Institutional Investors

CMC Markets – Cheap Opportunity?

I have bought into this at 105 the other day, only 2.5% portfolio weight, trading small given volatility, should possibly be in for more.

Q3 hedge fund letters, conference, scoops etc

Institutional Investors

mohamed_hassan / Pixabay

CMC Markets is a Spreadbetting / CFD firm, basically a brokerage. In the UK this has some advantages, no stamp duty (0.5% acquisition price) and no Capital Gains Tax (CGT). The inland revenue allows spreadbetting to be tax-free as it is classed as gambling and most lose. I think its good value at the current price as the balance sheet is very strong, relative to the market cap and the regulatory risk which has caused the fall in the share price is mostly priced in.

They are probably (distant) number 2/33 in the UK market after IG Index and possibly Plus 500, I don’t think this matters too much. Deposits are only insured up to £85k – so any reasonably sizable speculator will likely have multiple spreadbet accounts (though this isn’t everyone’s approach). 40% of their revenue comes from professionals – those trading decent size with experience. These are likely to be the most profitable clients and will likely be very sticky.

Regulation is being tightened on spreadbet / CFD Co’s in the UK/EU – c60% of the business. In the last couple of years, many moved to sponsor football teams etc, moving outside the usual city gents involved in this sort of thing. Offering 100X+ leverage on Crypto/ FX / Indices to the man on the street led to lots of losses and losers, its now a consumer protection issue.

There are now limits on advertising / incentives and leverage so joe public will, likely lose more slowly. I actually see this as a positive for the industry. If you are clueless the slower you burn through your pot the more likely you are to learn and become a competent trader / investor. In the long term these are the most profitable clients. There are other arguments, every year they need to recruit, roughly a third of their clients as they stop trading / move to other providers. But this probably isn’t where the value is – it’s those who have been trading for years, the rest is churn…. The jury is very much still out on what effect regulation will have. I suspect spreadbetting/trading will move back to being a pastime for speculators / the wealthy, where it belongs, not Joe public pointlessly losing money.

The stock price fell hard in September 2018 following a severe revenue downgrade due to quiet markets. Markets are certainly not quiet now and they announced trading was better, there was a brief upward blip in the share price followed by a move down with the rest of the market. There is a lot of operational leverage here – falls in revenue go down to the bottom line due to a high fixed cost base.

CMC has a £317m market cap but a tangible book value of about 220m. As it is dealing in leveraged products, not all this book value can be distributed. The company needs an 8% equity capital ratio – to enable to operate in line with regulator’s limits. As at the half year it is 26.8%. Obviously, the company couldn’t run at 8% but I would view (say) 16% as safe. This implies the possibility of a c£50-75m, or potentially bigger buyback / dividend / acquisition etc. Or the cash could be used to self-fund a takeover.

The founder still holds 62% so everything depends on what he wants to do. As he sold at 240p a share he raised c£217m. He is 65 so either can be viewed as too old to do this or young enough to have another go! Either way, if he buys the company it will be at a premium to the current price, if he wants to sell, he will want to maximise the value so has an incentive to take action either way. I more or less trust the guy.

The conference call at the HY was interesting, the CEO sees them as a tech company, not a brokerage. Their view is that they can add clients/products with little incremental cost – in a similar way to Interactive Broker’s bull case. They are having some success – via a white label deal they are now the no 2 stockbroker in Australia (c17% share). They say this should provide c £7m EBIT in its first year. As the ANZ clients were only moved in September (mentioned in Q2 results announcement). We can assume the £7m will come in the second half. This means a full year of Australia is probably worth c £14m of EBIT. As far as I am aware it only cost them c£25m of capital / and a couple of million of capitalised IT spend to get this.

If they are able to get more deals like this then this could start being seen as a tech co with a resulting valuation. You can see the effects of this in the playtechs of the world in the gambling space. Their platform / tech seems good, its whether they can sell it that is key. The tech isn’t capitalised on the balance sheet – a good thing, though it is misleading if it’s included or excluded!

Adding this to the rest of the business gives (say) 14-15m conservatively in H2 so c£20-30m on the full year (consensus at 31m). At consensus EPS of c9 and today’s price of 116 it’s only trading on a PE of 12 in 2019 and 9 in 2020 – far too low given balance sheet strength. Once H2 figures come out I suspect this will rerate. Though it actually appears it is rerating now – one of the reasons I bought it was l could see the share price breaking out of its long downtrend. I am not the most chart minded of investors but they do work sometimes on determining timing.

So to summarise – catalysts are:

‘Better’ Q2 markets

Australia and recognition thereof amongst investors, winning similar opportunities elsewhere.

Low valuation / Balance sheet strength

Corporate action

At the half year, the dividend was 50% of net income. No clarity on full-year dividend, consensus is c 7p or a 6% yield at the current price.

I only put a small position on as I was hoping to pick up more on a move down, easing in. It has gotten away from me somewhat since then. I will likely add on a pullback. My portfolio weight does not entirely reflect my conviction.

As ever, comments, positive or negative, are encouraged.

Article by Rob Mahan, Deep Value Investments Blog


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