Park Group — Building on strengths

Park Group, a UK-based, specialised financial services business, is one of the leading UK providers of prepaid gift cards, multi-retailer gift vouchers and digital rewards services, a fragmented market that the UK Gift Card & Voucher Association estimates to be worth c £6bn per year. These products and services are distributed by Park through its corporate and consumer businesses. In the corporate business they are used to supply more than 30k businesses with a range of incentive and reward products, often tailor made. In the consumer business they are purchased by more than 400k individual customers, most using prepayment plans that provide an effective, disciplined and convenient way to budget for Christmas. For the group as a whole, the majority of sales are generated online, which complements and supports traditional distribution through a direct salesforce and agents. Income is generated from the service fees paid to Park by partner retailers, leisure and other service providers, based on the face value of money spent via Park’s cards and vouchers. Interest is earned on all prepaid cash until the obligation to the redeemers has been settled.

Park has a good track record of growth in earnings, cash flow and dividends, over a number of years, and has a debt free balance sheet. A constant investment in digital capabilities and product innovation has been a hallmark of this performance. The charts below show the recent record on the newly restated IFRS 15 basis.

This is a very positive starting point for the new senior management team that has been assembled over the past year which, as may be expected, has undertaken a comprehensive review of the business with a view to ensuring that the group has the right strategy in place to strengthen its existing position, as well as taking advantage of the opportunities that exist to accelerate growth. As discussed in detail below, the review provided a generally positive message about the prospects for multi-redemption products, and Park’s existing products and services but also highlights opportunities for their improvement, allowing the group to accelerate growth and tap new areas of demand, while enhancing efficiency.

The new management team is led by chief executive Ian O’Doherty, who joined Park in January 2018. He brings a strong background in financial services, specifically in banking, payments and card services, which appears well suited to leading the continued development of the business. Prior to joining Park, his experience includes 25 years at MBNA, most recently as chairman and CEO of MBNA in the UK, where he oversaw the reorganisation of the business and the re-engineering of its digital capabilities. The new CFO, Tim Clancy, took up his post in August, joining Park from Assurant Europe, the European subsidiary of Assurant, the US-listed global insurance provider, where he had held the role of chief financial officer since 2013. That role has included overseeing a number of acquisitions in the UK and Europe and their integration into the group. Other important appointments have been made in the areas of operation and technology.

Park has a highly seasonal business, with around three-quarters of annual revenues, and all of the profits, recorded in the second half of the year, which includes the important Christmas trading period. For the current year (FY19), the interim results for the six months ended 30 September 2018 (H119) showed a reduced seasonal pre-tax loss of £1.5m (H118: £1.9m), good cash flow and a further increase in DPS.

The key financial highlights for the period were:

Key operational developments included:

The strategic review included a wide-ranging survey of the market, and an in-depth analysis of the group’s existing operations and platform, as well as the further requirements to support the business plan. Park gathered views from non-customers as well as customers, defining the latter broadly to include consumers of its products, businesses customers, and retail/redemption partners.

Feedback from this customer review showed that there is a strong appetite for the multi-retailer product in the market. Management will focus on enhancing and growing this part of its offering, where it has strong products and capabilities, representing 84% of current billings. Park is well regarded by its customers, but there is much opportunity to increase demand from existing customer groups and to tap new market segments, by improving and simplifying the product range, as well as how the products can be bought and used.

An analysis of the marketplace highlights a particular opportunity to address the broader consumer market for a multi-redemption product, alongside Park’s existing dominant position in the Christmas savings consumer segment and strong positions in the corporate market segments (Exhibit 4). Park believes that enhancements to its product offering are also likely to strengthen its appeal to business customers.

The other significant trend that will continue to shape strategy is that while the market as a whole continues to show good growth, with the UK Gift Card & Voucher Association estimating 8.7% growth in the first half of 2018, there is considerable variation in growth rates between different formats. The card format, and to an even greater extent digital, continues to grow strongly and increase share at the expense of paper vouchers. This trend is not new, and Park has been investing in its card and digital capabilities over a number of years. In FY18, card billings represented 42% of Park’s in-house, multi-redemption billings, with digital at 4% and paper vouchers the balance. We expect paper vouchers to be less than half of the total in the current year as card and digital formats continue to grow faster. However, management intends to push this transformation harder to support growth in existing markets, open new markets and improve efficiency.

Bringing together the business review and market analysis, Park’s strategic business plan has four key pillars, with initial action being undertaken on each.

The four strategic pillars, and announced early actions in support of these are:

These interim results were the first to be reported by Park under IFRS 15 which, as has been well flagged, has a significant impact on reported revenues and defers some profit recognition into future periods, but has no impact on billings, profitability or cash flow. We explain the changes and impact on the financial statements in a separate section towards the end of this note. The historical financial statements are summarised on page 11, and our forecasts are stated on a fully adjusted basis.

In underlying terms, the interim results appear substantially in line with our previous estimates. Our lower PBT forecast for the current year (FY19) is predominantly the result of the c £0.3m H119 strategic review costs and the full-year impact of IFRS 15 profit deferral. The latter impact follows through into FY20. Our forecast DPS growth remains unchanged. There is no IFRS 15 impact on our cash flow forecasts.

The key forecasting assumptions that we have made include:

Our approach to valuing Park is to consider a potential absolute valuation, based on a modified DCF analysis, alongside a relative value based on a comparison with a selected group of listed stocks that are engaged in activities which provide some overlap with Park. We would not go so far as to call this a peer group comparison because no such listed group exists. Park’s competitor employee benefits and service providers are either private companies or relatively small parts of larger groups, complicating any attempt at a relative valuation approach.

The average of these two measures points to an unchanged valuation objective of 87p per share.

Our modified DCF valuation is unchanged at 90p. It is modified in the sense that we include the interest earned by Park on segregated customer cash balances (but not on the group cash balance), as this is an integral part of the returns that the company generates. The customer cash itself is excluded from the overall valuation, and also the voucher provisions balance as this will eventually flow out in settlement of vouchers that have been issued but not yet redeemed. For now, our forecasts go out to March 2020, and beyond this we grow free cash flow at 5% pa until year 10 (FY28), enhanced by an assumed normalisation of interest rates to 3% from FY21. The terminal cash flow is valued at 10x, and we use a discount rate of 10%. The terminal value represents 47% of the total 90p value.

A 1% increase in the assumed discount rate, leads to a reduction in the terminal multiple to 9.0x, or a 1% reduction in the long-term growth rate reduces the value by c 6%, 5% or 5% respectively. Holding all of the other assumptions constant, the current share price could be said to be assuming a long-term growth in free cash flow of just below 2% pa.

Turning to the relative value comparison, in incentive and rewards products, Sodexo and Edenred are both much larger and more international than Park, and the overlap with Sodexo is limited; Sodexo Benefits and Rewards Services is only a minor part of Sodexo Group.

We have added data for two providers of payments services, Euronet Worldwide and Wirecard. Neither provides a direct overlap with Park, but we include them to provide an insight into the potential for Park’s plans for further digital enablement. Euronet Worldwide is a global provider of electronic payment and transaction processing solutions including, in its e-pay segment (c one-third of revenues) the provision of electronic processing of prepaid mobile airtime ‘top-up’ services and other non-mobile content through a network of point-of-sale (POS) terminals. It also provides vouchers and physical gift fulfilment services, gift card distribution and processing services, and digital code distribution. Wirecard develops a full range of products for mobile payments systems for customers in retail, services and banking sectors. It also provides systems to support merchant loyalty programmes and the analysis of point of sale data.

Finally, because there has historically been some demographic/socioeconomic overlap between the traditional customer bases of Park’s Christmas prepayments business (c 50% of Park) and the UK-based home collected credit lenders (HCC), we have included data for the latter in the table below. We readily accept that the read-across is somewhat limited, and recognise the difference between the savings nature of Park’s Christmas prepayments business and the lending nature of HCC. Given that Park has no credit risk and we believe it has less regulatory risk, we would expect a higher valuation.

Taking the data as a whole, and exercising our judgement, we continue to believe that c 14x prospective calendar earnings represents a reasonable valuation objective. This would indicate a value of 84p per share.

In addition, we note that the table highlights the potential upside to valuation from faster growth, increasing scale, and a greater focus on digital payments services.

IFRS 15 (‘Revenue from contracts with customers’) is a new accounting standard in respect of revenue recognition that applies to businesses across all industries. It was endorsed by the EU in September 2016 and became effective for annual reporting periods beginning on or after 1 January 2018. The main aim of the standard is to remove previous inconsistencies in revenue recognition and improve comparability. We discuss the main changes and the effects on the financial statements below. For readers requiring further details on this complex subject, Park has made a presentation available.

The main effect of the introduction of IFRS 15 is to bring the accounting treatment for prepaid cards and in-house vouchers into line with each other, as summarised in Exhibit 10.

It is worth remembering that it is the IFRS 15 impact on revenue recognition that drives the income statement changes and that:

What has changed under IFRS 15 is the way that some of the revenues, in respect of Park’s in-house vouchers are reported, and when:

There are other, less significant changes in the timing of the recognition of ‘breakage’, which itself arises from the fact that a certain proportion of the vouchers and cards sold by and distributed by Park will never be redeemed. In the case of in-house vouchers and cards (but not third-party products), this is a source of additional earnings. Under IFRS 15, breakage for in-house vouchers is slightly deferred, being recognised in proportion to the rate of redemption rather than at the point of despatch, as done previously. Breakage is only recognised on those cards that have no right of redemption (ie where the customer cannot request a refund of the value loaded), representing approximately two-thirds (c £44m) of card billings through the Corporate business in FY18. This is slightly deferred under IFRS 15, from recognition at the point of loading to recognition in proportion to the rate of redemption, as with in-house vouchers.

Complex as all of this sounds, it is worth making the point that the impact on historically reported profits is relatively small and is only a timing effect, with ultimate profitability (and cash flow) unaffected. In order to provide investors with a clearer insight into its impacts, Park has adopted the ‘full retrospective method’ of IFRS 15 application, providing restated financial statements from the beginning of FY15. Exhibit 11 shows the significant main impact on revenue in those prior years, substantially offset by changes to reported cost of sales, leaving a relatively modest impact on PBT. The extent of the impact varies from year to year depending on changes in the product mix as well as the timing and profile of customer redemption activity. Assuming unchanged redemption patterns, an increased share of in-house vouchers would be expected to increase the impact on revenues and the amount of profitability deferred to later periods.

The average impact on previously reported PBT over the four-year period was to lower reported PBT by c 3%, which represents the net impact of income deferred in the period less the recognition of income deferred from previous periods. Re-stated deferred income at the end of FY18 was £6.7m, an increase from the originally reported £1.9m, and with an adjustment for tax this was reflected in a restatement of the FY18 net assets from £17.9m to £14.0m. The majority of the deferred income balance is expected to be recognised over a two-year period, although it should be replaced by new deferrals with the amount dependent on the growth of the business, and the product mix.