Wednesday 25 February 2015

Tungsten (TUNG) ... thoughts on conversion

Tuesday 25th February 2015

Monday's post seemed to draw some focus. I thought it might be worthwhile expanding on how I draw my bearish view with some numerical examples. 

But first ...

An observer has drawn attention to the fact that while OB10 has historically been loss-making, that this is not unusual as a great deal of start-up companies tend to be. And that growth in the past year may have been stymied due to unforeseen operational challenges. Further, that due to the investment which has gone into the business, losses will continue to accrue but that this is only likely for the short term. 

Let's take a closer look at OB10. 

Firstly, yes, a great deal of start-up companies tend to be loss making. However, OB10 has been rocking along for over 14 years now and is still not looking like approaching a profit any time soon. Let's not forget that according to its auditor it was practically insolvent in 2013. Not to matter. 

From its recent interims (released 14 Jan 2015), Tungsten highlights that:
  • It transacted 14.4 million invoices or £117 billion in invoice value in the 12 months to 31 December 2014.
  • 14.4 million invoices for 2014 is up from a reported 13.3 million invoices for 2013. This is 8% growth.
  • 2013 invoice growth was 14% from 11.6 million invoices in 2012.
  • £117 billion invoice value for 2014 is up from a reported £109.2 billion in invoice value for 2013. This is 7% growth.
  • 2013 invoice value growth was 12% from £97.5 billion in 2012.
  • The interim statement to 31 October 2014 indicates that suppliers grew to 171,000 from 168,000 in April 2014. This is 1.7% half on half growth.
  • However, this differs with the accompanying interim presentation, which highlights 174,000 suppliers (up from 168,000). I can only presume that the discrepancy lies with this figure representing growth in the period 31 October 2014 to the release of the interims. That growth is a bit better, but still less than a 2% increase over several months.   

The group claims that the global e-procurement market is expected to grow by 7 to 10 per cent, between 2013 and 2015. This comprises e-invoicing growth at 8 to 10 per cent and supplier network growth at 17 to 20 percent. 

Based on the above, and despite the significant investment put into the loss making business, clearly OB10/Tungsten Network is failing to keep pace with the wider market. 

Maybe, this under-performance will all change and is down to clients being unhappy with the former OB10 masters and a brighter outlook will emerge under the new Tungsten stewardship? If the former, then the price paid for OB10 appears even more ludicrous. 

In two to three years time, Tungsten may well have gone from single digit growth and losing market share to say $400 billion in invoice value (implying growth of 30 to 40% per annum), but when I bear in mind that it is just one of at least 50 other providers, each with a market share of 1 to 20 million invoices per year, I find that scenario a bit of a stretch. 

Incidentally, it would seem that OB10's condition in 2013 may have been so precarious, that Tungsten had to lend it £4.8 million prior to its acquisition. Of course this remained outstanding and was then consolidated from the point of acquisition. Further, the timing of this loan is somewhat odd. Gold star to whoever can work out when the loan was granted.  

Now for some numbers is a pretty informative website, unsurprisingly on matters of invoice discounting and factoring. Here you will find some examples of the cost of invoice discounting amongst a range of companies from start-ups to medium to large. 

For example, reckons that a small sized business with £250,000 in revenue per annum and looking to release £35,417 through invoice discounting finance, is looking at:
  • An administration charge of 1.70% of turnover = £4,250 + VAT per annum.
  • A discount charge of 2.5% over bank base rate = £1,062 +VAT per annum.
This would come to a total cost of £5,312, and represent a cost of 15.0% of funds received; but it assumes of course that funds are drawn on one occasion and drawn for the entire year. I would imagine this could be beaten. But let's assume that the facility is available at this cost.

In reality, I reckon a small sized business is more likely to utilise a facility maybe once or twice a year. Say for 60 days in the year. 

Then the numbers break down as follows:
  • An administration charge of 1.70% of turnover = £4,250 + VAT per annum.
  • A discount charge of 2.5% over bank base rate = c. £175 for 60 days + VAT.
This would come to a total cost of £4,424, and represent 12.5% of funds received.  

Tungsten's cost of capital is reportedly close to 3.0%. 

So in order for Tungsten to extend this £35,417 in finance, it would be looking at a cost to itself of £1,062 per annum, or c. £175 for the 60 days. 

It's net fee would therefore be £4,250 for the 60 days advance. A net interest margin of 12% (which is basically all admin charge). Of course this is before any costs Tungsten have been incurred for data processing, due diligence, other overheads, etc. 

Market forecasts are for Tungsten Bank to achieve £50,900,000 in revenue for FY 2017. 

In order to arrive at this, using an average small sized business as above, the group is required to extend that order of finance, at least 11,979 times. 

This may well be no issue. The 174,000 suppliers may be lining up.

However, if of those 174,000 suppliers, it is actually 9 to 10 per cent that are using invoice discounting (as per reported market penetration) then 15,660 suppliers are in the market. 

So Tungsten needs to convert 11,979 of them to ditch their current provider (and they will have a current provider, probably their own bank) and switch over in order to achieve £50,900,000 in revenue. That's converting 76% of them. I reckon this is also a stretch by a long way. 

Here's an illustrative example to demonstrate required supplier conversion rates.

Conversion rate model
Source: Lordshipstrading
I reckon Tungsten will do well to achieve a 15% conversion rate of its supplier base that uses invoice discounting to use its product. And so that's 15% of 9% of 174,000 suppliers. If the average request of funds is say, £37,500 (as in the table above), then that means 2,349 suppliers requesting £37,500 in finance, at £4,250 net fees, then that equates to c. £10,000,000 in net fee income. 

Given that market forecasts for OB10 see it as remaining loss making to the tune of £5-6 million per year, for the foreseeable future, what with other costs in the business, I reckon profits will be pretty slim.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

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