Credit: Shutterstock photoBy Grant Smith :
The Company
Plus500 ( PLSQF ) is an Israel-based company listed on the London Stock Exchange. Retail customers in over 50 countries buy and sell CFDs on its online platform, which is accessible via desktop and mobile. The company is the second largest provider of CFDs in the UK, where it derives ~20% of revenues, and the majority of its revenue comes from European countries. The company promotes the ease of use and aesthetic appeal of its trading interface, as well as its product innovation (such as offering cryptocurrency CFDs) as key competitive advantages. Plus500 offers CFDs for a variety of instrument types: equities, equities indices, commodities, options, ETFs, forex, and cryptocurrencies.
Shares can be traded OTC in the US under ticker PLSQF, but I highly recommend trading them on the LSE where volume is much higher.
Contracts for Difference
A CFD is a contract between two parties where the profit or loss depends on the price movement of an underlying financial asset. CFDs are appealing for the following reasons:
No expiration date . Unlike futures and options, there is no expiration date or need to rollover a position. Profit or loss is taken whenever the position is exited.
Straightforward pricing . The price of a CFD is the same as the price of the underlying instrument, unlike options which can be difficult to price.
No need to invest in underlying asset . This makes it easier to gain exposure to assets that are harder to "actually" own, like commodities or cryptocurrencies.
High Leverage . Most CFD providers allow CFDs to be bought or sold using considerable leverage. The maximum allowed leverage typically varies depending on the underlying instrument type. For example, Plus500 offers up to 300:1 leverage on forex CFDs and up to 20:1 leverage on crypto CFDs.
Revenue Sources
Plus500 has two revenue sources:
Dealing Profit (95% of 2016 revenue)
Plus500 is the counterparty to all CFD transactions on its platform. For any given CFD, it will offer to sell at a higher price than it will offer to buy. Plus500 tries to profit from this dealing spread and not be exposed to changes in the price of the underlying instrument. In practice, its long and short positions in a given CFD won't equal, as these are dependent on client demand. Plus500 will tolerate a certain level of market exposure, depending on the instrument. If this exposure limit is exceeded, Plus500 will either hedge its position by taking the opposite position in the underlying instrument or reject new client orders that increase its exposure.
Financing Charges (5% of 2016 revenue)
Certain client CFD positions that are held overnight incur a financing charge.
Expenses and Margins
Plus500 enjoys high net profit margins, as the marginal cost to add a client to its already-developed online trading platform is minimal. Net profit margin was 45.1% in third quarter of 2017. Plus500's main expense is advertising to acquire new customers. For example, the company spent $61.2 mil in selling and marketing expenses in the first half of 2017 compared to $188.4 mil in revenue. New customers are essential to Plus500's business model, as its customer churn rate is significant (e.g. 35% of active customers churned from Q2 2017 to Q3 2017).
The company requires minimal capital expenditures to maintain its trading platform, allowing it to retain the vast majority of its net earnings as free cash flow. The company emphasizes returning capital to shareholders, and it has committed to a policy of returning at least 60% of its net profit to shareholders via dividends and share buybacks.
Net Cash and Enterprise Value
Current Price: 1,070 GBX
Market Cap: $1.703 billion
Q3 2017 Cash: $203.9 mil
Q3 2017 Net Cash: $149.9 mil (calculated by subtracting dividends payable of $27.2 mil and liabilities of $26.8 mil from cash)
Enterprise Value: $1.553 billion
Growth
Significant historical growth . Revenue grew from $56.13 mil in 2012 to $327.93 mil in 2016 (CAGR of 55.5%).
Significant Q3 2017 YoY growth . Revenues grew 50% YoY in Q3 from $77.5 mil to $116.5 mil, and EBITDA grew 110% from $33.3 mil to $70.0 mil. New customers increased by 69%, and active customers increased by 35%. Average User Acquisition Cost ("AUAC") fell by 47%.
Explosive Q4 2017 quarter over quarter growth from cryptocurrency trading . Plus500 released a trading update on January 3rd, 2018, that did not provide exact revenue or profit figures, but announced that it achieved record quarterly revenues and that new customers jumped from 42,492 in Q3 to 149,627 in Q4, an increase of 252%. The company noted that it recorded high volumes of cryptocurrency CFD trading during the period, which makes sense given the sharp rise in crypto prices during November and December of 2017. I estimate Q4 revenue to be $158.3 mil and net profit to be $71.3 mil. For those interested, this estimate is based off the following Q4 assumptions:
Average Revenue Per User ("ARPU") of $750 to account for the fact that 71% of Q4 customers are new and have less time to trade during the quarter (for comparison, Q3 ARPU was $1,232 when 45% of customers were new).
Same churn as Q3 (35%)
Same net profit margin as Q3 (45.1%)
(To follow the math used in calculating Q4 revenue and profit, see my below bull case and bear case tables.)
Proposed CFD Regulations
Plus500's share price has been held down by proposed European regulations on CFDs. In December 2016, the UK's Financial Conduct Authority ("FCA") proposed CFD regulations that would, among other things, restrict the maximum leverage allowed when trading CFDs. This sent Plus500's share price plunging by more than 50% in a week. Subsequently, the European Securities Market Authority ("ESMA") announced its own proposed CFD regulations. The FCA has announced it will delay implementation of its regulations until ESMA enacts its final regulations, which will take place sometime after its public consultation concludes on February 5th.
Of the proposed ESMA regulations, Plus500 has stated that only the proposed leverage limits could have a material impact on the company.
Estimating 2018 Financial Results
I will use my Q4 estimates of revenue and profit to extrapolate full year 2018 results under 1) a bull case where leverage limits do not affect ARPU; and 2) a bear case where leverage limits cut ARPU from European customers by 50%.
Both cases share the following assumptions about 2018:
New customers every quarter revert back to the Q3 2017 number of 42,492. This makes the conservative assumption that the Q4 surge in new customers was entirely due to a temporary spike in cryptocurrency interest, which won't persist into subsequent quarters now that crypto prices have crashed from their December 2017 highs.
Every quarter in 2018 has Q3 2017's ARPU of $1,232 as a starting point (before ARPU is cut by 50% in the bear case).
Q1 and Q2 churn is high at 50% to account for the majority of the Q4 2017 new customers losing money from lower crypto prices and leaving the platform. Q3 and Q4 churn reverts to 35%, which is the same as Q3 2017's churn.
Every quarter in 2018 has Q3 2017's net profit margin of 45.1%.
Bear Case
The bear case is characterized by the negative impact of leverage limits on ARPU from European customers. Plus500 derives 95% of its revenues through dealing profit, which is effectively a commission on the total CFD dollar amount traded by its clients. Therefore, if its clients trade a lower dollar amount of CFDs because of lower leverage limits, Plus500 will earn less in dealing profit.
The exact impact of new leverage limits will depend on how much clients actually reduce their leverage because of leverage limits. Plus500's current leverage limits vary based on the volatility of the underlying instrument type, from 5 for options to 300 for forex. However, it's likely that the current average client leverage across instruments doesn't exceed 50, as it's simply a bad strategy to be consistently trading above 50 times leverage. For example, at 50 times leverage, a 2% opposite price move in the underlying instrument will cause a 100% loss in the position, while a 1% opposite price move will generally trigger a margin call.
ESMA has proposed leverage limits ranging from 5 to 30 that, like Plus500's current leverage limits, would vary based on the volatility of the underlying instrument type. To be conservative, I'll assume these leverage limits will lower average client leverage by 50%, which implies that Plus500's clients are currently trading at 10 to 60 times leverage across a range of instruments, which seems reasonable. In turn, the total dollar amount of CFDs traded by European clients would decline by 50%, and ARPU from European clients would decline by 50% as well.
Leverage limits will only affect clients in European countries. Unfortunately, Plus500 does not provide a revenue breakdown by country. Based on the populations of the various countries that Plus500 does business in, I have estimated that Plus500 will derive 80% of its 2018 revenue from European countries. I have left this estimate on the high side to be conservative. This means that at least 20% of the group's 2018 revenue should come from Australia, New Zealand, Singapore, Hong Kong, Malaysia, South Africa, Israel, Kuwait, Saudi Arabia, Qatar, and the UAE; this seems reasonable.
Given my estimate of a 50% decline in European ARPU and my estimate of 80% of 2018 revenue coming from European countries, this implies that ARPU averaged across all countries will decline by 40% in 2018. Using Q3 2017 ARPU of $1,232 as a baseline, this implies ARPU of $763 in every quarter in 2018. Note that ESMA regulations likely won't take effect until Q2 2018, but to get a more realistic full-year estimate of financials under the regulations, my model assumes that regulations take effect beginning in Q1 2018.
The table below shows the estimated bearish 2018 results by quarter as well as the full year 2018 results:
The table below shows the estimated share price downside under the bear case:
If the bear case happens, it's reasonable that in 2018, the market will value the company at 8 times net profit, as the new leverage limits represent a one-time decrease in the company's earning potential; it's not as if the leverage limits will continue getting lower and lower as time passes. By contrast, some businesses in perpetual decline can fairly be valued at 5 times net profit or less, but this is clearly not applicable to Plus500. In fact, the company is likely to continue growing its active customers each quarter, which aren't directly related to leverage limits.
A fair 2018 P/E ratio of 8 implies 27% downside to the current share price. Note that this doesn't factor in the dividends and/or share repurchases that will take place in 2018, even under the bear case. Also, note that Plus500 has $149.9 million in net cash as of Q3 2017; had I valued the company using its enterprise value instead of market cap, the implied downside would have been only 16%.
Bull Case
Under the bull case, leverage limits do not affect ARPU. While the actual impact of leverage limits will most likely fall somewhere between the bear and bull cases, there are many reasons to think the impact will be closer to the bull case:
Actual average client leverage may already be within the proposed leverage limits, or only slightly higher
The final leverage limits may become more lenient after lobbying efforts by CFD providers
Some clients may compensate for lower leverage limits by depositing more capital and therefore allowing them to trade similar dollar amounts as they could before the new leverage limits
The final ESMA leverage limits will be of a more temporary nature, as they will be enacted under ESMA's Product Intervention powers. Any such regulations cannot exceed 3 months, but they can be renewed at the end of the 3-month period. It's unclear how many extensions ESMA will seek, but long term, it will be up to the national competent authority ("NCA") in each country (e.g. the UK FCA) to set leverage limits for its own country. It's unlikely that NCA leverage limits will be stricter than ESMA's leverage limits, and many countries may never implement leverage limits.
Plus500 is the second largest provider of CFDs in the UK and is likely one of the top providers of CFDs in other European countries. The complete package of proposed CFD regulations (e.g. leverage limits, standardized risk warning, restrictions on client bonuses) as well as the ban on binary options (which Plus500 has never offered) may force some weaker CFD providers out of business, allowing Plus500 to consolidate its market share.
Stricter leverage limits may actually provide a benefit by making inexperienced traders less likely to lose their entire deposit. If these traders are able to execute more trades and gain experience, they may on average provide a higher lifetime value by executing many trades under stricter leverage limits than they would by executing a few trades at significant leverage.
IG Group, the biggest provider of CFDs in the UK, estimated in a December 18, 2017, press release that the proposed ESMA regulations would have lowered its historical revenue by at most 10%. IG Group is a good comparable to Plus500 as it derives the majority of its revenue from "Leveraged OTC" products and from clients in Europe; in 2017, IG Group derived 73.4% of its total revenue from its EMEA and APAC Leveraged OTC segments. In addition, IG Group noted in its 2017 annual report that its clients with open positions are leveraged under 10 times. If the leverage of Plus500's clients is similar, then I would expect the leverage limits to induce a drop in ARPU that's closer to the 10% predicted by IG rather than the 50% drop I estimated in the bear case.
The table below shows the estimated bullish 2018 results by quarter as well as the full year 2018 results:
The table below shows the estimated share price upside under the bull case:
With the weight of any regulatory impact lifted, it's reasonable to think that a growing company like Plus500 should be valued at a P/E ratio of at least 10. This implies at least 64% share price upside by the time 2018 results are released in early 2019. Like the bear scenario, this upside doesn't factor in the inevitable dividends and/or share repurchases that will occur in 2018.
Why Both the Bear and Bull Cases are Likely too Conservative
Regardless of how leverage limits affect ARPU, both my bear and bull cases are likely too conservative for the following reasons:
Crypto upside . In my scenarios, I assume that the excellent Q4 2017 results do not persist past Q1 2018 as a result of the rapid decline in cryptocurrency prices (e.g. Bitcoin peaked in December 2017 and subsequently fell more than 50%). However, it's likely that the 2018 demand for crypto CFDs will remain above the Q3 2017 demand for crypto CFDs, as the public is now more aware of cryptocurrencies, even though crypto prices are no longer surging higher ever day. Google Trends research support this; even though Google searches for "Plus500" and "bitcoin" are currently below their December 2017 highs, in January 2018, they are still above the Q3 2017 levels. Furthermore, Plus500's Q4 2017 results demonstrate how well Plus500 can do in the event that crypto prices began rising again. So, in that sense, an investment in Plus500 includes a free call option on the price of cryptocurrencies, which has significant value given how volatile crypto prices are.
New markets . In February 2017, Plus500 was granted an operating license in South Africa, and in December 2017, Plus500 was granted an operating license in Singapore. It's not clear when or to what extent these licenses have already contributed to revenue, but they both provide a nice source of upside potential. Plus500 has stated that it wants to continue expanding to new markets.
Higher value customers . In recent quarters, Plus500 has tried to attract higher value customers, which has been successful. ARPU for all of 2016 was $2,103 (around $525 per quarter), while ARPU in Q3 2017 alone was $1,232. Without any evidence to the contrary, I'd expect this trend of attracting increasingly higher value customers to continue, even if at a slower rate.
Increases in marketing efficiency . The company lowered its AUAC from $1,195 in 2016 to $689 in Q3 2017 as a result of changes to its marketing strategies. As marketing costs are Plus500's main expense, changes to AUAC have a significant effect on profit margins. While the company's marketing costs can only decline so much, there's likely room for future decreases in AUAC.
Increased demand for CFDs . CFDs are still a relatively new and niche product, and most retail investors probably have no idea what a CFD is. Even putting the demand for crypto CFDs aside, I'd expect the demand for all CFDs to continue increasing gradually as more retail investors learn about CFDs and their benefits.
Conclusion
The market's overreaction to proposed CFD leverage limits has provided an excellent entry point to buy shares of Plus500. Even in the unlikely event that the bear case comes to fruition, the company would currently be trading at a reasonable 2018 forward P/E ratio of 10.2. While the market could easily overreact in the short term to any hint that the impact of leverage limits could be significant, the company will remain profitable and is likely to continue growing its customer base, allowing the share price to recover once subsequent financial reports are released.
However, if something close to my bull case takes place, the share price could easily appreciate 50% or more simply from the removal of the regulatory uncertainty. Combine the removal of regulatory uncertainty with underlying growth in the business, and it's not implausible to see shares increasing 75% or more by 2019.
Helpful Links
Plus500 Q3 2017 Trading Update
Plus500 Information on London Stock Exchange Website
Note: I originally published this article on my website RealStockPicks.net
Real Stock Picks provides actionable stock picks on under-followed companies, with an emphasis on foreign and small-cap companies.
See also Trump Solar Tariff's Winners And Losers on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
