In 2018 Funding Circle (LSE: FCH), which matches smaller business who want to borrow money with investors who are willing to lend it, made its debut on the London Stock Exchange with a share price of nearly 440p. Now, you could pick up shares for about 100p, but let me explain why I don’t think this is a bargain.
Who funds Funding Circle?
Small and medium-sized businesses apply for loans, and Funding Circle takes small sums from the accounts of hundreds or thousands of investor accounts to match the loan amount. Funding Circle charges a transaction fee on the principal balance of newly generated loans, which is deducted from the proceeds that borrowers receive, and collects a servicing fee on outstanding principal balances of loans under management from investors.
On, average Funding Circle collects 4.86% of the total amount of new loans generated annually as transaction revenue and 0.82% of the annual principal balance of loans under management in servicing fees. Increasing the amounts of loans originated, above and beyond the number of old loans that have been repaid, will increase loans under management and both revenue streams.
Stunted growth
By 2012, Funding Circle had £52m of loans under management in the UK. After growing by an average of 149.41% each year, it had £3,148m under management in the UK, US, Germany, and the Netherlands in 2018. This is a company that is investing heavily to grow so I am not surprised when I see that it has made a net loss of more than £30m every year since 2015.
Losses can be acceptable when growth is rampant, and share prices can go up in spite of continuing losses as shareholders expect juicy profits further in the indefinite future. But Funding Circle is seeing rates of growth moderating, so I want a reason to believe that it can at least start to move towards breaking even at the operating profit level because it looks like we are dealing with a late-stage growth company moving towards maturity.
Can’t catch a break (even)?
By regressing Funding Circle’s reported transaction and servicing revenues against operating expenses, I got an equation that I can plug forecasts of both revenue components into, get a prediction of future operating expenses, and then estimate operating profits. Assuming growth rates in both loans originated and those under management continue their short-term trend, and using the average percentages for servicing and transaction fees, I am forecasting that operating losses will continue for the foreseeable future and not move towards breakeven.
I have made a lot of assumptions in my analysis, and I could be completely wrong, but for now, I see Funding Circle as being in the later stages of its growth phase, and not moving towards making an operating profit. This could mean more bank borrowings, further equity issues, and dilution of shareholder claims, or worse.
It is also worth mentioning that Funding Circle has never operated through a recession, when businesses are not eager to lend and investors are put off by rising rates of defaults on their loans, nor has it dealt with historically normal interest rates. This, along with my outlook for profitability and growth, means I will be looking for another smaller UK company to invest in for now.
