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Funding Circle Share Price: Is Funding Circle A Buy?

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By on 29 March, 2021 | Read more by this author

It's with great pleasure that I'm permitted occasionally return to my old stomping grounds of share investing, even within the confines of 4thWay, where our focus is entirely on research and ratings for online direct lending. Funding Circle, a stock-market listed P2P lending company, gives me this opportunity today. With the Funding Circle share price still right down at 1/3 of its highs (where it's more or less been for two years), but with more history behind it upon which to base an assessment, I'm wondering whether times have changed and Funding Circle is a buy at last.

If Funding Circle is a buy, who is it a buy for?

I'm writing this prior to beginning my analysis of Funding Circle, because it's clear that no investment is suitable for everyone and that will definitely apply with Funding Circle. If it is a buy at all.

Funding Circle (listed on the London Stock Exchange as FCH for “Funding Circle Holdings”) is still loss-making after 11 years. While it's been on the stock market for two-and-a-half years and was valued at £1.5 billion at its initial public offering, it's still a startup in that it hasn't reached profitability and needs to grow revenues some more.

Personally I have never invested in a loss-making business. I always require a profitable history, strong signs of a durable competitive advantage and the ability to rake in cash before I become interested in becoming a part-owner of a business. (Warren Buffett style.)

Yet taking more risk for the potential of even greater rewards is a legitimate investing strategy (especially if you also want to try to contain the downsides at the same time). And if that's what you want, it's worth reading on to see if Funding Circle is a buy.

Even so, I would suggest that if you want to make a quick buck or double your money in 12 or 24 months, you should drop Funding Circle from your shortlist of possible investments. While such a result is not impossible, FCH shares are more suitable if you're ready and able to patiently hold for at least ten years. That will give it plenty of time to grow into a business that investors similar to me would be interested in buying into, at which point the share price will have flourished.

My analysis below is going to be with that investing horizon in mind. The Funding Circle share price could swing wildly in between.

About Funding Circle

Since 2010, Funding Circle does loans that are called small business loans in the US and SME loans in the UK. During the pandemic, it's offering government-backed loans in both countries and through these programs it has been able to continue to provide funding for borrowers.

It mostly operates in the UK and US, although it has fledgling operations elsewhere. Its focus has been on technology to improve both the speed and accuracy of its underwriting processes. It now approves around half of loan applications instantly, which is far quicker than almost all of its competitors. And it does this with three times the accuracy of standard credit reference agencies, leading to good overall lending results, even taking the pandemic into account.

At the end of 2020 it had £4.21 billion ($5.81 bn) in loans under management, a figure that has risen every year. £3.27 billion ($4.51 bn) of this is in the UK, with new loans up 26% to £2.11 billion ($2.91 bn).

In the US, lending fell a little to £759 million ($1.05 bn) under management due to a long pause in applications, as US businesses waited to find out if pandemic lending programs would continue. Loan originations were down 6% to £581 million ($802 m).

There are two sides to the normal, non-pandemic lending that Funding Circle originates:

Online “platform” lending

Funding Circle has online lending platforms in the UK and the US, whereby investors can lend directly to hundreds of small businesses in straightforward loans. In the US, business borrowers can also borrow in loans secured against their customer invoices (invoice factoring) or through overdraft-like credit facilities.

The majority of lending through Funding Circle takes place through its online platforms. In these loans, Funding Circle passes on both the risk of bad debts as well as the majority of the benefits of those loans. It earns fees from borrowers and platform investors instead.

Note that Funding Circle's UK online platform is temporarily paused to new lending, because its offering government-backed pandemic-relief loans that are not eligible as P2P lending. These are funded by financial institutions and by Funding Circle instead.

In the US, financial institutions have funded pandemic loans through its online platform. Funding Circle has done modest amounts of lending itself in the pandemic loans in both countries.

Offline lending

Funding Circle also generates revenue from its own investments. Both in the UK and the US, it does warehouse lending that builds up to a total of about £250-£350 million (about $350-500 m). Warehouse lending is leveraged, so Funding Circle borrows most of the money used for this from banks, although it funds a portion of it without borrowing. These facilities are held in a bankruptcy-remote company called a special purpose vehicle or SPV.

In the warehouse phase of its lending, Funding Circle takes the full risks and full benefits of the loans under management.

As soon as it can, Funding Circle securitises these warehouse facilities by creating another SPV and selling bonds in this new SPV to financial institutions. The money received for the bonds is used to buy the lending in the warehouse SPVs and transfer them to the securitisation SPVs. Once bonds are sold, the risk to Funding Circle on that portion of its lending disappears.

Funding Circle always holds on to at least 5% of the securitised lending itself, as this is a regulatory requirement. Historically it has also held onto other, higher-rate tranches of these securities that take the first loss in loss events, until those tranches are ultimately also able to be sold.

At the end of 2020, Funding Circle had lending valued at £220 million ($304 m) in warehousing and another £280 million ($386 m) securitised. Of this, £118 million ($163 m) is Funding Circle's own funds.

Revenue and profit

Results are improving as Funding Circle matures, especially if you adjust for the pandemic.

Lending volumes and revenue have grown at a rapid rate ever since Funding Circle was founded and this remains the case after it listed on the stock market in mid 2018.

Revenue before pandemic lending losses in 2020 was £222 million ($306 m), which is more than double that of 2017, where it was £95 million ($131 m). Fee revenue was dead stable at £156 million ($215  m) and investment revenue after investment expenses was three times higher than last year at £66 million ($91 m), largely because Funding Circle only began its warehousing and securitisation program halfway through 2019.

Overall, revenue was up 36% in the UK and 20% in the US.

Revenue (in £ millions)

Revenue 2020 2019 2018 2017
Transaction fees 122.5 121.2 112.9 76.5
Servicing fees 30.2 30.4 24.9 17.1
Other fees/revenue 3 5.3 4.1 0.9
Fee income 155.7 156.9 141.9 94.5
Investment income 89 28.3
Investment expenses -22.7 -7.9
Net investment income 66.3 20.4
Net income before fair value adjustments 222 177.3 141.9 94.5
Fair value losses/gains (on valuation of investments) -118.3 -9.9
Net income
103.7 167.4 141.9 94.5

Operating expenses in 2020 were £40 million ($55 m) lower than the prior year at £210 million ($290 m). Half of the reduction was due to a more targeted advertising and branding spend, which didn't dent its lending volumes.

Operating expenses (in £ millions)

Expenses 2020 2019 2018 2017
People costs -85.3 -90.3 -79.2 -52.3
Marketing costs (excluding employment costs) -46.8 -66.5 -57.8 -38.7
Depreciation, amortisation and impairment -30.9 -49.2 -8.2 -7.3
Other costs -47 -46.1 -48.3 -33.1
Operating expenses -210 -252.1 -193.5 -131.4

Funding Circle made an overall loss in 2020 of £108 million ($149 m), due to very large losses on its own higher-risk investments of £118 million ($163 m). If the pandemic had not occurred, it's likely that Funding Circle's annual losses would have narrowed considerably for the first time, taking them a good deal lower than the losses of £85 ($117 m) million in 2019.

Losses (in £ millions)

Losses 2020 2019 2018 2017
Operating loss -106.3  -84.7  -51.6  -36.9
Finance income 0.4 1.8 0.9 0.6
Finance costs -1.4 -1.2
Share of net loss of associates -0.8 -0.1
Loss before taxation -108.1 -84.2 -50.7 -36.3
Income tax -0.2 -0.5 1.4 1
Loss for the year -108.3 -84.7 -49.3 -35.3

More on expenses

Marketing costs will always be high for Funding Circle. They are typically around 1/3 of fee revenue, excluding people, and it's a good sign to see this consistency in terms of the sustainable and growing nature of a business, and not fluctuating sales with fixed marketing costs.

Based on the limited information in the past three annual results, research and development costs also appear to be steady. They are substantial in what they might achieve for the business's medium- and long-term results, but just a small piece of revenue. This lower cost helps the economics of the business.

The business' capitalised technology development needs, other capital expenditure, and related amortisation, doesn't appear to be a glaring issue and I don't see the reason why it would be for this business.

The economics on the expenses side seem to be of no concern.

Prospects

Losses have risen every year, from around £35 million (around $50 m) in 2017 up to about £110 million (about $150 m) in 2020. However, I am sure that Funding Circle's revenue growth will continue and this will turn it into a stably profitable business at some point inside the next ten years.

Funding Circle's UK business was right on the cusp of profitability both last year and the year before. Barring increased investment to go for even more rapid growth, it won't be long now. The US is on the same trajectory, but it started later.

A lot of geared investments are not really what I usually look for personally, but it's common in warehouse lending. Thus, investing losses for Funding Circle on its own lending during downturns might sometimes lead to poor years in between. This is probably going to be part and parcel of owning Funding Circle shares, so I'm not concerned by the investing losses of 2020.

Assets and liabilities

Funding Circle's accounts are straightforward compared to many listed businesses, with relatively few factors to get to grips with. This is also the case with assets and liabilities.

Funding Circle still had over £100 million (over $140 m) in cash at the end of 2020, which came from its IPO. The money owed to it by customers at year end was nearly £70 million ($95 m), and Funding Circle reports this has already come in.

Funding Circle's own warehouse lending is listed as an asset, as you'd expect, even where it borrows to do so. Perhaps surprisingly, securitised lending is also currently listed as an asset, even after the sale of the loans. This is because of accounting rules that require Funding Circle to keep showing these on its balance sheet because it controls the SPV and is still taking the riskier slice of lending through it, having been unable to sell during the pandemic.

Funding Circle therefore has £782 million ($1.08 bn) in assets, which compares with £565 million ($780 m) in debts. The bulk of those debts are bank borrowings for warehouse lending and bonds sold to investors in its securitised loans. It has no other substantial debts.

Cash situation

As a loss-making startup it still burns through cash. I think conservative investors should assume that it will need another cash injection or two over the next few years, either through borrowing or rights issues. I am not worried that it will be unable to raise the cash it needs to take it through to profitability.

A brief word on the short term

Investing horizons being ten years, I see no short-term considerations that might turn into long-term problems. Money lending during downturns (and pandemics) is obviously harder, but it isn't an issue that will kill Funding Circle, even if some individual platform investors are disappointed with their results and lack of liquidity.

Fee margins are a bit lower in pandemic loans, but lending volumes were still up somewhat during 2020 compared to the prior year. Downturns will delay the day it reaches stable profitability, but this still all fits comfortably within the ten-year horizon.

I think none of the extraordinary items in its 2018-2020 accounts are worthy of noting here for any investors with sensible investing horizons, although I would encourage you to include exceptional items in your calculations when analysing Funding Circle's historical accounts, which I think is appropriate in this case.

Funding Circle shares are a buy

I trust that Funding Circle will grow its revenues sufficiently to achieve the scale it needs to do so, and that its underlying products will continue to perform well and will weather downturns.

As I come to the end of my research, Funding Circle's share price has already risen about 30 pence to £182.40 ($251.71) and has a market valuation of £643 million ($887 million), Funding Circle shares are going to at least double over the next ten years when it pulls itself into eight-digit profits, and there's more upside than that too, with potential for significantly higher returns. Put another way, my main expectation is for at least a 7% annualised return for patient shareholders investing today, with possibly a lot more than that.

I think we can expect the Funding Circle share price to be 15 to 25 times earnings when it reaches this stage, thanks to its ongoing growth trajectory and exuberance from investors at its success.

Visit Funding Circle.

Funding Circle's share investor reports.

After Falling 11%, Are Funding Circle's Shares A Bargain? 28/11/2018.

After Crashing 70%, Are Funding Circle Shares A “Buy” At Last? 15/07/2019.

The author and 4thWay own no shares in Funding Circle.

Independent opinion: the opinions expressed are those of the author(s) and not held by 4thWay. 4thWay is not regulated by the ESMA or the FCA, and does not provide personalised advice. The material is for general information and education purposes only and not intended to incite you to lend.

All the specialists and researchers who conduct research and write articles for 4thWay are subject to 4thWay's Editorial Code of Practice. For more, please see 4thWay's terms and conditions.

Our service is free to you. We don't receive commission from the above-mentioned companies. We receive commission from some other P2P lending companies when you click through from our website and open accounts with them. This doesn't affect our editorial independence. Read How we earn money fairly with your help.

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Important information before you visit Wellesley & Co.

Wellesley & Co. is primarily a P2P lending website.

But, when you visit the Wellesley website, you’ll see that it also offers two “bonds”, one of which is available as an ISA.

Unlike its P2P lending service, neither of these bonds allows you to lend directly to 100+ borrowers.

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