| 2013 | 2014 | ||||||
| Price: | 7.80 | EPS | $0.00 | $0.00 | |||
| Shares Out. (in M): | 45 | P/E | 0.0x | 0.0x | |||
| Market Cap (in $M): | 350 | P/FCF | 0.0x | 0.0x | |||
| Net Debt (in $M): | 47 | EBIT | 0 | 0 | |||
| TEV (in $M): | 397 | TEV/EBIT | 0.0x | 0.0x | |||
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I am recommending Net1 (UEPS) as a long as I believe it is trading at a 30% discount to a conservative sum-of-parts valuation. More upside is possible if some of the blue sky opportunities linked to their “off-line” transactions technology are successful.
There is a great catalyst for the trade as from June 2013 UEPS will start lapping a depressed earnings base so expect strong earnings growth over the next four quarters.
Finally, I will throw in a long shot. UEPS are suing a competitor for $50mil. This could add some spice considering that the current market cap of UEPS is only $350mil.
DESCRIPTION
UEPS have developed and implemented smart card technology targeted at the 2.5bil unbanked consumers in the world. Essentially their technology uses smart cards to make electronic payments possible in an “off-line” environment. This technology is ideally suited to undeveloped areas with poor communications infrastructure where cash is currently the only way to transact.
UEPS has traditionally seen themselves as a competitor to MasterCard, Visa etc whose cards only work in an “on-line” environment. Recently the relationship seems to have shifted from competitors to partners. UEPS adapted their card to work in the “on-line” environment using the existing credit card infrastructure (EMV compliant) and MasterCard showcased the “off-line” technology at an investor day in Q3 2012.
Will Master Card enter into the off-line space and bring cashless transactions to the less developed regions of the world? Before dreaming this dream it is worth noting that the unbanked market has been a tough nut for UEPS to crack. To date it has enjoyed spotty degrees of success in Iraq, Ghana and South Africa. (Oops as I write this they have lost the Iraq contact.)
Over the last few years the longer than expected sales cycles and the dependence on one client has seen UEPS stray into adjacent businesses, mostly through acquisitions. The largest of which was KSNET, the second largest payment processor in Korea.
Although the acquired operations are closely related it does give the impression that UEPS is an unfocused organisation and the image of “a man with a hammer looking for a nail” is not that far off the mark.
While I list all of UEPS operations below I am only going to value the first three operations. The rest you can have for free.
TWO KEY DEVELOPMENTS
UEPS was written up on VIC at $11 in Feb 2012. The current price is $7.80.
Since this initial write-up there have been two key developments which make UEPS much easier to value. There is also a catalyst which will begin to kick in from June 2013 which I think will help clear the deserved negative investor sentiment.
The first development is that UEPS won a court case on March 27, 2013 which sent the stock price up 27% that day to $7.65. I had been following the court case closely and I must admit I was deeply sceptical of UEPS position given the very negative press. My perception changed after reading the 40 page judgment which convinced me to become a bull and do this write-up.
I will discuss the history of the court cases in an Appendix, but, for now I want to stress that the findings in the appeal court judgement are by far the most important reasons for motivating me to take a second look at UEPS. Because this judgement plays such a key role in this investment idea I strongly urge anybody considering an investment in UEPS to read the judgement.
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MTc3NDg4fENoaWxkSUQ9LTF8VHlwZT0z&t=1
For those who want a quick synopsis
1) Judge found corruption allegations against UEPS were hearsay which could not corroborated despite a lengthy discovery process.
2) The other alleged irregularities in the tender process where of a technical nature and did not subvert Sassa from it's mandate to seek out and choose the best possible solution.
The second key development is that accurate information is now available which allows investors to value the SASSA contract (UEPS’s largest income stream) to the nearest cent. I will discuss this in more detail in the valuation section.
VALUATION
Price $7.80
#shares 45
Mcap $350mil
NetDebt $47 mil
EV $397mil
So the market is valuing the assets at $397mil. What are the assets of the company and how much are they worth?
As I said above I am only going to focus on the top three largest operations in my valuation.
CPS
In January 2012 UEPS won a 5 year contract from the South African government to make 9.5mil pension and welfare payments per month. This is known as the SASSA contract. Prior to this award UEPS had a much smaller contract to pay 3mil recipients per month.
In terms of the contract CPS receive ZAR14.47 for each of the 9.5 million payments per month. A guaranteed ZAR1.65bil of revenue per annum.
In this 10 minute interview (see link to video below) the CEO says that the operating margins on the contract will grow from 20% to 27%. I will use an average 23% margin in the DCF of this income stream.
http://www.summit.co.za/current-show/face2face/current-show/face2face/20130327.html#4
Other inputs to the DCF include
There are currently 4 years left of the 5 year contract and during the remaining 4 years the net number of recipients are expected to grow by 500k per annum to 11.5mil.
The NPV of the after tax cash flows using a 10% discount rate is roughly $150mil assuming the current USDZAR exchange rate of 9.
The $150mil valuation is conservative as it assumes that UEPS will not participate in future contracts. Although this could happen it does not seem likely as the sunk infrastructure costs (over $100mil) will make is difficult for new players to compete on price.
KSNET
KSNET is the second largest payment processor (debit and credit cards) in Korea servicing 220k merchants.
UEPS acquired KSNET in November 1, 2010 for KRW270bil ($240mil). The acquisition EV/EBITDA multiple was 12.9. At the time KSNET had revenues of KRW101bil and an EBITDA of KRW21.4bil.
I am by no means an expert on the Korean payment processing market and have to rely on scraps that are fed by management. These include i) The card market is under penetrated relative to other countries. ii) There are tax incentives to using credit cards to make payments. iii) The top 4 players own 60% of the market.
This positive macro picture seems to be benefiting KSNET. Again information is scarce so some detective work is required to fill in the blanks. At the time of the acquisition the following financial information was disclosed.
Year ended Revenue EBITDA
The last data point I have shows that revenue has grown nicely to KRW137bil for the 12 months ended March 2013. EBITDA for the period was KRW34bil, impressive considering the KRW21.4bil at acquisition.
Even though the business has grown since it was acquired by UEPS I am only going to increase the valuation slightly over the original purchase price to $270mil. This implies an EV/EBITDA multiple of 8 which is in-line with peers such as Global Payments (GPN) = 8 times and Heartland (HPY) = 9 times.
This valuation could get a nice boost as the structure of the Korean payment processor market is about to change. To date the business model has been capital intensive as the processors paid for the merchants POS terminal. Furthermore, agent commissions were paid up-front with claw backs if the contract was cancelled. Going forward the business will require less capital because the merchant will pay for the POS terminal and the agent commission will be paid over the period of the contract.
EasyPay
EasyPay owns the largest merchant processing network in South Africa processing 65% of the country’s retail volume. EasyPay also sells pre-paid electricity and air time.
The EasyPay network processes 400mil transactions per annum on which they earn a fee of US3c per transaction. This implies revenues of $12mil per annum and an EBITDA of $7mil assuming a 55% margin.
UEPS management are on record that they have been offered $200mil for UEPS. I have found it difficult to corroborate this valuation as UEPS do not want to disclose the financial metrics of the operation. My calculations indicate that $200mil is too rich and I am more comfortable with a valuation of $100mil.
Sum-of-Parts Valuation
Summarising the above UEPS is conservatively worth $10.30 a share.
CPS $150mil
KSNET $270mil
EasyPay $100mil
Other $ Nil
----------
Asset Value $520mil
Net Debt $ 57mil
----------
Equity Value $463mil
======
#shares 45mil
Target Price $10.30
This represents a 30% upside to the current price of $7.80. As a reminder this is just for the three established business. It also assumes that the Sassa contract ends in 4 years time with a liquidation value of zero.
For more upside one could consider adding a value for the blue sky which I describe briefly below.
The Unbanked Market
The blue sky includes opportunities for “off-line” transactions in the developing world. While the usefulness of this technology is compelling for less developed areas the potential deals promised by management always see to be stuck in the pipeline. This may change given the recent closer relationship with MasterCard.
I did not mention this above, but, the 9.5 million smart cards issued for the Sassa contract are branded with the MasterCard label. I don’t think one really imagines MasterCard targeting the unbanked market. But, in less than a year MasterCard have effectively added 9.5mil cards which are being used by people who probably survive on $122 per month. I am sure MasterCard make no money from this and for now one needs to see it as a tiny step into the 2.5bil unbanked consumer market which has the potential to develop into a much larger business.
This is UEPS’s attempt to capture the transaction market for mobile phones. While e-wallets are a dime a dozen UEPS’s approach is unique as it creates a different credit card number for each transaction. Also, the transaction is authorised using biometric information reducing the risks associated with stolen credit card numbers and pins.
UEPS’s virtual credit card was introduced by Metro PCS and Green Dot in the US. Although the application was downloaded onto 2million phones the last I heard very few customers signed up for the service.
Banamex, the second biggest bank in Mexico, is currently rolling out the virtual credit card in Mexico and maybe UEPS enjoys better luck with this one.
CATALYST
The Sassa contract, which started in April 2012, stipulated that UEPS had to re-register all recipients by March 2013. To achieve the re-registration process UEPS had to hire 5000 temporary staff. The costs of the temporary staff as well as other start up costs have been charged to the income statement. As the table below shows these charges had a detrimental affect on the reported earnings.
Mar 2012 $28 803 ($ 7 000) $21 803
June 2012 $34 514 ($13 400) $21 114
Sep 2012 $35 129 ($15 800) $19 329
Dec 2012 $36 459 ($21 000) $15 459
Mar 2013 $32 931 ($27 100) $ 5 831
The implementation costs stop in March 2013 which means that from the June 2013 quarter the EPS growth rates will be boosted as they cross the depressed earnings base.
Back to valuation the normalised TTM EBITDA = $138mil which puts UEPS on a EV/EBITDA=2.9.
Other catalysts include:
Following the Appeal Court judgement in favour of UEPS it has transpired that Allpay, one of the competitors for the Sassa contract, allegedly planted stories in the press which now appear to be based on questionable evidence. The judgement (see link above) is very dismissive of this evidence which seems to be based solely on a recorded conversation in a restaurant with no corroborating evidence.
Allpay allegedly took this evidence to the FBI who responded by launching an investigation into the activities at UEPS.
Following the Appeal Court's contempt for this evidence there must be a strong possibility that the FBI will drop their investigation which should help the stock price recover.
Furthermore, in December 2012 UEPS sued AllPay for $50mil alleging that “AllPay wrongfully and unlawfully and with the intention of injuring our reputation, infringing our goodwill and reducing our share price, competed unlawfully with us.” In other words, UEPS is suing Allpay for planting evidence in the press in an attempt to get the courts to set aside the award of the tender.
RISKS
1) While UEPS report is USD all their income is earned in ZAR or KRW. A strong dollar relative to these currencies will depress reported earnings.
2) Management have been poor allocators of capital. I have some sympathy for them as all the acquisitions were made in an attempt to promote their technology in different regions or new markets similar to the transaction market. I am hoping the “new” relationship with MasterCard will make it easier for UEPS to find new markets.
CONCLUSION
The Net1 stock price has been on a wild ride from $11 to $3 and now back to $7 as court cases went for and against them. I was initially sceptical of UEPS, but, after reading the Appeal Court judgement in favour of UEPS I changed my mind and now believe that the stock price can recover to it’s sum-of-parts value of $10/$11. It was at this level before the lawyers started throwing mud.
The catalyst for the trade is the strong growth in earnings starting the quarter ended June 2013 as UEPS starts to lap an understated earnings base.
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