“Cutting wages does not reduce costs – it increases them. The only way to get a low-cost product is to pay a high price for a high grade of human service”
– Henry Ford
This week I have been reading The Loyalty Effect, by Frederick Reichheld and I have to say it is one of the better books I read in a long time. The premise underlying the book is that when firms focus on attracting and retaining the right customers, employees and investors it ultimately leads to superior economics. Reichheld is the father of the Net Promoter Score and throughout the book he uses several case studies of firms that he calls “loyalty leaders” to link the theory to actual outcomes. I highly recommend the book to any person involved in any type of business as there are many highly applicable concepts in the book that you could implement in your own firm.
The stock news that caught my eye this week, was a trading update by AIM listed FX company, FairFX. The company is a provider of pre-paid FX cards foreign money transfers via a cloud based P2P platform and they just announced that they will report their maiden pre-tax profit this half – earlier than expected. I think the company looks interesting because of the enormous operational leverage in the business model. The main costs are wages and marketing, both of which the company believes are sufficient to handle many times more transactions than they’re currently processing. Analysts at Cenkos reckon that given the strong top-line growth the company has been generating and the relatively fixed cost base, FairFX could be generating over £9m in PBT within 2 years. With a current market cap of around £60m and net cash on the balance sheet, the valuation doesn’t seem to be reflecting this growth potential.
However, on further inspection there are some concerns. Firstly, it looks like customer acquisition costs are increasing very quickly – in 2014 they spent £1.8m on marketing to attract 86,397 new customers (implied CAC of £20.83). But in 2016 they spent £3.3m to acquire 80,802 new customers (implied CAC of £40.84). There may be a sensible answer for this increase, i.e. they may be winning larger, corporate clients these days.
Another risk is the competitive dynamics of the industry. This is a highly competitive space and they are winning customers by providing a very tight FX spread. The strategy is that by being completely cloud based and not having any on premise locations to purchase/top up, they can charge a tighter spread than peers. However, barriers to entry don’t seem overly high and if they’re earning >30% operating it will likely attract competition. This could erode margins and operational leverage will work against them.
I’m going to have a meeting with the CEO while in London next week and will release a report if I progress any further. At this stage I hold no position.
This weeks further reading was rather limited as I’ve been busy preparing for a research trip over the next two weeks. The following articles caught my eye:
I won’t be positing much over the next two weeks while I’m away.
As always – happy hunting for those hidden compounders.