Interactive Investor

Stockwatch: a very curious potential takeover situation

Rather than wait for a potential suitor to make a move, this smaller company has put itself up for sale. Its share price is up almost fourfold in a nice and steady three-year rally since the Covid crash. Will anyone be tempted?

3rd November 2023 12:01

by Edmond Jackson from interactive investor

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Financial technology group Equals Group (LSE:EQLS) has put itself up for sale as it reaches an inflection point operationally. Does that make its equity an intelligent speculation? 

Equals provides foreign currency and banking services, mainly to small and medium-size enterprises. It was founded in 2005 and listed on the stock exchange in 2014, with brands such as Equals Money (a platform for corporate payments), Equals Money for Enterprise (a scale-up serving larger customers with more complex needs), FairFX for wealthy individuals and international holidaymakers. It also runs Card One Money for UK small businesses and individuals. 

It has real-time settlement accounts with the Bank of England and is a member of the UK Faster Payments Scheme, meaning customers can transfer money with immediate effect. Similarly in the eurozone it is a member of SEPA for instant transfer. 

It’s an established business then, if only making around £30 million revenue by 2020 and profitable essentially from 2022. It’s capitalised at £210 million with its share price currently at 113p. With revenue looking capable shortly to surpass £100 million, market value is just over twice sales and, with the first-half 2023 operating margin having breached 12%, a full-year net profit near £10 million looks likely.  

While earnings power is yet to be proved, it is another example how AIM can yield decent firms. 

Inflection point apparent from the first half

Equals has seen revenue accelerate 43%, hence a near £5 million net profit. 

Momentum continued into the third quarter despite an uncertain macro environment, with profit expectations for the full year guided higher, such that previously-expected earnings per share (EPS) of 6p might be nearer 7p targeted for 2024. On which basis, the forward price/earnings (PE) ratio is 16 to 17 times. 

“Equals continues to grow strongly because it has a product and capability suite that is hard to replicate,” the company says. That indeed makes it interesting to a trade or financial buyer. 

Despite a strong cash profile, a maiden dividend of 1.5p a share has only recently been proposed for 2023, hence stock perception is likely to remain very much about earnings.  

Equals Group - financial summary
Year-end 31 Dec

Turnover (£ million)15.526.130.929.044.169.7
Operating margin (%)1.56.8-25.0-29.9-7.65.3
Operating profit (£m)0.21.8-7.7-8.7-3.33.7
Net profit (£m)0.42.6-5.3-6.9-2.43.2
EPS - reported (p)0.41.6-3.2-3.9-1.41.7
EPS - normalised (p)0.51.9-0.3-3.6-0.71.8
Operating cashflow/share (p)
Capital expenditure/share (p)
Free cashflow/share (p)1.8-2.1-6.2-
Dividend/share (p)
Return on total capital (%)0.64.4-13.1-16.1-7.08.0
Cash (£m)17.87.911.310.013.115.0
Net debt (£m)-17.8-7.9-4.0-1.6-5.8-10.8
Net assets (£m)35.038.349.442.540.942.9
Net assets per share (p)22.624.627.723.822.823.7

Source: company accounts

Near £18 million cash offers scope for acquisitions 

A hesitant approach to dividends seems ironic unless it was always understood among shareholders that a “fintech” business like this should prioritise capital growth. 

Even so, the financial summary table shows operational cash flow consistently beating earnings, and after a period of heavy investment, free cash flow kicking in from 2021.

Cash at bank rose 19% near £18 million in the first half despite nearly £3 million spent on acquisitions, with the cash flow statement showing net cash inflow from operations doubling over £12 million. Over £8 million of this was applied for acquisitions, hence an impression of self-financed growth.  

While the end-June balance sheet had intangibles comprising 72% of net assets, that is to be expected from a business based on systems’ design and development, plus brand/customer goodwill. 

There is no debt beyond near-£4 million of leases, although it’s odd how the income statement shows nothing earned from nearly £18 million cash. Plenty of cash-rich companies have cited a rise in finance income after interest rates have risen. 

I review key aspects of the business like this before the tease of takeover interest, given anyone buying the stock needs first to be satisfied on such scores.   

Novelty of naming two buyers after being approached

Virtually always it is the other way around: an announcement in response to market speculation about potential buyers taking the initiative. 

This last Wednesday, however, Equals declared that as part of a strategic review, it had contacted them – going so far as to name the European subsidiary of Fleetcor Technologies Inc (NYSE:FLT), a $17 billion (£14 billion) global payments processing group, and Madison Dearborn Partners, a Chicago-based private equity group. 

Fleetcor would be a logical acquirer and the best hope of a premium offer, given it could likely generate operating synergies. But mind how despite its size and its last balance sheet having nearly $1.3 billion cash, it also supports $6.8 billion of debt.  

Madison Dearborn likewise has odds in its favour with almost 40 years of experience, and seven years ago becoming the second-largest shareholder in the UK insurance giant Towergate. Mind here, though, that private equity will want to get the business at the best possible price in order later to sell on to a trade buyer which can “make 2+2=5”.  

Also, while a strong cash flow business is attractive to private equity – which typically uses debt to acquire – it is harder to gauge such operators’ actions after interest rates have risen. Deals that would have closed in past years might not now.  

So it is by no means certain a sale will conclude, despite it looking pretty smart to buy Equals now. 

To actually name the parties involved still implies substance given they are now bound by the Takeover Code – each having until 29 November to declare whether they are making an offer.   

Imposing such could not really be done without their consent, implying they are serious.  

Non sequitur of selling if the business is so well placed 

Wednesday’s announcement reassured how “the company is well-positioned to create significant value for shareholders as an independent company” - and yet the strategic review reckons on exploring a sale.  

A cynical explanation would be that this is what happens when “independent” advisers such as a merchant bank are hired for the review and also later benefit from a sale fee. 

The stock had barely risen in near-term chart context to justify this announcement – unless there was a story online about takeover negotiations. The normal approach would have been to pre-empt chances of a leak by declaring “strategic review, formal sale process” beforehand. Perhaps the board and its advisers wanted to avoid embarrassment if nothing materialised. 

At a relative chart high, yet business is breaking out on the upside  

After a 14% jump to 117p in reaction to exploring a sale, Equals has settled back to 113p, although it breached 120p after last September’s interim results.  

Five years ago, it reached an all-time high of 140p but, as so often with stocks offering hope but unproven earning power, big swings can happen. The price plunged to near 20p when Covid struck markets in March 2020, which helped set up a long bull run.   

I re-iterate the need to be confident that this stock is worth owning in the event takeover discussions falter. Or, if that is too high risk, the situation may still merit attention as a potential “buy” should either or both parties declare against the proposition this month. 

Nerves will start to grate if either of them does this first. 

There is time, however, to investigate Equals more thoroughly and decide on a speculative “buy” potentially to gain at least 30% upside in the event talks conclude positively.  

Why ever would the board embark on selling the business if it did not believe such a premium – or better – was feasible? 

The downside should be much less than 30%, hence a favourable risk/reward profile, according to your view of event risk. 

Should talks fail, a speculative buyer of the stock would then average down into the drop and take a two-year view. 

This is sketchy, and it's your call as to whether it suits your risk appetite, but there is a good case to consider the shares a “Buy” if youcan stomach it.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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