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Portfolio Series: Arrowana Contrarian Value Fund


EPISODE TRANSCRIPT
Portfolio Series AWN_Gary Hui.mp4

 

[00:00:08] Welcome.

 

We're joined now by Gary Hui portfolio manager of Arowana Securities.

 

[00:00:14] Welcome Gary.

 

[00:00:15] Thanks Chris.

 

[00:00:16] Now Gary we've had a lot happened in the market, elections, quarterly updates but we're looking for opportunity and we see that we've had a good uplift in the IRA want a share price what's happened and what's been the driver for that year or so.

 

[00:00:28] So when we talk about what we do we're really stock pickers so we're really not influenced by overall market levels or what's going on in a macro context.

 

[00:00:35] We're trying to find situations where there's a under underpricing of security and we're looking to capitalize on that.

 

[00:00:42] So probably the latest addition in the portfolio in that context is a stock called After Pay and so we found this situation where online shopping is booming and as the magic and we've been looking at ways to get leverage that in the Australian market and after those really solutions if you'd like I can go into a fair bit of detail explaining tell us what's the catalysts we are looking for.

 

[00:01:04] So essentially online shopping if you look at the US data and most Western markets are analogous as are less developed markets as well as online shopping volumes in retail terms are growing at about 20 percent CAGAR are over there which is around about 3 percent growth rate for off line or high street shopping.

 

[00:01:21] But a corollary of that is that fraud rates in card payment systems are also skyrocketing as well and that the biggest source of fraud is seeing fraud or card not present fraud. And so that means that when someone makes a purchase for a particular product on the Internet or over the phone and their card isn't with the merchant that fraud is actually growing very very fast.

 

[00:01:44] And the big problem for merchants in this country who are trying to sell product online is that all of that cost that fraud cost gets recharged back to them in what we would term a three party card system i.e. a mix or a four party card system Visa or MasterCard. And so what we'd love about after pay is after pay solves that problem for merchants.

 

[00:02:05] So if you talk to a small online merchant about their fraud costs their chargebacks might be 2 3 4 times the size of the interchange fee. So their cost of acquisition in an online context may be as high as 10 percent of their sales which is an horrific number when you're running a business and After Pay internalizes that it takes that cost away from the merchant.

 

[00:02:28] And the reason it can do that is because it has this unique underwriting system where it underwrites every single transaction and so it uses a hundred plus factor association database to do that. And then the other big benefit of the merchant is the sales actually grow when after pay is employed.

 

[00:02:45] So the conversion rates increase the basket size increases and the sales levels increase. So their costs of processing online sales decline and their sales go up. And so what merchant would want to have that product in their online store and then for the consumers it's a massive win as well.

 

[00:03:03] Because they typically receive 56 days over which to pay off that payment. The purchase is very easy to make. Once you're signed up and the transaction costs are extremely low.

 

[00:03:15] And so the manifestation of this actually being a successful product is that the volumes are skyrocketing.

 

[00:03:21] So they've gone from a standing start at the time of IPO now to having over half a million customers unique customers in Australia.

 

[00:03:30] And GMV gross merchandise value sales levels of over 500 million dollars annualize in a very short space of time and we're particularly excited about this because when we look around the world for analogs we see this thing called Kleiner.

 

[00:03:43] In Sweden which started off in a very similar business model.

 

[00:03:46] They're now responsible for over 40 percent of online sales in Sweden and they moved into the US quite recently in their first six months. It is a billion dollars a GMV.

 

[00:03:56] So this is a massive potential price for this company and are we looking at just the domestic market use after pay or is there international scope as well.

 

[00:04:05] Well the wonderful thing about this business model and how we judge the success of this business model and its ability to actually transport both in terms of product extension internationally the returns embedded in it.

 

[00:04:18] And so we would define that as their take rate times the number of times their receivables book spins which translates into a return on invested capital. So in their situation their receivables book spins 12 times a year which means that the customers pay off on average in 30 days and their net take rate is the highest of any operator that we've seen.

 

[00:04:40] So we think that they're the most profitable and the most return generative business model we've seen in this space and so it's a logical thought to have that they would actually extend geographically in places like potentially New Zealand or Singapore or the US in time and then also potentially pull the lever and extend the product range as well which is essentially what clients did.

 

[00:05:02] So the key with this stock is that the total addressable market is fast and the fact that the sales aren't just growing they're accelerating tells you that they're very old in that path as well. So it's a very exciting event.

 

[00:05:15] So you've seen 500 thousand subscribers coming or users since Akio and I guess the important part there is to see what's been that timeframe how long has it taken to get to 500000 IPO in May 2016.

 

[00:05:31] So we're coming up near 12 months.

 

[00:05:33] So it's growing very fast. If you think back. So I never had one of these things but in an Australian context there was a uniquely Australian product called a bank card.

 

[00:05:42] And so probably haven't got a bank. 84 or so. So it came out in 1974 and within 18 months there were at one point bit over 1 million members actually. And then by the mid 80s there were 5 million members. And so that's the situation where you have what we would call financial inclusion.

 

[00:06:01] So whenever you have a new credit product coming into a market which addresses a demand which hasn't been met before you get this massive growth. And so that was bank cards a bank card went from zero to five million members not long a space of time. So this is a similar situation and again it's manifest in the fact that the merchants sales are increasing so dramatically.

 

[00:06:23] There's also a bonus for the merchant the birth bonus for the consumer. They're running a massive acceleration rate of growth. We've seen 40 years ago a similar. Disruptor if you like or entering into the market space. So if we cast ourselves through six or 12 months down the track what is it that we want we want to see after pay announcing and what updates do we want to see to make sure that they're on that directory incident in doing so the core of their business is their credit engine.

 

[00:06:53] So they're actually able to do what they do and internalize the risk of chargebacks or fraud in their system because their credit engine is so good and so we watch the cross in the net credit costs very very closely and then obviously just want to see customers continuing to join the system and the product continuing to build its rapport with the broader audience.

 

[00:07:13] So we think that the millennial demographic is a pretty easy win for the business and that is the core constituent right now it's really about over two thirds or three quarters their actual customer base. But what we're seeing when we talk to management is that that base is broadening through time and when you get when you think about the strength of the returns in their business they have a lot of levers to pull.

 

[00:07:36] So if we look at a mix or Visa or MasterCard we look at the competitive tension in that industry pretty much everyone has one credit card at the front of their wallet. They use all the time and the reason you use that card is because you think that the loyalty payments or the frequent flyers whatever you want to call them you get the best value for your money at that particular card's engagement with you behind the scenes they're actually paying someone to provide that service to you and the merchant pays for that.

 

[00:08:03] So as a cross subsidisation game here because After Pay's returns are so high and they're actually avoiding fraud in the first place.

 

[00:08:11] That means that if they would ever enter that space they have more bandwidth to play with.

 

[00:08:17] And so that's why we're really excited about the strategic potential in this business.

 

[00:08:21] Perfect.

 

[00:08:22] So we've got some milestones to look forward to.

 

[00:08:25] Thanks very much Gary.

 

[00:08:26] Thanks Chris.

 

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