Current Price: £0.94
Target Price: £1.48
Expiration Date: Q1-Q2 2021
This idea was shared by Cheese99.
ThinkSmart is a holding company with 6.5% ownership in the UK’s largest buy-now-pay-later company Clearpay + small remaining operations currently in wind down. The majority stake in Clearpay was sold to global buy-now-pay-later giant Afterpay in 2018 and the sale agreement included a put/call mechanism – Afterpay has a call option on the remaining 6.5% stake after August’23 and TSL has a put option exercisable after Feb’24. Since the sale in 2018, Clearpay’s growth has skyrocketed and TSL’s management started winding up remaining operations while waiting to unlock the value of the remaining minority stake in Clearpay. It seems that the time has finally come – under Clearpay’s sale agreement a change of control event gives Afterpay the right to exercise its call option at any time (not just after Aug’23). Afterpay is getting acquired by Square and the merger should close in Q1 2022. It is highly likely that Square/Afterpay will want to exercise the call as soon as possible in order to gain full ownership of Clearpay, thus unlocking the value for TSL shareholders.
TSL currently trades at a 21% discount to £1.235/share NAV. However, the NAV is significantly understated due to the conservative carrying value of the remaining 6.5% Clearpay stake. The stake stands at £1.17/share (£125m) and is discounted from independent evaluator assessment due to various issues (marketability, small private stake, etc.). Management itself states that the carrying value is conservative. Eliminating minority the discount would lift the value of the stake to £1.42/share putting the NAV at £1.48/share. Excluding Clearpay, the remaining NAV is mostly cash, while the operations in wind-down are cash flow positive. TSL management owns 41%+ of outstanding shares, so the interests seem to be very much aligned.
So there are 3 parts needed for the thesis to play out: (1) Successful closing of the Afterpay/Square merger; (2) Afterpay exercising the call option on Clearpay; and the riskiest one 3) Cash-out price of TSL’s stake in Clearpay being above carrying value.
I believe the first two are very likely to pass while the third one has more uncertainty. However, aside from the factors mentioned above, there are several other data points suggesting that the current carrying value of Clearpay’s stake is too conservative. Most importantly, the downside seems fully protected at current prices.
Background on TSL
ThinkSmart was founded in Australia in 1996 and commenced operations in UK seven years later. The company sold its Australian and New Zealand operations in 2014. With only UK business remaining ThinkSmart moved listing to London’s AIM exchange in 2016.
Clearpay has launched in March 2018 and in just 5 months, in August’18, ThinkSmart agreed to sell a 90% stake in Clearpay to Afterpay. The consideration stood at 1m Afterpay shares worth around £12m at the time. Under the sale agreement, out of the 10% TSL’s remaining stake – up to 3.5% belongs to Clearpay’s employee trust (ESOP), so TSL shareholders effectively hold only a 6.5% stake. The carrying value on the books (currently £125m) reflects only the 6.5% that belongs to shareholders (the management cuts out the ESOP part at the last step of the valuation assessment process).
Legacy operations include SmartCheck – digital credit underwriting system, Flexible Leasing – (platform for smartphone leasing service), and Upgrade Anytime (same but for a wider specter of gadgets). Since Feb’21 TSL is winding down its operations and as of June’21 had about £2.6m in lease receivables left from 6900 active customers. The contracts go up to 4 years. The company generated positive cash flow in FY21 and expects that to continue going forwards:
We are managing the wind-down by adjusting the cost base accordingly and are continuing to deliver net positive cash flows. Therefore, we expect our cash reserves to continue to build over the next few years.
TSL still provides some call center services to Clearpay (generated £0.9m revenues out of £4.3m total revenues in FY2021 ending June).
So far the company has already returned around £25m+ (£0.245/share) to shareholders by distributing relatively large special dividends in FY19, FY20, and most recently, in October’21. Following the recent distribution, the company should retained around £4m in cash (~£0.04/share).
(1) Afterpay/Square merger
The merger was announced on the 1st of August’21. Per-share consideration stands at 0.375 Square shares per each Afterpay share. Square shareholders have already approved the merger and all the regulatory approvals (US, NZ, AU, etc.), except for Spain’s, have also been granted. Afterpay shareholders were supposed to vote on the transaction on the 6th of December, however, the vote was adjourned due to delays in above mentioned regulatory approval, which is required due to very small Clearpay’s operations in Spain (150k+ clients vs 2.1m total for Clearpay or 16m+ for Afterpay). Given that all other regulators gave their consent, this delay really seems to be only a hiccup. Square and Afterpay are also confident in the eventual approval. From the most recent PR:
Afterpay and Square are confident that the Bank of Spain condition will ultimately be satisfied. Although the statutory deadline for Square’s application for the prior non-opposition of the Bank of Spain is currently February 21, 2022, at present Square expects that the non-opposition will be received in mid-January 2022.
Afterpay shareholder approval is also expected to pass. The company’s founders own 13.4%. Another 12% is owned by index funds. There has been no vocal opposition from shareholders so far. Overall, the combination was named a perfect fit by Afterpay’s founder. Afterpay’s buy-now-pay-later operations with the option to split payment and checkout will be incorporated into two Square’s segments – payment terminals/software to merchants and cash app (digital wallet for consumers).
The merger is likely to close successfully. The market seems to think so as well – only a 2% spread remains outstanding, most likely due to the remaining timeline and FX exposure (this is a cross-border transaction).
(2) Call option exercise
There are several arguments suggesting that Afterpay/Square will want to exercise the call option to buy out the minority Clearpay stake as soon as possible after the merger.
Firstly, the continued growth of Clearpay, the longer the buyout is delayed, the more expensive it will get. The 90% stake acquisition in 2018 has clearly been a slam dunk for Afterpay as the valuation of the UK’s operator has increased 100x fold during the last 3 years. From FY19 (ending June) to FY21 Clearpay has grown its clients and merchants base from basically nothing to 2.1m and 6.7m respectively. Clearpay’s clients now comprise 13% of Afterpay’s total clients (was 10% in FY20) and 12% of EBITDA. The growth of UK operations has clearly outperformed Afterpay’s other segments (APAC and NA – see graphs below) and the buyer itself has been mentioning that Clearpay’s growth was “better than expected”. In this light, the combined AFTPY/Square will likely want to consolidate one of its fastest-growing divisions and not leave the minority stake hanging for another 2+ years until TSL’s put option finally becomes exercisable.
From TSL’s factsheet:
Afterpay results FY21 (reports in AUD):
Afterpay results FY20:
Note: Underlying Sales reflects total turnover of products sold, while Segment Fee Revenue reflects the true revenue generated from merchant fees, etc.
Secondly, TSL’s management clearly expects the call option to get exercised shortly after the merger completion. and is highlighting this opportunity wherever they can (website, financial results, factsheet, etc). They also note that as Afterpay will become a privately owned company, the payment will have to be done in cash:
In addition, if the shares of Afterpay are no longer quoted on a recognized stock exchange at the time of the exercise then Afterpay can only elect to pay the exercise price in cash.
Finally, the payment for call option exercise would be a tiny part (1%) of the total consideration that Square is paying for Afterpay (£21bn initial consideration). Both companies certainly have more than enough cash to cover the buyout of Clearpay minority stake (over £4.5bn combined vs £125-£150m cost to cashout).
(3) Valuation of Clearpay stake
This is the most uncertain part of the equation and there are several data points that can serve as a reference.
But first of all, it is important to note that details on the actual valuation methodology for Clearpay’s minority stake are limited. TSL describes it like this (details on valuation can be found here):
The independent valuation process, in accordance with the agreed valuation principles, uses the same valuation metrics, multiples, and methodologies, including those used by market participants and with regard to sell-side analysts, to value the Clearpay business within the Afterpay listed group.
The key judgements that are critical to the valuation are the interpretation of the agreed valuation principles, market valuation of Afterpay Ltd in GBP equivalent, and the relevant proportion of this that relates to Clearpay, and the discount to be applied for minority holding and lack of marketability of Clearpay as a standalone entity.
The same “agreed valuation principles” will apply when evaluating the consideration for call/put options exercises.
Clearpay’s valuation (here) is done by a third-party global professional services firm and is updated every six months. The independent evaluator applies a “minority holding” discount, which until recently used to be 20%, however, in the latest annual report it was reduced to 17.5%. The evaluator then produces a range of values for the TSL stake after which management then takes two-thirds of the range suggested by the independent valuation. Finally, TSL management cuts out the employee trust (ESOP) part (35% of the stake held by TSL) to account only for the value attributable to TSL shareholders and ends up with a £125m valuation. Importantly, on TSL’s “Investment proposition” page and Factsheet management argues that this kind of discounting is “highly conservative”:
The Clearpay holding was conservatively valued at £125m as at 30 June 2021 for ThinkSmart’s year end accounts.
Highly conservative balance sheet underpins ongoing shareholder returns
Eliminating the 17.5% discount (as it should not apply for the buyout by controlling shareholder) would result in Clearpay’s stake valuation of £151m or £1.42/share. I think it should make sense at least directionally, especially given that Clearpay will have another half-year of growth by the cashout value is assessed.
Square’s offer (in stock) valued Afterpay at A$39bn (£21bn) at the time, which translated into 42x FY21 (June) revenue multiple. Using the same multiple the value of Clearpay’s stake would be worth £135m or £1.27 per TSL share based on Clearpay’s FY21 revenues ending Jun’21 (FY21 stood at A$92.4m). Valuation based on Dec’21 figures is likely to be even higher due to continued growth. It makes sense to think that Clearpay should be worth at least the multiple paid for Afterpay, given it is the fastest growing business within the company and has higher transaction/merchant fees (5% vs 4.5%-4.8% for other Afterpay segments). Clearpay’s Adj. EBITDA margins are somewhat lower, but the difference will likely disappear as Clearpay scales up. Market leader position in the UK, as well as fairly new and growing operations in continental Europe, might also contribute to premium valuation.
US peer Affirm IPO’ed this January at US$12bn valuation – 24x 2020 revenues and shares doubled on the first trading day. The company currently trades at 30x TTM revenues. However, Affirm’s growth profile is much weaker compared to Clearpay – revenues grew 93% in FY20 (ending June) and 71% in FY21 (vs 253% for Clearpay). Affirm’s growth slowed down even further to 55% YoY in the most recent quarter.
In Aug’20 Clearpay acquired Pagantis, a small European Buy-now-pay-later player, this way opening the door to expansion in Europe. The consideration was set in 3 parts: €5m initial payment + €45m guaranteed deferred payment in 3 years (so a total of €50m) + contingent consideration payment dependent on Pagantis’ EV 3 years after the acquisition. As of June’21, Afterpay was marking the contingent payment at £3.4m on its books. So let’s say in total the consideration for Pagantis stands at £46m. Meanwhile, Pagantis generated only around £1.6m in revenues in FY21, meaning Clearpay paid about 30x forward FY21 revenues multiple for the European operator.
Other points worth noting
- Afterpay records the Clearpay’s put option at A$99.9m (£53m) on its books, which is substantially below the carrying value on TSL’s balance sheet. However, this is the valuation for the put option (Feb’24) and not the actual TSL’s minority stake in Clearpay that would need to be cashed out in the next several months.
- Taxes. My understanding is that the sale of the remaining Clearpay stake will not be subject to UK Capital Gains taxes (18%). The previous 90% stake sale wasn’t due to Substantial Shareholder Tax exemption (more details here). Apparently, the conditions for this exemption are seller’s ownership of at least 10% of the target’s shares and being beneficially entitled to at least 10% profits and assets, in case of wind up. However, my knowledge on UK tax regulations is limited so take this with the grain of salt.