Plus 500: Does it add up?

17th Apr '15 by Mercurius

8 comments 10786 reads

Key Numbers

Revenue up 35% YoY to $60.7m. New customers up 63% YoY to 32.8k, actives up 34% YoY to 67.6k, ARPU up 0.8% YoY to $1,214 and AUAC up 55% YoY to $892. Should meet expectations.

Analysis

I don't usually comment on Plus 500. I definitely respect what these guys have done but there are obviously a few issues that have been left open. Either way, I think the question is: does the share price offer you the right margin of safety to take on these risks?

Well, unsurprisingly, the company has announced rapid growth in the first quarter. I think we can expect this to continue. Obviously, there is the question of churn but this is to be expected though and Plus 500 seem confident that profitable customers are coming through the door. The marketing operation is clearly working full steam.

Where it gets interesting is acquisition costs, up 55% against a 0.5% increase in ARPU. The company has the sponsorship deal with Atletico, which is probably contributing to this rise, I thought this was an extremely strange decision.

The company has been so profitable because of the huge gap between what it costs to acquire a customer and the revenue that this customer produces. The company is low-cost and employs affiliate marketing. As I understand it, the affiliate marketing agreement is a one-way bet for Plus 500. If the customer makes money, then the affiliate actually pays. Of course, almost all customers lose so it is a win-win situation resulting in a low cost and profitable operation.

My question is how the Atletico deal fits with this? The rationale appears to be either: ARPU increases or customers are added faster than costs increases. Now we actually saw the gap between ARPU and AUAC fall in the final quarter of last year too. At the time, management said that the automated marketing system would only acquire profitable customers, even as it moved to high value, but I see this addition of, probably rather substantial, fixed costs as the company moving away from what they were really good at.

Success to date has been based on that slick, low-cost marketing machine but I think management realised this isn't too scalable and that the churn is quite disturbing for investors. If we are really blunt about it, Plus500 has done so well because it is good at finding suckers. Plus500, unlike competitors, will take the other side of…

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AnonymousUser37607

17th Apr '15

FT Alphaville have probably done the worst "research"; filled with innuendo, inability to calculate basic KPI's such as "churn / inactive clients", inability to properly read the financial accounts in order to understand return on marketing investment etc. The list goes on. I have covered some of this previously on my blog (https://heisenbergblog.wordpress.com; as an aside if anyone is interested in GVC Holdings the latest article reviews the Director compensation which really is quite extraordinary).

No business is perfect and neither is Plus500. However, I am comfortable with the risk/return equation here and have been since my first investment in 2013 - the business today is more lowly rated now than it was then. I am always prepared to consider a coherent "bear" view - as yet I have not seen one in relation to Plus500; first it was too good to be true, then regulators were investigating (IG now seem to be copying Plus500's onboading process), then it was simply stated that it won't last; next came they don't hedge etc. I await the next set of accusations with interest. Whenever something new is raised I always review the claims no matter how spurious (odd sounding Director name accusations aside which came from EK). Thus far, the shorts have been a tremendous benefit to my overall return, particularly in some of the Q3/Q4 period last year (e.g. at one point I was able to buy on valuation metrics at the time of 5.9x PE NTM, c.14% dividend yield - the market threw all metrics out of the window for a time).

If something new emerges I will consider the facts at that point, again always with a view on the risk/return equation given that no business is perfect or without faults (however, in terms of an investment proposition I currently see a single digit PE and nearly a double digit yield; my numbers). If investors choose to believe what is printed in FT Alphaville that is their choice - I make no recommendations and each investor has to do their own research and balance the evidence. Whatever I have written on my blog states the data/information sources and calculations - if anyone interprets the data differently or finds other data that is contradictory then that is their call. Good luck to them and that is what makes the stock market so interesting and challenging.

A few comments on the latest piece from FT Alphaville. It is supposed to be about customer churn or "inactive clients" yet the author seems incapable of actually calculating the relevant KPI - when the "inactive client" percentage is calculated appropriately it changes the conclusion of the article.

Comparing Q1 2015 to Q1 2014 the "inactive client" proportion actually improves from 39% to 31% i.e. fewer clients, as a percentage, were inactive in Q1 2015. This is easily calculated form the disclosed quarterly KPI's (1 - (Active - New) / Active Last Period). Therefore, the conclusion that, "The churn rate deteriorated, in other words", does not stand up to scrutiny of the disclosed facts. This seems a fairly fundamental point in terms of quality of insight, analysis and basic fact checking at the FT. Also note that the average "inactive client" proportion over the previous 12 quarters is 30.4% so Q1 2015 was bang in line with recent historical trends. Not much of a "story" really when seen in that context - consistent really with the series on Plus500.

Still at least the authors attempted "churn" methodology was a slight improvement on the previous comical FT Alphaville invented metric of "cost per acquisition of net new active users". I doubt we will see that one catching on any time soon. That really did demonstrate a lack of understanding. Please refer to the article on my blog which sets out detailed calculations for the return on marketing investment - the return has been increasing.

The latest FT Alphaville article is also a marginal improvement on previous grossly misleading insights such as, "Yet this technology upstart reported capital expenditure in 2013 of just $92,000. In the first half of 2014 it invested $83,000. Generating so much money with so little investment, now that is magic." FT Alphaville should try reading the financial reports from the company - marketing investment in 2014 was over US$60 million. Investment in Q1 2015 was around US$30 million - this growth drives the business.

This was from one of my previous articles:

"Taking the US$55 million marketing investment for 2014 and annualising the US$83,000 figure for H1 2014 would suggest that Mr McCrum is out by a factor of at least 331 x (three hundred and thirty-one times) in terms of estimating the annual level of investment in the Plus500 business – based on the 2013 figures would suggest he is out by a factor of around 390 x (three hundred and ninety times)."

The US$55 million was an estimated figure and the actual 2014 figure was over US$60 million. How this quantum of investment was overlooked by FT Alphaville I have no explanation. Perhaps it did not support the angle of the article or the conclusions that the author wanted to make.

As for the disclosure points that Plus500 is criticised on in the latest FT Alphaville article lets take a look at the London-listed but UK-based established competitor, IG Group (40 year history). This is what FT Alphaville asks of Plus500:

"What might help to understand the business is more disclosure. How many active customers make more than, say, ten trades in any period? What was the total for segregated customer funds at the end of the quarter? What is the average size and duration for customer trades?"

Yet no such disclosure has ever been made by IG Group.

As for IG Group I will refrain from commenting too much here as the business model is quite different - however no-one should be under any illusions about IG's supposedly far superior client retention. On an annual basis IG's "churn / inactive clients" has recently been more than 30%. In 2014 IG Group only "converted" 61% of new accounts in the period i.e. 39% of new accounts actually never traded at all. Still this business has been around for 40 years.

In this type of business the performance in any quarter can be quite variable so I believe that one should not read too much into a single quarters performance - this applies to both IG Group and Plus500.

If someone chooses to go long, short or do nothing that is entirely up to them - all I try to do is review the available facts and draw my own conclusions.

Probably enough from me on a Friday evening.

shanklin100

Hi Mercurius

Rather than just cast aspersions about PLUS's business model, perhaps you could highlight the differences between its business model and that of competitors such as IGG and highlight the areas where PLUS is stronger than IGG and vice versa.

Am I to take it that there is no churn at IGG as you identify them as a paragon of virtue. This is despite the fact that their lack of suitable risk management cost them many millions of pounds due to the movement of the CHF, something you don't mention?

Just curious. Cheers, Martin

Edward Croft

Shanklin - read up on Alphaville... they've done the best research on Plus500 vs IG etc.
http://ftalphaville.ft.com/tag/plus500/

I personally believe that Plus may be one of those false positives you get on occasion in the high StockRanks... but that's just my personal opinion. DYOR etc.

Mercurius

I did highlight the differences, that is the point of the article...that we are seeing a transition towards a new business model. The obvious benefit is that the business keeps growing, the possible risk is that it is a bigger pond but the fish are bigger too.

On risk management, just because PLUS didn't lose money, doesn't mean their risk management is better. All we really know is that PLUS didn't lose money...in this instance. This is more an epistemological point than anything but, to me, it is an important distinction.

I think it is more useful to look at the process behind the numbers. Afaik, this is pretty good but one thing that you do hear is unhedged positions because PLUS are often just taking the other side of client's trades (afaik, management will only divulge this is in conversation, for obvious reasons). That doesn't sound like good risk management to me. What do you think?

WarrantStar

I am a holder of Plus500 (LON:PLUS). A part of their risk management process is that they only deal with retail customers / mugs. That way they avoid massive bets by hedge funds etc. It seems to have served them quite well with the recent Swiss Franc turbulence.
It's a very volatile share. The numbers they release are normally very good and the recent update was particularly good. Hence the high stockranks. But it may be that the information that they release is rather too selective. I hear the share is frequently shorted.
Four fund managers hold a total of about 25% of the company. One director holds shares worth £1.2m. The most recent director deals are small purchases.
The FT and Ed Croft both seem to have negative views on them.
I am undecided at the moment whether to hold or take profits.
Mercurius Please can you advise whether you have any short / neutral / long positions on them? Can anyone else offer any insight?

lucien2k

I did hold, but I was concerned by the reports they close accounts of customers who are successful (found by googling for their customer reviews).

I was concerned that their business model would not be sustainable (though it seems the number of mugs isn't as limited as I suspected), so I sold.

18th Apr '15

Hi Ed

"I personally believe that Plus may be one of those false positives you get on occasion in the high StockRanks... but that's just my personal opinion. DYOR etc."

Other than false accounting, how can stockopedia possibly generate false positives? I remember that at least one Chinese company(I forget which one)had a very high stock ranking which was not merited, IIRC because of false accounting, but do not recall any other rankings which you have viewed as "false". This includes Wincanton (WIN) where you and Paul Scott hold very different views on the business and you have seen the high stock ranking as justified.

Surely the whole basis of the Stock ranking system is that one is advised to take a portfolio approach but that overall there is a high level of correlation between stock rank and SP performance.

Regards, Martin

P.S. Please see Heisenberg's reply re the unconvincing FT Alphaville articles.

19th Apr '15

Warranstar, I don't have a position in anything I write about. For what I do, it would be a conflict of interest and I try to keep it all as objective as possible. I don't really have a strong view here either way anyway, I think it is really a personal choice about whether you think the valuation does compensate you for the risks. That said, I do think that Odey's position is pretty ballsy but that is their style.

Heisenberg, I think you are right about the FT. I don't think they have covered themselves in light here especially as you can assume that someone passed them idea (and probably did quite well out of it). They had some success with Quindell but I think that was a completely different case and they are just reaching here. Also, and this refers to the previous comment too, I have absolutely no view on IGG. Just to be clear.

I have had time to dig into the numbers a bit more. On churn, I (obviously) find much the same thing as you although I wonder if it is more accurate, if we want to think about churn in absolute terms, to use an average of the current and previous periods? I agree that it isn't a good idea to read much into the quarter but seeing as this quarter is the biggest yet in terms of new customers, it is important to see how the company converted...in this case, the answer is very well...which is great, their last push just lead to more churn so it looks like they have it cracked.

However, this doesn't quite explain away the problem and an example will make this more clear...lets say that you expect 35% growth in the top-line, assuming $1200 ARPU then we need to add 27k in actives that sounds achievable but then you also need to add another 20k to replace lost customers (assuming the current 25%) so to grow at this rate you need to add 47k in the period. I am just using last quarter numbers here and I am not meaning to hint at any particular conclusion but just showing the dynamics of growth here...the upside isn't quite as large as it may appear because as you grow, you just have a bigger and bigger gap to fill. I presume this is why management appears to be changing course slightly.

Now if we actually want to look at the real world, things get more complicated because the data in the first half of last year (big gap between ARPU and AUAC, very high churn) was very lumpy and this first quarter was very good. If you actually model through 35% growth rate every quarter YoY it doesn't model through to the bottom line and you end up with 29% "profit" growth (i.e. cumulative sum of the gap between ARPU and AUAC) for the full year. Said another way, if you actually add at the absolute numbers mentioned above you get much higher full year growth. So even if we see new customers of 15k for the next three quarters (i.e. no net growth in actives), full year growth will still be very high (~37% top-line)...I think.

So this kind of makes clear that the company is a crossroads. The amount added in the last quarter was huge and the conversion was very good. The question is, therefore, less about adds but conversion as the last time the company saw this kind of growth it was all churned away two quarters later...and that brings us back to the beginning: if your business is based on your customers losing then how do you grow? I think if we see conversion stay in this range in the next quarter then something really has changed. I have no idea, at this point, whether it has though and, again, I think it is really up to the individual deciding about whether they are getting a fair price.

Plus 500: Does it add up?

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Mercurius

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