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What Investors Can Learn From RateSetter’s Sale To Metro Bank

RateSetter and Metro Bank have done a deal: RateSetter has been sold to Metro.

RateSetter's existing lenders will see their existing loans paid off while borrowers meet their repayments, as usual. Buto new lending will occur through the platform. Metro Bank will use RateSetter's lending infrastructure to grow its own lending.

I want to tell you about the deal itself. Then I'll tell you what I think people investing in P2P can learn from this.

RateSetter is sold for up to £12 million

RateSetter is being sold to Metro Bank for no more than £12 million in total, as reported in P2P Finance News and the Financial Times. The total price depends on RateSetter's results over the next three years. It could be as little as £2.5 million, although I currently expect it to be closer to the full price, because such targets are usually set to be achievable.

Investors who have bought shares in RateSetter (rather than investors lending through its online platform – its lenders) have invested at least £43.3 million. RateSetter's current shareholders – its current owners – include Woodford Investment Management and Artemis.

RateSetter's last few published accounts indicate that this £43.3 million has been put into the reserves that RateSetter needs to keep to satisfy the regulator. These reserves are to ensure stability of RateSetter's lending platform. This is separate to RateSetter's reserve fund set aside to cover lenders' bad debts.

I asked Metro Bank and RateSetter if Metro Bank is buying its regulatory reserve pot as part of the deal. The alternative would be to return it to RateSetter's existing investors and replacing it with money from Metro Bank's own reserves. RateSetter hasn't responded yet. Metro Bank did respond, but unsurprisingly it wasn't willing to comment on the terms of the deal. That's standard practice and most likely is part of a confidentiality agreement.

(It's possible that we'll be able to scrape more information about that from Metro Bank's annual accounts that cover the period where RateSetter is officially taken over. That sent of accounts should arrive in the middle of 2021.)

How well have RateSetter's investors and founders done?

If Metro Bank does return the regulatory reserve pot to RateSetter's current investors, those investors will make a small, disappointing profit on the sale.

If Metro Bank doesn't return the pot, it looks like RateSetter's current investors will make a hefty loss of more than 70% of the money they put in.

I can see no other way that RateSetter's existing investors can do better than make a huge loss. It's a terrible result.

It seems from RateSetter's filed accounts that no dividends have been paid out to its current investors. (It would have been odd if dividends had been paid, because RateSetter it still hasn't started making a regular profit.) Therefore, its current investors have no consolation in the form of income payments.

RateSetter's founders, Rhydian Lewis and Peter Behrens, might have held onto enough RateSetter shares throughout its life in order to make a profit from the sale for themselves, but that information is not available. All I know is that neither of them own 25% or more of the business. RateSetter's accounts over the past few years indicate that they have likely been earning six-figure salaries.

Why is the sale price so low?

I think that the pandemic certainly might have hurried a sale along, and a quicker sale can always impact the price.

Higher bad debts caused by COVID-19 might also have impacted RateSetter's sale price. And yet I think that the sale price has less to do with COVID-19 and more to do with RateSetter's profitability.

RateSetter's published accounts and other figures give some clues. (Please bear in mind that I've not read every page of the accounts like I normally do, because in this case we're not assessing RateSetter with a view to buying shares in it or something serious like that. We're just speculating about the sale price.)

Its income grew rapidly up to March 2018. But its growth then stalled as it started to reach maturity.

12 months to March in… Change in RateSetter's revenue
2019 -3%
2018 +46%
2017 +36%
2016 +37%

As RateSetter's growth slowed in 2019, it turned to cutting costs. That's always the next phase for a startup after its big initial growth spurt comes to an end. After cutting costs, it made a loss after tax of £4 million off the back of £33 million in revenue. (This loss was down from £27 million the year earlier.)

It's likely that RateSetter would have become profitable as it continued this new phase of its business.

But accumulated losses over the years appear to have totalled £65 million since it started operations in late 2010.

Compare that to how its platform lenders have done. Lenders were lending £840 million at the end of the same period and since 2010 had earned £127 million between them.

Now, you need some context, because the difference between -£65 million and +£127 million is quite misleading. RateSetter was bound to make substantial losses in its early years, because those first eight years were rapid growth years. If RateSetter had continued as a P2P lending company for another eight years, it probably would have made money. And the results would have been considerably better for its existing owners.

But my point is that the next eight years were still going to be even better for its platform lenders. Many, many times better. The bulk of the benefits of P2P lending go to platform lenders and borrowers, not to P2P shareholders.

What assets did Metro Bank buy?

RateSetter's company accounts are simply too old to know, but what we can be sure of is that RateSetter was not rolling in assets.

RateSetter had net assets of £4 million in March 2019. As far as I'm aware, it received no substantial investment (cash injections) between then and now, that might have boosted its assets.

One industry source believes RateSetter had recently been burning through cash at a rate of £3.5 million a month, but I haven't been able to confirm that.

Update on 5th August, 2020: that same source believes RateSetter Australia was not included in the Metro Bank deal. He estimates £13 million of the total £43 million in investment went into this branch of RateSetter. The devil is in the detail! But if this is true I don't think that it dramatically changes anything – certainly not the underlying assessment that lenders get more bang for their buck than investors in RateSetter.

A sale of RateSetter Australia on the same basis is not likely to produce a huge gain for the investors either, since it's business model is essentially the same. But I can't do more than speculate on that today.

Pump up those valuations!

I have a separate point and that is not about the sale price of RateSetter's business, but the valuations given to it by its share investors.

According to RateSetter, investors buying its shares valued it at over £200 million in 2017. That is is considerably more than £12 million – or even £2.5 million.

Early share investors often show great astuteness, grasping the potential for a new-fangled product. However, it's a constant feature of innovative businesses like RateSetter that, in seeing how useful the new products are, investors seriously overvalue the rewards the business itself will receive from what they sell. And therefore the rewards that they themselves will get by buying its shares.

This happens again and again, and it even leads to big-name investment funds like Artemis paying a poor price for useful companies like RateSetter.

Funding Circle investors who bought into its intial public offering have so far suffered a similar fate, with prices on the secondary market – the London Stock Exchange – currently down by around 75% on the starting price.

I don't have enough information to put a sensible value of my own on RateSetter as a business, not least because the latest accounts are now well over a year old. But £12 million is very likely to be closer to a fair price than £200 million.

What can we learn from this?

I think there are two key points that those interested in P2P lending can learn from this:

1. Add smaller, agile platforms to your mix of lending

RateSetter needed a lot of people to run its operations. I think that P2P lending companies with smaller, more agile teams that reach profitability earlier on are more likely to remain as P2P lending companies for the long run.

You might therefore look to ensure some of your lending is at P2P lending companies that don't have high fixed running costs. This means you could look to companies that are still largely run by their owners, and those owners might have other entrepreneurial or investing ventures going at the same time.

If they are running their online lending platforms with just a few other people, they can more easily keep ticking over at times like this when borrowing and lending dries up.

These P2P companies might also get a lot of deals with borrowers through their networks and through word of mouth, where the supply of borrowers is perhaps less likely to shut down in a pandemic, or when cost-cutting (advertising and sales budgets) is required.

This is probably an angle of research that 4thWay should look into in more detail. Scanning 4thWay's comparison table, the P2P lending companies that appear to best fit the bill, to my knowledge, are CapitalStackers* and HNW Lending*, and for people with less money to lend, Loanpad* probably fits in this category too.

2. Don't be an early share investor

Valuing innovative startups properly is extremely difficult, even if you're an accountant and have access to visit the P2P lending companies for yourself. And even if you're deeply familiar with the industry or business model.

So don't buy shares in P2P businesses until they have matured and started earning a regular profit upon which to base some of your calculations as to a fair price for its shares.

Visit RateSetter.

Read the CapitalStackers Review.

Read the HNW Lending Review.

Read the Loanpad Review.

Two of the companies above are in our special report on The Best P2P Lending Accounts And IFISAs During COVID-19. Proplend*, at the top of 4thWay's PLUS Ratings table, is another one. To find out the fourth, sign up to our newsletter to get the report.

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