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Plus500 for 400p equals a gamble

But one we think is worth going along with
June 2, 2015

Just as price is not a guarantee of quality, the conclusion that something looks cheap does not mean it is a good idea to buy it. Such is the uncertainty hanging over the acquisition of troubled contracts for difference (CFD) provider Plus500 (PLUS), which is to be snapped up for the bargain price of 400p per share by our buy recommendation PlayTech (PTEC).

Compare that to the former's 52-week intraday high of 781p, and it looks like a steal: PlayTech taking a punt that investors have been too harsh on the Israel-based trading platform, after it suspended a raft of UK accounts to ensure it was compliant with money laundering regulations.

But it is too early to know the full damage done. As for the shares, Investors Chronicle received an immediate letter from a Plus500 investor saying it was "staggering" that the company made an announcement to Facebook before the London Stock Exchange.

Your correspondent also received a Twitter message from a user of the platform bemoaning the lack of communication he had received, which as a result pushed him towards competitor IG Group (IG.). How many others have joined him, the market is as yet uncertain, but certainly some reputational damage has been done for customer and shareholder alike.

We tipped PlayTech last month, fresh from its purchase of a 91 per cent stake in another CFD provider, TradeFX, which we saw as the next chapter in the company's growth story. PlayTech's rather straightforward acquisition strategy is to buy "profitable, regulated, highly cash generative businesses with market-leading positions". It is the "regulated" aspect that is key to this story.

From the regulator's perspective, the sector at question is the sum of the CFD, spread betting and retail foreign exchange trading providers. It is fair to say that the Financial Conduct Authority has been beefing up its scrutiny of this cohort as the industry has grown.

In February last year, it fined FXCM Securities £4m for misconduct that included keeping the profits from favourable market movements between the time orders were placed and executed, while passing on losses to clients. In July, it published a report into best practice on execution in general, including CFD providers within its scope.

At the beginning of last year it commenced thematic work specifically looking at the CFD market and how clients are taken on - or "onboarded" - and whether providers are properly following the "appropriate test" for new customers.

The intervention at Plus500, to request a review that its client onboarding was in step with anti-money laundering rules, demonstrates that CFD providers will need to spend more time on compliance, if they are not already doing so.

For Plus500 this means an extra 40 people now working through customer accounts, plus the extra management staff that analysts at Liberum believe will be added following an expected review of what they call the company's "previous structural under-investment in support staff".

Add that to the increased marketing spend that had been committed to building the company's brand, and you have Pluss500's conclusion in the acquisition announcement that group revenue for 2015 will be lower than 2014, with margins "significantly lower".

For Playtech, the deal is expected to be immediately earnings enhancing. It further maintains that its technology and "expertise [in] operating a multi-jurisdictional regulated business" will benefit the provider. It currently has a 10-strong compliance team out of 500 staff, and this is expected to be expanded if the deal goes through.