Piteco — Bold entry into the US marketplace

Piteco is effectively paying $14.5m for 60% of Wichita, Kansas-based LendingTools (LT). LT has net working capital of c $2.25m, most of which is cash. The deal is being carried out through Piteco’s fully owned subsidiary Piteco North America Corp, which is acquiring 55% of a special purpose vehicle (SPV) called Juniper Payments LLC (Juniper) for $3m and is providing Juniper with a $10m 10-year intercompany loan. Piteco is financing the deal through its internal cash resources and a €7m bank loan. Two key managers (see their biographies below) have each been granted a 22.5% stake in Juniper. Juniper has subsequently purchased the principal assets of LendingTools.com, Inc for $13m in cash. Piteco has an option to increase its stake by 2.5% in each of the next two years from the key managers for up to $1.5m, depending on the financial performance of the acquired business. Piteco does not plan to increase its stake any further, as it wants to keep the executives on board, with their interests tied to Piteco’s interests. However, if the acquired business fails to meet undemanding targets, Piteco does have an option to purchase an additional 20%.

The two key managers who have taken stakes in Juniper are Jon Budd, who has become CEO of Juniper, and Jorge Jimenez, who has become chairman of Juniper.

Jon Budd joined LT in 2003 to lead the sales effort, and currently serves as senior vice president of business development. In this role, Jon leads the sales and marketing efforts, creates and manages partner relationships, and influences product strategy including new product development.

Jorge Jimenez is currently CEO of eZforex.com. Jorge recently left the Federal Reserve System where he served as the director for international payments and product development. Jorge has been involved in payments systems for over 15 years, and consequently has a very in depth knowledge of the payments industry, both in the US and in Europe.

LT represents Piteco’s entry into the US market. In our view, Piteco has secured this investment at an attractive price (c 5x historical revenues and 14x operating profit) given LT’s growth prospects. Piteco is positioning itself for the accelerating development of the US payments market, which lags Europe in the payments space. The new LT management team has a bold plan to grow the business organically, by expanding the customer base and adding additional services. Further, Piteco aims to use the platform of LT to cross-sell its traditional Piteco treasury and cash management applications to clients of LT’s bank customers. We note that Piteco’s software is already operating in the US, via US branches of some of its Italian customers.

While the number of US financial institutions has been on a declining trend for decades due to mergers, consolidations and failures, the number of banks and credit unions utilising LT has been steadily increasing in recent years. Consequently, LT’s market share has been increasing, with market penetration approaching 40%, and LT has a goal to reach 50% penetration by 2018. If achieved, this would mean c 5,000 banks and credit unions in the US would be utilising the LT platform to originate, receive and manage some, or all, of their inter-bank transactions and settlements.

Based in Wichita, Kansas, close to the centre of the US, LT is the third largest player in the US correspondent banking software space, behind Fedline Advantage, which is owned by the Federal Reserve and another system owned by the banks. LT was founded in 2000 after three community bankers recognised there was a need for software tailored specifically for community bankers’ needs. Early offerings included loan analysis tools, along with a general CRM, hence the name LendingTools. However, LT was mandated to develop solutions for a local correspondent bank and after thousands of hours of R&D, it launched ExtraNet FP-S, its correspondent banking platform, in 2003. Today ExtraNet FP-S is LT’s technology backbone, flagship product and primary revenue generator. ExtraNet FP-S enables community banks to replace their Fedline connection with lower-cost services provided by their correspondent institution. LT has subsequently added additional services, primarily in the areas of cash management and cheque imaging. In 2005 LT launched its own data centre and all of LT’s services are delivered over the internet as a hosted application.

LT is profitable, strongly cash generative, with very high recurring revenues (90%), and has long-term contracts and low churn rates. More than $3bn of transactions from over 3,500 financial institutions are routed through LT’s data centre each day. A high proportion of its customer base are in the US mid-west. In FY16, LT generated revenue of $5m and pre-tax profit of $1.75m, for a 35% margin.

According to the Bank for International Settlements, correspondent banking can be defined, in general terms, as “an arrangement under which one bank (correspondent) holds deposits owned by other banks (respondents) and provides payment and other services to those respondent banks”. Large international banks typically act as correspondent banks for thousands of other banks around the world. Similarly, in the US domestic market, credit unions are respondents, utilising the services of larger financial institutions, which act as correspondents. The correspondents provide respondents with a wide range of services, including cash management, international wire transfers, cheque clearing, payable-through accounts and foreign exchange services. LT provides the software that enables these processes within an electronic environment.

LT operates on a SaaS basis, with 90% of revenue generated from contracted monthly billing, similar to a subscription service. LT provides the ‘right to use’ by end-users via its customer contracts and bills the customer directly while the customer bills the end-users. The remaining 10% of revenue is generated from upfront fees, customisation fees and technical consulting and support. The average initial contract term is five years and the average renewal term is four years. LT’s lifetime renewal rate is close to 85%, with many customers on their third or fourth renewal. LT charges a one-time fee for the implementation, which typically takes four to six months. This fee is primarily determined by the modules chosen and the size of the deployment, but also covers the length of term and the amount of customisation required.

We have included LT in our forecasts for 8.7 months in FY17, with annualised revenues of $5.2m (€4.9m) and growth at 10% pa in each of FY18 and FY19. We have not assumed any additional services or cross-selling of Piteco products and we have maintained all our operating assumptions for the rest of the business. We assume a 40% operating margin and a 35% tax rate for LT and have added minority interests and extra interest for the €7m borrowing facility.

In all, group net sales revenues rise by 25% in FY17, 35% in FY18 and by 36% in FY19. Adjusted EBITDA rises by 27%, 32% and 33% in the respective years, while adjusted EPS goes up by 13%, 12% and 14%.

We have assumed that Piteco has paid $13m for 55% of LT, which has cash balances of $2m and no debt. We assume that Piteco increases its stake over the next two years to 60%, at a cost of $750,000 in each year. Consequently, we forecast the group to end FY17 with net debt of €4.5m (previously €4.5m net cash), falling to €1.0m at the end of FY18 (previously €7.1m net cash) and swings to €2.5m net cash at the end of FY19 (previously €9.9m net cash).

We have assumed that costs relating to the transaction are included in the EBITDA. We have ignored amortisation of acquired intangibles, which have no impact on cash flows.

In our view, this transaction offers high potential rewards for Piteco shareholders, if Piteco can execute its plans effectively. Our DCF model suggests a valuation of 549c (previously 497c), which is 9% above the current price. The calculation uses the maintained assumption of a conservative 4.7% CAGR in organic net sales revenue over 10 years, a 9% CAGR for LT over 2017-26, a long-term operating margin (40% of net sales) that is below current levels and a WACC of 9%. It has also been adjusted for the dilution impact of the convertible bonds. Our forecasts do not take into account any additional services added at LT or cross-selling opportunities of Piteco’s existing solutions.