Description

NICE Information & Telecommunication Inc (NICE I&T) is a South Korean payment processor/acquirer trading at 5.3x earnings. TTM earnings were 4,887 per share compared to a stock price of 26,100. The company’s enterprise value is negative with 26,565 per share of net cash. Net cash including financial assets other than cash is 31,717 per share. Net cash and other financial assets excluding negative working capital is 23,870 per share. Whichever of these measures we select, there appears to be ample margin of safety in this stock.

Background

NICE I&T was founded in 1988 and listed on the KOSDAQ market on April 3, 2000. NICE I&T is part of NICE Holdings Co., Ltd., a publicly listed family-run group of companies, which holds 45.7% of its stock. The holding company itself is cheap and was recently written up by ahnuld in a post that gives valuable background information.

NICE I&T has been successful over time and is up over 5x in the last 10 years. Dividends have been paid for over 15 years and have only increased. The current year’s dividend rate hasn’t yet been decided but keeping the 2022 rate unchanged would give a yield of 2.3%.

Business

NICE I&T has two major divisions. In its offline payment processing business it is the market leader since 2014 (Q3 2022: 26.7% market share) and in the more recent fast-growing online payment gateway business it is number 3 with 17.5% market share as of the first half of 2022 (up from 11.8% in 2018). NICE I&T sits between the merchant and card company, providing data transfer services and gets paid a commission by the card company.

Earnings are only up by a quarter since 2017 while sales are just over double. The reason for this is that growth in sales is largely attributable to the online business which carries a lot lower margins. While the offline business contributes most of profit, its positive developments are also offset by negatives: while industry transaction volume is still increasing, up roughly 25% since then, and its market share is up from 18.2% in 2017 to 26.7% in Q3 2022, sales in this business are up only 2% presumably because of pricing deterioration.

NICE I&T is helped by the fact that payments in South Korea are traditionally credit card based, 80% of the population uses a credit card as a first option and consumers have little incentive to change. These payments rely on the value-added network (VAN) infrastructure. This has reduced the scope for disruptive payment apps trying to bypass the system and giving NICE I&T an important role as its payment infrastructure is plugged into many payment apps and wallets, including Kakao Pay and Samsung Pay. Even the government-promoted Zero Pay app had to use NICE I&T in the end without finding a way to bypass it. NICE I&T also dominates mobile card payments by providing a Shared App Card Module where customers enter a six-digit password to pay without the need to run individual credit card company apps. In the short term the payment infrastructure business seems to add a lot of low-margin revenue but will help defend the company’s business in the future.

NICE I&T has a small online payment gateway business in Indonesia where it is growing fast (49% in 2021) but facing a lot of competition. The company also has potential to generate more revenues from its existing base of merchants that many other payment processors around the world have done and where it has done very little.

Pricing

The fees that NICE I&T charges (their share of the interchange fees) are negotiated with credit card companies and financial institutions annually. NICE I&T market share is 26.7% (up from 18.7% in 2019) and another NICE entity holds 14.6%, adding up to a growing 40%+ market share (as of Q3 2022). South Korea has 8 major credit card companies, so NICE I&T has the upper hand in these negotiations for access to its 510,000 merchants which act as a barrier to entry. Currently it has contracts with all of them. However, all market participants have to contend with shrinking interchange fees from smaller stores, which are set by the government in an arbitrary political decision that tends to occur every 3 years or so. The last such cut occurred in December 2021 when the government cited the need to “cut credit card processing fees for small merchants to ease their burdens amid the COVID-19 crisis”. The rate for small merchants, which are very prevalent in South Korea, with an annual revenue of below 300 million won ($252,550) was lowered from 0.8 percent to 0.5 percent, between 300 million won and 500 million won, the rate went from 1.3 percent to 1.1 percent and for those in the 500 million-won to 1 billion-won revenue bracket from 1.4 percent to 1.25 percent.

The NICE I&T business model generates float in the form of cash that needs to be paid back to merchants. The company is just letting it pile up with its own excess cash. ROE used to be over 20% even without redeployment as the payments business is doing the heavy lifting but has been declining due to the increasing net cash balance headwind. It is now just over 15%.

Capital allocation

The company’s strategy is to acquire smaller payment processors that lack scale and come under pressure due to pricing declines. It recently acquired JTNet for KRW 56bn at roughly book value or what appears to be just over 6x earnings. However, there have been few such acquisitions recently and the company is carrying a far too high cash balance. The most obvious move would be to aggressively buy back stock but it has repurchased only 7% of its stock in its whole history. Last year it did an on-market share repurchase where it bought 5,000 shares a day without affecting the stock price. At that pace it would take about 1,000 trading days to buy back the whole company outside the holdco stake.

Why is it cheap?

It is likely not due to corporate governance concerns even though capital allocation has been less than ideal. Valuations of some of the family’s other subsidiaries are significantly higher. More likely there’s concern over the industry going forward because every time there is an interchange fee cut the stock turns downward and the company needs to prove that its business is still good all over again. Evidence is in the company’s favor as it has coped with industry headwinds for many years. Peer valuations are mixed but have all declined lately: KG Inicis is also cheap, NHN KCP seems fairly valued and Korea Information & Communication Co. Ltd. (KICC) is expensive.

Corporate governance

As the company is family-controlled and a subsidiary of another family holding company, corporate governance is a key risk. The dividend rate is far below what would be rational from an efficient capital allocation perspective and this could be driven by family and holding company needs and seen as disregarding of minority preferences. However, during the time that the NICE entities have been public we haven’t seen evidence of unfair treatment of minority shareholders or listed subsidiaries. Instead, the various subsidiaries seem to support each other through cross-selling opportunities. Nevertheless, being part of a sleepy family conglomerate will slow down any value unlocking.

Risks

-Controlling shareholder failing to act on the cash balance.

-Increasingly adverse government regulation.

-Depressed valuations can persist for long periods in South Korea, so one needs to be prepared for longer holding periods.

Catalyst

- Deployment of cash balance