eServGlobal — Banking on HomeSend

eServGlobal’s core business sells software to mobile network operators and financial service providers to manage prepaid subscriber top-ups and mobile money wallets, with a focus on developing markets. Growth drivers include the shift to using the mobile phone for financial services, the increasing popularity of mobile peer-to-peer payments, increasing penetration of the existing customer base across additional geographies and the development of channel partners. eServGlobal has also jointly developed a hub for cross-border payments, which operates through its 35.7% stake in the HomeSend joint venture.

FY17 revenues were in line with our forecast, reflecting the delay in signing contracts that were expected towards the end of the period. Since year-end, the company has signed €5m worth of these contracts. FY17 gross loss and operating loss reflected the lower revenues and one-off charges relating to the write-down of WIP and receivables. Entering FY18, the company has a much-reduced cost base, and estimates that to reach EBITDA break-even, it requires revenues of €12.8m/A$19.8m. Management hopes to reduce this to €12.0-12.5m/A$18.6-19.4m over the course of the year. The company used funds raised in October to pay down all remaining debt and invest in HomeSend, closing FY17 with a net cash position of A$10.8m. We introduce FY18 forecasts for revenues close to the break-even level and we assume that the joint venture continues to be loss-making in FY18, only reaching break-even in FY19.

We believe that the majority of the value of the company is provided by its stake in the HomeSend joint venture (c 86% of current share price). We estimate that the share price is factoring in adoption of HomeSend by banking customers to the tune of c $5bn in transaction volumes, a small proportion of the cross-border payments market. Evidence of recent bank signings transferring cross-border payments over to the HomeSend platform will be key to supporting and driving the current share price. Contract wins in the core business could also have a more limited impact on the share price.

Our forecasts and the share price are sensitive to the following factors. Demand: the timing and size of contracts in the core business are difficult to predict. Competition: eServGlobal’s core business competes with other specialist mobile money software providers, as well as with larger mobile telecom-focused companies with wider service offerings. HomeSend JV: eServGlobal has limited control over the JV. The JV’s ability to reach profitability will depend on adoption of the HomeSend platform by banks and money transfer organisations, the timing of which is uncertain. eServGlobal may need to inject additional funds into the JV. Economic and political risk: the company’s historic focus on developing countries has exposed it to the risk of political or economic upheaval in those countries; a growing pipeline in a much wider spread of geographies should start to diversify this risk. Currency: eServGlobal’s functional currency is the euro, while it reports in Australian dollars, leading to sometimes material translational currency gains or losses. In addition, as it has employees in several countries, there is some mismatch between revenues and operating costs.

eServGlobal is a software provider specialising in mobile money solutions for mobile network operators and financial service providers. Customers tend to be in developing markets: in FY16, 92% of revenues were generated from the Middle East and Africa. eServGlobal has also developed a hub for cross-border payments, which operates through its stake in the HomeSend joint venture. After a period of restructuring, the company is focused on reaching break-even in its core software business and supporting the growth of the HomeSend JV.

eServGlobal was founded in 1983 and has operated several different telecom-related technology businesses. The company currently consists of two businesses: software for mobile money and recharge services and a cross-border payments service (HomeSend). In 2013, eServGlobal created a joint venture with MasterCard and BICS for the HomeSend service, of which it now owns 35.7%. eServGlobal listed on the ASX in 2000 and AIM in 2004.

The company is currently led by Executive Chairman John Conoley, who was previously the CEO of Psion (where he restructured the business before its sale to Motorola). John joined the board as a non-executive director in 2013 and took on the executive chairman role in 2015. Andrew Hayward joined as CFO in 2016. James Hume, CTO for many years, assumed the COO role in 2016.

The core business of eServGlobal develops, sells and installs software to manage money on a mobile phone. The software is based on eServGlobal’s PayMobile platform; the latest version (4.0) was launched recently and provides a modular approach that allows customers to add features and services as subscriber demand allows.

Customers are typically mobile network operators (MNOs); the nature of eServGlobal’s products means the customer focus is more towards developing countries where subscribers tend to prepay rather than use post-pay contracts. The PayMobile platform offers:

eServGlobal’s PayMobile platform recharge solutions offer voucher creation, distribution in an agent network, sales and fulfilment (physical or electronic), a reporting service and a promotions engine. Roughly 80% of revenues are generated from Recharge (VMS and EVD). eServGlobal’s Mobile Money software enables MNOs to provide their subscribers with a mobile wallet to support domestic money transfers. As well as supporting peer-to-peer payments, the software can be used for bill payments (eg paying for water or electricity in advance without having to travel to a utility’s office), G2P (government disbursements such as salaries, pensions or benefits), aid payments and P2G (payments to the government for things like tax). The company is looking to upgrade existing Recharge customers to its Mobile Money solution, as well as targeting new customers with the solution. For more background on the prepaid and mobile money markets see On the front foot (September 2016).

eServGlobal’s customers are based in the Middle East, Africa and Asia-Pacific. In the table below, we show some of the customers that have been publicly announced (this list is not comprehensive). We have calculated the total numbers of subscribers served by these customers at the group level and identified, where possible, in which countries those customers have live services supported by eServGlobal. Even in the countries where services are live, operators do not always have licences covering their entire subscriber base and this is an area for potential licence extensions as subscriber adoption of services grows.

The core business competes with a variety of mobile billing software providers, most frequently with the companies in Exhibit 2.

The company has been through a long restructuring process in order to improve the efficiency of its sales process, to focus on profitable customers and to shift the structure of contracts to include more recurring elements. This has entailed, amongst other things, a reduction in headcount across several functions, the clean-up of various contracts where work-in-progress exceeded the amount that could be recovered, and provisions against several doubtful debts. The sales team has been reorganised, and the agent footprint reduced, with an increased focus on direct sales. Partners will still be used, but these are likely to be well-established multi-national organisations – the company recently launched a channel partner programme. To improve profitability, the business is promoting its software in a virtualised format, reducing the volume of low margin hardware sales.

More recently, recharge contracts with analytics functionality have been signed on a multi-year basis, which increases the level of recurring revenues and hence visibility. In addition to maximising the opportunity available from its existing customer base, the company is working to widen its geographic reach, in particular in Asia Pacific.

Management has focused on reducing the cost base to more accurately match the base level of revenues it believes can be generated from its existing customer base. Clean1 administrative costs fell from A$21.8m in FY15 to A$12.8m in the 12 months to October 2017 and A$14.5m for FY17 (14 months ended 31 December 2017). The company is targeting an EBITDA break-even revenue level of €12m/A$18.6m in FY18. It believes that this level of revenues could be achieved from the existing customer base, for example, as €2m in deferred revenues, €5m in recurring revenues (eg maintenance revenues, subscription licences) and a further €5m in changes and upgrades to licences. The enhanced focus on existing customers may result in a lower volume of new customer sales than the company has previously reported, but should result in higher quality and therefore more profitable orders.

The company has noted that central/PLC costs are in the region of €2.4m/A$3.7m per annum. Excluding these costs, at €12m/A$18.6m in revenues, the core business could generate an EBITDA margin of 20%. This highlights that the business could be of interest to a larger player or consolidator in this market who may be attracted by the strong relationship the business has with a number of Middle Eastern MNO customers.

eServGlobal has a 35.69% stake in the HomeSend JV (the other partners are Mastercard with 56.09% and BICS with 8.21%). HomeSend is a cross-border payments platform. For the history of how the JV was created see Supporting mobile money in the developing world (August 2015).

HomeSend’s platform aims to reduce the cost and speed up the process of sending money internationally. Its main focus is on supporting banks to make cross-border payments, a market that generates transaction volumes worth many trillions of dollars a year. HomeSend has proven the efficacy of its platform in the international remittances market and is now working, in many cases via Mastercard, with banking customers to help them transfer cross-border payment transactions onto the platform. Other applications that could make use of the platform include e-commerce cross-border transactions and disbursements eg ride hailing services with administration hubs in a few countries paying drivers in other countries or online retailers with merchants and consumers in different countries.

Typically, a bank will not have direct relationships with all recipient banks in other countries. Instead, it maintains a series of correspondent banking relationships ie banks that sit between the sending and recipient banks which use local knowledge to transfer funds. Each bank in the process adds processing time and fees, making cross-border payments more costly than domestic payments, as well as slower and more error-prone. Use of the HomeSend platform means that banks can bypass their correspondent banking relationships, reducing the cost and increasing the efficiency of the process.

The HomeSend hub connects the payment systems of the different hub members and processes the individual end-user transactions. It also acts as a clearing house that manages the multilateral settlement with the connected service providers. Members of the hub can get access to all other members through a single connection and commercial relationship.

HomeSend has technical integrations with a large number of MNOs and sending organisations (banks, MTOs2, post offices, payment processors, etc). To join the HomeSend hub, a company needs to technically integrate into the platform and then enter into commercial agreements with its opposite numbers in the corridors in which it wants to operate. This is a more efficient method than creating a commercial agreement with each necessary party and then creating the technical connections for each corridor. Customers can send and receive money via HomeSend using cash, mobile wallets, debit/credit cards or direct bank transfers, as well as traditional pick-up methods. The transfer is done in near real-time compared to hours or days for traditional remittance methods. In addition, senders and receivers have full transparency over the cost of the transaction and the amount that will be received. The hub has send/receive capabilities in 100 countries.

The first companies to sign up to use HomeSend were MTOs, we believe to supplement their existing remittance networks. This enables them to access countries where they do not have an existing agent network or to make use of mobile wallet capabilities, in order to expand their networks at much lower incremental cost. In other cases, sending organisations use HomeSend for lowest cost routing. We understand that the vast majority of revenues generated by HomeSend to date have been from remittances. Notable MTOs using HomeSend include, MoneyGram (the world’s second largest MTO), WorldRemit and Azimo. To appreciate the size of the addressable market, according to the World Bank, global remittances totalled $574bn in 2016. For further information on the international remittances market see On the front foot (September 2016).

HomeSend and Mastercard identified that the HomeSend hub could support banks making cross-border payments, a market that is multiple times larger than the international remittance market. The company estimates that this amounts to an addressable market of $22 trillion in payment volumes. Entry into this market presents a significant opportunity for the joint venture to grow revenues; with a relatively fixed cost base, growth in volumes processed from this market would have a significant positive impact on the profitability of the joint venture.

Mastercard announced in 2015 that its Mastercard Send service would use HomeSend for international payments and remittances. Through a single connection to the Mastercard Send platform, businesses, merchants, issuers, governments, non-profits and other senders can send money to consumers and businesses whether they are banked or unbanked, and located domestically or abroad. Senders or recipients do not need to be Mastercard cardholders.

In a recent analyst presentation, Mastercard demonstrated how important HomeSend is to its cross-border transaction capabilities (see Exhibit 3). Mastercard’s traditional card business addresses the $45 trillion personal consumption expenditure market, of which card payments make up nearly half. In recent years Mastercard has invested in expanding the services it can offer in addition to debit and credit card payments and has identified a further $180 trillion in payments volumes that it could address. These are in the business-to-business (B2B), peer-to-peer (P2P), and business-to-consumer (B2C) markets, and the company intends to support them via its recent Vocalink acquisition (for faster payments) and Mastercard Send, as well as with the existing cards business.

After Q118 results published in May, Mastercard’s CEO discussed the B2B hub, which includes HomeSend. He said “The idea there is to streamline accounts payable which otherwise has over the years become more and more of a nightmare to most people. There's lots of people you're buying from, lots of people you're paying to. Trying to reconcile those two together and find a way to ensure that complicated payments are reconciled appropriately and don't leave you with enormous issues at the end of the cycle as well as providing access to easy credit. That kind of stuff is what the Mastercard B2B Hub can help with..… I'm talking about capturing cross-border B2B payments. That's where Mastercard Send and HomeSend on the one hand combined with Vocalink on the other is to me the killer app”.

Mastercard has well-established relationships with a large number of financial institutions globally, with relationships in 210 countries and territories. As suggested by the company’s plans to expand the services it can offer, its salesforce is motivated to suggest solutions to its customer base that go further than traditional card processing. This gives HomeSend a substantial channel to market as well as providing a level of comfort to banking customers that know and trust Mastercard’s capabilities.

HomeSend is now focused on helping customers to go live and transition payment transactions onto the platform. To encourage this, it has invested in support to on-board customers and optimise their use of the platform.

There is a limited amount of direct competition for HomeSend. Earthport has developed a hub and spoke model for cross-border payments and has signed up several banks to use its platform, including Bank of America. In its most recent results, it reported that in the six months to 31 December 2017, it processed transactions worth $8.7bn (+12% y-o-y) to generate revenues of £15.4m (+8% y-o-y). In our view, the main challenge to uptake is the inertia of banks to change from their existing cross-border arrangements.

There has been much discussion about the use of blockchain technology for cross-border transactions. Ripple has developed a blockchain-based system, similar to SWIFT, for cross-border processing and is working with a number of banks to trial it. We expect to see blockchain (ie distributed ledger technology) used alongside existing payment mechanisms as a way to bring efficiency to ledger management. Longer-term widespread use of blockchain technologies for cross-border payment processing would need to solve scaling issues (both in terms of processing speed and cost) as well as achieving buy-in from the majority of banks (as it would be a permissioned network).

HomeSend concluded another funding round in December 2017. A total of €10m was invested: BICS decided not to participate in this round, Mastercard invested €6.11m and eServGlobal €3.89m. This has resulted in a change in joint venture ownership as follows: Mastercard from 55% to 56.09%. eServGlobal from 35% to 35.69% and BICS from 10% to 8.21%. Proceeds are expected to be used for working capital and to accelerate the development of additional functionality to meet the JV’s medium and long-term aims.

Our forecasts and the share price are sensitive to the following factors:

The company recently reported results for the 14-month period ending 31 December 2017 (FY17), reflecting the change in year-end from 31 October to 31 December. The company had previously reported results for the 12 months ended 31 October (12M17) in December 2017. Revenues were in line with our forecast, but the company incurred additional charges relating to challenging legacy contracts, resulting in gross profit and adjusted EBITDA below our forecasts. For FY17, the write-down of work-in-progress was A$3.5m. The provision against receivables was increased by A$4.9m in FY17, A$0.7m higher than for 12M17. In addition, cost of sales for the final two months of FY17 was higher than we had forecast. Adjusting out the WIP write-down, we calculate that gross margin was negative 8% for FY17, impacted by the delayed signing of contracts. So far in FY18, the company has closed contracts worth €5m that it had been expecting to close at the end of FY17. The company ended FY17 with a gross and net cash position of A$10.8m, having paid down all remaining debt.

We have introduced forecasts for FY18, working on the assumption that the company is able to achieve revenue close to the break-even level of €12m. With orders worth €5m received in the first two months of the year (not all of which will be recognised in FY18), the company is making progress with its plan to generate revenues from its existing customer base.

As eServGlobal is made up of two separate businesses, one that is not controlled by eServGlobal management, we have used a sum-of-the-parts valuation to assess the business. We look at the core business on a peer group multiples basis. We use DCF analysis to calculate potential values for eServGlobal’s share of the HomeSend JV.

In the table below, we show financial and valuation metrics for a selection of companies that specialise in selling mobile-related software. Median EBITDA margins are forecast to reach 13.3% this year and 14.3% next year, compared to our forecast for eServGlobal to be marginally loss-making in FY18e. We apply an EV/sales multiple of 0.55x FY18e revenues (a discount of 50% to peers to reflect the profitability profile), which results in an enterprise value of A$10.5m (0.64p per share).

In the table below, we show the history of disclosure relating to the valuation of the HomeSend joint venture. We note that eServGlobal has participated in two funding rounds since the inception of the JV, putting in €3.5m in 2016 and a further €3.89m last month. When the company commissioned a valuation in September 2015, a 20% minority interest (MI) discount was applied to the resulting valuation – we have used this discount for all of the non-book value based valuations.

The company has stated that it does not agree with Mastercard’s valuation of the JV in the most recent round, and believes it significantly undervalues it.

In the table above, we show a reverse sum-of-the-parts valuation. This takes the company’s current market cap, adjusts for the net cash position at the end of CY17, and removes our estimate for the valuation of the core business. This leaves the value of eServGlobal’s 35.69% stake in HomeSend. We then value the existing remittances business within HomeSend: we have constructed a DCF that assumes that HomeSend grows its share to 2% of the global remittance market over the next 10 years, that HomeSend charges 2.5% of the transaction value and earns 20% gross margins. We note that in two corridors, HomeSend has already achieved a 10% market share of inbound remittances. We assume that it moves to EBITDA profitability in FY19 and ultimately achieves operating margins of 13%. Based on working capital/sales and capex/sales both reducing down to 2% over the period, and using a WACC of 13% with a long-term growth rate of 2%, we value these cash flows at A$154.0m.

This leaves a further A$225.8m/US$169.8m which we estimate would be generated by processing banking payments on the platform. We assume that the bulk of fixed costs will be covered by the remittances business and that banking payments will also generate a 20% gross margin, with a further 5% of revenues spent on operating costs and a 25% tax rate. We therefore estimate that processing US$500m per annum in banking transactions value in perpetuity could be worth US$16.2m/A$21.5m to HomeSend. On this basis, we estimate that HomeSend is being given credit for processing banking transactions worth c $5bn, a tiny fraction of the cross-border payments market. Of the banking customers signed to date, the first 10 have average annual volumes of $300-500m (total addressable market $3-5bn pa) and the next five have average volumes of $30-50m pa (total addressable market of $150-250m pa). Progress in transitioning these banks’ volumes onto the HomeSend platform will be key to realising the value of the JV. The company has noted that it expects an inflection point in volumes in the short-term, although the precise timing is uncertain.