flexigroup (fxl) - initiation report

BBY Limited

Financial Services

FLEXIGROUP LIMITED Economic moat, competitive advantage and growth options - attractively priced!

Recommendation: BUY

Investment Summary Warren Buffett once said: “The key to investing is determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors”.

We believe Flexigroup Limited (FXL) has a uniquely attractive business model and sustainable competitive advantages to satiate even Warren’s discerning investment appetite. Recent performance, including the Certegy acquisition, has exceeded expectations. We initiate coverage with a BUY recommendation and 12-month share price target of A$1.92 (per DDM).

Attractive business model characteristics include: (i) attractive position within an attractive industry (Porter’s Five Forces analysis); (ii) pricing power, manifest in high and growing fee income and ROE >25%; (iii) product differentiation; (iv) strong customer/retailer value propositions; and (v) scalability into adjacent segments and new geographies.

FXL’s scalability and current price-value discount indicates investors implicitly receive a “free” call option on multiple strategic growth options. We analyse ten strategic growth options.

One leading indicator of when to buy stocks working through a bad debt cycle is when the rate of increase in impaired loans slows (ie. negative second derivative). This trend was evident in FXL’s FY09 results and also the major banks. This reinforces our BUY conviction.

Source: FXL

George Gabriel, CFA+612 9226 0091 [email protected]

8 September 2009

ASX: FXL

Share Price: A$1.45

Number of Shares: 238.9M

Market Capitalisation: A$346.4M

Average Monthly Turnover: A$5.0M

12 Month High/Low: A$1.70 / A$0.21

GICs Industry Group: Diversified Financials

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2 BBY Limited 8 September 2009

FLEXIGROUP LIMITED

Table of Contents INVESTMENT SUMMARY...................................................................................................................................................3 FINANCIAL FORECASTS...................................................................................................................................................4 BUSINESS OVERVIEW.......................................................................................................................................................5

Executive Summary ........................................................................................................................................................ 5 Business Overview.......................................................................................................................................................... 6 Certegy Acquisition ....................................................................................................................................................... 10

INVESTMENT CONSIDERATIONS...................................................................................................................................11 Broker Recommendations............................................................................................................................................. 11 Bearish Drivers.............................................................................................................................................................. 11 Impairment Expense Outlook ........................................................................................................................................ 12 Bullish Investment Case................................................................................................................................................ 14 Bearish Investment Case .............................................................................................................................................. 14

VALUATION ......................................................................................................................................................................15 Volumes ........................................................................................................................................................................ 15 Net Interest Margin........................................................................................................................................................ 16 Sensitivity Analysis........................................................................................................................................................ 16

EARNINGS ANALYSIS .....................................................................................................................................................17 Earnings Driver Trend Analysis..................................................................................................................................... 17 Fee and Other Income .................................................................................................................................................. 17 Du Pont Analysis ........................................................................................................................................................... 17 Earnings Quality............................................................................................................................................................ 18 FY09 Results................................................................................................................................................................. 23 FY10F Guidance ........................................................................................................................................................... 24

CORPORATE STRATEGY................................................................................................................................................25 Competitor Analysis ...................................................................................................................................................... 25 Competitive Strategy ..................................................................................................................................................... 25 Value Proposition – Consumer and Retailer ................................................................................................................. 25 Porter’s Five Forces Analysis........................................................................................................................................ 26 SWOT Analysis ............................................................................................................................................................. 28

COMPETITIVE ADVANTAGE ...........................................................................................................................................29 Identifying Competitive Advantage................................................................................................................................ 29 Sources of FXL’s Competitive Advantage ..................................................................................................................... 29 Revenue and Funding Model ........................................................................................................................................ 30 FXL Debt Facilities ........................................................................................................................................................ 32

TEN STRATEGIC GROWTH OPTIONS............................................................................................................................33 BOARD AND MANAGEMENT ..........................................................................................................................................34

Board............................................................................................................................................................................. 34 Management ................................................................................................................................................................. 34 Executive Options ......................................................................................................................................................... 35 Dilution scenario............................................................................................................................................................ 35

TIMELINE OF KEY EVENTS.............................................................................................................................................36 RETAIL SALES .................................................................................................................................................................37

Retail Market Overview ................................................................................................................................................. 37 Harvey Norman Overview ............................................................................................................................................. 40

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8 September 2009 BBY Limited 3

FLEXIGROUP LIMITED

INVESTMENT SUMMARY We initiate with a BUY and A$1.82 price target.

Warren Buffett once said: “The key to investing is determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors”. We believe Flexigroup Limited (FXL) has the competitive advantages to satiate even Warren’s discerning investment appetite.

We initiate coverage with a BUY recommendation and share price target of A$1.92 (per DDM).

Attractive business model characteristics include:

− Attractive position, attractive industry (Porter’s Five Forces analysis).

− Pricing power − manifest in high fee income, ROE >15% and EBIT margins >20%. Charts 2,3 and 8.

− Product differentiation. Total product solutions approach provides competitive differentiation.

− Sustainable competitive advantage.

− Highly scalable into adjacent product segments and new geographies.

Upside earnings risks include: (i) new product volume growth (eg. BLINK internet broadband); (ii) impairment expense normalisation; (iii) fee income growth; (iv) net interest margin normalisation; and (v) multiple strategic growth call options.

One leading indicator of when to buy stocks working through a bad debt cycle is when the second derivative of impaired asset growth turns negative. This trend was evident in FXL’s FY09 results. The trend is reinforced in current major bank trading updates. This reinforces our BUY conviction.

FXL’s scalability and current price-value discount suggests today’s investors implicitly receive a “free” embedded call option on multiple strategic growth options. Refer “Ten Strategic Growth Options” discussion.

Certegy’s performance has exceeded expectations. Originally expected to lose A$1.5M in Year 1, it generated +A$0.2M instead. Refer “Certegy Acquisition”.

Concentration risks are diminishing through increased product range and distribution channel diversification. Following the Certegy acquisition: (i) the Harvey Norman channel has reduced from 51% (FY06) to approx 25% (FY09) of total sales volumes; and (ii) the computer/electrical category has reduced from 90% revenue to approx. 45%.

The confluence of bearish drivers which drove FXL’s recent de-rating is now well mitigated. FXL was down 93% from peak-trough (A$2.90 on 31 Jan 07 to A$0.21 on 17 Nov 08). Refer “Bearish Drivers”.

We analyse: (i) competitive advantage: (ii) competitive strategy; (iii) Porter’s Five Forces; (iv) Du Pont; (v) value proposition; (vi) SWOT; (vii) strategic growth options; (viii) valuation sensitivity; and (ix) value driver time series trend analysis.

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FLEXIGROUP LIMITED

FINANCIAL FORECASTS Flexigroup Limited $1.45

Income Statement (A$'000) 2008A 2009A 2010F 2011F 2012F Operating Ratios 2008A 2009A 2010F 2011F 2012FInterest income 140,709 140,997 165,072 195,077 199,795 Fee and other income/total income 30.8% 37.4% 37.3% 33.6% 33.3%Non-interest income 51,358 68,919 80,358 81,147 81,945 Impairment losses/total net revenue -13.1% -14.7% -14.3% -12.0% -11.2%Total Revenue 192,067 209,916 245,430 276,225 281,740 Impairment expense/average IEA -4.5% -5.0% -4.5% -3.8% -3.9%Employee Expenses (31,682) (36,344) (38,305) (39,454) (40,638) Volume growth 1.2% 12.7% 14.9% -2.4% -1.1%Admin Expenses (9,290) (13,756) (14,169) (14,594) (15,032) ROE 32.7% 27.5% 26.6% 28.9% 26.5%Amortisation of capital'd costs (25,287) (25,422) (29,785) (35,030) (35,705) ROA 5.1% 4.5% 4.2% 4.6% 5.1%Depreciation (3,164) (4,940) (5,088) (5,241) (5,398)Impairment losses (21,910) (27,155) (30,826) (28,888) (27,604) Operating Margins 2008A 2009A 2010F 2011F 2012FOther Costs (8,616) (7,153) (7,368) (7,589) (7,816) SGA expense/total revenue 58.5% 59.7% 61.5% 60.6% 60.3%EBIT 92,118 95,146 119,889 145,429 149,547 Impairment expense/total revenue 13.1% 14.7% 14.3% 12.0% 11.2%Interest (44,844) (47,936) (67,732) (79,198) (79,501) Tax 9.0% 7.8% 7.3% 8.2% 8.5%Profit Before Tax 47,274 47,210 52,157 66,231 70,047 Net profit margin (NPAT/total revenue) 19.3% 17.8% 16.9% 19.2% 19.9%Tax (15,018) (14,408) (15,647) (19,869) (21,014) EBIT/revenue 48.0% 45.3% 48.8% 52.6% 53.1%Net Profit After Tax 32,256 32,802 36,510 46,361 49,033 Cash cost/revenue 68.4% 69.9% 70.9% 68.6% 68.0%Significant Items 0 0 0 0 0Adjusted Net Profit After Tax 32,256 32,802 36,510 46,361 49,033 Valuation Ratios 2008A 2009A 2010F 2011F 2012FWtd avg shares on issue 218,466 232,181 238,895 238,895 238,895 Book value per share (A$) $0.45 $0.51 $0.58 $0.67 $0.78EPS (cps) 17.4 14.8 14.4 15.3 19.4 20.5 NTA per share $0.19 $0.11 $0.18 $0.28 $0.38EPS growth on pcp -15% -2% 6% 27% 6% P/E Multiple 9.82x 10.07x 9.49x 7.47x 7.06xDividends (cps) 11 3 8 10 10 Price to Book Value 3.21x 2.83x 2.52x 2.16x 1.87xFranking 100 100 100 100 100 Price to NTA 7.83x 13.60x 8.02x 5.22x 3.81xCash dividend 7.6% 2.1% 5.3% 6.7% 7.1% EBITDA Multiple 2.63x 2.68x 2.24x 1.87x 1.82x

EBIT Multiple 3.44x 3.54x 2.89x 2.38x 2.32xBalance Sheet (A$'000) 2008A 2009A 2010F 2011F 2012FCash 59,426 52,583 48,560 95,700 98,243 Valuation (A$ / Share) 2009A 2010F 2011F 2012FNet Lease Receivables 447,920 404,505 547,696 623,231 576,182 Current share price $1.45Customer Loans 57,777 156,442 160,220 168,231 176,643Goodwill and Other Intangible 58,212 94,329 94,329 94,329 94,329 DDM Valuation 0Plant & Equipment 3,880 4,192 5,637 6,377 5,752 Estimated cost of equity 12.6%Other Assets 9,074 12,375 16,641 18,825 16,981 Assumed terminal value growth rate 3.0%Total Assets 636,289 724,426 873,083 1,006,694 968,129 NPV of Cash Flows $1.92Trade and Other Payables 25,512 31,487 42,341 47,898 43,206 Price target discount to NPV 0%Net Borrowings 478,309 542,483 651,014 750,354 696,649 DDM-based price target $1.92Tax Liabilities 32,824 29,846 40,134 45,402 40,954Provisions 999 1,531 2,059 2,329 2,101 Premium/(discount) to current share price 32.1%Total Liabilities 537,644 605,347 735,547 845,984 782,909 Dividend yield 5.3%Net Assets 98,645 119,079 137,536 160,710 185,220 Total 12-mth return 37.4%Source: Company Reports, BBY BBY recommendation BUY

Implied PE of price target 13.3x 12.5x 9.9x 9.3x

Source: BBY, Company Reports

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FLEXIGROUP LIMITED

BUSINESS OVERVIEW

Executive Summary We initiate with a BUY recommendation and A$1.93 price target.

FXL is a leading provider of point of sale lease finance products in Australia and New Zealand, focusing on sub-A$10,000 transactions through third party retail chains. FXL recently acquired the Certegy retail finance business, enhancing FXL’s product, channel and customer diversification.

We initiate coverage of Flexigroup Limited (FXL) with a BUY recommendation and 12-month price target of A$1.92 (DDM valuation). BBY’s BUY recommendation is based on:

(i) Attractive business model – high earnings quality, highly scalable, multiple strategic growth options, pricing power, barriers to entry, multiple revenue streams and established infrastructure. Table 1.

(ii) Valuation upside − 32% upside from the current A$1.45 to BBY’s DDM valuation.

(iii) Diminishing downside risks. Table 2.

TABLE 1: ATTRACTIVE BUSINESS MODEL

Attribute Description Pricing power Demonstrated ability to raise prices and fee income, despite

recession. Fee-based income generation Fee-based income has increased from 23.5% (FY06) to 37.4%

(FY09). Barriers to entry Customer database, exclusive distribution channels, IT

infrastructure, sales and marketing culture, funding model, brand, product innovation. Refer “Barriers to Entry” below.

Multiple revenue streams FXL generates lease interest; application fees; monthly account fees; residual payments and sale of leased products to third parties. Refer “revenue and funding model” below.

Highly scalable Multiple growth options exist. Refer “Strategic Growth Options”. Established corporate infrastructure Over 1M discrete customer profiles. High cashflow generation Unique funding model generates upfront cashflow from lenders

when leases are written. Figure 2.

FXL has an attractive business model.

High quality of earnings. High translation of accounting earnings to cashflow. Chart 9. Source: BBY

The bear case is now less compelling.

We believe the bear case is not compelling. Table 2 summarises the bear case which drove FXL down 93%, from A$2.90 (Jan 07) to A$0.20 (Nov 08).

TABLE 2: KEY RISKS AND MITIGANTS

Risk Probability Impact Mitigant

Concentration risks. Refer “Product Mix” below.

Low Medium Certegy has increased diversification of: (i) distribution channel; (ii) retail customer base; and (iii) product category.

Funding risk. Low High (i) Maintained funding through the credit crisis, including Certegy acquisition finance. (ii) Nascent capital market recovery. (iii) Existing facilities accommodate forecast volumes.

Certegy dilution. Refer “Certegy” below.

Low Low Performance exceeding expectations.

Slowing retail sales. Refer “retail sales” below.

Medium Medium (i) BBY forecasts discount guidance. (ii) Flat Flexirent volumes forecast. (iii) Cyclical risks diminishing (stimulus and cycle).

Impairment expense.

Medium Medium (i) Second derivative impaired assets negative. (ii) Unemployment peak cycle risks diminishing.

Source: BBY.

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FLEXIGROUP LIMITED

Business Overview

Product Mix

The FXL Group comprises three segments: (i) Flexirent; (ii) Certegy; and (iii) BLINK.

FXL comprises two businesses: (i) Certegy (45% revenue); and (iii) Flexirent (55% revenue). Chart 1 summarises revenue contribution per segment.

FXL provides consumer finance across 35 retail segments, including electrical, home improvement and jewellery. Since the Oct 08 Certegy acquisition, FXL has reduced its reliance on the computer/electrical category from 90% revenue to approx. 45%. Figure 1 illustrates the size of the point of sale market by segment.

BLINK is the emerging mobile broadband product (refer “Strategic Growth Options” below). Table 3 below compares Flexirent, Certegy and BLINK.

CHART 1: REVENUE BY PRODUCT MIX (FY09)

FXL has expanded its product range to reduce concentration risk and create earnings growth options.

Home Improvement

12%

Electrical 9%

Furnishing 9%

Lending 8%Medical 2%

Computer 36%

Other 12%

Jewellery 12%

Source: BBY, FXL.

Certegy Customer and Product Segments

Certegy’s average lease value is A$1,600, with an average lease term of 16 months. The product range comprises approx. 45% of total FXL revenue and includes:

12% jewellery (engagement rings);

12% home improvement (eg. sheds, building, solar panels, pools, shutters, renovations etc);

9% furnishings;

2% medical; and

10% other.

Certegy targets customers who are home owners as this generally reduces credit risk and suggests they can provide the requisite deposit.

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FLEXIGROUP LIMITED

Flexirent Customer and Product Segments

Flexirent lease terms range from 12-48 months (36 months average), with an average lease value of A$2k (max A$20k). The product range comprises approx 55% of total FXL revenue and includes:

36% computer;

9% electrical;

8% lending; and

2% other.

The average customer is male (>60%), aged 35-44, employed, with a mortgage and annual income of A$30-60k.

BLINK – emerging growth product

BLINK and Certegy are future growth drivers.

BLINK bundles sub-$1,200 notebooks with mobile internet broadband plans. It is a fast growing product segment; FXL estimates total industry activations of 70,000 per month, and industry CAGR of 26% over the next five years.

BLINK was launched in retailers in Feb 2009. In 2H09, FXL averaged 3,000 connections per month. BLINK comprised 13% of total volumes and up to 10% by value.

Together, BLINK and Certegy (51% of total 2H09 unit volume and 62% by value) are FXL’s future growth drivers.

BLINK is sold through Harvey Norman (HVN), Bing Lee, The Good Guys and other retailers. The new products are Blink Nomad and Blink Bundle.

(i) Blink Nomad is a month to month contract mobile broadband plan. The customer purchases a wireless USB modem and a gigabyte (GB) usage plan. FXL’s product differentiation is via a free equipment loan service to customers should their laptop/computer ever be in for repairs.

(ii) Blink Bundle bundles mobile broadband with a laptop into one monthly payment (like a mobile phone plan) and includes a free equipment loan and protection against theft, accidental loss and damage.

Other Product Segments

“Other” products include air-conditioners, IT, office equipment, brown goods, TVs, game consoles, SatNav/GPS etc.

TABLE 3: COMPARING FLEXIRENT AND CERTEGY

Flexirent Certegy BLINK

FY09 new business A$168M p.a A$195M p.a Est. A$20M p.a.

# Contracts 100,000 pa 150,000 pa TBD (launch Feb 09)

Ave. ticket value A$2,200 A$1,600 A$480

Retail Outlets 5,600 1,400 350

Customers 350,000 725,000 Est. 36,000 pa

Key Products Computer / Electrical Home Furnishings & Renovations

Jewellery

Mobile broadband

Laptops

Source: BBY, FXL.

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FLEXIGROUP LIMITED

FIGURE 1: VOLUME OF POINT OF SALE MARKETING BY MARKET SECTOR

Source: FXL, 18 Feb 09.

Barriers to Entry

FXL enjoy several barriers to entry.

Barriers to entry include:

Distribution agreements. Customer database. Approx. 1M unique customers.

Sales, marketing and training capability. Focused on “pushing” sales at point-of-sale, upselling and rapid point of sale credit approvals. FXL works closely with retail channel partners to co-ordinate marketing campaigns and develop product bundles.

IT platforms. Include customer databases, web-based rewards systems (“Flexichips”), interface with retailers etc.

Regulatory compliance. FXL has internal systems to comply with taxation, consumer credit and privacy codes.

Credit system. FXL has developed a proprietary credit scoring and collections systems.

Distribution Channels

FXL has over 11,000 channel partners.

FXL has over 11,000 distribution channel partners, including:

Harvey Norman (HVN)

– Distribution agreement through to 2015. – FXL has reduced its channel concentration risk post the Certegy acquisition, with

HVN’s sales contribution reducing from 51% in FY06 to approx. 25%.

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FLEXIGROUP LIMITED

FXL’s ideal distribution partner: (i) sells low priced

products; (ii) has sales focused,

often commission- based staff who respond well to training.

Noel Leeming – Similar to HVN, based in New Zealand (NZ). Over 80 retail stores throughout NZ, specialising in consumer electronics through “Noel Leeming” and “Bond & Bond” brands. Annual sales over NZ$500M.

Bing Lee – Electrical retailer, 37 stores through NSW and the ACT. FXL has a three year distribution agreement.

The Good Guys – One of the largest electrical and white goods retailers in Australia, with 88 stores nationally. FXL has a three year distribution agreement (approx. two years remain).

Certegy – 5,400 retailer network.

Travel agents – Agreements with Flight Centre and Stella Travel from FY08.

Other retail – Apple Centres, bicycle retailers etc.

Sales and Marketing Culture

Strong sales and marketing culture.

FXL’s sales culture is evident through:

Sales staff rewards programs. FXL provides “Flexichip” bonuses (proprietary “frequent flyer” type loyalty scheme).

Sales staff training programs. Staff are trained direct by FXL on product campaigns, FXL processes etc, selling skills etc.

Retailer incentives. Retailers receive rebates for achieving sales volume targets.

Direct marketing. FXL leverages its extensive customer database to profile the market, driving upsell and repeat business. In FY08, there were 65,000 new customers and 35,000 repeat purchases. Approx. 30% p.a. of new volumes are from existing FXL customers.

Channel partner marketing integration. FXL’s finance solutions are integrated into channel partners’ marketing strategies and new product launches (eg. FXL had a range of financing solutions and bundles ready for the initial release of X-box).

Sales Cycle

FXL drives sales through the four stages of the sales cycle. FXL sells “payments not a price”.

FXL drives the four steps in the sales process:

1. Pre-sale

Staff training. Trains sales staff and incentivises using reward-based schemes (“Flexichips”).

Co-marketing program. FXL’s creative marketing team (c. 30-40 staff) work FXL promotions into channel partners’ schedule and new product launches.

2. Point-of-sale

Sales strategies include: (i) add-on products; (ii) up-sales; (iii) increased credit limits where possible; (iv) “while you wait” credit approval; and (v) selling “payments not a price”.

3. During the lease

Direct customer marketing for cross-sell and repeat sales.

FXL area managers promote in-store training of retailers’ staff.

Sales process quality control. A “mystery shopper” program assesses the knowledge base of individual retail staff.

4. Lease residual – At lease end, there are four options:

Upgrade to another product, encouraged by waiver of last three payments on existing lease.

Purchase the goods at a price set by FXL (the majority of outcomes).

Stop lease payments and return the goods.

Become “inertia renters” ie. continue the payments.

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FLEXIGROUP LIMITED

High Operating Leverage and Scalability

FXL has a highly scalable business model given its:

Limited per unit marginal variable cost;

Business model transportable to new products and geographies; and

Existing operating infrastructure supportive of increased volumes.

Certegy Acquisition Certegy acquisition increases diversification, scale and expands the customer base.

On 13 Oct 08, FXL acquired Certegy’s business and selected assets, but not its existing loan portfolio. Certegy increased FXL’s diversification, scale and customer base. The Certegy acquisition was for A$31.4M comprising:

A$15M cash;

A$15M interest only subordinated vendor note with final maturity extendible to three years; and

3M FXL shares.

Certegy’s performance has exceeded expectations.

Since the acquisition, Certegy has exceeded FXL’s original expectations. Originally expected to lose A$1.5M in Year 1, it made A$0.2M instead. FY10F guidance is A$268M new volume, and +A$7.2M NPAT (A$6.0M NPAT post goodwill amortisation) as the Certegy portfolio reaches steady state.

Key features of the Certegy business:

“No interest ever” provider of finance. That is, products are de facto under lay-by, with FXL receiving its margin from the retailer, not the consumer.

150,000 transactions p.a.; 1,400 merchants.

Reduces credit risk by: (i) targeting home owners; and (ii) requiring a deposit of 10-25%.

Includes one of two major cheque guarantee businesses in Australia and New Zealand (approx 10% earnings), offered in 4,500 merchants through 16,000 outlets.

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INVESTMENT CONSIDERATIONS

Broker Recommendations The price-value gap in FXL is partially explained by limited sell-side analyst coverage.

TABLE 4: BROKER RECOMMENDATIONS

Firm Date Recommendation Target Price BBY 07/09/09 Buy A$1.92 Ord Minnett 29/07/09 Buy A$1.46 GSJBW 21/08/09 Buy A$2.40 UBS 20/08/09 Buy A$1.55 Foresight 18/02/09 Hold A$0.40 ABN AMRO 26/08/08 Hold A$0.53

Source: Bloomberg. Note that neither Foresight nor ABN AMRO have published research on FXL for many months. It is not clear whether their equity research coverage is continuing.

Bearish Drivers The confluence of bear market drivers which drove the FXL de-rating is now less cogent. Applying small cap index FY10F PE to FXL implies a share price of A$2.19.

We believe that the bearish stock drivers which drove FXL’s de-rating are now less compelling. A confluence of bearish drivers drove FXL down 93% peak-trough (A$2.90 on 31 Jan 07 to A$0.21 on 17 Nov 08). These bearish drivers were:

(i) Small cap market liquidity discount. As the market re-rates, we believe this will be unwound. Currently, ASX200 FY10F PE is 16.3x and the ASX Small Ordinaries index is 14.4x. This compares with FXL’s FY10F PE of 12.5x. Applying the 14.4x FY10F index average PE to FXL implies a share price of A$2.19. Indeed, FXL arguably warrants a premium to the Small Ords Index, given its attractive business model.

(ii) Cyclical rotation out of retail stocks. FXL should benefit as portfolios are re-positioned to for beta optimisation.

(iii) Refinance risk perception discount. At the height of the GFC, FXL received A$200M funding for the Certegy business. Refer “FXL Debt Facilities” below.

(iv) Complex business models out of favour. Though FXL is not “complex” per se, understanding the Loss Reserve, multiple product lines and modelling cash flows across multiple portfolios over an average run-down period of 4 years requires some effort. It appears that FXL was (unfairly) tarred with the same blemished brush as Babcock and Brown Ltd, Allco Group etc.

(v) Credit risk concerns. Refer “impairment expense” below.

(vi) Initial EPS dilution from Certegy acquisition. Given FXL acquired the Certegy cost base, but not its existing portfolio, Certegy was expected to be EPS dilutive in Year 1. Some investors have been waiting for evidence of successful acquisition integration prior to investing in FXL.

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FLEXIGROUP LIMITED

Impairment Expense Outlook BUY signal for lending stocks: when the second derivative of impaired asset growth turns negative. This trend is evident across the major banks and FXL.

FXL’s impairment expense losses are limited to the Loss Reserve, with excess losses borne by the Funders, though FXL’s margins are impacted. FXL writes off or recognises a 100% allowance for losses for all leased and loans greater than 90 days past due.

One leading indicator of when to buy a lending-driven stock working through the bad debt cycle is when the second derivative of impaired asset growth turns negative (ie. the rate of increase in impaired assets slows). This trend was evident in FXL’s FY09 results. This trend (and our BUY conviction) is reinforced by a similar trend among the major banks.

The data supporting our view that the bad debt cycle is turning is:

FXL. The rate of increase in FXL’s past due loans has slowed from 38.0% to 24.5%. Table 5.

CBA. Commonwealth Bank of Australia’s (CBA) rate of increase in non-performing loans (NPLs) slowed from 179% in 1H09 to 48% in 2H09. (Refer BBY Note on CBA, “Bad debt write-backs expected”, 18 Aug 09).

WBC. Westpac Banking Corporation’s (WBC) 3Q09 trading update (21 Aug 09) said: "the rate of increase in stressed exposures is unlikely to be repeated in coming months".

ANZ. Australia and New Zealand Banking Group Ltd (ANZ) impaired loans/gross loans growth rate was 31% in 1Q09, 18% in 2Q09 and 7% in 3Q09.

The fact that the rate of increase in impaired loans is slowing is a leading indicator of a peak in the bad debt cycle.

Other relevant considerations include:

1. Overdue loans/gross loans has increased from 4.6% to 6.3% to 6.9% (FY07 to FY09). The peak deterioration was from FY07 to FY08. This suggests the outlook is improving. Table 5.

2. The current Loss Reserve/gross loans ratio of 9.1% sufficiently covers BBY’s FY10F impairment expenses of A$30.8M. Even assuming FY10F impairment expense = 9.1%, our DDM valuation is A$1.85. Table 5.

3. The FY09 loss reserve balance exceeds FY09 impairment expenses by 1.8x, implying significant scope for existing reserves to cover the risk of material bad debt deterioration. Table 5.

4. FY09 impairment expense increase is being driven by the accumulation of the Certegy portfolio. Lease losses (Flexirent) have stabilised (A$8.3M in both 1H09 and 2H09); personal loan losses are falling (A$4.2M 1H09, A$3.2M 2H09) whilst this business segment is being run down, and Certegy losses are increasing (A$0.1M to A$2.7M) whilst the loan portfolio is accumulating. Table 6.

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TABLE 5: COMPOSITION OF GROSS LOANS AND LEASES

FY06 FY07 FY08 FY09 FY10F

Gross debt (A$M) 451.3 523.8 521.2 591.8 743.3

Gross loans and leases (A$M) 410.0 477.2 482.9 544.0 688.3

No. contracts (M) 258.5 280.7 389.1 428.1

% growth 8.6% 38.6% 10%

Average value/contract (A$) 1,846 1,720 1,398 1,608

Loss reserve (A$M) 24.6 36.2 42.9 49.3 79.4

- as % gross loans 6.0% 7.6% 8.9% 9.1% 11.5%

Provisions (A$M) -7.3 -8.2 -9.6 -13.7 -24.7

- as % gross loans -1.8% -1.7% -2.0% -2.5% -3.6%

Impairment losses (A$M) -10.6 -12.9 -21.9 -27.2 -37.0

- as % gross loans -2.6% -2.7% -4.5% -5.0% -5.4%

Loss reserve/impairment losses (x) -2.3x -2.8x -2.0x -1.8x -2.1x

Total >30 days overdue as % gross loans 1.9% 2.9% 3.5%

Total overdue as % gross loans 4.6% 6.3% 6.9%

% growth in past due loans 38.0% 24.5% Source: FXL, BBY

TABLE 6: IMPAIRMENT LOSSES/AVERAGE RECEIVABLE BALANCE

1H08 2H08 1H09 2H09

Impairment Losses (A$M)

Leases 8.3 9.4 8.3 8.3

Personal loans 1.7 4.2 4.2 3.2

Certegy 0.1 2.7

Subtotal 10.0 13.6 12.6 14.2

Recoveries/debt sales -2.2 -0.9 -2.3 -1.4

Subtotal 7.8 12.7 10.3 12.8

Impairment loss/avg. bal. (%)

Leases 0.9% 1.0% 1.0% 1.3%

Personal loans 1.7% 3.4% 2.7% 1.2%

Certegy 0.2% 1.6% Source: FXL, BBY

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FLEXIGROUP LIMITED

Bullish Investment Case Reason to BUY FXL include:

Attractive business model. Refer “Business Overview” and “Competitive Advantage”.

Sustainable competitive advantage. Refer “Competitive Advantage”.

Valuation upside. Price is at a 33% discount to BBY’s DDM. Refer “Valuation”.

Bad debt outlook improving. Refer “Impairment Expense Outlook”. Table 6. Chart 7. Existing loss reserves cover FY09 bad debts by 1.8x. Table 5.

Growth outlook for Certegy and BLINK. Refer “Certegy Acquisition”.

Highly scalable with multiple strategic growth options. Core competencies include sales and marketing and receivables management. Approx. 30% annual sales from existing customer database (over 1M customers). Refer “Business Overview” and “Ten Strategic Growth Options”.

Multiple revenue lines. Refer “Revenue and Funding Model”.

Established distribution relationships, including an exclusive through HVN stores. Refer “Retail Market Overview”.

Downside risks diminishing. Refer “Bearish Drivers”. Table 7.

Bearish Investment Case

TABLE 7: DOWNSIDE RISK MITIGANTS

Risk Mitigant

Channel concentration.

HVN contract expires 2015, no guarantee of renewal beyond then.

Noel Leeming contract signed to 2011.

Regulatory risk (consumer credit, tax).

New legislation not currently a part of government agenda.

Credit quality Rate of increase in impaired loans is declining.

Limited recourse loans.

Only Certegy bad debts are increasing (matching portfolio accumulation). Other segments are stabilising or negative (Flexirent, personal loans). Table 6.

Funding `Refinance risk is mitigated by: (i) five different funders; (ii) average tenure is 7.5 years and longest 21 years; (iii) funding support was evident through the GFC; (iv) nascent (debt and equity) capital market recovery; (v) all facilities reviewed in past 12 months renewed.

Margin risk Historical SPVs have fixed funding costs and fixed lease incomes.

Although new business volumes are being funded with higher cost funding, some of this is offset by being passed through to customers.

Retail volumes/interest rates

Low price elasticity of demand given low payments.

Macroeconomic outlook improving.

Diversified products and distribution channels.

New product growth options.

Source: BBY.

b


FLEXIGROUP LIMITED

VALUATION BBY’s base case dividend discount model (DDM) valuation of FXL is A$1.92. The key drivers are:

(i) volumes; (ii) net interest margin (NIM); and (iii) impairment expense. We discuss volume and NIM below. We discussed “impairment expense outlook” above.

Volumes Table 8 summarises FXL’s volume outlook. Key points are:

BLINK/other upside risk.

– BBY FY10F is A$17M. – FXL estimates that the Mobile Broadband market is growing at 26% CAGR. – The upside risk is increased penetration through existing channels (HVN, Bing Lee and

Good Guys) as well as roll-out through new channels (eg. Apple stores). FXL. BBY forecasts flat lease revenue (in line with guidance) as the credit approach is cautious.

Certegy upside risk.

– BBY FY10F is A$268M, in line with guidance, as Certegy portfolio reaches full maturity in Jan 2010.

– Certegy has recorded 35% volume CAGR over last five years (prior to acquisition). Relevant data suggests the retail sales cycle bottomed around Jan-Mar 09:

HVN sales. HVN has experienced positive sales revenue growth (qoq) through the entire financial crisis. Charts 20 and 21.

Australian Bureau of Statistics (ABS) data indicates that since 1999, monthly lease finance commitments appear to not fall below a floor of A$50M, implying FXL can expect some minimum ongoing level of IT leasing business. Chart 18. The growth rate in IT leasing appears to have bottomed in Jan 09. Chart 19.

Household goods sales appear to have bottomed Mar 09 at -0.7% (coincident with equity market nadir). Chart 17.

TABLE 8: VOLUMES

Volume (A$M) FY09 FY10F Growth

BLINK/other 54 56 0%

FXL Value 168 168 0%

Certegy Value 195 268 37%

Total new volumes 417 492 18% Source: BBY, FXL

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FLEXIGROUP LIMITED

Net Interest Margin Pricing power to offset rising borrowing costs.

We expect FXL to exercise pricing power to offset rising borrowing costs. We forecast NIM contraction in FY10F, then expansion in FY11F. Chart 5.

TABLE 9: NIM TRENDS

Driver (A$M) FY07 FY08 FY09 FY10F FY11F

Average IEA 443.6 480.0 513.4 614.0 722.2

Lease income 126.2 135.2 136.3 159.7 187.8

Lease income/AIEA 28.5% 28.2% 26.5% 26.0% 26.0%

Average cash rate 5.6% 5.7% 3.3% 4.5% 4.5%

Margin to average cash rate 22.8% 22.5% 23.3% 21.5% 21.5% Source: BBY

Sensitivity Analysis

TABLE 10: SENSITIVITY ANALYSIS

Sensitivity Downside assumption

Base case Upside assumption

5% volume change is worth +/- 10cps

FY09F Volumes A$467M A$492M A$517

DDM valuation A$1.81 A$1.92 A$2.04 1% NIM change is worth +/- 8cps

NIM Down 1% across all years

FY10F – 14.7% FY11F – 15.7% FY12F – 16.2% FY13F – 17.3% FY14F – 18.4%

Up 1% across all years

DDM valuation A$1.80 $1.92 $2.00 1% discount rate change is worth +/- 20-25cps

Discount rate 13.6% 12.6% 11.6%

DDM valuation $1.73 A$1.92 $2.19

Source: BBY

b


FLEXIGROUP LIMITED

EARNINGS ANALYSIS

Earnings Driver Trend Analysis We expect ROE to normalise from FY11F. Key drivers will be: (i) impairment

normalisation; (ii) falling cost of funds; (iii) rising non-interest

income; and (iv) Certegy/BLINK

volume growth.

We analyse FXL’s FY09 result and trends in key drivers in Charts 2-13.

Key trends are:

High ROE and ROA. In recent years, ROE has been diluted by impairment expenses, cost of funds and reduced volumes. As these normalise through FY11F, we expect ROE recovery. Also, we expect additional non-interest income growth as FXL exercises pricing power for margin recovery. Charts 2-4. Table 11.

Non-interest income increasing absolutely but stabilising from FY10F as % of total gross income. Chart 3.

Interest income growth rate declined in FY09, driven by net interest margin compression. Chart 5.

EPS growth. In FY07, as part of the initial public offering, EPS was diluted by a new 110M share issue. Going forward, we expect EPS growth to be driven by operating profit margin increase and impairment expense decline. Charts 7 and 8.

Trend decline in average lease values, offset by rising volumes of new product categories and rising non-interest income. Charts 11 and 12.

New product sales. BLINK product to drive FY11 volume growth. Expected to be a loss of approx A$2-3M in FY10, then positive thereafter. Investors should derive some confidence from Certegy’s performance exceeding management expectations.

Fee and Other Income Rising fee income manifests FXL’s pricing power.

Key drivers of non-interest income include:

Certegy fees ie. In FY09, fee income increased as low value, say A$2-3 per month, account fees were applied to all Certegy customers.

Interim rental ie. paying upfront for product access prior to official lease commencement.

Protect income ie. insurance.

End of term income including asset sale ie. “inertia” payments.

Du Pont Analysis We use extended Du Pont for key driver trend analysis. The basic formula is:

ROE = (Operating profit margin * total asset turnover – interest expense rate) * (financial leverage multiplier * tax retention rate)

Margin expansion is the key EPS driver.

Du Pont analysis indicates that margin expansion is the key driver of ROE/EPS growth. Margin expansion is driven by: (i) declining impairment expense; (ii) recovering net interest margin; and (iii) non-interest income growth.

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FLEXIGROUP LIMITED

TABLE 11: DU PONT ANALYSIS

Du Pont Analysis FY06 FY07 FY08 FY09 FY10F FY11F

ROA (%) 4.1% 3.7% 5.1% 4.5% 4.2% 4.6%

ROE (%) 38.3% 27.9% 32.7% 27.5% 26.6% 28.9%

Operating profit margin (EBIT/sales) 54.2% 53.7% 55.2% 51.6% 55.6% 60.3%

Total asset turnover (sales/assets) 0.23x 0.22x 0.26x 0.25x 0.25x 0.24x

Interest expense rate (interest expense/assets)

-6.5% -6.1% -7.0% -6.6% -7.8% -7.9%

Financial leverage multiplier (assets/equity)

9.2x 7.5x 6.5x 6.1x 6.4x 6.3x

Tax retention rate (1-t) 71.4% 63.5% 68.2% 69.5% 70.0% 70.0%

ROE 38.3% 27.9% 32.7% 27.5% 26.6% 28.9% Source: BBY

Earnings Quality FXL is generating high quality earnings growth.

High earnings quality is generally derived from: (i) high accounting-cash earnings translation; and (ii) increased sales volume, unit pricing and fee income. Conversely, low quality earnings is: (i) growth from unsustainable sources such as cost cutting or one-off gains; or (ii) accounting shenanigans.

We believe FXL is generating high quality earnings given:

(i) High translation of accounting earnings to net operating cashflow. Chart 17.

(ii) Earnings growth driven by sustainable earnings drivers (non-interest income, new product categories, NIM recovery, volume growth).

CHART 2: ROE AND ROA TRENDS

0%5%

10%15%20%25%30%35%40%45%

FY06 FY07 FY08 FY09 FY10F FY11F0%

1%

2%

3%

4%

5%

6%

ROE (%) LHS ROA (%) RHS

Source: BBY

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FLEXIGROUP LIMITED

CHART 3: NON-INTEREST INCOME TREND

102030405060708090

FY06 FY07 FY08 FY09 FY10F FY11F0%5%10%15%20%25%

30%35%

Non-interest income (A$M) LHSNon-interest income/total gross income (%) RHS

Source: BBY

CHART 4: INTEREST INCOME TREND

50

100

150

200

250

FY06 FY07 FY08 FY09 FY10F FY11F0%2%4%6%8%10%12%14%16%18%20%

Interest income (A$M) LHS Interest income % growth RHS

Source: BBY

CHART 5: NET INTEREST MARGIN (NIM) TREND

0%

5%

10%

15%

20%

25%

FY07 FY08 FY09 FY10F FY11F FY12F

Net

inte

rest

mar

gin

(%)

Source: BBY

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FLEXIGROUP LIMITED

CHART 6 : EPS GROWTH VS REVENUE GROWTH

-80%

-60%

-40%

-20%

0%

20%

40%

FY07 FY08 FY09 FY10F FY11FDiluted EPS growth (%) Revenue growth (%)

Source: BBY

CHART 7: EPS VS IMPAIRMENT EXPENSE/AVERAGE INTEREST EARNING ASSETS

01020304050607080

FY06 FY07 FY08 FY09 FY10F FY11F0%

1%

2%

3%

4%

5%

6%

Diluted EPS (cps) LHS Impairment expense/average IEA (%) RHS

Source: BBY

CHART 8: EPS GROWTH VS OPERATING PROFIT MARGIN

-20%-10%

0%10%20%30%40%50%60%

FY08 FY09 FY10F FY11FDiluted EPS growth (%) Operating profit margin (EBIT/sales)

Source: BBY

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FLEXIGROUP LIMITED

CHART 9: ACCOUNTING PROFIT VS OPERATING CASHFLOW

0%

20%

40%

60%

80%

100%

120%

FY06 FY07 FY08 FY09

(A$M

)

Operating cashflow/accounting profit (%) Source: BBY. Accounting profit adds back share payment expenses of FY07 A$6.2m and A$2.2M in FY08.

CHART 10: EBIT INTEREST COVER

1.70x

1.75x

1.80x

1.85x

1.90x

1.95x

2.00x

2.05x

2.10x

FY07 FY08 FY09 FY10F FY11F

Ebit/

inte

rest

cov

er (x

)

Source: BBY.

CHART 11: FLEXIRENT AVERAGE LEASE VALUE (A$M)

$1,900

$1,950

$2,000

$2,050

$2,100

$2,150

$2,200

$2,250

$2,300

$2,350

1H08 2H08 1H09 2H09

Flex

irent

ave

rage

leas

e va

lue

(A$M

)

-8%

-6%

-4%

-2%

0%

2%

4%

6%

% g

row

th in

ave

rage

leas

e va

lue

Source: BBY. Note: IT/electrical prices increased in 2H09 due to the lagged effect of rising import costs from a

falling A$ being passed onto consumers. We expect this trend to reverse in future periods.

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FLEXIGROUP LIMITED

CHART 12: GROUP PORTFOLIO AVERAGE LEASE VALUE (A$M)

200,000220,000240,000260,000280,000300,000320,000340,000360,000380,000400,000

FY07 FY08 FY09$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

No. contracts (LHS) Average $ value/contract (RHS)

Source: BBY

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FLEXIGROUP LIMITED

FY09 Results FY09 result demonstrates: (i) pricing power; (ii) earnings

diversification; (iii) scalability; and (iv) funder support. Certegy will be the main FY10 profit driver.

FXL’s FY09 result drivers are illustrated in Chart 13. Lower net interest margin (NIM) and higher impairment expenses were offset by higher fee income. Certegy generated +A$0.2M profit vs initial guidance of A$1.5M loss.

The FY09 result demonstrates: (i) pricing power through rising fee income; (ii) diversification of earnings away from HVN; (iii) scalability through new product category earnings growth (jewellery and mobile broadband); and (iv) funder support.

Key FY09 result features are:

NPAT. FY09 NPAT increased 4% to A$32.8M vs pcp A$32.3M.

Fee income/total income grew strongly from 30.8% in FY08 to 37.4% in FY09.

Certegy. Since the acquisition, Certegy has exceeded FXL’s original expectations. Original guidance was a A$1.5M loss in Year 1; it made A$0.2M profit instead. FY10F guidance is +A$7.2M NPAT (pre-goodwill amortisation) as its portfolio reaches steady state (ie. run off = new business volume).

Impairment expenses increased 23.9% from A$21.9M FY08 (4.5% of average interest earning assets) to A$27.2M in FY09F (5.0% of AIEA). BBY FY10F is A$30.9M (5.0% AIEA), then A$28.8M (4% AIEA) in FY11F.

EPS decline. EPS decline was partially driven by 3M scrip issuance for Certegy acquisition not offset by an income contribution from Certegy (since the Certegy portfolio was not acquired).

Net interest margin (NIM). NIM fell from 18.8% in FY08 to 17.2% in FY09. We forecast FY10F 15.2% and FY11F 15.2%.

CHART 13: FY09 NPAT DRIVERS (A$M)

32.3 33.5

16.7

-7

-1

-5.3

-2.2

0

10

20

30

40

50

60

FY08 NPAT Fee/otherincome

Opex Net interestincome

Bad debts Certegyexpense

FY09 NPAT

A$M

Source: BBY

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FLEXIGROUP LIMITED

FY10F Guidance Management’s recent guidance is summarised in Table 12 and described below:

NPAT. A$37-39M, up 13.4% vs FY09. BBY FY09F is A$37.0M.

Certegy. Portfolio reaches steady state in Jan 2010. A$7.2M FY10F NPAT guidance.

Flexirent. Flat lease volumes expected. We believe this is partially due to management’s stated “cautious approach to credit” and also unemployment concerns.

BLINK. NPAT loss of A$2-3M until FY11 due to subscriber acquisition costs as portfolio accumulates.

EPS. Cancellation of DRP and dilutive share issuance.

TABLE 12: FY10F GUIDANCE DRIVERS

Driver A$M

FY09 NPAT – starting point 33.5

Add: Certegy guidance 6.0

Less: BLINK ramp-up cost guidance (2.5)

FY10F NPAT guidance 37.0 Source: FXL, BBY

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FLEXIGROUP LIMITED

CORPORATE STRATEGY

Competitor Analysis Three main competitors.

The three main competitors are:

Original equipment manufacturers’ direct leasing. All the major IT hardware brands have some consumer finance product to facilitate sales eg. Dell, IBM, Technorent and CIT.

GE Money is a major supplier to HVN providing “interest free” plans (similar to Certegy) and store cards. Domestically, GE has over A$35bn in assets and 4,600 staff serving 3.1M customers through 10,000 retailers and 120 local branches.

Thinksmart (TSM). An ASX-listed company (market cap A$76M), started ten years ago in WA. It offers similar consumer IT leasing products to FXL under the Rentsmart brand through Coles Myer, David Jones, Dick Smith, JB Hi-Fi and Dixons (UK). Approx 70% revenue is outside Australia, including the UK, Spain, France, Italy and New Zealand.

Competitive Strategy Product differentiation strategy confers pricing power. FXL has multiple strategic growth options.

Product differentiation confers pricing power to FXL. Strategies include:

Total customer solutions approach. FXL provides product bundles and after-sales service including repairs and temporary replacement of damaged products (“loaner”). Table 13.

High retailer switching costs created through close integration into retailers’ businesses with sales training, co-ordinated marketing programs, driving repeat sales, sales rewards programs (“Flexichips”) etc. Table 5.

Product innovation. FXL continually creates new marketing campaigns and product bundles.

Other relevant strategies include:

Channel diversification. HVN channel concentration is reducing from 51% in FY06 to approx. 25% of total sales in FY09.

Product diversification. Computer/electrical products have reduced from approx 90% to less than 45% revenue. Chart 1.

Refer “Ten Strategic Growth Options” for list of possible strategies.

Consumer value-add. Tables 13.

Retailer value-add. Table 14.

Value Proposition – Consumer and Retailer

TABLE 13: CUSTOMER VALUE PROPOSITION BY SEGMENT

Customers receive benefits of: (i) immediate product access for small regular outlay; and (ii) total product solutions.

Customers Value proposition

Individuals (approx 65% total). Immediate product access.

Small regular outlay, improving cashflows.

Tax depreciation possible.

Ongoing “relationship” with retailer through FXL marketing

After-sales service eg. faulty product replacement, “loaner”.

Product bundling

Small business (approx 35% total).

Cash flow enhancement

Operating lease tax incentives

Asset obsolescence management Source: BBY

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FLEXIGROUP LIMITED

TABLE 14: RETAILER VALUE PROPOSITION

Retailers receive benefits of: (i) increased sales volume; (ii) higher margin; and (iii) increased staff training and engagement.

Stakeholder Value proposition

Retailer Increased volumes through FXL marketing focus on upsell, repeat business and product add-ons

Direct financial incentives paid – flat fee rebate of approx 3-4% made in cash within 10 days from time lease is signed

Retailer’s sales staff “Flexichips” – sales staff incentive programs

FXL sales and training programs Source: BBY

Porter’s Five Forces Analysis FXL is well positioned in an attractive industry.

Porter’s Five Forces analysis helps analyse an industry’s competitive intensity.

FXL is well positioned in an attractive industry, suggesting sustainability of high margins, ROE and competitive advantage. Table 15.

TABLE 15: PORTER’S FIVE FORCES ANALYSIS

This implies high margins, ROE and competitive advantage are sustainable.

Force Risk Impact

1. Threat of substitutes Medium Low/medium

2. Threat of new entrants Low Medium

3. Competitive rivalry Low/medium Medium

4. Customer bargaining power Low Very low

5. Supplier bargaining power Medium Medium/high Source: BBY

1. Substitute products Risk: Medium Impact: Low/medium

Purported substitutes are inferior to FXL’s value proposition.

The general rule is that close substitute products increase price elasticity of demand.

FXL’s substitutes include: (i) credit cards; (ii) direct leasing; and (iii) in-store finance. However, in our view, purported substitutes are inferior alternatives to FXL’s value proposition because:

Credit card providers do not add value to retailers in the form of sales training, upselling, direct marketing campaigns, rebates, volume generation, temporary product replacement (“loaner”), bundled packages etc..

Direct leasing does not provide product bundles, loaners etc.

In-store finance is possibly the greatest substitute risk in that it is available at point-of-sale and generally as user friendly as FXL finance. However, it still lacks FXL’s value propositions. Tables 14, 15.

The impact of this risk is low/medium (highest risk is in 2015 when HVN exclusive distribution agreement expires).

2. New entrants Risk: Low Impact: Medium

New entrant threat is well mitigated.

This risk is mitigated by:

FXL’s brand equity.

Entry barriers (infrastructure costs, regulatory, IT platform, sales/marketing experience).

Retailer switching costs.

Distribution channel access.

Learning curve, particularly consumer credit database and knowledge.

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FLEXIGROUP LIMITED

Incumbent competitor response (ie. FXL can leverage its customer base and extensive retailer network to offer bundles that would be difficult to replicate).

Compliance, e.g. consumer credit, privacy and other government policies.

The long-term impact of this risk is of medium intensity. In the short-term, the risk appears well mitigated.

3. Intensity of competitive rivalry Risk: Low/medium Impact: Medium

FXL mitigates price-based competition by “selling a payment, not the price”. FXL has flexibility in competitive response.

Industry competition is about channel access (ie. “land grab”) and total product solutions, rather than price-based. Price is less relevant when FXL “sells a payment, not a price”. When the consumer focuses on (say) A$8 per week, this is less relevant than ticket price. This is evident in FXL’s high margins and ROE.

The long-term impact of increased competition is of medium intensity. We believe that FXL’s experience, extensive customer database and broad distribution network positions it well for protective competitive response in the longer term.

4. Bargaining power of customers Risk: Low Impact: Low

FXL’s retail customers have low bargaining power as they tend to accept funding solutions at point-of sale for low-value items, and generally focus on regular payment amount, not total ticket price or implied internal rates of return (ie. >25%).

Given FXL’s diversified lending portfolio, the actions of any one customer will have a low impact.

5. Bargaining power of suppliers Risk: Medium Impact: Medium/High

High switching and direct competition costs reduce retail channel partner bargaining power.

5A. Bargaining power of retail channel partners Risk: Medium Impact: Medium/High

We analyse FXL’s two suppliers: (i) distribution partners; and (ii) wholesale financiers.

Retail channel partner bargaining power is medium, given high switching and competition costs. The risk of direct channel partner competition is low given competition would entail direct costs (IT, marketing and debt collection infrastructure) and indirect opportunity costs (sales staff training and engagement, direct marketing campaigns, sales volume upside, bundled deals etc.). Competition costs are likely prohibitive for most retailers except those with material scale (eg. HVN).

The impact of increased bargaining by retail channel partners would be medium/high. This risk is mitigated by FXL’s increasing channel diversification.

The risk is that wholesale financiers: (i) increase credit margins; (ii) increase the loss reserve; and/or (iii) shift from limited to full recourse.

5B. Bargaining power of wholesale financiers Risk: Medium Impact: High

Wholesale financier bargaining power is medium, but mitigated by: (i) nascent capital market recovery; (ii) A$577M drawn debt is diversified across five financiers; and (iii) evident funding support, manifest through finance being provided for the Certegy acquisition during the GFC.

The impact of increased bargaining by wholesale debt financiers would be high. However, we do not believe that wholesale debt suppliers would cancel debt facilities, but rather the risks are:

(i) Increased credit margins.

(ii) Increased loss reserve. This would constrain future volume and earnings growth.

(iii) Shift from limited to full recourse lending. This would likely increase FXL’s equity beta, as FXL becomes more leveraged.

b


FLEXIGROUP LIMITED

SWOT Analysis

Strengths

Barriers to entry – include distribution relationships; customer database; IT platform; channel partner switching costs

Pricing power – manifest in high margin, high ROE. Table 11.

Limited recourse debt finance – Bad debt losses limited to Loss Reserve. This unique funding structure generates high cash upfront for FXL and is unlikely to be made generally available to new entrants.

Weaknesses

Channel partner concentration – 25% total sales through HVN.

Opportunities

New retail product category expansion. Refer “Ten Strategic Growth Options”.

Distribution channel partner expansion – new stores and new geographies.

Threats

Bad debt cycle. We believe the outlook is improving.

Interest rate cycle.

Consumer regulatory reform. Increased point-of-sale disclosure and regulation may limit volumes.

Unit pricing decline.

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FLEXIGROUP LIMITED

COMPETITIVE ADVANTAGE

Identifying Competitive Advantage FXL’s competitive advantage is manifest in its pricing power, high ROE and high margins.

“You really want [a product] where, if they don’t have it in stock, you want to go across the street to get it – a differentiated product” – Warren Buffett

Competitive advantage allows a company to sustainably generate excess returns. It is generally evident through: (i) pricing power; (ii) ROE; and (iii) margins. FXL manifests these financial indicators.

However, investors should distinguish between competitive advantage and operational efficiency.

Operational efficiency means a company is better than rivals at similar activities.

Competitive advantage means a company is performing better than rivals by: (i) doing different activities; or (ii) performing similar activities in different ways. Only sustainable competitive advantage sustains excess returns.

We believe FXL enjoys competitive advantage because its business model is unique.

Sources of FXL’s Competitive Advantage The basis of competition is a total customer solutions approach (ie. product bundles, loaners etc), not price.

Sources of FXL’s competitive advantage are:

Switching costs. Retail channel partners who switch away from FXL face both indirect opportunity costs (sales staff training and engagement, direct marketing campaigns, bundled deals etc.) and direct costs (lost sales volume).

Distribution channels. It is difficult for any competitor to replicate:

– long standing/exclusive relationship with HVN; – ownership of Certegy channel; – diversified retail distribution channels.

Differentiated product. Refer “Corporate Strategy”.

Sales and marketing core competency. Selling retail structured finance and managing receivables are FXL’s core competencies.

Customer database. FXL has data on over 1M customers. Approx. 30% of FXL’s deals by value are repeat customer sales.

Technology. FXL has a bespoke IT platform used for marketing and rewards programs (“Flexichips”).

Revenue and funding model. FXL enjoys a funding structure that funders are not likely to replicate. Refer “revenue and funding model” below.

Compliance processes. Privacy, consumer credit and tax codes have been developed over time.

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FLEXIGROUP LIMITED

Revenue and Funding Model

Multiple Revenue Streams

FXL generates multiple revenue streams, including:

net interest margin on leases;

application fees;

monthly account fees;

residual payments by lessee; and

sale of leased products to third parties.

Limited Recourse Debt Funding Model and the “Loss Reserve”

FXL’s bad debt exposure is limited to the Loss Reserve. Customer loan defaults are funded out of the loss reserve provisions, with excess losses borne by the Funder.

FXL’s funding model is unique in that its debt facilities are limited recourse to FXL, ie. FXL’s losses on customer loans are limited to the Loss Reserve. Losses exceeding the Loss Reserve are borne by the Funder. The Loss Reserve works as follows:

FXL has five Funders. FXL has a separate special purpose vehicle (SPV) with each Funder. Lending assets go into the SPV.

The Funder takes security over the SPV’s assets and cashflows.

Different Funders have different % requirements for their specific Loss Reserve ratio. There are generally six monthly reviews for the SPVs and their loss reserves.

The Loss Reserve is cash on deposit, and accounted for as a debit on FXL’s balance sheet. It earns interest which is retained as additional loss reserves and contributes to FXL’s P&L.

On default, Funders recover the full loan amount from the Loss Reserve. The defaulted lease amount is recorded on FXL’s P&L as an impairment expense.

At the end of the lease term, any excess cash in the Loss Reserve is returned to FXL. Increased credit defaults negatively impact FXL’s profit margin. Also, we would expect that excessive drawdown on Loss Reserves is likely to result in: (i) higher Loss Reserve margin requirements going forward; and (ii) higher borrowing rates for FXL.

Cashflow Funding Model

Funding model generates high upfront cashflow.

Figure 2 illustrates the structure:

Step 1 − Retail product purchased. Assume product Face Value of A$2,200.

Step 2 – Funded Amount Advanced.

– Once lease is signed, within ten days the Funder pays the Funded Amount to the SPV. – The Funded Amount is calculated as the present value of the lease payments expected

over the life of the lease. In Figure 2, the Funded Amount is A$2,847.

Step 3 − From the Funded Amount, the SPV makes three payments:

– A Loss Reserve provision account (A$285). An agreed % of the funder’s advanced amount is set aside as a Loss Reserve provision to meet expected defaults. In this scenario, 10% loss reserve = A$285.

– FXL’s upfront gross cash margin (A$362).

Step 4 – SPV advances product Face Value (A$2,200) to borrower, who pays retailer.

Step 5 – FXL receives upfront cashflow. From FXL’s gross cash margin, it manages: (i) FXL’s general operating expenses; (ii) makes incentive payments to retailer’s staff (via “Flexichips” rewards program).

Step 6 – Borrower pays monthly lease payments to SPV.

Step 7 – SPV pays monthly funding cost to Funder. Cost of funds fixed in line with term of contract.

b


FLEXIGROUP LIMITED

FIGURE 2 FUNDING MODEL – LEASE CASHFLOWS

10

Funding Model – lease cashflows

Funder SPV Borrower

FXL

Loss Reserve(Cash at bank)

Step 1. Customer purchaseLease Amt : $2,200Lease rate : 30%Term : 36 monthsMthly payment : $91

FXL Cost of Funds : 10%PV@COF : $2,847Loss reserve : $285 (@10%)

$91 per month $91 per month

$2,200

Retailer

$2,847

$285 *Interest

$362 * $2,200

Flexichips

* $362 + $285 = $647 ( = PV of 36 months interest margins @ 20%, paid up front)

Step 2

Step 3

Step 4Step 4Step 5

Diagram 1 – typical lease cashflows

Step 6Step 7

Source: BBY.

Cashflow Model

The FXL model generates high cashflow upfront for the following reasons:

Limited growth capex requirement.

High upfront free cashflow generation from funding structure.

High upfront tax depreciation. Taxed as operating leases from FXL’s perspective (ie. FXL receives the product’s tax depreciation benefits), but accounted for as finance leases.

Funded Amount = lease amount + PV future interest margins (ie. A$2,847).

Accounting

Revenue and cost recognition policies include:

Revenue recognition. Lease finance interest revenue is recognised by applying the interest rate implicit in leases to the beginning period lease balance receivable. Most other revenue items (eg. Protect Plan, cheque guarantee, interest on cash balances etc) are accounted for on an accruals basis (source: note 1(e)(i) June 2009 accounts).

Cost capitalisation and amortisation. Initial direct costs associated with generating leases or loans are capitalised as a contra asset “unamortised initial direct transaction costs” (against receivables account) then are amortised generally at 50%/35%/15% over three years.

b


FLEXIGROUP LIMITED

FXL Debt Facilities FXL has total debt facilities of A$740M.

FXL has total debt facilities of A$740M. Key details are:

Drawn facilities − A$577M.

Undrawn facilities − A$163M, majority with two year availability, with 12-18 months to run.

Funding vs volume outlook. We estimate FXL will have A$96M in undrawn debt facilities by the end of FY10F, comprising available debt facilities of A$484M (ie. A$163M undrawn plus A$321M revolving use of repaid receivables) less new business volume of A$492M plus Certegy new volumes repaid during FY10F (ie. 36% of new Certegy volume of A$268M plus 50% of BLINK’s A$16M sales value).

Non-recourse. FXL has A$15M in Certegy vendor finance. All other debt is non-recourse.

Funders. The identity of FXL’s five funders is undisclosed; average tenure is 7.5 years.

Debt maturity profile. Chart 14.

Interest expense is increasing. Chart 10 and Table 11.

Cost of funds is increasing − both via rising swap rates and credit margin.

Debt facility extension could be a re-rating catalyst.

The terms of FXL’s variable debt facilities (A$106M) are not clear. Chart 14.

FXL says it is “exploring opportunities to increase and restructure facilities to further diversify base/lower funding costs; access capital markets when they re-open and fund growth opportunities”.

An announcement on debt facility restructure could be a near-term stock catalyst.

Comparable: Wholesale Mortgage Manager

FXL is analogous to a mortgage broker who “white labels” third party mortgages.

FXL is analogous to a mortgage broker who “white labels” third party mortgages. However, FXL goes one step further: it both originates leases and manages the underlying cashflow receivables.

Although FXL has 4.6x debt to equity, we believe this metric over-states financial risk given: (i) FXL’s unique funding structure (ie. impairment losses are limited recourse to FXL and loan assets sit in a special purpose vehicle (SPV) which FXL manages on behalf of its Funders); and (ii) FXL records its SPVs on balance sheet; and (iii) EBIT/interest is approx. 2.0x. Chart 10.

CHART 14: TERM DEBT MATURITY PROFILE

0

50

100

150

200

250

300

Variable 1 year or less 1-2 years 2-3 years 3-4 years over 4 years

Borr

owin

gs (A

$M)

Source: FXL, BBY.

b


FLEXIGROUP LIMITED

TEN STRATEGIC GROWTH OPTIONS FXL investors at current prices implicitly receive a “free” embedded call option on growth.

Historically, FXL has experienced five growth drivers: (i) increased sales volumes; (ii) price increases; (iii) rising fee and other income; (iv) selling new products; and (v) acquisitions.

Prospectively, FXL’s scalability and current price-value discount suggests today’s investors implicitly receive a “free” embedded call option on multiple strategic growth options.

We list below some strategic options (from lowest to highest risk):.

1. Increased pricing and fee income.

2. Cross-sell and up-sell to existing customers.

3. Increased operating efficiencies (variable cost reduction). FXL could focus on variable cost reduction, focusing on settlement costs, call centre productivity, approval processes, collections procedures etc.

4. Increased operating efficiencies (fixed cost reduction). FXL has consciously not sought to extract cost synergies from the Certegy-Flexirent integration until the Certegy portfolio/outlook stabilises.

5. Increased channel penetration (ie. existing products, existing channels). This is the current strategy for BLINK roll-out. This requires a continuous focus on sales, marketing and training to maintain cross/up-sell. An example of an opportunity is that FXL has approx. 20% penetration in the IT market at HVN but <2% in consumer electrical.

6. New products, existing channels. This includes bundling, new product launches (eg. Microsfot X-box). Figure 1 above illustrates multiple new product growth options.

7. New geographies, existing retailers, existing products. Following retail channel partners into new geographies (eg. HVN into Europe) is possible.

8. Existing products, new channels. New channels are likely to add cost with unknown upside. Currently, FXL is sensibly focusing on #5.

9. New products, new channels. In our view, FXL is more likely to launch new products through existing channels to mitigate risk.

10. Acquisitions. Whilst this could be high risk, Certegy shows that FXL can execute value-adding acquisitions. Figure 1 illustrates the range of adjacent product segments where FXL could acquire a leasing business. We do not expect FXL to acquire a “bricks and mortar” retailer (which would be a poor strategy, in our view). Targets include lease portfolios, insurance and finance companies.

b


FLEXIGROUP LIMITED

BOARD AND MANAGEMENT Warren Buffett once said: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”.

Fortunately, FXL enjoys both good economics and an experienced management team. We summarise Board/management experience and also consider executive options below.

Board Margaret Jackson Non executive Chairman

BEc, MBA, Hon LLD (Monash), FCA, FAICD

John DeLano Managing Director and CEO BA

CEO of FXL Group since Dec 08 and CEO of Flexirent since Sep 2003. Former MD of Avis Australia; Senior VP Operations of Travel Services International (NASDAQ listed).

Andrew Abercrombie Director BEc, LLB, MBA

Founding Director of the original Flexirent business in 1991 and CEO until 2003. Experienced commercial and tax lawyer; founding partner in a legal firm operating in both Sydney and Melbourne.

Rajeev Dhawan Director BCom, ACA, MBA

Currently a partner of Equity Partners with 14 years venture capital/private equity experience. Formerly represented Colonial First State Private Equity on the FXL board and has continued in an advisory capacity following Colonial’s exit.

John Skippen Director ACA

Finance Director and Chief Financial Officer of Harvey Norman Holdings Limited for 12 years. Over 30 years experience as a chartered accountant.

Management Garry McLennan CFO

24 years of financial services experience with 23 years at HSBC Australia, including 10 years as CFO and four years as COO and Executive Director

Pearl Laughton CIO

15 years of experience managing the development of large scale IT systems and delivering commercial grade software. Held senior IT management roles at Travel Services International and Amadeus in the US

Doc Klotz Head of Operations

20 years in executive management, sales, operations and business integration 2002-2006 he was Senior VP of Hotels.com/Expedia. Previously he was SVP of Sales and Operations for Travel Services International

Marilyn Conyer Head of Marketing

Over 20 years experience, mostly recently as Marketing Director of Optus Business. Former General Manager, Products and Marketing at Hutchison and held senior marketing roles with Alcatel and Telstra

b


FLEXIGROUP LIMITED

Executive Options Management is incentivised to exceed the A$2 share price.

As at 30 Jun 09, FXL had approximately 17.7M unissued ordinary shares subject to options and performance rights as follows:

Options. 9.2M options with 31 Dec 2011 to 31 Dec 2012 expiries and a A$2.08 weighted average exercise price (exercise prices range from A$1.59 and A$2.93). Given our DDM valuation, we do not assume that these options cause any dilution.

Performance rights. The remaining 8.5M shares are subject to performance hurdles, with expiry dates between 31 Dec 2012 and 31 Dec 2014. There are multiple hurdles and tranches disclosed in the annual report.

Key details of the CEO John DeLano’s options are:

13M options with an exercise price of A$2 and expiries ranging from 31 Dec 2011 to 31 Dec 2012. 7.6M options relate to shares currently held by the founders exercisable on similar terms so their exercise would not be dilutionary.

7,500,000 deferred shares; and

2,174,820 performance rights.

Dilution scenario A reasonable share dilution scenario would result in a DDM valuation of A$1.83 per share.

Our base case scenario does not discount dilution through exercise of Board/management options. However, if we assume the scenario where say 50% of performance rights (4.25M) and the CEO’s deferred shares (7.5M) are exercised, BBY’s DDM would be diluted to A$1.83 per share.

b


FLEXIGROUP LIMITED

TIMELINE OF KEY EVENTS 1988 FXL established, originally offering IT equipment vendor finance.

1995 Secured distribution agreement with HVN. Then grew into a small ticket lease provider, specialising in IT equipment.

1997 FXL opened in New Zealand.

1998 Consumer lease product launched.

2003 Introduction of professional management (John Delano – CEO) and corporatisation.

2004 Investment in core reporting, collection and credit scoring systems.

2005 Ezyway product launched for the electrical channel.

2006 Five year contract with Noel Leeming signed.

12 Dec 06 First listed on the ASX.

13 Oct 08 Certegy acquisition completed.

28 Jul 09 Earnings upgrade.

20 Aug 08 FY09 results.

2015 Expiry of formalised contracts with HVN.

Source: FXL

b


FLEXIGROUP LIMITED

RETAIL SALES

Retail Market Overview IBIS expects retail trade to increase at 2.5% pa average over five years to 2013-14.

Retail sales have increased by an average of 1.8% over the past five years, despite headwinds including rising: (i) interest rates; (ii) fuel prices; and (iii) inflation. Chart 15.

IBIS expects retail trade to increase at an average 2.5% pa over the five years to 2013-14, driven by resurgent consumer sentiment, job growth, government investment and housing market strength. However, rising interest rates are the medium term risk. Chart 15.

Monthly retail sales growth appears to have bottomed in Feb 09, coincident with the apparent. equity market bottom. Chart 16.

Household goods sales appear to have bottomed Mar 09 at -0.7%. Chart 15,16.

CHART 15: TOTAL RETAIL SALES GROWTH YOY (%)

0

2

4

6

8

10

12

14

16

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

% c

hang

e (y

oy)

Source: ABS

CHART 16: TOTAL RETAIL SALES GROWTH MOM (%)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

Jan

08

Feb

08

Mar

08

Apr

08

May

08

Jun

08

Jul 0

8

Aug

08

Sep

08

Oct

08

Nov

08

Dec

08

Jan

09

Feb

09

Mar

09

Apr

09

May

09

Source: ABS

b


FLEXIGROUP LIMITED

CHART 17: HOUSEHOLD GOODS SALES GROWTH YOY (%)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Source: ABS

Computer Retail

Laptop sales growth has been very strong since 1999. Laptop price falls are expected to continue, offset by volume increases driven by replacements. Computer retail distribution markets are relatively concentrated.

FXL’s exposure to computer retail includes desktop PCs, laptops, software, storage media and computer accessories. Key trends include:

57% CAGR in laptop unit volume sales from 1999 to 2003 (22,000 to 135,000 units). Volumes increased at 10% CAGR from 2003-04 to 2007-08 (150,000 to 220,000).

The total computer/software goods market was approx. A$6.4bn in FY08 (IBISWorld).

Over the next five years, FXL expects 6% p.a. market growth, with price falls offset by volume increases.

IBIS expects “sales will largely be driven by the replacement market and will stem from the lower end of the price spectrum”. This trend will benefit FXL.

Distribution channels including appliance stores, department stores and online shopping sites.

The Australian retail IT equipment market is concentrated, with 75% market share held by the top four retailers (HVN, JB Hi-Fi, Retravision, Dick Smith). HVN, the market leader, holds approx 40% market share.

In New Zealand, the retail IT equipment market is concentrated among Noel Leeming, Dick Smith and Harvey Norman.

IT leasing

ABS data indicates:

Since 1999, monthly lease finance commitments appear to have a floor of A$50M.

The growth rate appears to have bottomed in Jan 09. Chart 18,19.

b


FLEXIGROUP LIMITED

CHART 18: ELECTRONIC DATA PROCESSING MONTHLY LEASE FINANCE COMMITMENTS (A$M)

50

100

150

200

250

300

350

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

A$M

Source: ABS.

CHART 19: ELECTRONIC DATA PROCESSING LEASE FINANCE COMMITMENTS (% MOM GROWTH)

-40%

-20%

0%

20%

40%

60%

80%

Jul08

Aug08

Sep08

Oct08

Nov08

Dec08

Jan09

Feb09

Mar09

Apr09

May09

Jun09

% G

row

th M

oM

Source: ABS.

Jewellery Retail

Jewellery demand is driven by marriages and consumer sentiment. Key market metrics include:

0.7% sales growth to A$3.39 bn in 2008-09.

1.5% pa growth over the last five years; similar growth expected over the next five years.

Approx. 90% of total watch and jewellery retailing is through duty free stores, antique/used good stores, online shopping and mail-order channels (source: IBISWorld).

b


FLEXIGROUP LIMITED

Domestic Appliances Retail

Drivers include disposable income, consumer sentiment, interest rates, housing construction and new household formation rates.

In recent years, demand has increased for electronic entertainment goods, telephonic goods, and high-tech whitegoods, driven by improved technology. The market grew 6.3% in 08-09 to approx. A$23.6bn (source: IBISWorld). IBIS expects growth to stabilise at 2.7% pa over the next five years.

85% of sales are distributed through department stores and online shopping.

Harvey Norman Overview Distribution channel concentration risk has diminished following Certegy acquisition.

FXL has an exclusive agreement through to 2015 to distribute through HVN’s 200 stores and 11,000 retail staff. FXL’s Certegy acquisition has reduced its HVN sales to 25% of total revenue, diminishing distribution channel concentration risk.

HVN sales growth appears to have bottomed in Mar 09. Charts 20, 21.

CHART 20: HVN TOTAL SALES REVENUE

Rolling annual quarterly growth

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Mar-07

May-07

Jul-0

7

Sep-07

Nov-07

Jan-0

8

Mar-08

May-08

Jul-0

8

Sep-08

Nov-08

Jan-0

9

Mar-09

May-09

Rolli

ng a

nnua

l % s

ales

gro

wth

(qua

rterly

dat

a)

Source: BBY, HVN

CHART 21: HVN TOTAL SALES REVENUE

11.11.2

1.31.41.51.6

1.71.8

Mar-07

May-07

Jul-0

7

Sep-07

Nov-07

Jan-0

8

Mar-08

May-08

Jul-0

8

Sep-08

Nov-08

Jan-0

9

Mar-09

May-09

Qua

rtely

Sal

es (A

$B)

Source: BBY, HVN

b


FLEXIGROUP LIMITED

NOTES

b


FLEXIGROUP LIMITED

This report has been prepared and issued (in Australia) by BBY Limited (ABN 80 006 707 777/AFS Licence No. 238095) (BBY) and is subject to the disclosures and restrictions set out below.

Analyst Certification: The research analyst(s) identified on the cover of this report individually certify that in respect of each security or issuer that the research analyst covers that: this report accurately reflects his or her personal views about any and all of the subject issuer(s) or securities; and no part of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or views expressed by the research analyst(s) in this report.

Legal Entity Disclosures Australia: BBY is Market Participant with the ASX and regulated by ASIC. U.K. BBY is authorised and regulated by the Financial Services Authority (FSA) Registration No. 146367. U.A.E BBY (Dubai) Limited is authorised and regulated by the Dubai Financial Services Authority, Licence No. CL0705 General Disclosure BBY and its associates (as defined in Chapter 1 of the Corporations Act 2001), officers, directors, employees and agents, from time to time, may own or have positions in securities of the company(ies) covered in this report and may trade in the securities mentioned either as principal or agent or may be materially interested in such securities.

BBY does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Contact with FXL has been made during the preparation of this report for assistance with verification of facts.

Disclaimer & Warning This report may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This report does not purport to contain all the information that a prospective investor may require. Before making an investment or trading decision, the recipient must consider Market developments subsequent to the date of this document, and whether the advice is appropriate in light of his or her financial circumstances or seek further advice on its appropriateness or should form his/her own independent view given the person’s investment objectives, financial situation and particular needs regarding any securities or Financial Products mentioned herein. Information in this document has been obtained from sources believed to be true but neither BBY nor its associates make any recommendation or warranty concerning the Financial Products or the accuracy, or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. This document is not an offer, invitation, solicitation or recommendation with respect to the subscription for, purchase or sale of any Financial Product, and neither this document or anything in it shall form the basis of any contract or commitment. Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by BBY, its associates, officers, directors, employees and agents. The securities of such company(ies) may not be eligible for sale in all jurisdictions or to all categories of investors.

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Any opinion or estimate constitutes the preparer's best judgement as of the date of preparation and is subject to change without notice. BBY or Jefferies, Jefferies International Limited or CIMB-GK Securities (USA) Inc, and their associates or affiliates, and their respective officers, directors and employees may buy or sell securities mentioned herein as agent or principal for their own account. United Kingdom: This report is issued and distributed by BBY (which is authorised and regulated by the Financial Services Authority (FSA) Registration No. 146367) only to persons falling within Articles 19 (5), 38, 47 and 49, of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, (all such persons together being referred to as “relevant persons”). Directors, officers and employees of such entities are also included provided their responsibilities regarding those entitles involve engaging in investment activity. Persons who do not have professional experience relating to investments should not rely on this document. U.A.E: This report is prepared or published by BBY (Dubai) Ltd (BBYDL) which is regulated by the Dubai Financial Services Authority (DFSA). This document is intended only for Professional Clients and should not be relied upon or distributed to any other person. The writer of this document or a close relative may have a financial interest or material interest in any investment to which this document relates. BBYDL or its associate may hold 1% or more of the total issued share capital of any issuer referred to in this document. BBYDL or its associate may act as corporate broker for any issuer referred to herein. An issuer mentioned herein may have a material shareholding in BBYDL or its associate. BBYDL or its associate may have undertaken corporate finance business with or for any issuer mentioned herein over the past 12 months, and/or may undertake such business in the future. An associate of BBYDL may be a market maker in any investment referred to herein. Canada: The investments or investment services referred to in this document are available in Canada only to “Designated Institutions”, as defined by the Securities Act (Ontario). Analysts’ Compensation: the research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of the analyst(s) research, client evaluation feedback, independent survey rankings and overall firm revenues, which include revenues from, among other business units and corporate finance. Other International Investors: International investors outside the US, UK, UAE or Canada are encouraged to contact their local regulatory authorities to determine whether any restrictions apply to their ability to purchase this investment. 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RESEARCH BBY Limited ABN 80 006 707 777 – Participant of the Australian Securities Exchange and is authorised and regulated by the Financial Services Authority (FSA) in the UK Melbourne Level 38, Rialto South Tower, 525 Collins Street, Melbourne, Victoria 3000 Telephone 613) 9226 0000 Facsimile 613) 9226 0222 Sydney Level 17, 60 Margaret Street, Sydney NSW 2000 Telephone 612) 9226 0000 Facsimile 612) 9226 0066 London 27 Knightsbridge, London, SW1X 7YB Telephone 44 (0) 207 201 2183 Facsimile 44 (0) 207 201 2181 Internet http://www.bby.com.au/

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