ABC arbitrage — Equity markets remain calm

ABC arbitrage (PAR: ABCA)

Last close As at 20/06/2024

3.83

0.02 (0.39%)

Market capitalisation

229m

More on this equity

Research: Financials

ABC arbitrage — Equity markets remain calm

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.

Milosz Papst

Written by

Milosz Papst

Director, Financials

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

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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United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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CI Games’ H123 results were reasonably robust, underpinned by continued strong back catalogue performance, especially Sniper Ghost Warrior (released in 2021) and releases from United Label. We are expecting a substantial revenue and profit uplift following the launch of Lords of the Fallen (LotF) on 13 October, with lead indicators continuing to look positive. Borrowings increased to invest in the development and commercialisation of new releases including LotF, Project Scorpio and the group’s new Survival title. Its current pipeline shows management’s efforts to expand its IP portfolio, entering the increasingly popular survival genre as indicated by strong comparable sales. We expect LotF profits to return CI Games to a strong net cash position by year-end, and we will update our forecasts shortly following the release.

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