Description

Evertec (EVTC) is a payment processor in Puerto Rico (78% of revenues) and Latin America that was spun public by its then parent, Banco Popular (BPOP), and Apollo in 2013. The parent/subsidiary relationship ended last year when Evertec divested a portion of its Business Solutions segment to Popular in return for EVTC shares that the bank owned. I think this has created a short term headwind on the share price because of reduced revenue and margins, but it has opened up long term opportunities for growth and ultimately a pathway to being acquired. In the meantime, though, owning a >40% EBITDA margin, high ROIC business at <10x forward EBITDA is attractive. 

Separation from Banco Popular

In February 2022, Popular and Evertec announced that Evertec would be selling EVTC assets that were being used exclusively for the Popular relationship (approximately $30 million of higher margin Business Solutions revenue) back to Popular in exchange for ~$191 million ($197 million of EVTC stock less a $6 million credit for the reversal of a CPI adjustment). As a part of the transaction the two companies agreed to amend their Independent Sales Organization Sponsorship and Services Agreement (ISO Agreement) that was set to come up for renewal in 2025. They extended the MSA agreement until 2028 (subject to a lower cap on CPI adjustments), the ATH Network Participation agreement through 2030, and the Merchant Acquiring relationship through 2035. 

In August, after the asset sale, Evertec announced that Popular was selling the remainder of its equity interest (about 10%), which they did through a secondary (EVTC participated, buying back $25 million of their own stock).The company has indicated that the impetus for all of this was to enable more growth and acquisition, especially in Latin America, as separating from Popular would give them reprieve from the Bank Holding Act and allow them to expand more aggressively. Ultimately, I think this paves the runway for the business to be acquired.

While the revenue and margin impact will cloud the results in the near term, extending the Popular agreements alleviates some of the risk that was looming upon expiration in 2025, and even though there’s a near-term cost, having less reliance on Popular long term should make the company more attractive to outside investors. BPOP does still remain the company’s largest customer, and it accounted for 39% of revenues in 2022. 

Segments

EVTC operates in three segments in the payments space: Merchant Acquiring (~20% revenue), Payment Processing (~45%), and Business Solutions (~35%). The company is one of the largest merchant acquiring companies in Latin America and the largest in the Caribbean and is the largest card processor in the Caribbean. Since a trough in 2017 from Hurricane Maria, Merchant Acquiring revenue has grown at a 12% CAGR.

Latin American Payment Processing has grown at a 15% CAGR since 2017, but still is one of the lowest margin portions of the business. In the first quarter of 2023, revenues grew 23% yoy. While this business is growing organically (“double digit” organic growth in 2021), growth has and likely will come from acquisition as well. Evertec made two in the last 12 months BBR (expansion into Chile for ~$50 million closed July 2022) and paySmart (expansion into Brazil for ~$25 million announced in Feb 2023) although the precise revenue contribution from each wasn’t disclosed. The company announced in 2021 that they would be processing MercadoLibre (the largest ecommerce platform in LatAm) debit cards in Mexico, and because that relationship has gone well, they’ve expanded that to Chile, and in the most recent quarter they announced they will be processing transactions for MELI-issued credit cards as well. I think this business continues to grow in the mid-double digits on the top line and ultimately goes from just under 30% EBITDA margin to above 40% (the PR and Caribbean margin was 58% last quarter, so there could even be upside to that). 

Business Solutions, which is what they call their banking application software and processing solutions, revenue, down 11% in the first quarter, took a step back in 2022 because of the divestiture to BPOP, but using simpleton math, it was flat to slightly up on an apples to apples basis ex-the divested business, and the company expects yoy growth in the back half of 2023.

Return on Invested Capital

ROIC for this business is very high but perhaps a little bit subjective to nail down exactly for this business. If you traditionally exclude goodwill and other intangibles, I get to about 135% ROIC. But given the acquisitive path to growth (tuck-in acquisitions to expand the payment network), it’s probably not completely fair to ignore all the intangible assets. If you do include them, however, ROIC averages out to be about 14%, but I think that probably unfairly penalizes them for about $400 mil of goodwill that's been on the balance sheet for the last decade). I prefer to look at the change in profit over the lagged incrementally invested capital here (incremental capex, software additions, customer relationship purchases, and acquisitions)--doing so yields just over 40% ROIC if you exclude the 2022 return which was reduced from the aforementioned divestiture that happened during the year. I think that’s the right number to think about going forward for the business.

Overall the most recent quarter was a solid beat $0.69 vs $0.61 consensus and the stock has reacted favorably since then, but the optimism is muted by implied conservative guidance in the back half of 2023 (raised annual EPS guide by only $0.06 for the year vs the $0.08 beat). But I think numbers are likely too conservative for the out years. With the credit/debit card penetration and ecommerce as secular tailwinds (~50% of transactions are still done in cash), I think high single digit topline growth isn’t unreasonable. Coupling that with good execution to get back to mid-40% EBITDA margin (pre-pandemic, pre-divestiture levels), I think there’s 10-15% upside to sell-side estimates. EVTC trades at 9.6x 2023 consensus EBITDA and has a 2023 FCF/EV yield of 8.4%.

Risks

Insiders who don’t own a ton of stock to begin with have sold relatively recently which has historically been a pretty seasonal pattern for them. I would prefer more insider ownership here. 

Catalyst

Cleaner 2023 financials than 2022

Growth from continued expansion into Latin America