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It was an interesting week in Cyprus. It was hot. The hotel kitchen staff were cooking kebabs in the car park next to a large skip and a stray cat. I got food poisoning. I tried to get in one of those Exness taxis. I got thrown out.
Still, it was nice to catch up with people in the Eastern Med. I learned I need to change my LinkedIn picture to better reflect how I look in reality. I met a couple of people looking at starting brokers. Some people appear to be doing ok even if things aren’t as great as they were a couple of years ago. And lots of stuff is happening in the prop space. I don’t know if this will be a long term phenomenon but it’s something that brokers shouldn’t ignore short term.
On the other hand, there was a sense that things are not going well. As I said to one reader, it feels like a lot of brokers are the evil guy in V for Vendetta, except instead of shouting ‘Die! Die! Why won’t you die!?’, all of you are going ‘Buy! Buy! Why won’t you buy!?” as you pump as many trade tips as possible at your clients.
Things can get worse I guess. The impact of rates starts to be felt after a lag. Inflation stays high in Japan. The BoJ stops printing yen to buy government bonds. The Japanese have to stop buying US treasuries to replace the BoJ. Yields on treasuries go up as a result. The whole dynamic of Asian countries running mercantilist policies and creating artificially low currency rates that fuelled a debt bubble in the west comes to an end. Oil goes up. With no other option except total collapse, western governments run inflation higher to slowly erode debt. All of this makes sense probably.
But as wonderful as it would be if that did happen, it might not. And even if it does, it may take a while and the clock is ticking. Speaking to Michael Ayres from Rostro earlier this month, as well as a couple of other people in Cyprus, you get the impression that there are companies with a pile of cash in the bank that are running cash flow positive. Then there are people who are cash flow negative and seeing their money in the bank slowly drip away.
The former may buy the latter but all they have to do is wait – the closer the balance gets to zero, the more the acquisition target feels the heat, and the worse the deal they get.
For example, Naga issued an $8.2m convertible bond in April. Shares in the company have not hit the strike price and the bond matures next month. Interest is borderline mafia rates at 11% over a 6 month period (ie. 22% annualised on a simple basis). So if the purchaser of that bond cannot convert before expiry, then Naga will have to pay a little over $9.1m back, reach an agreement of some sort with the buyer, or get bought out / raise money somehow. Or they are toast.
ThinkMarkets is another one where you look at the balance sheet and have questions about what will happen. The company has loans due in excess of $26m this year, much of which appears to be drawn from a two year $30m credit facility dating from December 2021, with rates at 11.11%. The company was cash flow negative in 2022 and had $14.6m of cash on hand at the close of that year.
The company is supposed to go public via a SPAC but it’s not clear if that will go ahead, with most investors redeeming their shares. You could argue SPACs are mostly just a way for some fund managers to do a risk-free trade (redeem shares at par, keep the warrant). On the other hand, redemptions are also a sign they aren’t such a fan of the company they’re supposed to be merging with.
To be fair, both companies may also end up being completely fine – we don’t know the precise details of what’s going on at either today and can only infer from past data. It can also look like I’m singling them out for a shellacking but it is basically because one is public (Naga) and the other wants to go public (ThinkMarkets). That means we actually have information about them, whereas that’s obviously not the case for private companies, which may be in a far more precarious state. You only have to look at the ‘yuge’ number of licences on sale to realise that.
But all of this raises the interesting question of how you would actually value most firms in the business today.
You could argue that a buyer would be doing something like a value / turnaround play. You acquire everything at a cut down valuation, go in and fix what is crap, and then keep the business long-term (or flog it if you are a private equity buyer – how you would do that is probably a whole other article).
Looking around the industry, I don’t get the impression that there are many companies where people attempt to do that. In reality, sales end up being more of an asset stripping exercise, where the company sells off individual components, rather than the whole.
This makes sense if you think that you are basically very unlikely to find a private equity buyer to do a turnaround in this industry. As a result you have to find a trade buyer and the odds are they already have the sorts of stuff you do.
For example, when ETX / OvalX was sold earlier this year, no one bought out its technology or licences, or at least they haven’t done that yet. What they did do was strip out the client book, with Capital taking most on a CPA-type agreement and Alvus / Intertrader onboarding Sports Direct. HonorFX was also acquired by Orbex a couple of weeks ago and it seems like it may be on a somewhat similar basis, perhaps with licences included.
As you can infer from that, your client book is probably your best asset. Clients are annoying to acquire and if you can get a book then that is great. How much the buyer is willing to pay obviously depends on its quality.
To think about this in another way, if you looked at the client book as a whole and then looked at how revenues were generated vs the time the client had been with your firm, the bigger the share of revenue generated by long-term clients, the better the client book.
ETX / OvalX was probably a good buy as it likely had a decent number of mid-50s ADVFN lurkers that like punting semi-regularly. HonorFX probably had IB churn clients from Vietnam that will burn out in <12 months>
The other thing that can attract a buyer is a licence. In theory, you could say that a licence is often costly and time intensive to acquire. The price might therefore be something like…
Cost x (1+r)^t
However, you only have to check Telegram or LinkedIn to see these being shifted constantly. With the exception of maybe that much vaunted Belize licence, that suggests there isn’t going to be massive demand for them. And that being the case, if you only get one buyer for your licence then you probably aren’t even going to get the amount generated by using the formula I just made up…which people definitely use. Definitely.
The final part that might be of interest is tech. You may have your own platform, for example, or some MetaQuotes licence. This is probably going to be the least interesting part for any buyer, for the simple reason that…
1) Another broker is going to buy you
2) Unless their business is even worse than yours, they have a trading platform already
Given that no one appears to have acquired ETX / OvalX’s ‘tech stack’, this suggests that even proprietary platforms that cost a lot to develop may not be worth that much. Which brings us to a tale one of my cousins told me a few years ago.
He was running a business that wasn’t working well, so he called in another relative, an accountant, to try and see if he could figure out what the problem was. After a few days looking through the accounts, this other relative emerged from his office and said he’d figured it out.
“Your problem,” he said, “is that you are spending more money than you are making.”
As you can imagine, my cousin was not happy with this initially but came to realise that he’d been overthinking everything – that was the problem. Today a lot of brokers seem to be in a similar position.
Given that many are basically high churn, offshore licenced firms, with a platform that all their peers already have, the question is whether, if the time comes to turn in the towel, there will actually be anything of value left.
