eServGlobal — Update 5 September 2016

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 international remittances, which operates through its 35% stake in the HomeSend joint venture – the JV is focused on driving adoption of the hub with the aim of reaching profitability in 2017.

We have revised our forecasts to take into account the recent fund-raising and debt restructure. We estimate that as at the end of FY16, the company will have a net cash position of A$0.6m, with more than sufficient cash on the balance sheet to fund the core business. Our underlying forecasts for the core business are unchanged; we continue to forecast a small positive EBITDA in FY16 rising to an EBITDA margin of 6.1% in FY17.

Based on a sum-of-the-parts valuation, we calculate a per share value of 10.7p. We value the core business at a discount to mobile software peers to reflect its profitability profile. We assume that the HomeSend JV is successful in reaching break-even in FY17, growing its share of the international remittance market to 2% by FY25 and achieving operating margins of 16% in the long term. For the JV value to be reflected in the share price, investors will need to see regular operational updates tracking new hub members, live corridors, volumes transacted and progress towards profitability.

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 for international remittances by 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. Exposure to large shareholder: the largest shareholder has a 24.8% stake and has lent the company £7m. Regulation: regulation related to mobile money could reduce demand for eServGlobal’s mobile wallet software.

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 FY15, 80% of revenues were generated from the Middle East and Africa. eServGlobal has also developed a hub for international remittances, which operates through its stake in the HomeSend joint venture. After a period of restructuring, the company is focused on growing its core software business and supporting the HomeSend JV.

eServGlobal was founded in 1982 and has operated several different telecom-related technology businesses. The company currently consists of two businesses: software for mobile money and recharge services and an international remittance service (HomeSend). In 2013, eServGlobal created a joint venture with MasterCard and BICS for the HomeSend service, of which it now owns 35%. eServGlobal listed on the ASX in 2003 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 April. Paolo Gagliardi took on the COO role in 2015. In the medium term, the board composition will be reviewed, and may ultimately require a CEO and CFO.

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 (3.0) was completed in H115 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:

Roughly 70% of revenues are generated from Recharge (VMS and EVD), although Mobile Money is growing faster so is making up an increasing proportion of revenues. The company is looking to upgrade existing Recharge customers to its Mobile Money solution, as well as targeting new customers with the solution.

Prepaid subscribers are mobile phone users who buy credit for their phones in advance on an ad hoc basis, as opposed to customers on a monthly contract with an MNO. Due to lower income levels, many customers not having bank accounts and customers with little or no credit history, prepaid contracts are a prominent feature of developing markets (see Exhibit 2).

The crucial difference between prepaid and contract subscribers is the way that the MNO is paid for airtime/data. In developed markets, prepaid subscribers tend to phone up, use an ATM or use an app to buy airtime credit; this is possible as subscribers tend to have bank accounts to which they can link, either via direct debit or by charging a debit or credit card. In some cases, subscribers may choose to go to a shop that offers this service and pay in cash. In developing markets, for the majority of users, the cash route is the only option. This means that the MNO needs a network of agents across the country that can take cash in return for issuing some kind of airtime credit: either a paper voucher in the form of a scratch card or an electronic voucher (typically an SMS with a code that the subscriber enters into the phone). In either case, there is a network of agents that needs to be managed and vouchers for airtime that need to be created and tracked. Paper vouchers need to be designed, printed, distributed and tracked. Electronic vouchers need to be tracked from issue to redemption in real time.

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.

In many developing countries, there are more mobile phone subscribers than there are adults with bank accounts. This has led to the development of services that exploit the agent network and ubiquity of phone ownership to provide mobile phone subscribers with financial services. In this case, the airtime that is acquired is treated as a store of value. Someone wanting to send cash to a relative in another part of the country where one or neither party has a bank account, or where access to a bank branch is difficult, can use the transfer of airtime as a means of transferring cash. The sender buys $10 of airtime via an agent and provides the agent with the phone number of the recipient. This is transferred via the mobile phone network and the recipient visits their closest agent with their phone to redeem the cash value of the airtime. The best-known and most successful example of this is M-Pesa in Kenya, operated by Safaricom. At the end of FY16 (31 March 2016), M-Pesa had 16.6 million active users, out of a Safaricom subscriber base of 25.2 million and a population of 47 million. The service generated revenues of c £310m in FY16 (+27% y-o-y).

While the most basic method of transfer involves airtime, more operators are offering mobile wallets that act as a store of value that can either be cashed in or used to pay for things where wallets are accepted. 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). From a government perspective, sending or receiving money this way reduces the potential for corruption and reduces cash management expenses and complexity.

Globally there are currently c 7.8 billion cellular subscriptions across c 4.8 billion subscribers (source: GSMA). We note the total subscription number includes machine-to-machine connections estimated at c 3% of the total. In many countries, the number of subscriptions exceeds the size of the population as subscribers may have mobile contracts on more than one device, may have a work and personal phone; or in the case of prepaid subscribers may own multiple SIM cards, which they swap around to make the best of special offers from MNOs.

It is estimated that there are two billion adults (c 37% of the adult population) who have no or very limited access to a bank account1 (source: World Bank - The Little Data Book on Financial Inclusion 2015). Of the 62.7% of the population with an account, 60.7% or 3.18 billion adults have an account with a financial institution, 1% or 53 million have an account with a mobile money provider and another 1% or 53 million have a mobile money account linked to a bank account (source: World Bank Findex Report 2014). In high-income OECD economies, bank account penetration stands at 94%, whereas in the Middle East it stands at 14% and sub-Saharan Africa at 34%. In sub-Saharan Africa, a third of adults with access to a bank account have access solely via a mobile money provider. At the end of 2015, the GSMA estimated that there were 270 mobile money schemes deployed across 90 countries, up from 100 deployments three years previously. Most mobile money accounts are available via multiple-access methods on the mobile: the most common is USSD2 followed by apps, STK (SIM toolkit) and IVR (interactive voice response).

With its smartphone app, eServGlobal is able to support the growing number of smartphone owners in the developing world. Smartphone penetration currently stands at more than 50% in the EU versus c 20% in sub-Saharan Africa and c 40% in the Middle East. This is forecast to grow to 75%, 55% and 65%, respectively, by 2020 (source: GSMA 2014 State of the Industry – Mobile Financial Services for the Unbanked). Roughly two-thirds of current mobile money services are available on smartphone apps and we expect this proportion to grow as smartphone penetration increases.

eServGlobal’s customers are based in the Middle East, Africa and Asia-Pacific. The company currently has no customer in Latin America, but is now actively marketing in the region. 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.

After using eServGlobal Recharge solutions for several years, in 2013 Zain signed a three-year framework agreement for the provision of end-to-end mobile financial services solutions at a group level. In some of the countries in which Zain operates, more than 90% of the adult population have no access to financial services. Zain launched live services in Jordan and Saudi Arabia in 2015 and in Iraq earlier this year. We would expect to see additional licence sales as Zain rolls out the services to its affiliates.

The core business competes with a variety of mobile billing software providers, most frequently with the companies in Exhibit 4.

eServGlobal’s direct sales team consists of six employees in Dubai (covering the Gulf, Asia and Africa) and two in Latin America. Pre-sales staff are located in Dubai, France and Indonesia.

To supplement direct sales, eServGlobal is increasing the number of partners with which it works. This includes working with larger telecom equipment vendors to provide the recharge/mobile money element of larger deployments.

eServGlobal also aims to work with HomeSend. For example, to use the HomeSend platform for international remittances via mobile, end-customers need to have a mobile wallet provided by their own MNO – eServGlobal is able to provide software to support an MNO’s domestic wallet requirements. HomeSend and eServGlobal are working on their first joint deployment, due for imminent launch.

Management is targeting growth in the core business from:

eServGlobal has a 35% stake in the HomeSend JV (the other partners are MasterCard with 55% and BICS with 10%). HomeSend is an international mobile remittance platform. For the history of how the JV was created see “Supporting mobile money in the developing world” (August 2015).

The international remittance3 market was worth $582bn in 2015 according to the World Bank, of which $432bn was sent home by migrants from developing countries. The market is made up of traditional MTOs4 (global and regional), banks, post offices, card networks and newer digital-only companies. The two largest players are Western Union (FY15: revenues $5.5bn, transactions processed $82bn) and MoneyGram (FY15: revenues $1.4bn).

Traditionally, an MTO would operate a network of agents in many countries. Agents can receive or pay out remittances and are able to service the segment of the market that does not have a bank account. More recently, digital-only MTOs have been established (Azimo, TransferWise, WorldRemit, Xoom) where users send and receive money via mobile or online channels, removing the need for an agent network.

The World Bank’s international remittances database is updated quarterly for 365 country corridors (consisting of 48 sending countries and 106 receiving countries), tracking the cost to send money by sending party (eg Western Union, WorldRemit), sending method, receiving method and time to access funds. Data as at June 2016 shows an average cost to send $200 (or local equivalent) of 7.60%, only marginally down from 7.68% in Q215, but more materially down from 9.67% at the beginning of 2009. This cost varies by region: the average cost to send to sub-Saharan Africa is 9.58% compared to 5.56% to send to South Asia. HomeSend is aiming to achieve a total cost of remittance of 4-5%, of which it retains c 1% with the remainder shared between the sending and receiving organisations.

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 (MTOs, banks, post offices, etc). eServGlobal reported that at the end of April, HomeSend had 3,800 live corridors from more than 200 sending countries and 36 receiving countries. 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.

Companies that have joined HomeSend include those in Exhibit 5. We expect that many MTOs sign up to use HomeSend to supplement the networks they have already created. This enables them to access countries where they do not have an existing agent network (by working with an MNO that already has one) or to make use of mobile wallet capabilities, enabling them to expand their networks at much lower incremental cost. In other cases, sending organisations will use HomeSend for lowest cost routing.

Since the launch of the joint venture, HomeSend has signed up a number of MTOs, including some of the highest profile (eg MoneyGram, Xoom, Viamericas, WorldRemit), and has expanded the geographical coverage of the network. MoneyGram signed up in 2014, as it does not yet have a mobile send/receive facility. It started with Kenya as a receiving country, where funds can be transferred to an M-Pesa account, and we believe it plans to expand the use of HomeSend to other corridors. Digital MTOs are also signing up – WorldRemit joined HomeSend in 2013 with an initial focus on corridors between Europe and Africa; Azimo joined in 2015 and now provides mobile wallet services in 10 countries. Paysafe strengthened its relationship with HomeSend: Skrill already used HomeSend and Paysafe recently extended its agreement to cover the NETELLER wallet – it has live services using HomeSend in six countries.

Partners invested an additional €10m in the JV over the last year; eServGlobal invested €3.5m to maintain its 35% stake. This was used to fund several initiatives to support the growth of the JV, including co-funded marketing initiatives with MNOs to stimulate subscriber demand, a new PCI-DSS5 compliant data centre in order to connect to the MasterCard network and acquisition of a payment institution licence.

MasterCard announced last year that MasterCard Send would use HomeSend for international remittances. Through a single connection to the MasterCard Send platform, businesses, merchants, issuers, governments, non-profits and other senders can send money to consumers whether they are banked or unbanked, and located domestically or abroad. Senders or recipients do not need to be MasterCard cardholders. MasterCard Send has been launched in three “send-to-card” markets (Russia, Ukraine and the Philippines) and intends to rollout to other countries over the next two years.

MasterCard is encouraging its customers to use HomeSend for more than just remittances and H116 saw the platform used for payments and disbursements.

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

Via a conditional placing, the company recently issued 300m shares at a price of 4p/A$0.08. In addition, via an open offer, the company has issued 74.4m shares at the same price. In total the company has issued shares worth £15.9m, with net cash proceeds totalling £10.9m. The company has used £0.6m of the cash proceeds to repay some of the £12m debt previously lent by AlphaGen Volantis and swapped £4.4m of that £12m debt for 110.14m shares. To settle the remaining £7m debt outstanding, AlphaGen Volantis advanced a new £7m loan repayable on 30 June 2019 at an interest rate of 1% per month (all payable at the end of the term).

The table below shows the changes we have made to our forecasts to reflect the share issue and debt restructuring. We have also updated our forecasts for the contribution from the JV to reflect the most recent HomeSend accounts. We have made no other changes to our forecasts, which continue to assume that the company reaches EBITDA break-even this year.

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. We look at the core business on a peer multiple. We use a DCF 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 16% this year and 19% next year, compared to our forecast for eServGlobal achieving an EBITDA margin of 0.2% in FY16e and 6.1% in FY17e. We apply an EV/sales multiple of 0.9x FY16e revenues (a discount of 50% to peers to reflect the profitability profile), which is equivalent to an EV/EBITDA multiple of 13.7x FY17e and results in an enterprise value of A$26.9m (2.42p per share).

The book value of eServGlobal’s stake on inception was A$31.1m, implying a book value for the JV of A$89m. At the end of H116 the book value of eServGlobal’s stake was A$27.6m, reflecting the losses generated by the JV to that point as well as the additional investment made in FY15. In September 2015, the company commissioned a DCF valuation of the JV. Using a WACC of 13% and a 20% discount to reflect its minority stake, eServGlobal’s share in the enterprise value of the JV was valued at €18.78m/A$29.9m, up from €16.8m/A$24.9m at the inception of the JV. This implies an enterprise value of €67m for the JV, or A$100m at current exchange rates.

We have constructed a DCF that assumes that HomeSend grows its share to 2% of the global remittance market over the next 10 years, earning 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 FY18 and ultimately achieves operating margins of 16%. Based on working capital/sales reducing down to 3% and capex/sales to 2% over the period, and using a WACC of 13% with a long-term growth rate of 2%, we value the JV at A$300m, of which eServGlobal’s share at a 20% discount would be worth A$84m. This assumes that sufficient working capital is available until break-even is reached. At such an early stage in the life of the JV, there are obviously many assumptions underlying this calculation. In the table below, we provide a sensitivity analysis that shows how this value changes depending on market share and gross margins assumptions.

As a cross-check, we have looked at the financial and valuation metrics for companies involved in the remittances market. Western Union and MoneyGram are well established MTOs with large agent networks and wide geographic coverage. Earthport has developed a bulk cross-border remittances platform and is yet to break even. PayPoint operates bill payment and other payment-related services across its network of retailers. Using the base case valuation, for FY17 the JV valuation equates to an EV/sales multiple of 6.4x. Assuming that the JV’s profitability ramps up from FY18, EV multiples fall to 1.2x FY19e sales and 8.9x FY19e EBITDA, much more in line with FY17 peer group multiples.

In the table below, we show the range of valuations for the group based on using peer multiples for the core business and three different valuations for HomeSend: DCF, book value and the most recent independent valuation.

Clearly, if the HomeSend JV manages to achieve growth in market share to 2%, the share is undervalued. To close this valuation gap, it will be crucial to see operational metrics from the joint venture to monitor its progress.

Based on our sensitivity analysis in Exhibit 8, achieving a 1% higher or lower share of the international remittances market over a 10-year period (keeping the gross margin at 20%) would change the valuation to 13.7p or 5.5p. Keeping market share at 2% but varying the long-term gross margin up to 30% or down to 15% would take the valuation up to 17.2p or down to 6.8p.