Description

Disclaimer: This report is the work of an investment adviser affiliated with the author. The report is the result of the adviser executing its investment strategy. The adviser holds a position in the security, however there is no assurance that the adviser will continue to hold the investment, or make additional investments, and will not update the information to reflect future changes in the adviser’s assessment of the investment.

Thesis

Lesaka Technologies (LSAK) is a combination of a special situation and an open-ended long-term growth story. With the closing of a transformational acquisition in April, the company has put in place what we believe are all the ingredients to transition from an unloved, mismanaged holding company into a growing operating company. Because the company is still perceived as a money-losing holdco, it is trading at ~9x 2023 CY EBITDA for a profitable fintech/payments company in South Africa which has grown EBITDA at a 25% USD CAGR over the last 3 years (including 30%+ in the last year) and is poised to compound EBITDA at ~20% in USD in the coming 2-3 years. For perspective, even after the recent tech sell-off, public fintech comparables in EM suggest a business with this kind of profile could trade on low/mid-teens EBITDA.

It is our opinion that the company’s management team, board members, and shareholders are rockstars in their respective fields, and certainly punch well-above their weight considering the company’s market cap of just above $250mn. Importantly, Lesaka is effectively controlled by Value Capital Partners (VCP), VCP owns ~22% % of LSAK and is considered South Africa’s pre-eminent activist fund with a strategy modeled off of ValueAct Capital in the US. Based on public filings, numerous insiders, including VCP, have been acquiring shares in Lesaka in recent periods. 

We think Lesaka can be an interesting investment for both value/special situation investors and for growth investors looking to take advantage of the market correction to buy into quality long-term growth assets at discounted valuations. The former category of investor can focus on the re-rating to a normal multiple as the company just now has completed its transformation, will print EBITDA for the first time as an operating company with June and September results, and the company is planning major investor relations initiatives over the coming months. After this potential re-rating, this category of investor could exit with a ~50% potential return. For the second category of investor, Lesaka offers the opportunity to buy a long-term strong growth asset at a low absolute valuation with plausible potential over time to become the fintech champion of South Africa.  In the medium/long-term, the company aims to become a leading South African payments company primarily serving micro, small and medium enterprises (“MSMEs”) and underbanked consumers - given the quality of individuals involved in Lesaka, we think this is a plausible outcome. We therefore believe shares could rise by over 2.5x over 2-3 years.

While South Africa may not be a market that is familiar to many US-based investors, it is a country with a strong rule of law, property rights, etc. compared to most emerging market countries. The strong increase in commodities over the past year has directly benefited the economy and has been a tailwind for the currency (the rand). Lesaka’s primary listing is in the US, and as we will detail, we think this is actually one of the sources of opportunity as a US investor base isn’t the natural constituency for the company. Now that its transformation is complete, Lesaka is going to focus on telling its story to South African and emerging market investors, where this is very much an under the radar story (no sell-side coverage in South Africa, for example) and where there is scarcity value for strong growth technology stories as these companies are much rarer than they are in the US. We think Lesaka will be able to attract strong interest when it reaches out for the first time to its natural investor base, driving a re-rating for special situation investors today. 

As a final introductory note, Lesaka is focused on financial inclusion and serving micro/small businesses in South Africa and underbanked consumers. The company is aware of the demand from ESG/impact investors and the potential for lower cost of capital pools to lead to a higher valuation in the public markets. 

Near-term catalysts + why does the opportunity exist 

For those previously involved, this company was known as “Net1 UEPS” up until last month.  There have been four UEPS write-ups on VIC in the past.  While the stock has a poor long-term track record, these write-ups were effectively about a different business run by different people. In 2020, VCP acquired a 20%+ stake in the business and replaced the board and management. Up until April, "Net1 UEPS" was holding company with cash of ~200mn of cash, no debt, and a money-losing legacy business. As of April, the cash has been deployed into the acquisition of “Connect Group” acquisition (see below), which will effectively represent all of the profits and most of the value of the company going forward. In short, the company has been entirely transformed compared to 2 years ago.

We think there are a number of catalysts which will help the company re-rate in the short-term:

• Release of pro forma financials and quarterly earnings – To date, very little information has been disclosed on the Connect Group, which now represents the vast majority of the company’s value. If you check Bloomberg or CapIQ today, LSAK financials, even the most recent quarter, looks like the old money-losing, cash-rich Holdco. Audited financials for Connect Group are expected to be released within the next month and Connect Group will be included in the financials going forward. We think a few quarters of reported 20%+ USD organic EBITDA growth will attract investor attention.

• Increased IR and PR efforts – All of the company's stakeholders are incentivized to raise the share price and recognize that this requires IR/PR comparable to an IPO of a business.   

• The most recent earnings call on May 10 was the first one that included info on Connect Group and where management articulated an overarching strategy.

• In the last month, management presented at two major South African conferences (Morgan Stanley and Avior) after years of not doing them. 

• One can simply compare the old website ( http://www.net1.com/) to the new one ( https://www.lesakatech.com/) to get a sense for the change underway. 

• Last month, the company also changed its name from "Net1 UEPS to "Lesaka", a word with symbolism for the company's target customers. (See pg. 4 https://www.sec.gov/Archives/edgar/data/1041514/000106299322010202/formdef14a.htm)

• Sell-side coverage - FBR is the only sell-side firm that covers the stock currently, but we would expect South African, EM, and potentially other small-cap focused U.S. brokers will pick up coverage given the company's IR efforts. Given the scarcity of publicly listed growth names in South Africa as well as EM markets outside of Asia, we believe that this is an attractive stock for South African and EM brokers to cover.

• EM + South African investor attention – The legacy of this shareholder base was deep value U.S. small-cap investors (several of which we think expected UEPS to return its cash and have been exiting in recent months as that thesis has not played out). The natural shareholders for Lesaka are now are global EM investors and South African institutions (noticeably absent from the current shareholder list!), whereas most of the trading liquidity is in the US ticker versus the South African one. 

In addition to the undervaluation, strong catalysts and positive signaling (recent insider buys), we are comforted by the fact that there are also a number of identifiable reasons why Lesaka is mispriced:

• Core business immediately prior to the Connect Group acquisition was loss-making.  New management is working to right-size the overhead at legacy Net1 and that piece of the company (now <10% of value) should no longer be loss-making in a couple of quarters. Quarterly EBITDA losses in the core business averaged ~$12mn in FY 2021, however they have improved to only $3mn in the most recent quarter. Experts agree that losses can get to zero in the near-term and/or the business can be shuttered (therefore losses shouldn't continue in perpetuity). 

• No financials for the Connect Group – Considering the TEV of the Connect Group acquisition at $315 million was larger than the market cap at the time of the acquisition, the company may look like a bit of a black box to new investors considering how little info on the Connect Group has been disclosed.

• Past mismanagement – The old management team overpromised + underdelivered and were poor stewards of capital (e.g., a South African payments company investing in fintechs in Korea and India). 

• SASSA dispute – Under the old management team, the company lost the contract to distribute social grants for the South Africa Social Security Agency (SASSA).  The subsequent ongoing legal dispute received a significant amount of negative media coverage putting a stigma on the company. However, the liability has been ringfenced and we spoke with a local South African law firm who felt that it is highly unlikely there is recourse to Lesaka from this. Moreover, relations with the government have been materially improving under new ownership.

Rockstars at the helm

VCP

Value Capital Partners (“VCP”) was founded by Antony Ball in 2016 and effectively controls Lesaka.  Ball was previously the co-founder of the private equity firm Brait in 1990.  From 1991 until Ball’s departure in 2011, Brait delivered an IRR above 30% to its limited partners.  We think VCP is among the best private equity style public markets investors in South Africa and we view their team on par with elite developed market PE firms. The firm is highly regarded locally in South Africa as well as by foreign blue chip institutional allocators. VCP has been consistently increasing their stake, buying >$10mn in 2020, $4mn in 2021, and again recently in March of this year at an average share price of $5 per share.

Ali Mazanderani (non-executive director)

Ali is one of the more respected fintech investors outside the U.S.  He was formerly a partner at Actis, an EM-focused private equity firm, responsible for payments.  He has been on the boards of StoneCo in Brazil, Network International in Dubai and Fawry in Egypt.  He currently runs a European-based fintech unicorn, Saltpay.  Mazanderani was the architect of Lesaka’s current strategy and presented his vision on the fiscal Q4 2020 earnings call. 

IFC

The International Finance Corporation (IFC) is the second largest shareholder and has been of the most active investors in developing markets financials and fintechs. Given their experience and deep network in South Africa, their involvement in Lesaka helps us gain comfort that there was no impropriety under past management.  

Management / Incentives

Our reference checks on the members of the senior management team have been very positive and we feel that every one of them could have executive roles at much larger organizations:

• Chris Meyer, CEO – Joined the company in July 2021, was previously the head of international corporate and investment banking at Investec, a GBP 100Bn+ asset management and investment banking firm. 

• Steve Heilbron, Connect Group CEO – Another former Investec executive, Heilbron came over to Lesaka as part of the Connect Group acquisition.  He is responsible for helping to put Kazang on its current growth trajectory. 

• Lincoln Mali – Appointed the CEO, South Africa, in May 2021.  Mali is a highly regarded veteran executive from Standard Bank, one of South Africa's largest banks.

• Basie Kok - Chief Technology Officer - Former senior exec at SaltPay (Ali Mazanderani's unicorn fintech) and considered a top fintech talent in South Africa.

The senior management team is fairly well incentivized for a small-cap with the company matching purchases of shares in the open market up to $1 million when a new exec joins.

Background 

VCP began acquiring shares of Net1 in mid-2020, initially acquiring a 13% stake in May 2020, leading to Antony Ball (as well as his colleague Monde Nkosi) and Ali Mazanderani getting appointed to the board.  VCP proceeded to replace the entire senior management team, completed the remaining divestitures of most of the remaining non-core businesses, replaced another three board members and began restructuring the core business.

The company laid out its updated strategy presentation at the Fiscal 4Q20 earnings call in September 2020.  A key part of the strategy was to deploy the company’s large cash balance (into a transformational acquisition). The main operating assets of Net1 UEPS at the time were:

• Universal Electronic Payment System (UEPS) technology protocol and the ability to provide secure payment processing in off-line and rural environments (technology which allowed them to win the initial SASSA contract to distribute social grants to South African pensioners via Net1’s biometric cards)

• EasyPay, a card payment processing business focusing on bill payments at large retailers (e.g. Woolworths, Pick n Pay, Shoprite)

• EasyPay Everywhere, essentially mobile banking products (including microloans and life insurance) for some of the previous SASSA grant recipients serviced by the company  

Given the customer base had fallen from 10 million subscribers to ~1 million, the EasyPay Everywhere business was generating losses due to high of fixed overhead costs, including 350 retail branches and a network of mobile and fixed ATMs.  This is the part of the business driving losses. However, hidden from the consolidated financials, EasyPay was solidly profitable and generally a good business. Despite the name, EasyPay isn't integrated with EasyPay Everywhere and will be profitable even if EasyPay Everywhere is shuttered.

SASSA / CPS – Net1’s former subsidiary, Cash Paymaster Services (“CPS”) has been in a drawn out legal and PR battle over alleged corruption stemming from the 2011 SASSA RFP.  CPS was put into liquidation in 2021 and the liability is ringfenced at CPS, so Lesaka is not subject to any liability.  This was confirmed by local lawyers we spoke with in the past. Still, the news flow has been persistently negative for so long that it tarnished the reputation of Net1 among investors, the government and consumers.  Lesaka is doing a good job of distancing itself from “the old Net1” and Lincoln Mali is working hard on improving government relations.            

As a legacy of previous management's capital allocation, Lesaka owns non-core assets which the company will seek to dispose of in the coming years. The most important of these is MobiKwik, the #3 independent payments operator in India.  MobiKwik has over 100 million users of its mobile wallet and has a first-mover advantage in Buy-Now-Pay-Later. 

On November 1, 2021, the company announced a transformational acquisition of the Connect Group for ZAR 4 billion ($315 million) or 12.8x Feb 2022 EBITDA. The deal closed on April 14, 2022.  

• The Connect Group is the combination of two assets, Kazang and CashConnect.  CashConnect is a provider of “smart safes” (more below) to formal SME merchants.  Kazang is a provider of mobile top-ups, prepaid electricity, bill payments, money transfers and other value-added products (e.g. sports betting, lotto tickets) to 46,000 micro and small merchants across South Africa (~36k of the 46k merchants would be classified as being in the “informal” market).  Excitingly, Kazang has a burgeoning MSME merchant acquiring business, KazangPay, that is generating VC fintech type exponential growth. 

• We believe that the Connect Group acquisition was acquired at an attractive multiple relative to the growth runway. A key reason for this is that private assets in South African hadn't experienced the type of rerating seen in the US in recent years. Additionally, Lesaka was an advantaged buyer because Connect Group was too small to take public, there are a limited number of strategic buyers, and South African PE firms don't tend to focus on fintech businesses. 

Kazang / Connect Group

Connect Group’s revenue can be broken up into four segments:

• Value-Added Service (VAS) Platform: Kazang - Estimated 40% of EBITDA

• Offering mobile top-up, prepaid electricity, bill payments, value-added products at micro-SMEs in the informal market

• Kazang’s competitive advantages stem from its strong brand equity, broad offering, sticky merchant relationships and vertical integration in prepaid electricity 

• Smart-Safe Business: Cash Connect - Estimated 40% of EBITDA

• Digitized cash vaults for SMEs facilitating cash deposits and supplier payments with instant cash access 

• 4,000 cash vaults installed at retail merchants around the country taking in ZAR 99 billion

• Sticky, oligopolistic, capital-light (cash-in-transit outsourced) business

• Merchant acquiring to MSMEs + Growth Capital to Formal SME Merchants - 20% of EBITDA

• KazangPay – Merchant acquiring solution to MSMEs 

• Traditionally POS terminals have been too expensive for these store owners but KazangPay is positioned at an attractive price-point

• Offers merchants instant settlement on card transactions (vs. the typical 24-48 hour wait for funds to be made available)

• This business is growing exponentially, from less than ZAR 5 million/month in November 2020 to >ZAR 300 million/month in February 2022

• CardConnect / CapitalConnect – digitized provider of merchant acquiring and growth capital to formal SME merchants 

1. Capital is approved in under 60 minutes and is in the merchant's account within 24 hours

2. Capital is provided by assessing the merchant's existing transactional data and ancillary data points through Connect’s digital ecosystem.

Note: Exact segment contribution has not yet been disclosed by the company.

The Connect Group overall grew EBITDA at a 40% CAGR in Rand over the past three years.   

We believe KazangPay is the most exciting revenue stream as it’s growing rapidly, has significant penetration upside within existing Kazang merchants and there should be a very long runway for growth as 90% of these merchants' transactions are still conducted in cash. 

Growth Drivers / TAM

• Management estimates the pro forma TAM across MSMEs and financial services to underbanked consumers is an $11 billion market

• Lesaka estimate they currently have less than 1% market share in the formal SME space and less than 4% in the informal MSME space

• On the consumer side there are ~26 million people in South Africa who fall into Lesaka’s target market

• There are at least three ways for Lesaka to attack this TAM:

• 1) Growing merchants – Lesaka has 58,500 total merchant touchpoints today and there are ~700,000 and ~1.4 million formal and informal merchants in South Africa

• 2) Grow throughput per merchant 

• Cash-to-card migration

• Cross-selling more value-added services to the merchants: issuer and acquirer processing, bill payments, VAS, cash deposits/withdrawals, working capital lending, mobile wallets, insurance, etc.  

• Over time Net1 thinks there is a ~2-5% addressable take rate with these MSME merchants

• 3) Offering more services to consumers (e.g. C2C payments, global remittances)

Lesaka's public listing in the US sets the company up to be a consolidator of payments businesses in South Africa, which is one of the key reasons why the company is so focused on investor relations. We understand that there are many payments/fintech companies that Lesaka could acquire at attractive multiples (given the discount in South African private markets relative to public markets) and which would be highly synergistic tuck-in deals. Given there are capital controls in South Africa, founders of these businesses like the idea of getting paid in US shares and their alternative exit options have gotten more complicated given what's happening recently in late-stage VC markets globally.

Strategy

This SME merchant acquiring model has been proven in different emerging markets with a number of public players generating strong growth, profitability and sticky customer relationships. The bull case for these names has been around offering more and more services to merchants over the long-term, like accounting/ERP software and working capital loans (given the merchant acquirers have strong visibility into a merchant’s daily cash flow). The more services which are offered, especially if it involves lending, the stickier the relationship becomes. 

What is particularly unique about Lesaka, from combining all of these assets, is having an offering on both the consumer/issuing side and acquiring side.  Combined with their distribution channel and brand strength, this should allow Lesaka to be the most competitively priced on the acquiring side over time and still make more money than their competitors acquire new customers (looking at the customer holistically, taking all of the products into account). So, over time, Lesaka’s LTV/CAC should become very hard to compete with if they get it right and their competitors don’t have those pieces put together. And Lesaka is the only business in South Africa —other than the big banks—that has both the issuing side and the acquiring side, as well as cash management.

From our diligence with industry and local experts, we believe the Connect Group is the leading player when it comes to cracking the informal market and is the only player to have made progress on a combined VAS/card acceptance and cash management solution, which is very compelling to the informal merchants. Other players like Yoco and Ikhoka are more focused on the formal market and don't have a core VAS solution. Flash, the other major player in the informal market, doesn't have an in-house card payments platform. Finally, the banks in South Africa have historically proven to not be capable of making meaningful inroads into the informal merchant market.  

Model Assumptions

We construct our model based primarily on conversations with industry experts and the data disclosed on slide 11 from the 3Q22 Lesaka investor presentation.

We've illustrated the EBITDA growth assuming that Connect Group was acquired on March 1, 2022 (the beginning of Lesaka's fiscal year) and ex-one offs. The primary drivers of EBITDA growth are explained below. Given all the moving parts, we thought it was most helpful to illustrate EBITDA growth along the three categories below.*

• Connect Group Growth

• Value Added Services - This business compounds at a ~20% CAGR over the next 4 years as the group grows the number of devices and value put through these devices offset by a decline in take rates. This accounts for roughly half of Connect Group EBITDA growth over the period.

• Merchant Acquiring + Capital - Driven predominantly by the merchant acquiring side, this business grows 5-10x from current levels over the next 4 years as the offering penetrates Connect Group's current merchant base. It drives over 25% of EBITDA growth over the period.

• Smart Safe - This business compounds at a CAGR of 10% over the next 4 years.

• Legacy UEPS

• We model losses in the money-losing, EasyPay Everywhere business going to 0 and staying there in perpetuity (note management believes this can be a materially profitable business) and for the profits from Legacy UEPS to be driven by EasyPay. Given EasyPay's reach and brand, industry experts tell us EasyPay EBITDA can nearly double over the next 5 years just from better management as this was a mismanaged asset in the past.

• Synergies

• Synergy estimates are driven based on feedback from industry experts about the potential to (a) cross-sell Kazang value added services to EasyPay customers and vice-versa and (b) reduce the cost base at Kazang and EasyPay given overlapping technology and central costs.  

Note: For illustrative purposes, assumes Connect Group and Legacy UEPS are consolidated at start of YE Feb 22. Connect Group follows a February year-end and we've therefore modeled based on this given this is how the limited financials on the company have been disclosed thus far; Lesaka's year end is in June.

*The company will report segments going forward along two lines: Merchant (Connect Group, EasyPay) and Consumer (EasyPay Everywhere). 

Valuation

As further details about the Connect Group are disclosed, we would expect the market to value Lesaka on a multiple of EBITDA or EPS. (The FBR analyst shifted from valuing the business on a SOTP to valuing it on a multiple of revenue in May.)

Over the next 6-12 months, we believe the shares could trade at $6.84/share, which represents ~50% upside.

• This is based on a multiple of 12.6x CY 2023 EBITDA which we think is justified on a EV/EBITDA versus USD growth basis considering Lesaka's forward growth of ~20% and where EM peers are trading on this basis. 

• For the EM comparable universe, we focused on payments/fintech companies with limited credit exposure. This includes Egyptian payments names (E-Finance and Fawry), GHL which operates in S.E. Asia, and Network International which operates in the Gulf and Africa. 

• As a sanity check, this corresponds to a <1x PEG ratio whereas South African growth companies trade on 1-2x PEG.

• While there are only a handful of South African publicly listed growth stories, these include Dis-chem, Transaction Capital, Karoooo, Capitec, Pick n Pay, and Clicks.

• In this math we give no value for LSAK's non-core assets (e.g., Mobikwik) as we don't believe these will be monetized over the period and therefore may be given no value by the market.

Over the next 2-3 years, we believe the shares could trade at $12.60/share, which represents ~2.8x upside.

• This is based on $10.28/share in value from applying a multiple of 11.2x CY 2025 EBITDA (compared to the target multiple above, forward growth will have slowed to mid-teens in USD although the mix of businesses will have improved to higher multiple businesses). 

• As a sanity check, this corresponds to well below a <1x PEG ratio whereas South African growth companies trade on 1-2x PEG.

• We give $0.82/share in value to the company's stake in Mobikwik. Lesaka carries its investment in MobiKwik at an implied 100% valuation of $750 million (based on the previous funding round).  We value MobiKwik based on where its shares trade in the secondary market in India.  MobiKwik will attempt to IPO when market conditions improve and Lesaka will ultimately look to monetize its stake.

• Finally, we give $1.40/share in value for accretion from future deals. We know that the company will seek to leverage its position as an advantaged buyer to do tuck-in M&A and our research indicates there are several synergistic businesses which can be acquired for an attractive multiple. 

 Risks

• Execution and competition – While Lesaka's business model is highly relevant to the informal merchant base in South Africa today, the company must continue to evolve its business mix as more of the economy is digitized while also fighting off competition which will invariably be attracted to this TAM. The Connect Group has demonstrated a strong track record of doing this historically and experts we spoke with believe the pieces are in place within Lesaka for this to continue going forward and for Lesaka to emerge as one of the winners in the space. 

• Leverage – Pro forma for the Connect Group acquisition, we would expect leverage to be at to ~3-3.5x net debt to run-rate EBITDA by the end of this year and to fall to ~2.5x for CY 2022 and ~1.5x for CY 2023. The company's main businesses are FCF generative and have proven resilient and growing even in a weak economic environment (e.g., Covid). 

• Currency – Nearly all the revenue for the company is generated in rand.  While South Africa's economy and fiscal situation have struggled for years, the current commodity upcycle should be positive for their balance of payments.  We assume 4% p.a. devaluation in our base case as this is the cost to hedge the rand in global forward markets and indicates what the market expects the rand to devalue at. 

• SASSA / CPS – Lesaka does not reserve for any losses arising from this dispute but in 2019 the Supreme Court of South Africa ruled that CPS is liable for ZAR 317 million plus interest (likely >ZAR 600 million in total).  The liability is currently ringfenced at CPS and has been separated from the group. We spoke with a local South African law firm who felt that it is highly unlikely there is recourse to Lesaka from this and relations with the government have been materially improving under new ownership.

Catalyst

Pro-forma company printing consolidated EBITDA 

Strong IR strategy focused on the natural shareholders of the company vs. current shareholder profile 

New sell-side coverage, very limited to date 

Growing earnings