Description

Paysafe is a broken SPAC down 90% from its post-IPO announce high that is in the midst of a turn-around that looks to be gaining traction. PSFE's troubles have been largely self-inflicted but unlike other SPAC's down 90% it is a real fintech/payments business that generates cash and has good growth tailwinds given its igaming leadership. Leverage and a large PE shareholder overhang are the key current deterrants. The stock has the potential for multiples of upside with just marginal success in the turnaround given the potential for the deadly combination of multiple appreciation, EBITDA growth, margin expansion, cash accretion, and overall de-leveraging. The recent investment to double the direct acquiring salesforce with minimal benefit yet accrued should mean margins and take-rate are close to trough, de-risking the bet a bit given the ability to cut heads if unsuccesful. Shares could see 70% upside ($38) in a year without any multiple expansion and be >2x in two years ($48). Shares trade at just 7.5x NTM EBITDA, a 15% levered FCF yield, and a 10% unlevered FCF yield for a business that should grow revenue HSD and EBITDA low-DD. Every 1x multiple on current EBITDA is worth ~$8 per share, or ~35% upside, and every 10% growth in EBITDA with commensurate FCF is worth another ~$10 per share. Plus the company is actively repurchasing shares. The business should de-lever by ~0.8x turns per year and be <3x by the end of 2026 while key debt maturities extend to 2028 providing runway to success.

Pre-SPAC History:

Paysafe is new to VIC in its present form, however some may know it by one of its many old names, Optimal Payments, posted on VIC back in 2012. Paysafe is largely an amalgamation of acquired payment processing businesses historically focused on in the internet gambling vertical given its start as Neteller. The company was listed on AIM in 2004, it bought Netbanx, an internet merchant acquiring business in 2005, then entered Asia with the Netbanx Asia business, prior to withdrawing from the US in 2007 due to the Internet Gambling Enforcement Act. In 2011 it acquired Optimal Payments, changing its name.

In 2015 it bought Skrill in a transformative acquisition. Skrill at the time was the #2 competitor to Neteller in Europe in the digital wallet gambling ecosystem. It also gave the company exposure again to the US gaming market which at the time was mostly fantasy sports based. Skrill was bought for 1.1bn euros, or ~13.5x EBITDA, but given the similarity of the two businesses and the ability to combine the back-end systems there was ~$40m of expected synergies for a 9.3x post-synergy multiple. Skrill was also expected to reduce the company's customer concentration. Skrill had a few years prior bought Paysafecard, a prepaid voucher system that allowed consumers to physically fund a prepaid card through a retail distribution channel. Those funds could then be used online, usually for gambling purposes, and gave PSFE comprehensive funding access across its processing ecosystem. 

After the acquisition of Skrill, the company executed on organic growth, synergies, accretive M&A, and outperformed expectations, and the company had the scale to uplist to the main market of the London Stock Exchange, eventually being included in the FTSE 250 in 2016. It also changed its name to Paysafe. However, the stock would have a perpetual overhang from the remnants of a late 2015 hack of customer accounts, and the crackdown in Chinese gambling in 2015/16 that threatened a large part of their business with the Asia gateway business accounting for ~35% of revenue and 15-20% of EBITDA. A Dec 2016 short seller report claiming the company aided in evading Chinese capital controls did not help either. Shares traded generally at a HSD EBITDA multiple (as low as ~6x) during this period with the expectations that the company could lose 15-20% of its EBITDA immediately (or post-loss ~10x+ multiple).

In Aug 2017, Blackstone and CVC (which previously sold Skrill to PSFE) announced the acquisition of Paysafe for 590pence. In conjunction, they sold the the Asia Gateway business for ~$300m (5x EBITDA). Net of the acquisition of Merchants Choice Payments for $470m, the sale of the Asia gateway business, the core Paysafe business was acquired for ~$4.2bn or a ~13x EBITDA multiple. Shares trade at ~7.5x today.

Post-SPAC History; How We Got Here:

In Dec 2020, Foley Trasimene, a SPAC run by famed fintech investor/operator Bill Foley (FIS and Cannae Holdings), announced the acquisition of PSFE for a $9.0bn EV, with reports indicating BX and CVC would earn a 3x return; not bad over 3 years. Plans were to raise a $2.0bn PIPE, with $850m to come from Foley entities Cannae, Fidelity National and Chicago National. The deal closed on Mar 30, 2021 with the stock at split-adjusted $15 or~$11bn market cap and leverage at ~4.2x LTM. At the time, like all SPAC forecasts, management was overly aggressive, forecasting 60-100m of EBITDA accretion from Bill Foleys playbook, $500-560m of total 2021 EBITDA, and $670-744m of 2023 EBITDA.

The stock went straight down from there as within 6 months 2021 EBITDA guidance was lowered to 425-435 (from 480-495 and vs the $500m+ SPAC forecast). The business was impacted due tough covid related comps in the eCash business (highest take rate at 7%) with growth going negative in 4Q21, continued impact of sports related covid disruption and European gambling regulations in the neteller/skrill digital wallet business (revenue -8% in both 2020 and 2021), and the acquiring business seeing slow growth and take-rates go down by by ~25% due to the integration of a deal in 2020 (PAyLater). In addition, the acquiring business started optimizing risk-reward in the merchant channel, effectively removing higher risk, higher profitability merchants. From the peak in 2018, consolidated EBITDA margins declined by 800bps due to slower growth, lower take-rates, and higher costs with investments and public co costs.

On top of that, the company did three expensive acquisitions in 2021 at the top of the fintech cycle for ~$665m (ViaFintech a German wallet, PagoEfective a Peruvian wallet, and Safetypay a Latam platform). Leverage would spike 5.8x in 2022 after the company again reduced guidance in Aug 2022 by ~10% due to FX, Ukraine-Russia, continued European gambling reg impact and mid-teens neteller/skrill (+ recent acquisitions) revenue decline. By 2022, however, the acquiring business had started to recover and was performing quite well. 

Basically the entire management team was fired in early 2022, with current CEO Bruce Lowthers being appointed in Apr 2022 (15 years at FIS), followed by a new CFO and CRO in August 2022. Bill Foley stepped down as Chairman in March 2022. A 1:12 reverse split was effected in Dec 2022. The former heads of digital wallets and acquiring businesses stepped down in Feb and Jun of 2023, respectively. With a clean slate, the current management team has since been executing fairly well. Despite that the stock continued to decline into 2023, reaching a post-split low of <$10 in 2023 prior to recovering to current levels with 2024 EBITDA expected to be ~$475m (+15% from 2022 trough).

The Businesses:

By geography ~55% is US, 35% Europe, ~10% Latam and RoW. By vertical, PSFE says 30% is in igaming (mid-teens growth) with $26m of North America revenue in 2022 and targeting $175m in the Americas by 2026E, 50% retail and hospitality (M-HSD), 10% digital assets (LDD-mid-teens), 6% travel and leisure (HSD-LDD), and 4% video games and streaming (HSD-LDD).

Merchant Solutions:

This is a traditional acquiring business that almost all US based and ~30%+ ecommerce based, a positive attribute versus some of the traditional independent acquirors like FI, GPN, etc. PSFE believes it is the #4 independent acquiror (likely somewhere in the top 10 overall), somewhere between sub-scale and the scaled players, with revenue of ~$1bn in 2024 (vs GPN and FI of ~$7bn). Of that revenue about 15% is integrated. EBITDA is ~$205m and margins will be ~21% in 2024, down from 33% in 2018, and FI/GPN of high-30% to 50%. Take rates in this segment are the lowest of PSFE's businesses at ~75bps on volume of ~$128bn. The low take rates are a function of PSFE distribution and sales which historically was 50/50 direct vs ISO/ISV where those partners take a cut of the gross take-rate. This should be a HSD growing business but with potential to grow double digits given the tailwinds for US internet gambling as new states come online and as more people sign up and bet more. There are roughly 30 states that have legalized online sports betting, so there is still significant room for growth with this vertical expected to grow well into the double digits in the US (recently growing 50%+ after the launch of new states in 2023).

Digital Wallets: 

Digital Wallets is comprised of the old digital wallet business (Neteller and Skrill) and the eCash solutions business (Paysafecard). There are about 2.5m active neteller/skrill users and 16m eCash solutions users. Based on last reported data in 2022, neteller/skrill comprised ~55% of segment revenue and 60% of EBITDA (likely a bit higher given the 2021/22 acquisitions of PagoEfectivo and viafintech). Take rates in this business are ~2.0%, more akin to traditional acquiring businesses as most of the revenue generated from the neteller and skrill wallets are from charges to the merchant when a consumer makes a transaction using the wallet. This is the highest gross margin business at ~75% given there is minimal sharing of transaction revenue. EBITDA margins historically were ~45-50% but have likely come down given competition with ACH and other direct payment methods. This business is primarily Europe based and focused on the hardcore gambler and gamers which need a platform they can use to quickly shift money between gambling sites and games.

eCash solutions or paysafecard is 45% of segment revenue and 40% of EBITDA. Take rates are highest in this business at ~7.0% with a 4% loading fee and 3% transaction fee, plus annual card fees. This is a prepaid debit card usually branded Mastercard that underbanked users can use to make online transactions, historically to use for gambling, using PSFE's 650k+ distribution points. Gross margins were ~55% and EBITDA margins ~35%. 

Combined the Digital Wallets business will generate ~$800m of revenue and $350m of EBITDA in 2024 at a ~44% margin, inline with its historical mid-40% margin. Revenue will likely grow 7% in 2024 after ~7% growth in 2023. While this business also has the massive tailwind of igaming, coupled with what should be outsized growth in the emerging markets, I think there is generally more long-term risk around both the core neteller/skrill wallets and paysafecard given disintermediation, free government ACH, and tough competition from the large companies like PYPL. So I underwrite ~HSD growth in this business or ~7%.

Given the verticals and use-cases for the digital  wallet products Paysafe has invested significant resources in KYC and regulatory compliance. This is a key moat relative given PSFE's 20+ years dealing in the gambling vertical where many of the scaled, blue chip processors find it to be too risky.

Turnaround Strategy:

Bruce Lowthers came in as CEO and has thus far succeeded in returning both businesses to growth. His strategy is alot of blocking and tackling and focusing the organization in a holistic manner versus which was historically a disparate group of unintegrated businesses that were always integrating another new business. There has been no M&A since 2022 to that point. The goal is to be able to leverage the B2B and B2C aspects of each business and cross sell products to the merchant or the consumer to create a stickier and higher value ecosystem. Importantly, he put all of the salespeople under one person and separated the salesforce into end-market vertical expertise.

Coming into 2024 the goal was to 2x the salesforce, adding 170 people in the acquiring business investing $25m. This investment alone will negatively impact acquiring margins by ~260bps and it is expected that it will take 6 months for salesforce to be productive. Of those 170 people, 100 will be focused on the direct channel as managements goal is to mix shift away from lower margin ISO revenue and more towards higher margin direct revenue. The company has noted that direct marghins are 4x the size of indirect margins. Recently the indirect channel has been growing faster than the direct channel, contributing to the acquiring margin decline, but as the direct sales force ramps up mix should be a positive contributor to margins.

Another 70 salespeople will be focused on the enterprise channel ($100k+) which was also a key focus in 2023 when the company doubled enterprise sales which it historically was under scale in. While acquiring is still ~90% in North America, there was not sufficient coverage by state, with only mid-teens states covered prior to the expansion effort in 2023. PSFE has a small acquiring presence in Europe and Latam and the goal is to cross-sell with the strong digital wallets business in those areas. There should be significant growth potential in those regions off a tiny base. Another focus area is on attacking the core SMB space while making it easier to onboard new merchants. Thus far management believes it is seeing success with the enterprise sales team contributing $100m to revenue versus $20m

Within Digital Wallets the goal is to expand usage more into the mainstream user vs core gambler. To do this PSFE is trying to become the cash register versus a payment method within the cash register, ie its trying to become more of a platform, akin to PYPL's strategy, with better user experience, product enhancements, etc. On the customer acquisition front, the goal is to focus CaC around key events versus broad based marketing. In 2Q digital wallets saw transactions per average user grow 20% and ARPU grow 6% and the core digital wallets saw the third quarter of active user growth. Next step is to increase grow in paysafecard.

If the turnaround is successful we will see it reflected in higher acquiring growth, but more importantly a higher gross margin/take-rate, which should result in significant EBITDA margin expansion given the fixed cost of the doubling of the sales team will be largely complete by the end of 2024. Backing into PSFE's statement that direct margins are 4x those of indirect, assuming 45% of revenue was ISO in 2023, would imply gross margins for direct are ~70% and indirect are ~17.5%. With larger scaled EBITDA margins at least 1000bps higher than PSFE's acquiring business, there is massive room for upside if the direct sales approach gains traction. For conservatism in my modle I asusme margins only appreciatre ~100bps per year to 24.4%, still below 2023's 25.3%. At 8-9% revenue growth that results in $300m+ of EBITDA by 2027.

On the Digital Wallets side, it is less about margin expansion, and more about growing volume while keeping take rates flat to grow revenue. I dont assume anything heroic in this business despite the tailwinds from emerging markets and gaming with ~7% revenue growth and a 45% EBITDA margin in 2027 for ~$435m of EBITDA. The ability to grow the eCash business would potentially improve take-rates, which would be a welcome KPI for investors.

Note that PSFE provides a nice excel model in their 2Q24 portal for anyone that wants to see the trends in the business and/or build a model easily. 

Valuation: 

Assuming ~8% consolidated revenue growth, ~200bps of margin expansion (75bps per year), yields ~$650m of EBITDA in 2027 and a 29.4% margin (versus 28.6% in 2023 and 35.8% in 2018. At the current multiple of 7.5x, that would yield a $48 stock at the end of 2026. FCF should be ~$4-5 per year in 2025/26, absent large swings in settlement funds. Peers trade for double digit multiples, even GPN which is universally hated, trades for ~8.5x. NVEI bought Paya, another broken SPAC with a similar, but smaller acquiring business, for 13x EBITDA. At a 10x multiple, given by the end of 2026 leverage should be ~2.6x (assuming no share repos), the stock would be worth >$70 for a 3x+ in two years. Given the recent positive trends in the business, despite the leverage on the company, I think the upside skews favorably relative to the risks at the current price. 

I think PSFE will eventually become a takeover target for a more scaled acquiror looking to gain exposure to the gaming sector.

Risks:

Regulation always has and always be the biggest risk, specifically as it relates to internet gambling. Whiel I think the train has left the station and states/countries need the revenue, they can make life difficult for operators and their servicers, as they have in the past.

The business has a significant European footprint, so FX will always be a risk here, both on the P&L and on the cash on the balance sheet. 

CVC and Blackstone still own a combined 38-39% of the stock. They are likely either under-water or not willing to sell here, so the near-term risk of secondary sales is likely low, but over time there will be secondary sales - large investors should use those opprotunitys to establish a core position, but it will drive the stock down.

As gaming becomes less taboo and risky, legacy acquirors/processors will likely compete for business with take rates given their scale. 

Catalyst

Continued execution, de-levering, direct sales force contributing high margin revenue in acquiring, new states legalizing gambling