value and opportunity

Intro: Why am I looking at this ?

Fintech companies these days are hot. Not many days past that not another big deal is announced. Most of the “action” though takes place in the Venture Capital market which is normally closed for most retail investors.

There is clearly a lot of hype in the sector, on the other hand there are more and more really disruptive business models that might do to traditional finance (Insurance, banking, Asset management) what Amazon has done to retail

As financial services is one of my core interests in investing, I think it will pay of to keep an eye on what is happening in Fintech.

Credishelf IPO

An exception is the German company Creditshelf, which despite being a pretty early stage startup, has just successfully completed its IPO on July 18th.

The IPO prospectus can be found here.

The company was able to sell around 200k shares for 80 EUR per share, raising in total around ~ 16 mn EUR. Total market cap at EUR 80 seems to be 106,5 mn EUR. This is slightly below the targeted 250k shares they intended to offer according to the IPO prospectus.

In VC Terms one would say that the “pre money” valuation of the company has been 90 mn EUR (106-16). The resulting market cap would be called the “post money” valuation.

Interestingly, the IPO was “backstopped” by the largest shareholder (more below):

Under an agreement entered into between Hevella and the Company on July 4, 2018 (the “Back Stop Agreement”), Hevella has committed itself irrevocably for the term of the Back Stop Agreement (i.e. until July 31, 2018) to purchase Offer Shares at the Offer Price for a total amount of up to EUR 15,000,000 if and to the extent the Offer Shares are not subscribed for by investors in the course of the Offering. The ordinary termination of the Back Stop Agreement is excluded. An extraordinary termination is in particular possible if there is an important reason which would also entitle the Underwriter to an extraordinary termination under the Underwriting Agreement (as defined in E.5).

It looks like that Mr. Elget had actually to chip in another 1,5 mn EUR in order to reach the 200k shares, however he didn’t backstop up to the 250k of offered share which I find strange, reading this above,

The cost of the IPO all in is around 3,7 mn EUR wihich is a lot. It is >20% of the actually raised amount plus ~ 3x 2017 company revenue. More on that later.

Management:

CEO Tim Thabe has an Investment banking background, mostly in operational roles (Risk controlling COO). Cofounder Daniel Bartsch also has an IB background plus some early consulting experience.

So they clearly have the required banking experience, however at a first glance, the company is a little bit short on Start-up experience.

Business model:

Creditshelf itself “only” offers a platform that should connect investors with companies that are looking for loans, the brand themselves as “peer-to-peer” platform. Creditshelf scores the companies and prices the loans. The actual loans are originated by a “fronting bank”:

Currently, creditshelf works with only one Fronting Bank, i.e. MHB-Bank Aktiengesellschaft, Frankfurt/Main, Germany.

Interestingly, Creditshelf also seems to have outsourced work out services in case a loan turns sour:

For this reason, creditshelf service and the investors enter into a syn-dicate which holds the loan receivables and which is managed by creditshelf service. In case of a potential default of the borrower, creditshelf service will perform limited workout services. Such lim-ited workout services include reaching out to the borrower, inquiring about the status of the repayment and requesting payment. Neither creditshelf nor creditshelf service will, however, engage in any fur-ther enforcement actions. Rather, creditshelf service has servicing agreements with a third-party service provider (HmcS Gesellschaft für Forderungsmanagement mbH (“HmcS”)) in place. HmcS will provide services for distressed debt collections and also performs standing back-up servicing. This means that in case that creditshelf service should no longer be able to service the loans as described above, HmcS would take such services over to avoid any disruptions of services.

As they are currently offering only unsecured loans, the recovery potential under German bankruptcy laws is very limited anyway.

If I have understood everything correctly, they are using the established way of syndicating loans. Loan syndication is a traditional way of distributing loans between banks and institutional investors. One or a handful banks usually “front” a large loan to a corporate and then “syndicate” this out to other banks and investors.

The innovation in this case seems to be to apply the established loan syndication mechanism to smaller loans and smaller investors.

Creditshelf itself is part of the syndicate but not taking on any exposure, so Creditshelf has positioned itself as a pure advisor/service provider which in theory is a good position as it minimizes regulatory required capital.

Although on page 137 they mention that they seem to at least temporarily own the loan:

After creditshelf service has purchased the loan receivables from the Fronting Bank and sold them (in tranches) to the investors, creditshelf service then collects payments from the borrower on the loan including interest and distributes such payments net of servicing fees to the respective investors. For this reason, creditshelf service and the investors enter into a syndicate which holds the loan receivables and which is managed by creditshelf service.

The revenue comes in via 2 sources: The company receiving a loan is paying a one time fee to credishelf. On the other hand, the investors are also paying a fee to Creditshelf tied to repayments (principal and interest):

The Company receives a brokerage fee from the borrower that falls due in case of the successful pay-out of a loan. The fee amount generally ranges from 1% to 5% of the principal loan amount, depending on the credit scoring of the borrower and the term of the loan. The brokerage fee will typically amount to 1% per year of loan duration plus a listing fee that increases with a decreasing credit score (indic-atively 1.25% in the case of a B+ rating, for creditshelf’s internal credit scoring see Section 13.3.5 “creditshelf’s Understanding of the SME Market”)). The entire fee is deducted from the loan at the disbursement of the loan amount.
• creditshelf service also receives a servicing fee from the investor which is generally 1% p.a. of the invested amount and which falls due when the loan is repaid by the borrower. For details of the pricing of the creditshelf loan products and in particular the revenue model see also Section 13.5 “Revenue Streams”.

So far, the company is only offering loans to small and mid-size (“Mittelstand”) German companies and the only available form of loan is one an unsecured basis.

Main shareholder: Mr. Elgeti

Mr. Rolf Elgeti indirectly holds 519,129 shares in the Company which corresponds to 46.145% of the voting rights. This indirect participation is based on Mr. Rolf Elgeti’s control of the indirect shareholder Obotritia Capital which controls the direct shareholder Hevella. As personally lia-ble shareholder of Obotritia Capital, he is responsible for the management of Obotritia Capital, and he also holds 20.8992% of the limited partner-ship shares of Obotritia Capital directly and another 4.0582% of the lim-ited partnership shares indirectly via Midgard Beteiligungsgesellschaft mbH, of which all shares are held by Mr. Rolf Elgeti, and 1.9174% of the limited partnership shares indirectly via EFa Vermögensverwaltung KG, of which he is the personally liable shareholder.

Although this is not a dark red flag, Mr. Elgeti has a somehow mixed reputation in the German capital market. I don’t know him personally and he seems to be extremely smart. He made his fortune in real estate as CEO of listed TAG but then had to leave the company abruptly in 2014 because there was the rumour of him doing a lot of side deals for himself.

Revenue:

In 2017, the company generated  1,2 mn EUR revenue. Around 2/3 (775k) were one-time brokerage fees, the remainder more recurring service fees from investors.

In 2018 Q1 they show 0,35 mn EUR vs. 0,03 mn in EUR in Q1 2017. This looks like a 10 fold increase, however it also looks like the normal run rate in the rest of 2017.

On page 133 of the IPO prospectus they show the underlying loan volumes and numbers.  I looks like that they really only started in Q2 2017. Interestingly enough Q1 2018 was a lot weaker than Q3 and Q4 2017. Normally beginning of the year is the “peak financing” time for corporates. So it will be interesting how growth develops.

The “invested capital” before the IPO was roughly 5 mn EUR.

Competition:

This is what they mention in the prospectus:

Selected competitors comprise the lending market places Funding Circle (UK), Lendix (France), Lendico (Germany) and Kapilendo (Germany) as well as challenger bank RiverBank (Luxembourg, the latter being a balance sheet lender, rather than a P2P platform, for details see Section 12.5 “Competitive Environment”). However

However in my opinion there are a lot of players missing, especially the many online platforms offering cheaper working capital funding for SMEs.

Offereing “cheaper” financing to smaller companies is clearly one of “THE” hot sectors in Fintech and I would guess that dozens if not hundreds of start-ups are active there in one way or the other.

My Assessment

There is one thing that I like about Creditshelf: The fact that they don’t put their loans on their own balance sheet (or only for a very short period of time). A lot of similar startup think it is easier to raise more money and put the loans “on balance sheet”. The advantage is that revenues grow faster and in “start-up land” revenues are king. However, the high cost of VC capital puts this start-ups from a cost of capital perspective to a huge disadvantage against the established players. Whereas a bank these days is super happy to generate 8-10% RoE, a start-up needs to deliver at least 20-30% to make its investors happy. This often leads then to risky loans and high defaults.

However there are a couple of things that I think are problematic in Creditshelf’s business model:

• The company doesn’t seem to have any informational advantage. Although they mention that they have

developed proprietary credit decisioning support and credit scoring algorithms and models. It seeks to improve the creditshelf Platform and its data-driven risk analysis management on an ongoing basis fostering creditshelf’s competitive edge. These algorithms and models also use artificial intelligence and a net-work analysis of potential borrowers to assess the borrower’s creditworthiness. Such network analysis seeks toidentify and analyze amongst others (i) cash flow streams around the borrower, (ii) relationships with custom-ers, as well as (iii) past and present legal interdependencies.
Together with outside forensic experts from PwC, creditshelf has also identified a number of data points that can help to identify fraudulent credit applications. The Company incorporated these insights into its review process and seeks to constantly improve its capabilities to identify potentially fraudulent applications.

I haven’t seen any more details and therefore would conclude that they do not have any major capabilities in that respect. Also using “Artificial Intelligence” these days is something that any Fintech claims these days but only thorough proprietary data one can generate unique insights and I doubt they have this at this times. As far as I understand they request data from potential borrowers at registration but there is no other “real-time” kind of data gathering going on, which in my opinion is one of the key diferentiators for top Fintechs.

• The product (unsecured loan) is not optimal. Clearly this is the easiest to start with, but it is also the easiest one for anyone else to start with and its normally not the optimal product for their target companies. Asset backed financing (receivables, inventory based etc.) is usually much cheaper. The rates they show look quite attractive for investors (high single digit % for ~ 15 month on average) but one could wonder what kind of companies need to pay that much.
• Acquiring all these small companies to loan to will be difficult and cost a lot of money, especially if one wants to find the really good ones.. Scaling this side of the market place will be difficult. Relying on referals from banks is especially dangerous. We have seen very well from the “Mittelstandsanleihen” fiasco.
• Based on the current business model (fronting bank, work out service provider, o only one product etc.) I don’t think that they are able to build up “real” customer relationships. Combined with the potentially significant CAC (customer acquisition cost), in my opinion they will run into trouble at some point in time because they will not be able to generate real recurring revenue.

Especially the last two point in combination in my opinion makes it difficult to quickly scale the business in a profitable way. If they execute really really well then yes, they can succeed but in my opinion this will be difficult.

Valuation:

Finally a word on valuation: This looks VERY expensive even compared to the current Fintech craze.

Valuation to revenue is after the capital increase something like 80 times 2017 revenues. Even if they double revenue this year, this would still be far above anything I have seen so far in the VC space. Even prime cloud SaaS companies could not expect to raise at such levels at this stage.

The 90m mn EUR “pre money” valuation is also around 18 times the money invested so far (money multiple), which also would be a very hard multiple to swallow for a VC.

Would I short the stock ? No. Becasue there is so much money out there chasing Tech & Fintech companies, that no one knows what will happen over the short term. A lot of Fintech ETFs and Theme funds are desperate to get their hands on these companies, no matter how the valuation looks like.

Why IPO ?

My biggest issue with this IPO is the high cost associated. Almost 4 mn EUR for a company that had 1,2 mn EUR of sales in 2017 doesn’t sound right. Yes, it looks that they have achieved a valuation that might have been difficult to achieve in the VC market, but that came as a cost to the company.

A “too high” valuation at such an early stage could also make future equity raisings more difficult if the price goes below the IPO price.

The only obvious beneficiary of this IPO are the current shareholders who now have a relatively more liquid investment,

Summary:

So in general, creditshelf seems to be a quite smart idea: disrupting SME loan financing in a way that doesn’t burden the company with high capital requirements.

However, as described above, there are many potential competitors and the business model will be difficult to execute and scale quickly.

Combined with the very high valuation, I don’t think that creditshelf is an interesting investment at this stage. However I think it makes sense to monitor their progress, especially to see how quickly traditional banking will be disrupted by them and their competitors.