Description

The writer of this note, related persons, and / or entities ("Writer") currently holds a long position in this security. The Writer makes no representation that it will continue to hold positions in the securities of the issuer. The Writer is likely to buy or sell securities of this issuer and makes no representation or undertaking that Writer will inform the reader or anyone else prior to or after making such transactions. While the Writer has tried to present facts it believes are accurate, the Writer makes no representation as to the accuracy or completeness of any information contained in this note and disclaims any obligation to update such information. The views expressed in this note are the opinion of the Writer, which may change at any time. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Writer harmless and hereby waives any causes of action against Writer related to the below note.  This note should not be construed as a recommendation to buy or sell any security.

Summary

WEX shares currently offer an opportunity to invest in a well-managed, high quality business with secular growth tailwinds at a cheaper price than a sophisticated financial sponsor that invested in the company through a private placement during the depths of COVID. The financial sponsor (Warburg Pincus) is incentivized to drive WEX’s share price well above $200 / share, compared to the current price of ~$140 / share.

I believe WEX shares will generate a 21% IRR over a three-year hold ($244 price target – 13x EBITDA multiple on 2024 EBITDA of ~$940mm) assuming only organic growth and deleveraging, which leaves accretive share repurchases and / or M&A activity as a free option that I believe will likely drive higher returns than my projections. WEX has a strong management team / board with a long track record of sound capital allocation and an opportunity to aggressively reinvest cash flows at high rates of return for the foreseeable future – I expect WEX to generate ~$1bn of free cash flow over the next three years and they can quickly raise an additional $375 – $700mm via an incremental term loan facility with existing lenders to reinvest in the business and compound value. The company is nearing the finish line off a multi-year migration of its software applications to the cloud, which should free up technology resources for bolt-on M&A as well.

Warburg Pincus invested ~$390mm into WEX at the end of June 2020 when COVID uncertainty was high, in order to bolster the company’s financial position. ~$90mm of the proceeds were used to acquire shares at ~$156 / share and the remaining $300mm was structured into ($310mm face value) of convertible notes with an initial conversion price of $200 / share. I also believe that WEX will become an acquisition target for strategic and financial buyers if shares continue to languish at these levels – For reference, Thoma Bravo recently announced the acquisition of Bottomline Technologies for ~23.7x forward EBITDA. WEX’s fleet segment will not command a 20x+ EBITDA multiple, but the private market value of WEX’s Travel &/ Corporate and Health segments is likely close to Bottomline’s multiple. Furthermore, I expect these segments to eclipse fleet revenues in the next five years (or after one large strategic M&A transaction, whichever comes first) and continue to become a larger part of WEX’s revenue mix going forward (i.e. they will continue to grow faster than fleet revenues), which will support a multiple re-rate over time (this is one of the cheapest names in the fintech space).

Investment Overview

In a market where it is difficult for investors to invest in businesses benefitting from secular trends or with clear paths to highly accretive reinvestment opportunities at a reasonable price, WEX is an anomaly that I believe is misunderstood by the market. The company has best in class technology / minimal technology debt and benefits from the ongoing digitization of payments, inflation in fuel and healthcare costs, and stands to benefit from a COVID recovery in travel. Mr. Market currently allows us to purchase ownership in this business for ~10.5x 2022E consensus EBITDA (sub-13x 2022E consensus earnings). Or if you prefer to invert, by looking out to 2024 and backing out the value of WEX’s Travel / Corporate Payments and Health segments, I believe purchasing shares of WEX at today’s price allows you to create WEX’s cash cow, duopoly fleet / fuel card business for sub-6.5x 2024 EBITDA.

I believe this opportunity exists due to WEX’s complexity (how many other companies require an understanding of fuel prices, software / payments, travel, and the healthcare industry to invest? To add insult to injury, WEX also owns a bank). The market views WEX as a COVID recovery laggard – WEX’s travel business recognizes revenue after hotel stays are completed versus other payments companies that recognize revenues at the time of booking (short-termism) + WEX's corporate payments likely recovers as business travel / spending which should be slower than leisure, concerns around the profitability of the Travel / Corporate Payments segment (de-bunked in recent disclosures showing segment EBIT margins of 34% in 3Q21), and concerns / uncertainty around the duration / durability of the fleet solutions’ fuel card business, which I believe are overblown (Penske notes that electric truck adoption will likely be 13% - 38% by 2035 – https://www.chargedfleet.com/10138425/electric-vehicles-adoption-will-take-longer-than-expected). In an extreme downside case where electric vehicles eviscerate WEX’s fleet business (which I do not believe will occur), it appears that the fleet segment still has at least 15 years of life left (per GM, Walmart, state regulators, etc. press releases), during which it will deliver billions of cash flow into the hands of strong capital allocators that have a demonstrable track record of developing and acquiring attractive, capital light revenue streams.

WEX Overview

WEX operates in three segments, I highlighted 2019 revenue mix to normalize for COVID. 

1.      Fleet (~60% of 2019 Revenue): This is WEX’s fuel card business, which is operates under a duopoly market structure in the U.S. along with Fleetcor and is a cash cow (~50% EBITDA margins; cash gross margins of 70%+). Despite a duopoly structure, this market is very underpenetrated as this segment generates ~$1bn of revenue in a market with an estimated TAM of $10bn (according to WEX’s 2018 analyst day) and ~$7mm outside the U.S. and Canada (per an Accenture report). This segment owns and operates a two-sided, closed loop network that can be thought of as the “American Express of fleet operators and gas stations / truck stops.” Fleet operators use WEX to reduce / prevent employee spending fraud (SKU level purchase controls), comply with laws and regulations (https://www.pymnts.com/transportation/2021/telematics-software-and-fuel-cards-streamline-fleets-fuel-tax-compliance/), obtain discounts on fuel / maintenance purchases, and aggregate spending data and analytics on a centralized platform. Gas stations and truck stops use WEX to sell more fuel and drive recurring business.

This segment generates ~45% of its revenue by charging merchants a percent of each transaction for the privilege of transacting with WEX’s fleet customers (a la AMEX interchange) and the other ~55% of revenue by charging fleet operators subscription / account fees and finance fees (late fees, interest, etc.). WEX also dominates the white label fuel card market and possesses long term, systemwide contracts with large oil companies’ retailers (e.g. Exxon, Chevron, etc.). However, the company has recently stepped up its digital marketing efforts to SMB customers and grew that channel 94% YOY (through 3Q21). Fleetcor has experienced regulatory issues and PR issues with its treatment of customers over the years (FTC investigations into overcharging, etc.) – It seems that WEX has been a victim of its own success. My research points to strong execution and technology investment by WEX (who has taken share from Fleetcor), yet Fleetcor has been rewarded by the market for shrinking its fuel oriented revenue mix.

I expect this segment to exhibit MSD growth driven by LSD market growth, plus increased WEX penetration (particularly in SMB). TAM expansion through network (tire, repair / maintenance shops, etc. – https://www.pymnts.com/news/b2b-payments/2021/smbs-reap-savings-shed-headaches-outsourcing-fleet-vehicle-fuel-maintenance/) and geographic expansion represent material upside opportunities (European oil companies have yet to outsource / private label to the same extent as North American peers). Furthermore, I model $3.00 / gallon gasoline going forward – increased inflation, fossil fuel taxes, or other price increasing regulations (mandates for inclusion of higher cost biofuels, environmentally friendly blends, etc.) also represent additional free upside that could push annual growth to LDD – MDD. Electric vehicles / mixed fleet management also represent an upside opportunity, because it adds an element of “omnichannel” complexity to fleet operators that WEX can help solve. For example, WEX must account for how electric vehicles can be charged for trucks on route to their final destination, at work, and / or at employees’ homes (at different times, locations, and utility rates) and total cost of ownership reporting that can be compared to the fleet operators vehicles with internal combustion engines. Charging a vehicle requires 3-4x+ the amount of time versus refueling with gasoline / diesel, which could enhance WEX’s spending and time compliance value proposition as well. WEX is actively working with fleet customers and infrastructure providers (e.g. WEX has a partnership with ChargePoint) to develop new product offerings as North America’s energy transition occurs.

In addition to Fleetcor, EdenRed is another large public comp for this segment (only has significant fleet operations in Europe and LatAm). W.A.G Payment Solutions is another public comp (albeit a subscale European one).

2.      Travel and Corporate (~21% of 2019 Revenue): This segment is really two subsegments that historically have combined to generate persistent 40%+ EBTIDA margins: (i) Travel is an issuer of virtual cards (V-Cards) to online travel agencies and (ii) Corporate Payments is a B2B payments and AP automation business. WEX pioneered V-Card usage, first with OTAs (to book / hold hotel rooms on behalf of their users) and now V-Cards are generally one of the fastest growing areas in the payments industry (https://www.pymnts.com/news/b2b-payments/2021/international-b2b-virtual-card-payment-market-projected-to-total-553b-by-2024/), because they allow for payers to earn rebates, among others. Two OTAs dominate in the U.S. (Expedia and Booking) and they have used their scale to pressure WEX’s take rate over the years, but this has been offset by global growth in travel spend and OTAs’ increasing share of travel bookings. WEX has deep integrations with the OTAs, global capabilities (~200 countries), and 20+ years of data chargeback / fraud data and money transfer compliance experience – all of which are difficult to replicate, especially if only to command a take rate of 35 – 70bps as WEX’s Travel segment does. Corporate Payments is also an “integrated payments” solutions wherein WEX handles the AP automation and backend B2B payments processing for bank, corporate, and fintech channel partners and has historically commanded a stable ~130bps take rate. Corporate Payments benefits from vertical network effects (e.g. suppliers to one construction company are likely suppliers to other construction companies as well). Corporate Payments recently entered into a partnership with Stampli, an AP automation business with $20bn of volume, which is a positive sign of continued momentum.

The overall Travel and Corporate Payments segment generated ~$160mm of EBITDA in 2019 and acquired eNett / Optal during December 2020 (which generated ~$97mm of 2019 EBITDA) and expects to realize $40mm of synergies from the acquisition ($30mm already realized on a run-rate basis). WEX believes this segment will grow revenue 10% - 15% p.a., which I believe is conservative when accounting for the COVID rebound (HSD grower pre-COVID and eNett / Optal grew 36% p.a. in the three years leading up to COVID) and the rapidly growing Corporate Payments segment (over 30% growth p.a. in 2020 and 2021). WEX’s recent disclosures at the Citi FinTech conference in November show that the Corporate Payments segment is a ~$200mm revenue business, if Corporate Payments grows just 20% p.a. going forward (which approximates projected V-Card usage growth per the above pymnts link), it will be a ~$345mm revenue subsegment by the end of 2024. If Travel recovers back to the 2019’s proforma (for the eNett / Optal acquisition) $50bn of gross volume in 2024 and we apply a 35bps take-rate, then Travel is a $175mm business in 2024, which equates to $520mm of segment revenue that can likely return to generating ~45% EBITDA margins given operating leverage
 

3.      Health and Employee Benefits (~19% of 2019 Revenue): Provides compliance software and backend payment functionality for the administration of Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs), and commuter / other employee benefits. HSA accounts have grown 5x and balances have grown by 8x over the past decade (https://www.devenir.com/wp-content/uploads/2021-Midyear-Devenir-HSA-Research-Report-Executive-Summary.pdf) as healthcare costs continue to outpace inflation. About 2/3 of this segments revenue is subscription-based, with the interchange revenue making up the balance. WEX expects LDD – MDD growth in this segment, which exhibits EBITDA margins of 25% - 30%.

Management Team and Warburg Involvement

Warburg is entitled to a board seat with membership on both Wex’s (i) Leadership Development & Compensation committee and (ii) Finance Committee, so long as WP owns at least 50% of the shares issuable upon conversion of the converts. The Finance Committee is responsible for advising the board on Wex’s capital allocation strategies and decisions (https://ir.wexinc.com/governance/governance-documents/default.aspx)

WP’s seat is currently filled by James Neary, who is WP’s Co-Head of U.S. private equity. Mr. Neary joined WEX’s board in 2016 in conjunction with Wex’s acquisition of a WP portfolio company (Electronic Funds Source or EFS) for ~$1.5bn (~$400mm in stock). WP became WEX’s largest shareholder after giving effect to the transaction. I did some googling and Mr. Neary is a veteran in the payments / fintech space – he led WP’s acquisition of Metavante back all the way to 2007 and used to sit on FIS’s board.

Melissa Smith is WEX’s CEO (since 2014), although Ms. Smith has been a WEX employee since 1997. WEX has completed 13 bolt-on acquisitions since she became CEO, including those that established WEX’s Corporate Payments and Health businesses. From 2014 to February 2020 (when the COVID sell-off began), WEX shares compounded at more than 15% p.a.

My impression of this management team and board is that they are very adept acquirers and capital allocators. After originally agreeing to acquire eNett / Optal from Travelport in January 2020 for $1.7bn (over $400mm of stock), WEX negotiated with Elliott Management / Siris Capital to lower the price to ~$578mm of cash by 4Q20 (sub-6.0x 2019 EBITDA). In June 2020, Ms. Smith and team negotiated the convertible notes transaction with Warburg in order to protect against an adverse judgement while litigation / negotiations with Elliott and Siris were ongoing. I also believe Ms. Smith and the board have done an excellent job of managing their capital structure, renegotiating / refinancing to increase dry powder and term out their maturities at favorable rates when advantageous market conditions exist.

Catalyst

- Repurchase / M&A

- Higher / persistent inflation

- Mix shift toward non-fleet revenue or change in market view (fintech versus fuel-oriented) 

- Sale of company to strategic or financial buyer

- Time