It’s time for a dose of reality in the peer-to-peer (P2P) sub-sector of FinTech. Funding Circle is looking to float its shares in the London Stock Exchange later this year. The investment bankers – notably Goldman Sachs and Morgan Stanley – are talking up the price, as they always do.
My personal view is simple: these bankers may well damage the P2P sector. if Funding Circle is overvalued, the share price will fall after the initial burst of IPO-driven euphoria.
So how do they arrive at a price? First up, here’s the value they put on the model. See below an extract from a piece I wrote in City A.M. ahead of the IPO of the biggest US P2P player, Lending Club, in December 2014.
Imagine taking a tenner in a pub from a friend, putting it in your wallet, then taking it out and handing it on to a friend sitting on the other side of you. The first friend has loaned the money. The second one has borrowed it. And your wallet, by virtue of brokering the transaction, is worth a tenner too.
Nice work if you can get it. If you can, you’re probably an investment banker.
Now this is a deliberately simplified – some might say simplistic – model of P2P lending activity. P2P lenders really are doing the jobs that the banks can’t or won’t do. Businesses need the capital, and savers deserve a much better return than the deposit accounts offer – so lending to fuel growth and get an excellent yield is a double win.
But this aggressive pricing of Lending Club is just that – aggressive. The bankers behind Lending Club’s IPO have played the media like a knackered trout. They were going to price this asset at nearer $4 billion than $5 billion – still a huge price. But now the financial rabbit has been pulled out of the hat, and here’s Lending Club – fluffy, cute, and possibly just a bit too expensive for its own good.
Perfect market theorists argue that the market will be the ultimate arbiter. What’s something worth? What the market will pay for it. After all the rationally relevant information has been priced in, the market will determine fair value.
And determine that value it has. The share price has staggered to around the $3.35 level at the time of writing. The IPO valuation was $5.4 billion, with a surge seeing something north of $8 billion, with a close of $25.74 in late December 2014. Lending Club has seen changes in senior management, and class-action law suits as shareholders alleged manipulation of key figures as management struggled to meet aggressive growth targets, agreed to before the IPO.
Now other commentators are coming to conlclusions similar to my own. This excellent comment from Victor Basta of Magister Advisors has my wholehearted support. On that basis, I trust Mr Basta and FT Alphaville, which published it, will forgive me for lifting a large extract. It makes excellent sense to subscribe to the FT online, by the way. It’s an oasis of trustworthy facts and common sense in today’s “fake news” world.
There’s a danger this flurry of IPO activity could be a mixed blessing for the wider fintech industry. In a market buzzing with hyperbole and over-generous funding-round valuations, the reality of IPOs could present a real danger not just to company shareholders but across the wider industry.
Nowhere is this more apparent than at Funding Circle. Bankers and investors are talking up Funding Circle’s valuation at £2bn, despite the company having last raised money at below £1bn. £2bn for a business generating only something around £100m of revenue annually, even if it’s growing at its current rate of around 50 per cent, is an awfully big sticker price for any industry. That amounts to over 16x revenue – for perspective, Google and PayPal are both valued at only 7x revenue.
The curse of comparability
Relative to other similar publicly listed companies, Funding Circle’s trumpeted valuation looks heady to say the least. There are several US companies including Lending Club ($1.4bn market value) and OnDeck ($400m market value) directly comparable to Funding Circle’s business model which are valued at far less.
This “curse of comparability” is bound to threaten Funding Circle’s IPO valuation and share price performance. Even with fast growth and a high-end price tag, Funding Circle would be doing very well to get far above £600m, a fraction of the valuation chatter so far.
There’s much more to be said on this topic, including an interview with Funding Circle CEO, Samir Desai.