ABC arbitrage — Equity markets remain calm

Financials

ABC arbitrage

Equity markets remain calm

Company update

Financials

4 October 2023

Price	€5.86
Market cap	€349m
£0.867/€

Shares in issue		59.6m
Free float		51.9%
Code/ISIN	ABCA/FR0004040608

Primary exchange		Euronext Paris
Secondary exchange		N/A

Share price performance

%	1m	3m	12m
Abs	(4.2)	(1.3)	(7.7)
Rel (local)	0.2	4.4	(22.5)

52-week high/low

€6.81

€5.79

Business description

ABC arbitrage is a quantitative trading and asset management business specialising in a range of market-neutral arbitrage strategies (liquidity, statistical, risk and derivatives arbitrage). The company also manages third-party capital (c €185m at end-H123).

Next events

10 October 2023	€0.10 ex-dividend date
5 December 2023	€0.10 ex-dividend date

Analysts

Milosz Papst	+44 (0)20 3077 5700
Michal Mordel	+44 (0)20 3077 5700
Alastair George	+44 (0)20 3077 5700

financials@edisongroup.com

Edison profile page

ABC arbitrage is a research client of Edison Investment Research Limited

ABC arbitrage group (ABCA) reported net income of €8.8m in H123, down 46% y-o-y, which in our view represents a reasonable result amid unfavourable market conditions. The market continues to be characterised by low volatility and limited M&A activity, weighing on ABCA’s main arbitrage strategies. After the end of June 2023, both ABCA Opportunities and ABCA Reversion funds managed to show strong performance, improving the outlook for the H223 results. Meanwhile, ABCA’s AUM remained flat in H123. The company reiterated its intention to pay out 80% of profits in dividends, with a minimum DPS of €0.30.

Year end	Revenue (€m)	EBITDA (€m)	EPS* (€)	DPS (€)	P/E (x)	Yield (%)
12/21	64.3	37.1	0.48	0.40	12.2	6.8
12/22	61.4	30.8	0.49	0.41	12.0	7.0
12/23e	45.6	20.0	0.30	0.30	19.3	5.1
12/24e	62.1	28.8	0.45	0.36	13.2	6.1

Note: *EPS is as reported by the group.

Flat third-party AUM

An equity bull market and a low volume of trades (STOXX 600 Europe and US traded volume down 21% and 15% y-o-y in H123, respectively) benefit long trades. At the same time, low volatility and low M&A activity make it difficult to market ABCA's strategies successfully to new potential investors. Indeed, ABCA did not attract any meaningful amounts of third-party capital in H123 and, according to management, until September 2023. In turn, we cut our expectations of net inflows in 2023 to zero. At the same time, ABCA remains confident that the current rally in equities is nearing its end, as the P/E and Shiller ratios are currently among the highest in the last 100 years, which should result in increased volatility and increase the attractiveness of its offering. We agree that volatility is likely to increase in the event of an economic downturn.

Valuation: Not reflecting any net inflows

ABCA Reversion and ABCA Opportunities funds showed good results over the 12 months to end-August (+8.6% and +6.8%, respectively) as ABCA managed to benefit from movements in the VIX curve and narrowing of pre-merger discounts, despite underlying volatility and M&A activity remaining low. In turn, we increase our FY23 net income forecast by 19% to €18.1m (which implies that the H123 results fulfil 49% of our FY23 estimate), while retaining our long-term expectation of ABCA’s funds’ annual results. On the other hand, the lack of new capital inflow in 2023 results in slightly lower estimates, and as a result we arrive at a fair value estimate of €6.68 per share, broadly in line with our previous estimate (down 2%). Our current estimate implies 14% upside potential over the current share price and, assuming no capital inflows, our bear case scenario implies 0.4% upside. Assuming that ABCA manages to reach its Springboard 2025 target of €800m third-party capital by 2025, we see 39% upside to the current share price, although we would not be surprised if ABCA revisits its plan alongside its FY23 results.

H123 results: In line with market conditions

The first half of 2023 was characterised by low volatility and M&A transactions have not accelerated to the extent that they fully offset lower revenues from volatility-based strategies. As a result, ABCA’s net revenues decreased by 36% y-o-y to €20.2m, of which €18.9m came from investing its own capital and €1.3m (7.8% of total fee income) from management fees on third-party capital. ABCA did not attract any meaningful amounts of new capital (AUM was flat over H123), as management highlights that in the current conditions of steady growth (S&P 500 up 15% in H123) and low volatility (VIX Index at 14% at end-H123 compared to 26% on average in 2022), investor interest in ABCA’s products is subdued.

The H123 results were also affected by global developments. ABCA no longer uses any strategies on Russian securities, which historically delivered net revenues of €0.5–1.0m annually. At the same time, it is not currently trading in cryptocurrencies, as the collapse of several services providers (see our March 2023 commentary) has left some infrastructure gaps across the digital assets sector. ABCA needs to secure contracts with new service providers, alongside regulatory approvals. According to our discussions with management, crypto-based strategies delivered c €1.5m annually in net revenues (in H123 cryptocurrency strategies delivered less than €0.25m in revenue).

Meanwhile, ABCA continues its expansion plan Springboard 2025 (see our initiation note for details) and increased its headcount to an average of 107 people in H123 (from an average of 95 in 2022). While its payroll costs are predominantly results driven and overall were 30% lower y-o-y in H123, higher fixed salaries resulted in a return on equity of 11% (H122: 20%).

ABCA continues to pay a €0.10 dividend per share quarterly and confirmed the next two payments (ex-dividend in October and December) of €0.10, implying a 6.8% annualised yield on the current share price. Meanwhile, we expect that ABCA will be able to pay only its minimum target dividend of €0.30 per share from FY23 profits, which implies that it will either decrease its third and fourth quarterly dividends, or not make the final distribution (usually paid in July). The annual €0.30 DPS implies a 5.1% yield.

Exhibit 1: H123 results highlights

	H123	H122	y-o-y
Investment services fees	9.0	14.9	(40%)
Net gains at fair value through profit or loss	11.2	16.6	(33%)
Net revenues (€m)	20.2	31.5	(36%)
Payroll costs	(7.4)	(10.6)	(30%)
Other expenses	(4.0)	(4.7)	(15%)
Net income (€m)	8.8	16.2	(46%)
Earnings per share (€)	0.15	0.27	(44%)
Return on equity	11.1%	20.2%	(9.1pp)

Source: ABC Arbitrage

Outlook and forecast revisions

ABCA calculates that performance fees earned on third-party capital in H123 amounted to €0.3m on a pro forma basis (a performance fee is charged once a year, at end-December), and remains confident in the full-year figure of c €1.5m as both ABCA Opportunities and ABCA Reversion showed a meaningful revival in performance after June 2023. The reversion strategy benefited from movements in the VIX curve and managed to capitalise gains on VIX-based contracts (allowing it to improve returns even as volatility remained at a low level) and the risk arbitrage strategy benefited from overall compression of discounts in the market (resulting in positive mark-to-market performance), assisted by improved sentiment towards pharma M&A after the US Federal Trade Commission struck a deal with Amgen over the Horizon Therapeutics acquisition.

In September, ABCA changed the structure of its Opportunities Fund and will not allocate part of the fund into ABCA Reversion, keeping the funds separate. At the same time, it will retain the allocation to strategies with a similar risk profile to ABCA Reversion, and we believe this change will not affect the future results materially. A detailed description of the strategies implemented by ABCA can be found in our initiation note.

So far in 2023, volatility in both the US and European markets is limited (the annualised standard deviation of daily returns stands at 12% for the S&P500 and 10% for the STOXX600 compared to 24% and 19% respectively in 2022) and we expect volatility to remain subdued for the remainder of 2023. ABCA estimates the realised volatility so far in 2023 at 14% in the US and 15% in Europe, and expects them to return to their usual long-term levels of 16% and 19% in 2024, as it believes the ongoing equities rally may be nearing an end. We share the company’s view that volatility is likely to increase in the event of an economic downturn, of which there is increasing evidence; underlying macroeconomic data are not particularly encouraging, as the manufacturing purchasing managers’ indices have remained below 50 points in both the eurozone and the US for several months now, and at the same time equity valuations look demanding (the S&P 500’s forward P/E ratio is now 15% above its 20-year average).

Based on the above assumptions, ABCA expects FY24 EPS of €0.42 in its Average+ scenario (see Exhibit 2). It expects to be able to relaunch its digital assets strategies in early 2024 and potentially launch a crypto-based product to external investors by mid-2024.

Exhibit 2: FY24 business plan

Scenario	ABCA equity (€m)	ROE	Recurring net income (€m)	Third-party AUM (€m)	EPS (€)	DPS (€)	Average realised volatility* (%)
Minimum	165	10%	17	350	0.28	0.30	<16/19
Average +	170	15%	25	500	0.42	0.33	16/19
Excellent	175	20%	33	700	0.55	0.44	>16/19

Source: ABCA. Note: *Annualised standard deviation of daily returns of equity markets in the US and Europe.

We have increased our expectations of ABCA Reversion's performance in FY23 to 8.6% (from 2.9%) and left our expectations for ABCA Opportunities’ performance broadly intact at 6.8%, on the back of the funds’ post-June 2023 returns; our assumptions are in line with the realised performance over the 12-month period ending 31 August 2023. We reiterate our assumption that over the long term, the strategies should deliver average annual returns of 11% and 8%, respectively. We have also trimmed our estimates for headcount in line with the pace of new hires. We have reduced new third-party capital inflow in FY23 to zero, while keeping the expectation of ABCA’s ability to attract €50m in new capital a year (€80m in FY24 due to expected new product launch). As a result of all the above, we increase our FY23 net income forecast by 19% (predominantly due to our expectations of the funds’ higher return), while reducing FY24–27 net profit by c 2% each year (due to lower AUM).

Exhibit 3: Forecast summary

€m, unless otherwise stated*	2022	2023e	2024e	2025e	2026e	2027e
Revenues – internal equity	57.4	40.3	54.6	55.2	55.7	56.2
Third-party AUM	185.6	200.7	303.1	382.8	467.5	556.9
Revenues – third-party capital	4.0	5.3	7.5	9.8	11.5	13.2
As % of average AUM	1.4%	2.7%	3.0%	2.8%	2.7%	2.6%
Total revenue	61.4	45.6	62.1	64.9	67.2	69.4
Operating expenses excl. D&A	(30.6)	(25.6)	(33.3)	(35.6)	(36.4)	(37.3)
EBITDA	30.8	20.0	28.8	29.4	30.8	32.1
Net income	29.2	18.1	26.5	27.0	28.3	29.5
EPS (€)	0.49	0.30	0.45	0.45	0.47	0.49
ROE	18%	11%	16%	16%	16%	16%

Source: ABC arbitrage, Edison Investment Research. Note: *Year ending 31 December.

Valuation

We see ABCA’s current valuation as undemanding, and our base case scenario implies 14% upside to the current share price. We believe that FY23 results represent earnings at the bottom of the cycle and at the current price, ABCA shares may be considered an attractively priced option on increased market volatility for investors. We continue to value ABCA’s shares using a DCF approach based on three scenarios, and we have slightly adjusted the taxation to better reflect income from third party capital. In our base case scenario, which assumes moderate inflow of third-party capital, we arrive at a fair value estimate of €6.68 per share, with 14% upside to the current share price (down 2% on our previous valuation). Our base case forecast implies a P/E ratio of 13.2x 2024e EPS. As a point of reference, Man Group, Virtu Financial and Flow Traders currently trade in the range of 6.7–8.2x based on Refinitiv consensus. However, we note that none of the companies acts as a direct comparator.

In our bear case scenario, we value ABCA as it is – without any additional capital raised from third-party investors – and arrive at a fair value of €5.88 per share (0.4% upside). Alternatively, assuming ABCA will be able to attract external capital in line with its Springboard 2025 target, we arrive at a fair value of €8.14 per share, which suggests 39% upside to the current share price.

Exhibit 4: ABCA’s DCF valuation model

€m, unless otherwise stated*	FY23e	FY24e	FY25e	FY26e	FY27e
EBIT	18.3	27.1	27.7	29.1	30.4
Excess gains adjustment	0.0	(0.9)	(1.7)	(2.6)	(3.6)
Tax rate	1.0%	1.8%	2.3%	2.6%	2.9%
Net operating profit less adjusted taxes	18.2	25.8	25.4	25.8	26.0
D&A	1.7	1.7	1.7	1.7	1.7
Change in working capital	0.0	0.0	0.0	0.0	0.0
Capital expenditures	(1.7)	(1.7)	(1.7)	(1.7)	(1.7)
Free cash flow to firm	18.2	25.8	25.4	25.8	26.0
Discounted free cash flow to firm (DFCFF)	16.7	22.8	20.7	19.4	18.0
WACC	8.5%
Terminal growth rate	2.0%
Sum of DFCFF	89.2
Terminal value	284.7
Enterprise value	374.0
Net debt/(cash) end-2022	(16.8)
Equity value	390.8
Share count (fully diluted) (m)	59.8
Fair value per share (€) end-H123	6.54
Fair value per share (€) current	6.68
Current share price (€)	5.86
Upside/(downside)	14%

Source: Edison Investment Research. Note: *Year ending 31 December.

Exhibit 5: ABCA’s valuation sensitivity to WACC assumption

WACC	5.5%	6.5%	7.5%	8.5%	9.5%	10.5%	11.5%
Fair value per share (€)	12.13	9.50	7.83	6.68	5.83	5.19	4.68

Source: Edison Investment Research

Exhibit 6: Financial summary

Year end 31 December, IFRS, €000s	2018	2019	2020	2021	2022	2023e	2024e	2025e	2026e	2027e
Income Statement
Investment services fees	16,757	14,423	22,504	59,921	27,438	24,941	34,134	36,540	38,415	40,179
Net gain/loss on financial instruments at fair value through profit or loss	23,133	22,520	46,023	4,134	33,711	20,286	27,625	28,033	28,435	28,831
Total revenues	40,232	37,246	69,108	64,342	61,437	45,592	62,124	64,938	67,215	69,376
Payroll costs	(12,778)	(11,654)	(25,519)	(19,823)	(21,518)	(16,964)	(24,140)	(25,944)	(26,615)	(27,274)
Administrative expenses	(6,214)	(6,723)	(5,467)	(5,769)	(6,249)	(7,501)	(7,866)	(8,217)	(8,570)	(8,741)
Other operating income/(expenses)	(865)	986	(455)	(1,356)	(2,535)	(1,093)	(1,343)	(1,389)	(1,245)	(1,283)
EBITDA	20,032	19,552	37,086	37,107	30,847	20,034	28,775	29,388	30,786	32,078
EBIT	19,118	18,072	35,467	35,371	29,156	18,343	27,084	27,697	29,095	30,387
Pre-tax profit	19,318	18,073	35,440	35,353	29,091	18,277	27,020	27,633	29,032	30,323
Net income	19,679	18,339	35,093	28,038	29,151	18,095	26,530	27,008	28,285	29,460

EPS (€)	0.34	0.31	0.60	0.48	0.49	0.30	0.45	0.45	0.47	0.49
DPS (€)	0.43	0.33	0.48	0.40	0.41	0.30	0.36	0.36	0.38	0.40

Balance Sheet
Property, plant and equipment	973	1,057	1,392	1,166	1,236	1,520	1,520	1,520	1,520	1,520
Right-of-use assets	0	1,815	932	5,385	4,771	4,577	4,577	4,577	4,577	4,577
Intangible assets	188	174	126	99	118	172	172	172	172	172
Non-current financial assets	603	620	625	630	669	364	364	364	364	364
Deferred tax assets	389	167	113	269	79	70	70	70	70	70
Non-current assets	2,153	3,832	3,188	7,550	6,873	6,704	6,704	6,704	6,704	6,704
Financial assets at fair value through profit or loss	133,901	127,363	150,319	133,986	154,175	159,875	169,524	179,127	184,811	190,891
Other accounts receivable	8,690	7,155	10,569	25,410	12,051	9,545	9,545	9,545	9,545	9,545
Current tax assets	281	214	215	0	0	0	0	0	0	0
Cash and cash equivalents	6,958	7,789	8,767	18,252	14,226	9,305	4,962	760	734	546
Current assets	149,830	142,521	169,870	177,648	180,452	178,725	184,031	189,432	195,089	200,981
Total assets	151,983	146,353	173,058	185,198	187,325	185,429	190,735	196,136	201,793	207,685
Share capital	936	936	936	949	954	954	954	954	954	954
Share premium	59,472	47,517	47,517	39,752	41,441	41,441	41,441	41,441	41,441	41,441
Net income	19,679	18,339	35,093	28,038	29,151	18,095	26,530	27,008	28,285	29,460
Retained earnings	66,204	73,110	70,484	91,285	90,110	101,378	98,249	103,172	107,553	112,270
Total equity	146,291	139,902	154,030	160,024	161,656	161,868	167,174	172,576	178,233	184,125
Lease liabilities	0	0	0	1,133	1,301	1,321	1,321	1,321	1,321	1,321
Taxes payable	0	0	0	5,431	5,394	5,436	5,436	5,436	5,436	5,436
Other liabilities	5,642	4,161	17,879	14,356	14,575	12,702	12,702	12,702	12,702	12,702
Current liabilities	5,642	4,161	17,879	20,920	21,270	19,459	19,459	19,459	19,459	19,459
Non-current liabilities	50	2,292	1,148	4,255	4,400	4,102	4,102	4,102	4,102	4,102
Total equity and liabilities	151,983	146,355	173,057	185,199	187,326	185,429	190,735	196,137	201,794	207,686

Ratios
ROE	13.3%	12.8%	23.9%	17.9%	18.1%	11.2%	16.1%	15.9%	16.1%	16.3%

Source: ABC arbitrage, Edison Investment Research

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London │ New York │ Frankfurt

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