Description

Summary Thesis: Worldline (WLN FP) stock fell by >60% in the wake of a controversial Q3 2023 earnings report in which guidance for 2023 was reduced and the company’s medium term plan (through 2024) was scrapped. While the next year could be messy (costly French restructuring, uncertainty on when merchant revenues return to GDP+ growth), the shares are clearly cheap at a ~6x multiple of EPS and EBIT in 2025 for a business that should mid-single digits topline with operating leverage even with mediocre management. With recent activist pressure on the stock and news that the company has hired advisors, it appears others are taking notice of the value as well. I think the shares could double or more in the next 24-36 months.

Company Description and History: Worldline SA is the #2 merchant acquirer in Europe based on 2022 Nilson volumes. It reports in three segments 1) Merchant services (which is ~70% of revenues and will be the focus of this write-up given it is proximate cause of the opportunity), 2) Financial Services (primarily issuer processing for European FIs) and 3) Mobility and e-Transactional Services (including ticketing services for French railway SNCF and service/outsourcing type work for various governments – this segment resembles IT services more than the scaled payments processing activities with much better incremental economics that comprise the balance of the business).

The company traces its roots to the payments processing activities of Credit Lyonnais in the 1970s before becoming a foundational part of the French IT services firm Atos in the 1990s; Worldline was subsequently IPO’d in 2014 with Atos completely spinning off much of its holding in 2019 and completely divesting its stake by 2021 (we return to the tire-fire that is Atos in the governance discussion).

M&A was a key part of Worldline’s journey “from a regional challenger to a pan-European leader” and was especially important in building up the Merchant segment. A summary of key transactions since the IPO are below (note the cumulative >EUR15bn spent vs current ~EUR6bn TEV – though admittedly some of the M&A was done with currency which was, in hindsight, quite overvalued):

[NOTE: Equens deal was structured in three parts over two distinct time periods – I lump it all together here]

Like other roll-up acquirers on both sides of the Atlantic (Nexi, FIS/Worldpay, Fiserv, Global Payments, etc.), there are some questions about the technical integration of acquired assets – there does seem to be some technical debt here though it seems manageable in my view.

Gilles Grapinet has been CEO the entire time WLN has been a public company (he previously served as deputy-CEO of Atos).

Industry Discussion: I am not going to rehash the entire payments value chain in a ton of detail here – if you want to get into a lot of detail there are many sell-side primers or you can find the excellent textbook overviews of the payments system provided by the consultancy Glenbrook on Amazon.

For purposes of this write-up I include the below depictions from Glenbrook to level-set the reader on the relevant terminology which is important to understand the business and relevant controversies.

Worldline is a merchant acquirer which means that it stands in front a merchant and its bank and represents them to various payment schemes (most prominently Visa and Mastercard). In return for this service (the service comprises three primary activities: 1) getting the customer, 2) taking the risk of the merchant on behalf of the schemes and 3) processing transactions), Worldline gets paid a fee for every transaction. It could be a couple Eurocents per transaction (in the case of an in-store card transaction at a Carrefour) or it could be tens or even hundreds of basis points of the transaction value (in the case of an online gaming establishment – more on this high risk category later).

Historically, this business was done by banks (who after all already bank the merchant and used to own the various payment schemes) but over time it has become dominated more by payment service provider specialist firms though in Europe it is still heavily bank influenced (~48% of volume in 2022 per Jefferies).

Below we see Nilson data on volume share in Europe; however, it is important to recognize that in spite of ECB/EU rhetoric to the contrary, Europe is not a monolithic payments market: so Worldline has a clear leading share in Germany, Nexi dominates Italy and Credit Agricole leads in France. That said, individual countries are still reasonably fragmented markets. Given the importance of scale to this business and attractive incremental economics it seems reasonable to expect further consolidation in time.

There are a few considerations to evaluate when thinking about the European acquiring market. First of all Europe has a plethora of domestic schemes and alternative payment methods (A2A of various flavors, more BNPL than US, etc.)  which makes acceptance more complicated than US (where you can connect to 3-4 networks and be done). Europe also has fragmented regulatory regimes and language barriers which prevent the same type of cross-continental scale that the size of the market as a whole might imply. See some examples of this from FIS/Worldpay and Bernstein/Adyen below:

Additionally, Europe has lower digital payments penetration than the US (~20-40pp of spend/transaction volume depending on exactly how you measure/which source you use). I think of Europe as a whole as being ~10 years behind US in terms of loss of cash – that should be a tailwind for Worldline – you can see cash usage at POS in key WLN markets below.

Finally, Europe has regulated interchange.

I think this regulated interchange is in some ways a saving grace for Worldline which prevents the same type of deterioration that FIS/Worldpay saw in its SMB book on any sort of concerning timeline. Interchange (as shown above in graphic) is paid to the card issuer by the merchant/acquirer. Interchange comprises the bulk of the merchant discount fee in the US and I believe creates a pricing umbrella  has allowed integrated hardware/software point of sale providers (I refer to providers like Clover, Square and Toast) to scale rapidly at fairly attractive unit economics in the US.

To put some illustrative numbers around this “umbrella”: if issuer like JPM is taking 1.5% of the transaction value (which, in fairness, is mostly returned to consumer via rewards) what does it matter if Square takes another 20 bps, even better what if Square takes 150 bps in the event that a consumer uses their debit card and the interchange is capped? Those economics are illustrative but Visa and Square publish enough pricing data that I’m not out of line (the networks have pricing books that are dozens of pages for you to peruse!) The integrated POS providers have had much less success in the European context where fees are skinnier so the value proposition to the merchant is inferior. I think this dynamic is likely to slow any rapid deterioration in the WLN back book in the event I am wrong about WLN’s own value proposition.

One final piece of industry context that is important is that “fintech” writ large and acquirers specifically are out of favor right now. There are many reasons for this (ranging from the Wirecard fraud to the massive capital influx that the space saw in recent COVID/tech bubble) but if you look at the price action of Adyen in H2 2023 you can see that the market is in a “shoot first, ask questions later” mood on these businesses. I think the below tweet from FOUR CEO sums up the mood well.

[Note: I believe “Best in the business” = Adyen, “best product company” = Block/Square, “best wallet” = PayPal. GPN was subsequently rumored as buyer of FOUR though those rumors have now been denied by both companies.]

Key Controversy and My Possible Variant Perception: The proximate cause of the massive drop in WLN share price was the Q3 report where guidance for 2023 was brought down and 2024 performance was also talked down. This H2 2023 underperformance which drives the revised guidance flows into the next year.

GS summed up the drivers of the miss below but in my mind there are really two key issues.

First there is economic weakness in core Worldline markets, especially Germany (volume is down with attendant non-discretionary mix shift which hits take rate – a double whammy but really one issue). Anybody with a newspaper subscription is aware that Germany is in a precarious economic state (GDP growth very slightly negative in 2023) given uncompetitive energy prices and the associated hollowing out of the German industrial base; however, given the composition of German GDP (limited consumer orientation, arguably room to boost consumption share if they’re going to be responsible member of EU) and still high cash usage in Germany it’s not clear to me this should permanently hamper Worldline’s (material) business in the country. I expect this issue is truly temporary though have no idea when it alleviates.

More idiosyncratic to Worldline is the reset of the high-risk book being mandated by the German regulator (Bafin). This is causing a direct EUR130mm hit to revenues in the near-term.

“High-risk acquiring” means acting as acquirer for businesses (generally an online business accepting CNP transactions) that have high incidence of fraud/charge-backs/other issues – acquirers are punished by the networks for these issues and in turn charge higher fees to these merchants. In many contexts airlines are considered high risk (airlines have been known to go out of business and leave ticketholders in a lurch) but more classically high risk refers to gambling and adult entertainment. So while WLN’s reset could in theory be anything from Lufthansa to Onlyfans, the bias of the market is to assume that the high risk reset means they were up to no good. This high risk perception is compounded by the fact that fraud Wirecard had the core of its business that was actually legitimate doing high risk acquiring.

The perception of payments industry participants is that it is Bafin’s overzealous regulation in the wake of the Wirecard fraud (where Bafin was asleep at wheel if not complicit to a degree in the fraud) that is driving this dynamic. Unfortunately, to date WLN management has not done enough publicly to allay fears that there will be further regulatory action driving issues in the business.

One former Worldline VP I spoke to described management’s handling of this issue on the Q3 call as “a massive strategic error in communication”. Following up with the company it is clear that ~EUR90mm EUR of the EUR130mm headwind is viewed as “salvageable” and represents business that WLN is cutting pre-emptively to get ahead of other European regulators adapting a Bafin-like approach. If WLN is truly able to salvage these customers (for instance by encouraging them to use in-country bank as primary account for settlement instead of a Cypriot bank), then there could be upside to near-term financial performance. In the event that this issue deteriorates instead (which strikes me as unlikely but I must admit management credibility is not great) then at a maximum there could be EUR700mm of other e-comm revenues – the disappearance of which might actually be priced in already!

Governance Risk/Opportunity: Gilles Grapinet is politically connected in France and serves at the pleasure of a board (19 people until very recently!) with several Atos legacy connections. Anyone who has studies Atos seriously (it has been described as a generic IT services firm on this site previously, which is an incredibly charitable view) knows it is poorly managed. Likewise, it seems clear that Grapinet has destroyed a substantial amount of value over his decade leading Worldline but is not clear there are many changes imminent (in fairness IR does pay some lip service to some of these areas and thinks streamlined BoD and tighter capital allocation policy could be adapted during 2024 – but I’ll believe it when I see it).

Sell-side analysts have indicated that there are multiple activists snooping around Worldline but the only one that has gone quasi-public (via a letter which was leaked to Bloomberg but has not been published publicly to my knowledge) is Bluebell Capital Partners (who have an undisclosed stake). Their demands are reasonable but I would argue don’t go far enough. Management needs to go – if a credible payments executive took over the business WLN’s stock price would increase 50% overnight.

Worldline has hired MS and Rothschild for defense against potential hostile takeovers. I am all for being aggressive to protect against a low-ball takeout but my fear is that the advisors are really there to keep management entrenched.

For elimination of doubt, if Fiserv’s Frank Bisignano was going to run this business it would be worth SO MUCH MORE than under Grapinet. Whether the French state or WLN Board would ever let a strong payments executive run the business (via market for corporate control or via strong executive hire) is a subject for debate.

Earnings Power/Valuation:

WLN trades at ~6x 2024 consensus EPS and ~6x 2024 consensus EBITDA – clearly the market doesn’t believe these numbers or otherwise finds the business impaired. I hope my discussion above shows that the business is challenged but not impaired – in time it should grow at mid-single digit topline (represents underlying growth of markets which basically excludes e-comm) with operating leverage – if management doesn’t blow the cash (a risky assumption for current team) the business could compound earnings at >10% from these levels.

I think this therefore represents too cheap a price for this business. I acknowledge that 2024 could be messy in terms of one-time cash costs for restructuring – it may be worse than I model below. I equally think that by 2025-26 this business will have substantially better quality of earnings and will look crazy cheap.

There are some more things that could go wrong here, but the valuation creates an asymmetry. If anything starts going right the stock could be up materially.

Catalyst

In rough order of likelihood:

1) Management gets religion and/or the axe.

2) Bafin regulatory issuer proves slightly less bad than expected

3) Quality of earnings/FCF inflection in 2025-26