20-30, and you have a market cap range from £1,040m-4,230m.
There are 103.5m shares in issue, so that gives a target share price of 1004p to 4087p per share.

Simplistic, but this method reflects what TUNG is all about - it's a bank bolted onto an e-invoicing platform, and the money will be made lending against invoices. So the historic figures are almost completely irrelevant.

There's no reason why lending would stop at $3bn either. It could go a lot higher, who knows?

Hopefully this better explains the potential that I see in this share. No guarantees it will happen of course, that's the speculative part!

Regards, Paul.

pka

Does anyone know what are the risks, if any, for Tungsten with invoice discounting?

For example, what happens if Tungsten discounts an invoice from its own bank, the invoice is paid by the purchaser of the goods or services that were invoiced for, but then later there is a dispute between the purchaser and the supplier over the quality of the goods or services and the purchaser demands his money back? Who is responsible for repaying that money, the supplier or Tungsten Bank?

Tungsten (LON:TUNG) Worth mentioning that your calcs do not assume any profit contribution from spend analytics.

alterego

Paul, a quibble; you've done your calc in dollars whereas Tung said recently that the deal with Insight would amount to "several billion £'s" I suspect therefore that your back of fag packet figures may be on the light side.

Hi alterego,

Ah OK, thanks for pointing that out.

At my error goes in the right direction - i.e. my figures were too conservative!

Regards, Paul.

Hi Paul -
I have used the CanaccordGenuity model assumptions and come up with answers in line with the bottom end of your range. Here are the details.
- assume annualised financing volume is £2bn ( approx $3bn)
- model assumes gross margin is 5% ( 8% gross - 3% cost of funds)
- also assumes operating margin of 4%
- so Gross Profit = £100m and Operating Profit = £80m
- Net Profit = 80% of 80 = £64m
- at PE=20, gives market cap = £1280m
- calculated share price = 12800/103.5 *100 = 1240p

Doing a bit of sensitivity analysis, I see the final numbers can go up or down by anything up to 50%. Your range therefore is as good as any modelling.

As mentioned before this price does not include contributions from the e-invoicing transactions and analytics. The main prize is definitely the invoice discounting side of the proposition.

R. Ram

All E & OE are mine

jraitt

My query on this would be having worked for a Company that factored it invoices. The system is back to front. Why would a Company only factor sales invoices to one Company? Surely most that need to factor factor all their sales invoices through negiotiated agreements. This would surely greatly restrict those interested to large suppliers who may need a short term cash injection.

MichaelFBS

16th Jan '15

Hi Paul

Thanks for the analysis of Tungsten. I have a small holding 1% of portfolio based on you analysis and am happy to take the punt at losing a couple of K for the chance of a multi x. Add a bit of excitement to a portfolio that I try to keep boring.

Brian Hill

Re ; TUNGSTEN Unless times have changed , the only companies raising cash by factoring were small and/or dodgy ones who could not get cash from any other source . If factoring is expected to be Tungsten's main earner , the numbers may be much smaller than predictions .

Brian,

I think times have changed. Quite a lot of the smaller Listed recruitment companies use invoice factoring, some on quite a large scale. Also, you'll find that SMEs are still finding it incredibly difficult to get bank financing, and it's often only available at punitive rates. The arrangement fees can quite routinely be in the 5-7% ballpark too. So I think Tungsten will find a considerable market for their invoice discounting offering. Indeed, they said in the latest webcast that take-up in the early trials has been 9.9% of suppliers. So their target of 10% looks to have been accurate so far.

Regards, Paul.

chemistdude

6th Feb '15

I am now invested substantial weighting of my portfolio in this having taken advantage of the below IPO pricing at the minute. I hope the shorters don't cause too much trouble. What an opportunity though. Excellent management. The next few years should be exciting.

Small Cap Value Report (14 Jan 2015) - TUNG, GMD

Tungsten (LON:TUNG)

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Paul Scott

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