Description

Edenred SE – Investment Thesis

Recommendation: Long Edenred Common Stock

Note: All metrics are in Euros.

Edenred SE (“EDEN”, “the company”), is a global payment solutions company trading at a 7.9% FCF yield and historically low 16.8x EV/EBITDA multiple (2016 was the last time it traded under 17x). It is known for being the food stamp giant but has 250 purpose-specific payment programs in 45 countries, servicing 60mm platform users, 1mm corporate clients, and 2mm merchant partners. The company is a cashflow generator with a 10-year FCF CAGR of 9%, has grown EPS 120% over 10 years (31% since 2019), increased revenue +55% and EBITDA +64% since 2019, with record breaking FCFE production of €1,189mm in F2022.

Edenred commands a dominant industry position in 70% of the markets it serves, has never had an unprofitable year, and maintains a fortress balance sheet of very low leverage (1.0x net debt / EBITDA ~F23). The company continues to exhibit record breaking performance, and yet the stock is down -19.50% YTD. Here’s why: 

Situation overview / Reasons for shares trading lower.

1. Legal Investigation (Italy)

On February 21st, 2024, it was reported that the Rome Prosecutor's Office launched an investigation against Edenred Italy (EI) for (i) auction rigging and (ii) fraud against the state relating to 4 regional lots of CONSIP tenders awarded to Edenred in 2019. The Prosecutor's Office has accused the company of entering into parallel agreements with commercial establishments such as supermarkets, leading to altered tender offers and non-disclosure of discounts (prohibited under tender terms). The report mentions, the regulators have seized €20m from Edenred, equivalent to profits earned on the tenders, and mentions EI mgmt. is being investigated by Guardia di Finanza (Italian Financial Police). Here is a link to an Italian media report describing the events: https://www.ilfattoquotidiano.it/2024/02/21/edenred-italia-buoni-pasto-accusato-turbativa-d-asta-truffa-sequestro/7453299/

Auction rigging sounds bad enough, but fraud against the state?! Let’s take a deeper look. 

After EI won the tender, a competitor (Repas Lunch Coupon srl) appealed the decision, and investigations were ultimately brought against the company and 4 senior executives after being accused of not having complied with the rules of a CONSIP (“Concessionaria Servizi Informativi Pubblici”) tender. CONSIP is the Italian government's national procurement agency, and they have clear rules regarding the tender process. One of those rules being, “the discount applied to the public administration customer (the public office whose employees would enjoy the meal vouchers), must be equal to the commission applied to the affiliated commercial establishments (the business where employees would spend said vouchers).” This is the rule that EI allegedly violated (naughty!). 

4 regional lots worth €578mm were awarded to EI, granting them supply of meal vouchers for the majority of public employees in specific regions. As seen below, some regions are some of the largest in the country, and if recurring, are a good source of incremental revenue. 

After doing a little digging through Italian court filings, we now at least know what these agreements tend to look like. See below for the Campania Region (Lot 9) agreement and link to the court filing. https://www.corteconti.it/Download?id=f5fab23d-29f9-4e4d-a855-b367aa704d82

Translated into English (thanks google):

“The conditions of sale established in the aforementioned Convention provide that the fees due to the supplier for the provision of services in object of each purchase order are calculated by applying a discount of 19.80% to the face value of the meal voucher;”

Although the CEO and President Fabrizio Ruggiero and Mari Gildas Erulin Arnaud were charged, according to the accusations, the chief architects of the scheme were previous CEO Luca Albino Palermo (current CEO of Fiera Milano ~ 2020) and Stanislas Andrea Jacques De Bourgues (CEO of Edenred Spain), who made the affiliated commercial businesses sign undeclared, parallel agreements. Here’s how it worked:

i) The value of the meal voucher awarded to the Edenred platform for “the benefit” of the public employees, was awarded at a discount to nominal value. Which we know was 19.80% (in the case of Campania).   

ii) According to Guarda di Finanza (the finance police), Edenred took the liberties of constructing a parallel compensation agreement calculated “as a percentage of the face value of the meal vouchers used". This compensation "fluctuated between 0.50% and a maximum of 5%" and was meant to be paid by Edenred “for promotional activities" which apparently, "was almost never carried out". 

iii) What made the deal so pernicious is that the commercial businesses were unaware that Edenred failed to declare the agreement to CONSIP. Therefore, the businesses most likely viewed (innocently) the face value commission agreement as another way to lower costs via relatively cheap advertising, not knowing it influenced the tender.  

Based on this logic (If true), Edenred falsely declared the equivalence ratio applied to affiliated businesses and influenced the tender results in their favor, by effectively passing on part of the expected commission to the business. This was a deal sweetener, but a clear violation that consisted of paying the supermarket an additional 0.5% to 5% of the meal vouchers face value. Since the “kick-back” was only 25% of what they stood to make (19.80% less 5%) it could have been a win-win: EI is awarded the tender, and the supermarket lowers its net discount commission.

Note: This is the worst-case scenario and is currently being defended by management, but given the price action, it is worth deciphering what market participants may be thinking. Guilty or not, we will not know until the prosecutors conclude their investigation. It does however present an opportunity, as the risk has already been priced into the stock (See Thesis #1).

2. Regulatory Concerns (France / Brazil)

France: On the 2nd of October 2023, EDEN shares plunged 11% after Olivia Grégoire (French minister delegate for SMEs and Commerce) suggested that the government may consider a reduction in merchant commissions to the bottom end of the current 3-5% range. In other words, a price cap on a key revenue stream, in a key market (15% of total revenue).

This announcement (if materialized) would have a direct impact on earnings. Although the risk is legitimate, as you will see in my thesis #1 commentary below, a subsequent announcement from the French Competition Authority proved the stock was indeed oversold. It only provided a cheaper price for opportunistic buyers; a situation I believe we are in once again.   

Brazil: Another regulatory concern on the hearts of investors, stems from the anti-monopolistic ambitions of previous Brazilian President Jair Bolsonaro. He sought to diminish the competitive advantages Edenred (and its main rivals) hold over the benefits market, by establishing a new “portable” system law (passed in 2022) where employees can transfer their lunch credits between any provider and spend it at any participating restaurant. Such a law would give more optionality to employees, and potentially strip lucrative interchange fees from Edenred (reportedly as high as 7% vs a 2% credit card fee, and 1% debit card fee). Risk was priced in immediately, but New President “Lula”, stalled its implementation and other forces may alleviate the overall risk (See Thesis #1).    

Thesis Overview

1. Negative sentiment, but temporary. 

2. A continuation of compounded growth and free optionality via strategic execution, and capital allocation.

Business Overview

Following the launch of the original meal voucher concept in the UK (1954), allowing companies to subsidize midday meals without having to run their own canteens, Ticket Restaurant was founded in 1962 by Jacques Borel, “the man who introduced fast food to France”. The company was acquired by Novotel SIEH in 1975 to create the multinational hospitality company Accor S.A. Over the next 50 years, the company expanded its business model across Latin America, Western Europe, and digitized its offerings. In 2010, shareholders approved the spin-off of the meal voucher business (Accor Services) from Accor’s hotel franchise, leading to the establishment of Edenred SE (traded at a 5.7x EV/EBITDA post spin-off). See below for a business model breakdown.

Edenred operates in 45 countries with 12,000 employees and generated a record total revenue of €2.5bn and record EBITDA of €1,094m in 2023. Their competitive advantage is in Benefits & Engagement and is embedded in their technology platform for “specific purpose” payment solutions. These solutions can pre-configure all aspects of a digital transaction (who, where, when and how much) with a high level of granularity. Contracts with large clients are typically 1 – 3 years, generating recurring revenues and business volume. They operate under 3 key segments: 

Benefits and Engagement (€1.15bn operating revenue / 63% of group total): A unique business model that enables corporations to pre-load employee benefits onto “digital cards” that can be spent at partner merchant establishments. The benefits are tax-friendly in most jurisdictions and are generally financed jointly by the employer (min. 50% contribution to max. 60% of vouchers face value) and the employee (portion paid by employer is exempt from income tax).

The value proposition is that employers can pay benefits in a more cost-efficient manner and better engage employees, employees receive purchasing power (e.g. daily limit of €25 for meals), and a simplified expense / mobility experience, and merchants receive additional traffic, recurring revenue, and consumer loyalty. It is in the best interest of the merchants to participate because the alternative would mean employees who have meal vouchers would spend them elsewhere, resulting in lost business. Additionally, public authorities benefit by formalizing the economy and with local job creation. 

Fleet & Mobility (€539mm / 25%): This segment helps manage employee mobility expenses more effectively, helps businesses to manage fleets and improve their traceability, while reducing costs and optimizing the time spent managing them. Other services include payment solutions for multi-energy (fuel and EV charging), freight payments, maintenance, toll, and parking. It is currently the market leader in Latin America.

Complementary Solutions (€253mm / 12%): This segment provides solutions to companies and local authorities, particularly Corporate Payment Services that help companies transfer & receive funds more efficiently and securely. It also provides Incentive & Reward solutions that help companies retain and motivate employees, and a Public Social Program that provides solutions to help local authorities with unemployment and welfare assistance.

The total amount of pre-loaded funds for these segments generates issue volume (via mobile apps, online platforms, and cards), which leads to multiple revenue streams:

• Commissions from the corporate clients (offering employee benefits – food, gift cards, mobility etc.)

• Discount fees / commissions from partner merchants (supermarkets, restaurants, energy providers, freight etc.)

• Fees on value-added services

• Breakage fees (damaged paper vouchers)

• Fees calculated based on the number of transactions processed and % of face value of underlying goods/services. 

• Float – Like Berkshire Hathaway, financial income stems from the interest generated by investing the unused funds preloaded by corporate clients (€5.7bn float in 2023).

Each segment serves different counterparties, but the payment mechanics remain the same (just tailored to each specific use-case), giving way to a scalable business model with positive incentives for all parties involved. Each commission stream combined, forms the “take-up” rate, which improved from 5.2% to 5.3% YoY. 

Industry Overview

The purpose specific payments market is broken up into various verticals targeting different segments of the market. As seen below, Edenred is #1 in the Benefits market ahead of natural competitor Pluxee (recently spun-off from Sodexo), 3rd in the mobility market behind Corpay (formerly Fleetcor) and WEX who are the leading players (although their revenue is mainly generated in the U.S vs EDEN’s global footprint).  

Cashflow metrics and operating/EBITDA margins are attractive industry wide with Edenred coming in 2nd only to Corpay ($21bn mrkt cap) but superior to competitor Pluxee (€3.6bn) due to its diversified segments, ability to scale services on its global platform, tap into unpenetrated markets, up/cross sell existing clients, and attract more business volume while reducing expenses (56% operating expenses as % of revenue vs 58% in 2022).

The industry is countercyclical to inflation as when prices rise, so does the face value of meal vouchers / transactions, increasing revenue. It is also insulated by economic downturns as seen by Edenred only reporting 3 revenue declines over the course of 2008 to 2023. Most notably: 2008 (GFC) total revenue grew 12.8%, 2009 (GFC) declined only -4.4%, followed by a 7.2% growth rate the following year. 2019 saw a growth rate of 18.1%, 2020 (COVID) declined by -10%, followed by 11.1%, 24.8%, and 23.8% (2023) growth rates the 3 proceeding years.

Thesis 1: Negative sentiment, but temporary

1. Legal Investigation (Italy)

On February 22nd, Barclays equity research announced that after speaking with the Edenred SE management team, the group confirmed that “the enquiry relates to a failure to disclose marketing service charges paid to merchants (e.g. fees for brand promotion, stickers on walls etc.), which the Italian commercial court thinks implies lower net merchant commission rates than the ones quoted by Edenred during the tendering process.” From the company’s perspective, this suggests the agreement was indeed above ground, but they simply failed to disclose the charges in the appropriate manner (hence the violation). At worst this sounds like a convenient excuse, and at best an unfortunate error which could eventually be cleared in court.  Note: management have publicly stated “Edenred Italia s.r.l. is working with the Italian legal authorities to provide all necessary explanations during this investigation and remains confident about its outcome.” 

The negative sentiment now relates to skepticism about internal controls and potential reputational and contagion risks. I take some comfort knowing:

• According to Barclays research, Italy represents 15-16% of the group's operating revenues but with public contracts only contributing a ‘low single digit % of Italy's revenues’ (with below average margin) implying a very small revenue/EBITDA hit (1%) if the group decided to cease all Italian public sector activities and not tender for future CONSIP contracts.

• Given Edenred’s size and engrained European roots (commercially and socially – directly benefiting/promoting local business), I doubt they will completely stop public sector activities. Even if they did, this worst-case hypothetical would not materially impact cash flow.

• If guilty, the financial impact would be negligible, a max. €20mm penalty (which has already been seized by the court). One could argue further financial losses from reputational damage, but I believe a couple of factors offset this claim:

• Generally good reputation across multiple countries and a long-standing history: Edenred has been providing socially positive services globally since the 20th century and have developed a good reputation which I do not believe will be tarnished by potentially “failing to adequately report the promotional activities” of a subsidiary. 
• Technological superiority and wide product mix over rivals which fuels demand (as seen in revenue divergence).

o Legitimate value creation in society: 

• Edenred guarantees purchasing power and cost of living relief by relieving workers of the need to sacrifice their budget earmarked for necessities (e.g. food, housing, energy, and entertainment).
• Meal vouchers are essential in inflationary environments.
• Edenred directly supports local business. Channelling sales and additional foot traffic to local economies worldwide.  

This is a global cashflow generating business. The speculation surrounding this case may take some time for the stock to be “re-rated”, but this is contained event, in a geographic region responsible for a fraction of the company's overall operating revenue.

2. Regulatory Concerns (France / Brazil)

France: The stock plunged beyond earnings risk after the French Minister’s commission cap announcement, but a week later, the French Competition Authority (“FCA”) rejected the suggestion as it “does not constitute the most appropriate response to market failures”. Their reasoning for market (competitive) failures and proposed market remedies are quite enlightening though:

Reasons:

1. Barriers to entry: Implying a wide moat for the biggest industry players (Edenred being the biggest), enjoying network effects, economies of scale and the inertia of corporate clients. This is a sticky business model.  

2. Market power of the four historical issuers: Edenred France, Bimpli-Swile, Sodexo Pass France and Up Coop have dominated the market for decades (combined market share 99% as of 2022, Edenred holding the majority at 40%)

3. Increase in the overall commission rate: Edenred is a price maker, not a price taker! The increase in rates is due to “the low bargaining power of merchants, who in practice can ill afford to lose sales by refusing widely distributed meal vouchers.”

Remedies:  

1. Do not introduce a price cap: Such an action would have adverse, counter-productive consequences towards consumers. 

2. Regulation to increase advertising for both corporate clients and approved merchants. Would most likely benefit Edenred vs competitors, given their financial position (industry costs would increase, albeit negligible).

3. Removal of exclusive right of each issuer to accept the securities it issues i.e. separation of issuance and acceptance of meal vouchers enabling merchants to choose an intermediary of their choice which can accept all meal vouchers.

• This is a legitimate risk long term as it would force larger players like Edenred and Pluxee to directly compete in an open network, pushing down rates as merchants would regain more pricing power. 

4. Accelerate dematerialization – Paper vouchers represent 40% of meal vouchers in France (20% for EDEN) today vs. 80-85% in 2018. The panel proposed accelerated shift to 100% digital (another area where increases costs would hurt comps).

I deem the risk to be low in the short to medium term given Edenred’s leading position in market share and technological resources (which they continue to invest in), and although the explicit recommendation NOT to introduce a price cap brings me comfort, the proposal of an exclusivity removal is something to monitor closely. Ultimately, the report introduces an element of risk (but does not outweigh my overall thesis), and actually highlights Edenred’s durability as a company, as well as its pricing power.  Here’s a link to the official report: https://www.autoritedelaconcurrence.fr/en/press-release/meal-vouchers-autorite-de-la-concurrence-issues-opinion-government

Brazil: The “portable” system law was passed in 2022 but after new President Lula da Silva took power, the implementation of it was pushed back and is set to begin operating on May 1st, 2024 (the postponement was reportedly due to government ministries being unsuccessful in persuading the central bank to implement the regulation.). This opens up the field to smaller fintech companies. This risk is like the proposed exclusivity removal in France, but this law was passed vs only proposed. As Brazil is one of the biggest contributors to operating revenue, the risk is legitimate, but I believe the market is underestimating the resiliency of Edenred as a market leader with deep pockets. Additionally, other areas that can alleviate this risk are:

1. Product Mix: Edenred has an integrated platform offering a wide product mix that competitors do not provide. I believe this could be attractive to clients that can have an “all-in-one” solution (Employee meals, benefits and incentives, mobility etc.) 

2. Corporate Inertia: Clients are used to the larger companies’ products. The smaller companies are yet to prove themselves technologically and operationally and would require substantial investment to adequately compete.

3. A lack of investment: There is an ongoing debate between the Brazilian Central Bank and Finance Ministry as to whether transferring voucher credits could create new barriers to entry by requiring substantial investments in operations. This would hurt new entrants as it would only decrease margins and growth capital. 

4. Expansion: Although Brazil is their biggest driver of total revenue (18%), Edenred’s ongoing strategy to diversify into other business segments and geographies should offset any concentration risk.

5. Edenred Capital Partners: Edenred has a Ventrue Capital arm dedicated to “European Tech entrepreneurs reshaping interactions between companies, workers and merchants” & will “invest up to €5m in Seed to Series A rounds”. Edenred has enough cash to buyout the competition before they get too big.   

Thesis 2: A continuation of compounded growth and free optionality.

The current CEO, Bertrand Dumazy, has been running the company since 2015 and has done a great job of consistently compounding all key financial metrics over the last 5 and 10 years. Despite M&A being a growth strategy, there have been only 2 major acquisitions over the last 10 years and average capex spend (5yr average of €131) has been low relative to EBITDA (€770) and FCF (€667) . Organic growth has also been a key contributor, which speaks to customer acquisition and volume growth.

With regards to future growth, Group CEO Bertrand Dumazy, had this to say: "Building on its sound financial position, low level of debt and strong cash flow generation, Edenred intends to seize external growth opportunities while maintaining its Strong Investment Grade rating. At the end of 2023, the Group had M&A firepower of more than €2 billion. The Group will therefore target opportunities in line with the strategic ambitions of its Beyond 22-25 plan – namely Scale, Extend and Expand – within its three business lines." 

The growth strategy consists of:

• Scaling the core business and technology by expanding into unpenetrated markets (as seen above, is exceedingly above current penetration rates of 30-35% for core businesses), targeting SME’s (3-5x less penetrated than global market), personalized benefits (a key component in attracting talent to organizations), green B2B mobility (fuel, toll, maintenance - servicing the energy transition), and various other niche payment markets.   

• Being opportunistic with external bolt-on acquisition targets as seen by: 

o Reward Gateway, a record acquisition (£1.15bn at 20x EV / EBITDA) of a profitable, and fast-growing benefits based SaaS platform that has a presence in the U.K, Australia, and the U.S (areas Edenred lacks exposure). 

o GoIntegro (expansion into Argentina and other LatAm countries).

o PagBem, making Edenred the #1 Freight management / payments provider in Brazil (70% ownership).

o RB, targeting the Brazilian transport market (30% of total workforce use public transport to commute daily), reinforcing a multi-benefits platform in Brazil.

o SPIRII, an EV SaaS platform that provides EV charging station solutions, covering 18 European countries. 

• Accelerating the deployment of services beyond core businesses: Leveraging connectivity and network effects. 

o EDEN has invested heavily into technical talent (3000 employees focused solely on tech) to distribute to a wider audience and enable third-party solutions.

• Expanding into new geographies.

The acquisitions have cemented Edenred as a global employee benefits leader with a growing presence in the mobility business, and I expect growth to be materially reflected in the coming years. I also believe there is room for more accretive M&A transactions within the next few years given the companies €2bn war chest and willingness to be opportunistic. 

Cash generating position provides free optionality for dividends and buy-backs.

Edenred is increasing its dividend by 10% from €1 to €1.10 and have consistently shown a shareholder-friendly dividend policy (June 11th Record Date, June 12th Payment Date). As they continue to increase FCF and create value for shareholders, I believe they will continue to increase the dividend and attract new buyers of the stock.  

Management will also be updating a share buy-back program at the May 7th, 2024, Annual Shareholders Meeting. The terms will be for 18-month’s, the maximum amount to be bought back will be 10% of the shares outstanding at the buyback date, i.e., on an indicative basis, on December 31, 2023, 24,958,805 shares, at a maximum purchase price of €80 per share. The total amount allocated to this buyback program could not exceed €1,996,704,400 on this basis. 

My view is that Edenred will continue to compound capital for investors via strategic execution and prudent capital allocation but given a strong cash and cash equivalents position of €3,352mm (+11% YoY from €3,024mm), growing FCF generation, and a Net Debt / EBITDA of 1.0x (0.4x prior to £1.15bn Reward Gateway acquisition), investors are provided free positive optionality in the form of share buy-backs, increased dividends and accretive M&A. All positive events for holders of the stock, especially those that buy now at historically low prices. 

Valuation

Despite record earnings, at €43.71/share, EDEN trades at a 16x EV/EBITDA multiple, making it historically cheap, as the last time it traded under 17x was in 2016. I believe the negative sentiment surrounding the company is temporary and has provided an opportunity to begin accumulating shares at an attractive valuation, for a company that presents legitimate compounding potential over the next few years. In other words, I believe it is time to be greedy while the masses appear to be fearful.

If you buy this stock today, what you get is a:

• Phenomenal cash flow generating company.

• Legitimate compounding candidate.

• Management team that is shareholder friendly. 

• Historically attractive entry price. 

Risks

1. Reputational risk from ongoing Italian investigation: See Thesis #1. 

2. Regulatory: 

a. General Risk: The benefits and solution business are enabled by the tax and legal laws of national governments, so laws could change in ways that are unfavorable to Edenred. Mitigated by:

i. Management building long term relationships with core players in the government, government departments, the corporate world and academia that are involved at the international or national levels influencing policies that effect Edenred solutions. 

ii. Active in international debate to protect their interests and promote their business. 

iii. Active “partnerships” (most likely political lobbying) to promote/defend policies that effect Benefit and Engagement solutions. Given the net positive contribution to society, I doubt there will be much opposition.  

b. Proposed exclusivity removal in France/Brazil: See Thesis #1.

Catalysts:

1. Favorable ruling on Italian investigation.

2. Another record-breaking earnings print (earnings calendar Q1: April 18th, Q2: July 23rd).

Catalyst

1. Favorable ruling on Italian investigation.

2. Another record-breaking earnings print (earnings calendar Q1: April 18th, Q2: July 23rd).