Tungsten Corporation — Update 23 February 2016

Tungsten Network, the core operating activity of Tungsten Corporation, participates in the global supply chain by allowing some 180 buyers to electronically process e-invoices from around 200,000 registered suppliers digitally rather than by paper and so allow buyers and suppliers to save costs. E-invoicing is a fast-growing business – Tungsten quotes an industry source (Billentis) forecasting compound annual growth of 20% per year in e-invoice volumes from 2010 to 2020, but it is fragmented and has historically been unprofitable for Tungsten with the buyers and suppliers obtaining virtually all of the benefits, as we explained in our January 2016 initiation note. The average EBITDA margin earned by Tungsten was c -14% from 2011 to 2015 inclusive and was -18% in H116.

Tungsten plans for Tungsten Network to achieve EBITDA profitability on a run-rate basis by the end of FY17 by undertaking the following measures:

In our initiation note we estimated that EBITDA break even could be achieved by FY17 and the EBITDA margin rise to 36% by 2020 if the company were to:

During the CMD Tungsten outlined various measures it is undertaking that it believes will enable it to achieve its financial targets. In the following sections we have grouped these into two categories, those that support revenue growth and those that help control costs.

In our initiation note we explained how an average buyer price of c £108,660 would be more than justified by the value buyers receive compared with paper processing. In H116 Tungsten managed price increases of 70% for 14 buyers. Though Tungsten did not give an update on the re-pricing achieved in Q316 during the CMD, it did elaborate on the measures it is implementing that it considers will contribute to revenue growth through higher pricing and increased buyer/supplier numbers. These include:

Standardising contracts. In the past Tungsten Network had bespoke contracts for each of its customers, which added considerably to its service costs. Even routine queries about the contracts had to be checked against the database, making the contracts comparatively expensive to service and inflexible. Moreover, many of them were found to “auto renew” and be “front-end loaded” so that Tungsten often found itself serving customers who were processing many times the number of invoices than envisaged when the contract was initiated. The contracts were renewed without the appropriate re-evaluations being made. Tungsten has been systematically going through all of its contracts to standardize them as much as possible, which should boost revenues and control costs.

Standard revenue model for buyers. This will consist of an implementation fee paid by the buyer when it joins the network, an annual fixed fee and a variable fee based on transaction volume. Previously Tungsten did not charge an implementation fee on a consistent basis despite the costs of on-boarding buyers and suppliers to its network. Tungsten believes the combination of fixed and variable transaction fees will offer favourable incentives for buyers to increase volumes through the Tungsten Network (more suppliers and more invoices per supplier) to cover the fixed costs.

Upgrading sales penetration. Tungsten has upgraded its saleforce so it is engaging with more influential individuals such as CFOs and corporate treasurers rather than the mid-level accounts payable executives with whom it was previously dealing. Tungsten believes that presenting itself as a strategic problem solver to organisations rather than just a processor of invoices will boost its revenues from buyers.

Working with partners. Tungsten is also seeking to expand its partnership offerings. It provides its e-invoicing service to the customers of a US bank, PNC, on a white-label basis and is aiming to develop similar partnerships elsewhere. This should reduce the cost of Tungsten to acquire additional customers and also boost revenue.

A holistic operating structure. Tungsten Network was originally organised into two pillars, one for buyers and one for suppliers. In the past, a buyer joining the network would tell Tungsten which suppliers it wanted to be on-boarded, then there would be insufficient contact between Tungsten staff looking after the buyers and those looking after the suppliers. Tungsten has found there needs to be a more holistic approach to reap on-boarding and cross-selling opportunities. Now one point of contact is responsible for both in an end-to-end process. This should be particularly helpful for on-boarding suppliers as Tungsten personnel will now be able to inform suppliers how keen the buyers (their customers) are that they join the Tungsten network. With knowledge about its suppliers, Tungsten sales teams should also be more effective in turning suppliers on the network into buyers of its services.

Improvements in IT. The Tungsten Network IT infrastructure was developed over 15 years and its predecessor organisation, OB10, was one of the pioneers in the field of e-invoicing. This has resulted in a network that was good for e-invoicing but was not state of art for undertaking other activities, including maintenance and expansion. Under a new chief technology officer (it did not have one before) Tungsten is revitalising its technology platform to implement current best practice across its businesses. Among the measures being implemented are:

Tungsten Network’s cost control ambitions rest heavily on its use of IT and digitalisation to lower costs of on-boarding buyers and suppliers and reduce the costs of processing invoices. Many of these IT initiatives are connected to those it is proposing to implement to boost revenue growth but they are so important for achieving its ambitions to control costs that we believe they should be reiterated in the context of saving costs. The main initiatives discussed at the CMD were:

Tungsten reiterated its ambition to develop a significant invoice financing business. It has appointed a senior figure from the banking industry with experience in invoice financing to head its revitalised invoice financing activities. He is due to start work in April 2016.

Tungsten’s initial attempts to develop invoice financing have not been as successful as it originally envisaged. Since it stated offering an invoice financing service in October 2014, Tungsten has financed £104m of invoices to January 2016. During that time around £131bn of invoices were processed through the Tungsten network, of which around half were probably in the US and UK where it is targeting its invoice financing efforts. Industry statistics suggest that around 8.5% of invoices processed are probably subject to invoice financing, implying a financing market of around £5.5bn from Tungsten’s US and UK activities. As we explained in our initiation note, Tungsten has attributed the low penetration of its invoice financing offering to:

We can also add that entrenched supplier relationships with their existing invoice financing partners, often part of a bank with whom they may have had a strong business relationship for years, has probably also held back the growth of Tungsten’s invoice financing activities.

It will take some time for the new appointment to design and implement his own strategy for Tungsten’s invoice financing activities. In the meantime, Tungsten will undertake some measures that it believes will develop its invoice financing efforts.

Upgrading Tungsten’s sales team to address higher-level employees at its customers would help promote its capabilities with decision makers and could enhance its credibility compared with incumbent finance providers. That leaves the first identified problem, the cumbersome and time consuming procedure to on-board suppliers to be addressed.

Tungsten has focused on two activities it believes have been an impediment to it on-boarding suppliers: the requirement for invoices to have a payment defined date (PDD) specified by the buyer; and the requirement for buyers to set up bank accounts specifically for paying invoices, which Tungsten has arranged to finance.

Tungsten has said that at any one time around 90% of invoices that have been approved for payment by buyers would not have a specified PDD because that is either not the normal buyer procedure or for some reason it has not been done on a particular invoice. Its previous policy was to only consider financing invoices with a stated PDD, although it says that most of the incumbent operators in the invoice financing industry do not require a PDD. By insisting on a PDD Tungsten has considerably restricted its addressable market. In future it will not require a PDD before arranging for an invoice to be financed. There is a risk to Tungsten from doing this but it believes that its knowledge of the buyers and suppliers on its network mitigates it considerably.

Tungsten has also required its buyers set up separate bank accounts into which they will pay any sums due on invoices its suppliers have arranged to be financed through Tungsten. This meant buyers had to do additional work for the benefit of their suppliers, which proved problematic and encountered resistance. Tungsten will scrap this requirement so, in future, buyer payments will go to the suppliers who in turn will pay Tungsten or those buying the financed invoices. This means that Tungsten will incur supplier credit risk, but it believes this risk is mitigated by its detailed knowledge of transactions undertaken by buyers and suppliers. Tungsten believes this information puts it in a strong position to assess credit risk. This information could be a comparative advantage over some potential competitors.

Tungsten is also considering expanding its invoice financing offering beyond the US and UK to other countries, considerably expanding its addressable market.

Tungsten also announced it is considering other ways to generate additional revenue from its network. We have not included any revenue expectations from these initiatives in our forecasts, so they do represent potential upside. Tungsten indicated that it will seek to develop these initiatives through partnerships to minimise the risk and costs of undertaking them to Tungsten’s shareholders. Among the initiatives that have been suggested are:

Offer a VAT reclaim service for buyers.

At its CMD Tungsten re-iterated its previous guidance:

In our initiation note of January 2016 we calculated that if Tungsten increases buyer prices and supplier numbers as it has indicated and controls costs then its financial guidance is attainable. We have maintained our indicative financial forecasts after the CMD. These are shown in the following exhibit.