Description

Global Payments (GPN) was recently written up by kismet and gandalf. See their solid write-ups and the 10-K for a business description. Apologies to anyone new to the story; this write-up assumes familiarity with the company. The purpose here is not to repeat what other VIC members have covered, but to add to the conversation. The quick summary is that GPN shares have 13% downside to my worst case estimate of $83, and 53% upside to my base case estimate of $145.

Why the stock trades at 2017 levels

GPN shares dropped by >20% since reporting 1Q24 results on May 1, while the S&P 500 is up 9%. GPN now trades at its lowest P/E in 20 years and near the low-end on EV/EBITDA given the increased leverage it has taken on in recent years. Other than missing margin expansion guidance by 10 bps (40 bps actual vs. 50bps projected), there appears to be nothing in the report to justify the sell-off. Underneath the surface, 1Q24 marked the tipping point for management’s lack of respect for shareholders and weak FCF resulting in shareholders voting with their feet. 

Breaking the golden rule

Warren Buffett states that he writes his annual shareholder letter as if his role was reversed; he discloses what he’d want to know if he were a minority shareholder. GPN management does not believe in this model whatsoever. If they owned a business and hired a CEO to run it who communicated with them the way they’ve communicated with shareholders, they’d fire that CEO. In effect, passive shareholders have fired them after their 1Q24 report. 

GPN not only discloses less than the average payments company, but presents data that tries to make the business look stronger than it is. A few examples:

(1) GPN talks about “adjusted free cash flow” but doesn’t disclose how this number in computed. As an example, on the 3Q23 call, the CFO stated: “From a cash flow standpoint, we produced adjusted free cash flow for the quarter of $733 million, representing 102% conversion rate of adjusted net income to adjusted free cash flow despite a modest increase in capital spending this quarter. We continue to target converting roughly 100% of adjusted earnings to adjusted free cash flow for the full year, excluding the roughly 5-point impact of the timing change to recognizing research and development tax credits.”

Actual FCF (CFFO – Capex) was $258mn in the quarter. Their definition of adjusted FCF is: “Our measure of adjusted free cash flow reflects management’s judgment of particular items and may not be comparable to similarly titled measures reported by other companies … We are not able to reconcile adjusted free cash flow to our projections for the most directly comparable GAAP financial measures without unreasonable efforts due to the complexity, variability and nature of these estimates.” In addition, there is no mention of research and development tax credits in any 10-Q or 10-K. 

(2) In April 2023, GPN disclosed that it sold the consumer portion of its Netspend business for $1B and its gaming business for $400mn. One would expect to see net cash from business sales of $1.4B on the cash flow statement, but this number is only $479mn with disclosure about seller financing of ~$700mn, totaling about $1.2B in “proceeds.” I’m left to assume the $1.4B includes interest they expect to receive? GPN recognized $58.3mn in interest income associated with seller financing in 2023, some of which was PIK. The bigger question is why is a company with a leverage ratio that it needs to bring down post the EVO Payments (EVOP) acquisition in the private credit business? And why is this only being disclosed to the owners of the company in SEC filings?

(3) At its last Investor Day in 2021, management projected $4B in adjusted FCF (the number they can’t even define) by 2025. While it was obvious at the time that M&A was required to reach this target, they are nowhere close to achieving this number having just acquired EVOP. Actual FCF (CFFO – Capex) was $1.6B last year, including a large working capital use of cash and a one-time tax payment together totaling just over $800mn. If we exclude these items, FCF was $2.4B. My estimate for 2025 FCF excluding WC is $2.8B.   

(4) 1Q24 was the straw that broke the camel’s back when management decided to no longer include a slide in its presentation. The following table illustrating Merchant Solutions revenue and volume growth last appeared in the 4Q23 presentation. The numbers are presented in an aggressive way where dispositions are excluded yet acquisitions are not (their definition of “adjusted”). In 1Q24, management disclosed that adjusted volume growth was 16%, but clearly did not want investors to notice the sequential decline from 19% in 4Q.

This was pretty stupid because GPN’s core volume growth, excluding acquisitions and divestitures, was in-line with the end market. When asked on the call, management said organic volume increased by 7%-8%. Mastercard disclosed that its US volumes increased by 6% while ROW volumes were up 13%. Given GPN’s 75% US/25% ROW mix, it should have grown by 7.75% in order to maintain share, and it did. Management’s attempt to hide the sequential decline shot themselves in the foot.

In addition, the CFO disclosed $509mn in adjusted FCF on the call, while actual FCF was $271mn vs. $437mn in 1Q23. GPN still did not provide a reconciliation showing how they arrive at adjusted FCF. Shareholders simply had enough of the nonsense, and the stock took a nosedive. 

Actual FCF

In the following table I compare actual FCF to their reported adjusted EPS. GPN had high earnings quality from 2018 to 2021, then quality dropped in 2022 and 2023 (see the FCF/Adj. EPS line). Working capital swinging to a far bigger use of cash in 2022 and 2023 explains much of the degradation.

Within working capital, the “settlement processing assets and obligations, net” line is a large culprit. It became a far bigger use of cash in 2022 and 2023 when 6 out of the 8 quarters ended on a weekend or holiday. This line item reflects timing differences between when GPN pays merchants and when it gets paid by the issuing banks. It should net to zero over time, but it becomes a use of cash when the quarter ends on a weekend or holiday. In addition, management stated that 2023 included a tax payment of $200mn for the sale of Netspend. Given the low trust this company has, every excuse needs to be fact checked. The supplemental cash flow table in the 10-K does show a +$200mn increase in cash taxes in 2023, so I believe them on this item, but it makes the seller financing decision even more questionable. They paid cash taxes on the sale yet provided financing for most of the value?     

The good news is that 2Q24 is the last quarter that ends on a weekend, and the following 6 quarters end on a weekday, meaning that the large use of cash from settlement assets and obligations should go away and FCF should rebound.  

If overall working capital returns to historic levels of around a $100mn annual use of cash, GPN’s FCF/Adj. EPS ratio should return to the +80% range, indicating good earnings quality. Moreover, GPN would generate just over $10.00 per share in FCF this year and next. For comparison, Fiserv’s FCF/Adj. EPS ratio in 2022 and 2023 was 80%. Strangely, FI nets out settlement assets and obligations each quarter, as if every quarter ended on a weekday. I’m not even sure how that’s allowed as their cash flow statement doesn’t provide an accurate picture of how much cash they generated in the period, but their auditors apparently allow such accounting. 

Let me say that I have 80% confidence in my FCF projections in the preceding table, and therefore 80% confidence that the gap between actual FCF and adjusted EPS will narrow. Given the low trust this company has exhibited, there’s a 20% chance that there’s aggressive accounting here that’s being revealed as non-cash through working capital line items. I’m not aware of any of the accounting frauds having done it quite this way, but that doesn’t mean fraud hasn’t evolved. Nonetheless, there are real businesses here, some of which we can have high confidence in. 

SOTP: $145 base case, $83 worst case 

The entire concern around the legacy payment processors is that they’ll lose share to the next-gen players like Adyen, Stripe and Toast and their historic growth rates aren’t sustainable. This concern played out at Worldpay whose growth deteriorated to the low-single digits in a short period of time. There was mismanagement at Worldpay which was acquired by FIS, and FIS’s management did not fully understand the payments business. Last year, GTCR acquired 55% of Worldpay for 8.2x EBITDA and brought back its old CEO Charles Drucker to turn it around. The looming concern is that the other legacy players will see the same deterioration in growth and will be worth 8x EBITDA. GPN’s Merchant Solutions segment falls into this category.

The following table shows precedent transactions of legacy processors, but valuations have recently come down. Advent acquired Nuvei for 12.5x EBITDA, and GPN acquired EVOP for 13.5x NTM EBITDA (18.5x LTM). These are good comps for GPN’s Merchant Solutions segment as Nuvei had 9% revenue growth last year (in-line with GPN’s recent 7-8%) but as a smaller player Nuvei has far lower margins. EVOP’s revenue growth was also in-line with GPN’s. In my SOTP, I valued Merchant Solutions at 12.5x EBITDA in a base case and at 8x in a worst case, pricing GPN’s business like Worldpay. I use the segment EBITDA disclosed in Note 18 – Segment Information in the 10-K which is after SBC. The only adjustments I make is to add back the acquisition, integration and facilities exit costs disclosed in the same note. Whatever “adjusted EBITDA” GPN reports, I ignore.    

FWIW, Cameron Bready, GPN’s new CEO (prior COO and prior CFO) stated at the last Investor Day that the average Merchant Solutions customer in North America had been with GPN for 6.6 years. International markets (25% of Merchant Solutions revenues) should see even better retention given less competition. GPN derives 27% of its Merchant Solutions revenues from faster-growing e-comm/omni-channel (one of the larger exposures among the legacy players), but much of the rest of the portfolio is under the radar of some of the next-gen players in such old-economy areas as dental, vision, automotive, carwash, construction, chiropractic, veterinary, salon/spa, C-store, self-storage, dry cleaning, legal practice, field services, real estate, restaurants and universities. In essence, GPN is part of the plumbing that lets SMBs take digital payments. Payments processing is a business with high fixed costs where margins can expand significantly as volumes grow. GPN’s margins have expanded substantially over the years, and management expects continued expansion as incremental margins are far higher than average margins.          

GPN’s Issuer Solutions business is the #1 global player, and it has been gaining share. In an industry growing at ~3%, it has been growing revenues at ~5% and having strong success in Europe. It generates a 44% EBITDA margin pre-corporate expenses. Moreover, GPN is in the process of upgrading the on-prem technology of the old TSYS and will launch cloud-based services next year. TSYS’s growth rate could potentially rise to the high single-digits in a few years. I valued Issuer Solutions at 12.5x EBITDA in a base case, and at 11x in a worst case. It’s worth underscoring that there’s no controversy around this business.   

GPN’s prior CEO, Jeff Sloan, was a pioneer in combining software and payments (something the entire industry does today), and he acquired a few vertical software companies during his time. These businesses are reported within the Merchant Solutions segment, but GPN has provided enough disclosure that we can value them separately. Collectively, in 2021, these SaaS businesses had $1.4B in revenues, 115% net retention, +10% revenue growth and a +40% EBITDA margin (pre-corporate expenses). I valued GPN’s Owned Software businesses at 14x EBITDA in a base case and at 12x in a worst case. Corporate was valued at 8x.     

My base case SOTP yields a share price of $145, for 53% upside. My worst case which values Merchant Solutions at 8x EBITDA and haircuts the valuations of Owned Software and Issuer Solutions, even though there are no concerns around these two businesses, values GPN at $83 for 13% downside risk. 

As a sanity check, if we assume GPN see’s no shrink in working capital from ’23 levels and we add back the $200mn one-time tax payment, its FCF run-rate is $6.84 per share. The stock trades at 14x, and the worst case values it at 12x. 

The lack of trust that management has instilled in shareholders has resulted in GPN trading near its worst case value. Here are some data points that suggest the company might be worth its base case value. 

• The short position in GPN is just 3 days and its 2029 bonds yield 5.5%. Fitch recently rated GPN BBB/stable and projects FCF to rebound to +$2B in 2024-2026. If there was fraudulent accounting here, one would expect a far greater short position and more distress in the bonds. It appears that the recent sell-off was an equity market phenomenon driven by longs liquidating out of frustration with management. When Jamie Dimon took over Bank One to turn it around, he said “the disease is only at corporate,” meaning that the underlying businesses are fine. We certainly know there’s a disease at corporate at GPN. If the FCF turns around in 2H, we’ll be able to say the disease is only at corporate. 
• In the GFC, GPN’s Merchant Solutions segment had flat EBIT on an organic basis throughout the entire crisis. GPN sold through ISOs at that time and did not have the software businesses that it has today which result in stickier retention. In addition, GPN is overweighted to SMBs which are far more economically sensitive and exhibit far greater churn. While GPN’s moat was weaker at that time, the business was less competitive as well. Net net, a flat outcome during the GFC suggests a resilient recurring revenue business.
• Cameron Bready recently talked about streamlining the portfolio and divesting of businesses where GPN doesn’t have scale. Jeff Sloan was a deal junkie so there would be a lot to do in this area. For example, GPN gained businesses in Chile and Greece through the EVOP acquisition that would be better served in someone else’s hands. As long as GPN gets out of the seller financing business, divestitures would be welcomed as its $16B in net debt is on the high side. Reuters recently reported that GPN is looking to sell AdvanceMD, a software business that allows doctors to run their practices more efficiently. Finally, GPN will hold an Investor Day in the fall and provide more color around divestitures and the core portfolio going forward.
• The rapid deterioration in growth at Worldpay was due to a couple of factors that are unique to Worldpay. First, Worldpay was very exposed to the UK which went into a recession. Second, Worldpay is the most legacy of the legacy players. It was slow to adopt and slow to respond to client needs. It was also far more in Adyen’s way. Third, there was clear mismanagement at Worldpay as the CEO who came from FIS didn’t have payments experience. Its 8x EBITDA valuation was a steal in light of the fact that First Data was also growing at a low-to-mid single digit rate when Fiserv paid 11.9x EBITDA for it. GTCR is likely to do well on this investment.
• While the odds that Fiserv would buy GPN are low, there’s an interesting strategic overlap here as Fiserv also has an Issuer Solutions business as well as Merchant Solutions. Cost synergies would be substantial but revenue synergies are hard to see. Fiserv has communicated an interest in tuck-in acquisition only, but GPN’s valuation might make it tempting. 

Forrester Wave

Industry experts are not big fans of Forrester Wave’s evaluation process which is focused on reference customers of participants who pay to play. They say Forrester Wave is a starting point, but one needs to do more research. Unfortunately, the sell- and buy-side look at such reports and believe in them more than industry insiders do. Forrester Wave ranks GPN’s Merchant Solutions business dead last, and GPN did not pay to play.    

However, in reading the write-ups on each company, GPN comes across as one of the better providers. I’ve pasted the write-up on GPN below and, in this LINK, you can read the write-ups on its competitors. Strangely, Forrester Wave points out more weaknesses in Adyen and Stripe, the top 2 in its ranking, than it does in GPN.     

Global Payments has scale but must hone its vision and strategy to meet market needs. In 2019, Global Payments acquired issuing, merchant business, and consumer solution giant TSYS. TSYS is the largest of a series of acquisitions that Global Payments has made in the last decade, many of which were for verticalized solutions or extending its geographic footprint. Global Payments leans into its impressive scale to drive its strategy. But the company lags others in this evaluation in areas such as vision, innovation, and partner ecosystem. Global Payments is focused on integrating the banking and the acceptance sides of its merged business with TSYS. If that integration is successful, it will be differentiating now that FIS has spun off Worldpay. Global Payments is doubling down on its verticalized go-to-market strategies, building out specializations in industries such as higher education, restaurants, and events. Global Payments’ core strength is its impressive global reach, which can offer respite to merchants that are tired of manual reconciliation in a multi-acquirer scenario. Its reach means merchants can consolidate acquirers to as few as possible. It also may have industry specializations that others lack (e.g., higher education, events). Global Payments has made many of its products accessible via API. However, as with many of its competitors that have grown by acquisition, there is still deeper integration work to be done. Global Payments is a good fit for merchants with vast global acquiring needs and where local office support in those global markets is appealing. Global Payments declined to participate in the full Forrester Wave evaluation process.

Are they hiding something?

My best guess is, yes they are but this isn’t Valeant Pharmaceuticals.

There was a great discussion on VIC earlier where most of the participants concluded that the edge in value investing is more behavioral, whereas in growth investing it’s more about identifying great businesses. The behavioral edge is about remaining rational and taking advantage of attractive prices set by others who are gripped by emotion.

In my view, the GPN situation plays into the human quality of assuming the worst when we pick up on someone hiding something from us. For example, Jeff Sloan’s departure appeared abrupt and many wondered if he knew something that shareholders didn’t. The following blog post (LINK) does a good job of rationally dissecting why Sloan may have been motivated to leave. It concludes that his total compensation was set to be cut in half with Silver Lake on the comp committee and, as such, he was able to invoke the “good reason” clause and trigger a $34.4 million payment to walk away. In other words, Jeff did what was best for Jeff, and the decision may have had little to do with his outlook for GPN.

Similarly, my base case is that management is likely hiding something, but if we knew what they were actually hiding we wouldn’t conclude GPN is imploding. All three businesses are relatively resilient, recurring revenue businesses that don’t stop on a dime. While I expect Merchant Solutions, the most competitive business, to struggle to continue growing in-line with the end market, I don’t see it as a rapidly melting ice cube, yet is it being valued as one.

If there was something bigger going on, I think other indicators like short interest and bond yields would be waving red flags. I think GPN represents a behavioral investment opportunity rooted in the actual issue that they’re hiding (and we may never find out what it is) not being as bad as what’s priced into the stock. As the saying goes, “the market hates uncertainty more than any known negative.”   

Risks

• GPN is the Valeant Pharmaceuticals of payments and I’m dead wrong. 
• Retail sales experience a material slowdown.

Catalyst

• Working capital normalizes and FCF rebounds.
• Divestitures and deleveraging.
• Investor Day this fall.
• New CEO realizes trust must be rebuilt and improves disclosure.
• With $1.5B in convertible senior notes that convert at $140, Silver Lake is motivated to right the ship.
• GPN takes a big write down turning uncertainty into a known negative.
• Fiserv decides to bulk up.