Pop quiz: what would you expect the share price chart to look like for a company whose industry will soon face tough regulatory reforms, where a temporary rush of business is ebbing, and whose founders have sold large amounts of stock?
It looks like this:
In the last year Plus500, the contract-for-difference group, has reached a value of £1.9bn, to become one of the largest companies on AIM, London's junior market favoured by soon-to-be-bankrupt miners, disappearing Chinese entities and tech-focused gobbledygook merchants.
The business is best understood as a bucket shop. It operates a closed system that allows customers to place bets on currencies, stocks, financial markets and the price of crypto-tokens, using large amounts of leverage to magnify the gains and losses.
Plus500, which declined to comment, always maintains it is a market-maker. It says its profits come from a spread - the difference between the price at which customers can buy and sell contracts - and interest charged on positions held overnight, rather than customer losses.
Its argument rests on semantics. The reality is that leverage magnifies the cost of the spread, eating away at the limited capital of small-time traders. High levels of churn in the customer base, with new punters found online to replace the old, point to a longstanding pattern: traders join, lose money, then stop trading.
It isn't just Plus500. Regulators across Europe have repeatedly found that more than three-quarters of CfD traders lose money, with 89 per cent on the losing side in a French study. Which is why the European Securities and Markets Authority has ordered a crackdown, including restrictions on the amount of leverage and the way CfDs are marketed to the stupid, vulnerable and inexperienced.
For instance, the permissible leverage on currency pairs will be 30:1. Plus500 currently offers 300:1.
Such limits should impact the revenues and profits of CfD providers, and the evidence is that they do. After Japan introduced leverage limits in 2011, IG Group's sales in the country halved. IG has also said that it expects ESMA's changes to hit group revenues by around 10 per cent, in the year starting June 1st.
The leverage limits only apply to retail traders, not those classed as experienced professionals, but note what IG said in a recent update (with our emphasis):
“The Group has received around 15,000 applications since November 2017 from clients to elect to be categorised as professional, and 3,800 clients are now categorised as professional. The Group's process for assessing these applications is appropriately rigorous and over three-quarters of the applicants to date have been rejected. Clients categorised as professional contributed over 35% of UK and EU OTC leveraged revenue in the last three months, and the Group continues to expect this proportion to rise to 50% when the ESMA measures come into effect.
Since Plus500 experienced a regulatory intervention by the UK's Financial Conduct Authority in 2015, it has tightened up its act on compliance. Penny Judd, a compliance expert, is non-executive chairman, so we'll assume the company is going to play by the new rules.
Yet it offered guidance in May that there will not be a material impact to full-year numbers from the new ESMA rules. Analysts' forecasts are for sales and earnings growth in the years after.
Considering Plus500 mainly caters to retail customers, such an outlook is hard to square with a regulatory approach designed to reduce the customer losses that provide as the bottom line for CfD houses.
At the same time, Plus500 has just experienced a record quarter thanks to the crypto boom. It was one of the few places punters could bet on bitcoin, with leverage, which had two positive but temporary effects.
One was the company had to pay far less in marketing fees to find customers. User acquisition costs almost halved, compared with the first quarter of 2017. Second was the crash in crypto prices at the start of the year, which we suspect wiped out large numbers of the new traders. Plus500 reported revenues had almost tripled, and fully 80 per cent of those revenues were captured as ebitda, a phenomenal margin no business can expect to maintain.
Just matching these numbers next year will be tough, even without the imposition of leverage limits.
So what should shareholders think? The company has said it intends to apply for admission to the main market, which would bring new investors and attention. Yet in March the founders of the business, who we assume understand its potential better than anyone, sold £80m of stock, almost two-fifths of their collective holdings. The sensible strategy would be to leverage that insight, and follow suit.
The trading magicians of Plus500 - FT Alphaville
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