Funding Circle Share Price: Is Funding Circle A Buy?

Funding Circle is a stock-market listed company, registered as FCH for “Funding Circle Holdings” on the London Stock Exchange since autumn 2018. The Funding Circle share price is right down at 1/6th of its highs and it's unchanged since releasing its 2021 results three days ago. Is this price deserved or is Funding Circle a buy?

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

I only publicly write my buy-or-sell opinion on a share investment if I have very strong convictions about it, based on what I believe to be excellent insight into and understanding of the business and its valuation.

I assure you, that doesn't happen often. Indeed, this has happened just four times since co-founding 4thWay, which is ordinarily focused on helping people to make more money, more safely, through online direct lending, which we call peer-to-peer lending.

However, one of those times is today, on Funding Circle. Ironically, Funding Circle announced at the same time as its results that it won't re-open its P2P lending operations after pausing them during the pandemic. So I'm stretching 4thWay's remit to the limits by covering its shares while the last P2P loans are being repaid!

Before you take the time to assess Funding Circle's business, let's make sure these kinds of shares are potentially of interest to you, based on your own investing wishes and style.

Here in a nutshell are the four basic things I think you need to know to see which investors might find it worthwhile to take the time to assess Funding Circle for investment:

• It was valued at £1.5 billion ($1.98 bn) at its initial public offering and is now valued at £259 million ($342 m). Put another way, its share price started at £4.40 ($5.81) in 2018 and fell to 70p (92c).
• It made a loss for 12 straight financial years since it started, before finally making an annual profit in the past year, according to results released this week.
• Funding Circle is now forecasting lower revenue in the short term – 25% down on last year – due to anomalies around pandemic lending and shifts in its business.
• Funding Circle UK remains far larger than Funding Circle US, even though the market on the other side of the Atlantic is enormous. Investors' can only salivate about large markets for so long before many ask when they'll get to sample its caramelised almonds for themselves.

Now, those four things don't give you any insights whatsoever into whether Funding Circle a good investment. But they provide some clues as to whether these shares might fit your style and are worth investigating further. Here's what I make of it:

Is Funding Circle for investors with a Warren Buffett style?

No.

If you prefer to invest in businesses that have reached stable profitability and investor trust for a long time, or that have proven through results that they have a durable competitive advantage or the ability to rake in cash – Warren Buffet-style – this one is clearly not for you.

Is Funding Circle for investors with a 10-year investing horizon?

Yes.

I think that it's worth reading on to find out if Funding Circle is a buy if you like to invest over a long time period of 10 years or more. The Funding Circle share price will surely swing wildly in between.

Today's investors must give it the runway it needs to grow into a business that investors with more of a Buffett-like style will be interested in buying into. By that point, they'll be willing to pay a higher price for the shares that you sell them.

Is Funding Circle for investors who want to sell in one or two years?

No.

Last time I wrote about Funding Circle shares, I said that right now they are certainly not for the kind of rapid trader who likes to buy shares and sell them soon afterwards for a great profit. (Indeed, the share price halved after that, nicely demonstrating my point about the expected wild swings over short periods.)

I don't see the share price halving again any time soon, but I do expect its lower revenue forecasts to suppress its price in the short term, as share prices are often driven by short-term thinking. The risks might be a bit lower for short-term share investors than a year ago, but the rewards over these timeframes are simply not certain enough. Not by a long shot.

About Funding Circle

Funding Circle operates in the UK and US. It was founded as the first peer-to-peer lending company to arrange loans directly between investors and small businesses. These are called small business loans in the US and SME loans in the UK.

Since the pandemic started, it's mostly been doing government-backed business loans in both countries, funded by financial institutions and Funding Circle itself. It's now transitioning to ordinary, non-P2P, non-pandemic business lending.

Funding Circle as a non-P2P lending business

Funding Circle has now ditched plans to return to P2P lending. While I suspect this change makes some share investors uncertain, it actually shouldn't matter; it's Funding Circle's job as a listed company to find the best way to earn fees or interest on loans, and ultimately to achieve rising profits for shareholders.

Indeed, since Funding Circle floated on the stock market, I've been explaining to journalists that P2P lending could well prove to be one of those industries where the users of its services get the vast bulk of the rewards, rather than their shareholders.

In this case, I'm referring to its lender customers, who receive the bulk of the gains from lending to borrowers, which therefore lowers the profits of the company itself. This is a reversal of banks, where savers are paid a pittance and the bank profits off our money.

One way or the other, Funding Circle will find ways to fund borrowers and earn fees from this, as it isn't the hardest part of its business model. In short, if it believes its own best path lies in being a non-P2P business, then that's what it'll do.

How big a lender is Funding Circle?

At the end of 2021, Funding Circle had £4.46 billion ($5.89 bn) in loans under management, a figure that has risen every single year by at least 20%-30%. Four-fifths of that is in the UK, where most of the growth has come from so far.

In the UK, it's grown to be one of the biggest lenders to SMEs and it has approved more than its fair share of pandemic loans. It's done this partly down to its competitive advantages in technology, which I'll get to shortly.

Funding Circle's non-pandemic lending

Institutional lending

Funding Circle's non-pandemic lending is funded mostly by institutions. In addition to straightforward small loans to businesses, it's been moving into loans secured against business borrowers' customer invoices (invoice factoring) and into overdraft-like credit facilities. A credit card for businesses is also on the way, as well as buy now, pay later products.

Funding Circle earns fees from borrowers and from the institutions funding the loans.

Funding Circle lending

Funding Circle also generates revenue from its own investments by lending in the same sorts of loans. These are loans it has funded to businesses by itself in the UK and the US, and it earned around £40 million on this lending last year, which is a small and shrinking portion of overall lending, as it shifts its lending model.

Competitive advantages

Regardless of where its borrowers get their cash from, Funding Circle's focus has been on technology to improve both the speed and accuracy of its underwriting processes.

Underwriting speed

It now makes an instant decision on over half of its loan applications, which is substantially better than its competitors. In the UK, this figure is now an astounding 70%.

This advantage isn't likely to last forever. Large competitors even now will be improving their speeds and a lot of new third-party technology providers can help them. Funding Circle will need to try to get as much market share as possible before they catch up.

However, history has repeatedly shown that banks can take a long time to adapt, just as they did when Capital One's machinery first started going, for example.

Underwriting accuracy

Funding Circle claims that one of its highlights is that its underwriting is three times more accurate than the assessment provided by credit-reference agencies, leading to good overall lending results, even taking the pandemic into account.

Funding Circle is far from the only lender to combine different sources of data and analysis to perform better than using credit reports alone. Other lenders also have vast historical loan books on which to base their future assessment of borrowers.

With no detailed data, it's not possible to compare Funding Circle's accuracy with the competition. Nevertheless, being three times more accurate is easily within the realm of providing a high-quality loan book with sensible borrower interest rates.

Funding Circle isn't a bank

Another thing that Funding Circle has going for it is that it's not a bank. Banks' reputations with borrowers are often not very good, to put it mildly. Simply being a large lender that isn't a bank gives it an advantage in securing many jaded customers.

Potentially, therefore, Funding Circle doesn't need to price rates quite as low as a typical bank, on average. At the very least, its potential customers will be more positive-minded about applying for a loan through them.

Market size

In a fast-growing business, you have to talk about market size and potential with a very large grain of salt, but there's a thoughtful combination of two statistics that Funding Circle uses which shows serious promise.

In OECD countries, around half the combined economy is supported by the small businesses of the kind that Funding Circle serves as borrowers.

Meanwhile, the percent of banks' lending to these businesses is just 2% of their entire lending, even though banks are the main lenders in these kinds of loans.

The disparity between those two figures is so large that, absent some extraordinary hidden explanation, businesses have been underserved by banks and Funding Circle has a strong case when it says the market potential is huge.

Funding Circle's assets and borrowings

This is a company where its net assets are now higher than the company's entire market valuation. At the end of 2021, it had net assets of £288 million ($380 m) up 32% from a year earlier.

Included in those assets is £224 million ($296 m) in cash, up 117% on a year earlier, all generated from operations. This means that its valuation at the start of the day at £259 million ($342 m) is actually lower than the sum of its assets and borrowings.

Borrowings and other outstanding bills are now down by about half to £278 million ($367 m). They were £565 million ($746 m) a year earlier.

That is a bit of an anomaly though, rather like its total (non-net) assets, which is £566 million ($747 m) down from £782 million ($1.03 bn). The large reduction is caused by weird accounting rules that mean Funding Circle often has to put loans made to businesses in its own accounts, as if it did the lending itself, even when it really just arranged the loans and the lending was done by other institutions.

Funding Circle also then needs to put a debt entry on the accounts to show that it must pay back the actual lending company. Even though it doesn't have to pay them anything – the small-business borrowers do. So the large reduction in both assets and borrowings is because its been winding down a lot of the kind of lending that is accounted for in this way. Basically, it's artificial and can be ignored.

Profitability, P/E ratio and trajectory

This time last year I wrote that Funding Circle's results have improved as it matures. Its results since then have been especially impressive, particularly on the bottom line: profit.

Looking back, Funding Circle made an overall loss in 2020 of £108 million ($143 m). These came from very large losses on its own higher-risk investments, totalling £118 million ($156 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 million ($112 m) in 2019.

The second half of 2020 was extremely strong for Funding Circle, though, and a big turnaround from the massive, initial shock of the pandemic. It's from here that it finally started making very solid, half-yearly profits for the past 18 months to the end of 2021.

In 2021, it made a full-year profit of £64 million. This is before tax, as we don't have that figure yet, but it's still a highly satisfactory result.

We can finally begin to estimate its P/E ratio as a profitable company. Based on the share price this morning and 2021 results, the P/E is extremely low, probably at around 5.20.

For a fast-growing business with potential, I think this is a superbly attractive P/E. It will become completely outdated as Funding Circle continues its huge momentum.

Profit/loss (in £ millions)

Profits/losses	2021	2020	2019	2018
Operating profit/loss	64.2	-106.3	-84.7	-51.6
Finance income	0.1	0.4	1.8	0.9
Finance costs	-1.1	-1.4	-1.2
Share of net loss of associates	-0.9	-0.8	-0.1
Profit/loss before taxation	64.1	-108.1	-84.2	-50.7
Income tax	Not yet known	-0.2	-0.5	1.4
Profit/loss for the full year	Not yet known	-108.3	-84.7	-49.3

Revenue

Revenue in 2021 was £207 million ($273 m), which is nearly triple that of 2017, where it was £95 million ($125 m). Loan fee revenue has been stable for a few years, with £166 million ($219 m). Investment revenue after investment expenses was two-times higher than 2019 at £41 million ($54 m).

Revenue was, however, down some on 2020, and Funding Circle expects it to drop further over this year by around a quarter, although it will still be around double that of 2017. It will then grow again, as borrowing through its service normalises post-pandemic. It's forecasting revenue about 40% higher in 2025 than in 2021.

Revenue (in £ millions)

Revenue	2021	2020	2019	2018
Transaction fees	115.0	122.5	121.2	112.9
Servicing fees	47.0	30.2	30.4	24.9
Other fees/revenue	3.5	3	5.3	4.1
Fee income	165.5	155.7	156.9	141.9
Investment income	53.7	89	28.3	0.0
Investment expenses	-12.3	-22.7	-7.9	0.0
Net investment income	41.4	66.3	20.4	0.0
Net income before fair value adjustments	206.9	222	177.3	141.9
Fair value losses/gains (on valuation of investments)	28.6	-118.3	-9.9
Net income	235.5	103.7	167.4	141.9

Operating expenses

After a cost-cutting drive that was very much appropriate at this stage in its business, operating expenses in 2021 were £81 million ($107 m) lower than two years ago, now standing at £171 million ($226 m). A large part of this reduction has been due to a more targeted advertising and branding spend, which didn't dent its lending volumes.

Operating expenses (in £ millions)

Expenses	2021	2020	2019	2018
People costs	-77.7	-85.3	-90.3	-79.2
Marketing costs (excluding employment costs)	-46.9	-46.8	-66.5	-57.8
Depreciation, amortisation and impairment	-17.8	-30.9	-49.2	-8.2
Other costs	-28.9	-47.0	-46.1	-48.3
Operating expenses	-171.3	-210.0	-252.1	-193.5

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 four annual results and reports, Funding Circle's 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 economics on the expenses side seem to be of no concern.

Other items

Funding Circle is a straightforward business with straightforward accounts, relative to many other financial businesses. For example, 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 only extraordinary item to understand, usually, is when there are larger losses due to a major downturn, like in the first half of 2020.

Cash flow is extremely important in a business, but Funding Circle is loaded with cash and it's now profitable, so I haven't covered it in any detail above. It's simply not a concern.

There are no particular items in the accounts or results in any of its first four years as a public company that I think require your attention, other than those I have pulled out for you above.

Funding Circle shares are a buy

I'm extremely delighted to see that the market hasn't reacted by surging into Funding Circle shares and raising the price. Indeed, they're now a couple of pence lower than after the results came out.

Apparently, the typical investor is missing the insights that they need into Funding Circle as a business, its competitive strengths and the likely trajectory in the coming years. They are wary.

Most likely that's down to the typical short-term investor-think, related to its lower revenue forecasts for this year. Perhaps its also that Funding Circle is changing its business model away from P2P lending, and they're unable to assess the risks.

Funding Circle's profits are going to be considerably higher in the future than they are today and this will ultimately be recognised in its share price and P/E ratio. I see no reason to wait until the average market investor recognises this and pushes the price up.

I consider Funding Circle a strong buy. Indeed, I would have still considered it a strong buy if its share price hadn't halved from this time last year.

As usual, be very patient and be prepared for extreme fluctuations along the way.

Visit Funding Circle.

Funding Circle's share investor reports.