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Prospa IPO: Are shares in this fintech lender a buy?

It looks like small business or fintech lender Prospa (ASX: PGL) is set to hit the ASX boards this afternoon after an aborted attempt earlier in the year reportedly due to regulatory concerns not being allayed over its operating model. 

According to its IPO prospectus Prospa will raise $109.6 million via the issue of 29 million shares to give it a market cap of $609.9 million and a valuation trading on 3.8x its enterprise value to forecast financial year 2019 pro forma revenue. 

Prospa reports that since its founding in 2012 it has lent over $1 billion to 19,000 customers across its core online loan platform and newer line of credit facilities and business-to-business lending platforms. 

It describes its core product as an amortising term loan offered in value between $5,000 to $300,000 over 3 to 24 months that small businesses can apply for in just a few minutes and potentially have forwarded to them the next business day.

Other notable points are that Prospa does not normally require collateral or asset security against its loans partly because it reports to have built a “Credit Decision Engine” that uses data analytics and proprietary technology to make credit decisions.

This is important as much of the small business lending it is picking up is that politely declined by the banks such as Westpac Banking Corp (ASX: WBC) on the basis that it is too risky.

For example banks prefer to focus on the home loan lending space as not only is it very profitable but also low-risk as the loans are backed by the physical collateral of the properties themselves. 

Whereas small business lending is far riskier as there’s often little or insufficient physical collateral to back a loan against, while cash flows in the small business space can be notoriously unreliable in the restaurant or retail industries for example.

As the banking adage goes on a risk-adjusted basis there’s no such thing as a bad loan, only a good loan that turns bad, which helps them turn sky high profits in avoiding anything but relatively minuscule bad debts.

The twist, kicker, or value proposition with peer-to-peer or fintech lending is that the funding is often sourced from third party lenders, rather than on a proprietary basis from the balance sheet of the lender, which means most of the credit risk is transferred to the third party lender.

Consequently this serves to complicate the financial reporting, investment view, and regulatory classification of peer-to-peer lenders.

As you can guess, Prospa’s funding sources are diverse and complicated with investors advised to take a look at the prospectus document for themselves as I don’t have room to cover this further. 

The upside for Prospa is that it can charge higher lending rates in return for taking on more risk, but clearly it and investors are relying heavily on its data sets, proprietary technology, off balance sheet funding arrangements,  and special regulatory position to avoid a bad debt or general blow up. 

For the financial year ending June 30 2019 it expects to report a net loss of $16.9 million on revenue $136 million to give investors another reason to conclude this is a business higher up the risk curve. 

The UK has recently seen a number of peer-to-peer lenders collapse including Lendy where the Financial Times reports investors are now at risk “of losing a large chunk of the more than £160m in outstanding loans on the platform.”

Given the financials and risks then Prospa is not my idea of a good investment, however, that’s not to say that the shares or business cannot go onto perform well.

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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