Park Group — Innovating to grow earnings and cash

Park Group is a UK-based, specialised financial services business. It is a UK leader in the provision of prepaid gift cards, multi-retailer gift vouchers and digital rewards services, a market that the UK Giftcard & Voucher Association estimates to be worth more than £5.6bn 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 31,000 businesses with a range of incentive and reward products, often tailor made. In the consumer business they are purchased by more than 430,000 individual customers using prepayment plans that provide an effective, disciplined and convenient way to budget for Christmas. The majority of sales are now 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’s business has been transformed over a number of years as it has harnessed the opportunity for product and distribution innovation provided by fast-developing digital technologies, allowing it to reach new customers, in new markets, with a constantly developing product offering. The group’s IT spend runs at c £600k pa, with a total spend including technical support of more than £3.5m, a significant commitment in relation to its size. As a result, it has built a strong track record of growth in sales, profits and dividends, which we expect to see continue as the group benefits from growth in the digital platform that has been created and recent new product and distribution initiatives.

Park partners with leading retail brands to provide its customers, both consumer and corporate, with a broad and attractive choice of shops, restaurants and attractions at which to redeem the range of flexible prepaid gift cards, e-codes and vouchers that it supplies. The retailers have an interest in the additional revenues that the partnership brings to them and, in return, provide Park with service fees, representing the gross margin reported by the group. Park-branded cards and vouchers, to be redeemed with its retail partners, represented c 80% of total billings of c £405m in the last full year (Exhibit 4). Billings through the consumer business represented 54% of the total and corporate billings were 46% of the total. Billings also include retailer-branded, third-party gift vouchers, physical products including a small amount of hampers, travel services through Park’s own full-service travel agency, and prepaid Mastercard product, for which Park became a licensed issuer in 2017.

Park’s own-branded Love2shop voucher is the UK’s leading multi-retailer gift card and prepaid card brand, with high levels of customer awareness. It is accepted by 184 retail partners (as at 30 September 2017) with more than 20,000 outlets across the UK and Republic of Ireland (RoI). However, it is prepaid cards that are driving growth, producing compound annual growth in billings of 14% in the past three years, while Love2shop voucher sales are broadly flat.

Park’s FCA-authorised prepaid card offering includes both physical and digital cards, and is driven by its proprietary flexecash card infrastructure, developed in house over a three-year period and first introduced in 2010. The introduction of flexecash was one of the most significant developments in recent years and card sales continue to be a major driver of underlying growth. Sales of flexecash rose 16% in FY17 compared with overall growth of 5%, and reached 26% of the total. Indications from H118 are that strong growth is continuing in the current year. The number of retail partners accepting the card is lower than for vouchers due mainly to the systems upgrading required by some other smaller redeemers, but it has steadily grown to reach 99 retail brands (as at 30 September 2017) covering c 13,000 outlets, and Park works hard to continually add selected retailers.

Historically, the redemption of cards, like vouchers, has only been possible in Park’s “closed-loop” network of retail partners from which it receives service fees. However, in 2016 Park began to sell a Mastercard product, for “open-loop” use at a broader range of outlets. Customers have proved willing to pay a premium for this added flexibility and, despite the absence of service fees, margins are similar to other products. In January 2017 Park became a licensed Mastercard issuer and plans further product introductions. The first Mastercard to be offered (the Your Choice card) is a digital card that can be used online at selected retailers. The offering will be expanded in the coming months to physical cards that can be used at any retailer accepting Mastercard, both online and in store. Mastercard sales in FY17 were £10.1m or 2% of the total and we would expect this to increase as new product is introduced and new markets addressed.

Compared with vouchers, the card provides a broader, more flexible product offering that can be tailored to the customer and serviced online, while providing a secure and convenient alternative for customers to use. End-users can access online retailers using e-codes, obtained from the cardholders’ e-wallet account, or a digital Mastercard version of flexecash. Increasingly, partner retailers have begun to accept the existing flexecash card online; starting with Argos, this now includes Virgin Experience and Park expects other retail partners to follow.

As discussed above, the consumer and corporate businesses are best seen as distribution channels for a substantially common product set. They nevertheless address different customer groups, operating in different market conditions, in unique ways and it is worth reviewing each in turn.

Digital investment has completely transformed the consumer business over the years in terms of products, distribution and interaction with customers. The effects are to broaden the appeal of this long-established business while improving efficiency. It effectively represents Park Christmas Savings plus a small amount of other income generated by third-party use of the group’s cold storage and packaging facilities, and accounted for 54% of FY17 sales and 47% of operating profit before central costs. Christmas Savings customers purchase vouchers and prepaid cards, gifts and, in a minority of cases, hampers, on a 45-week prepaid instalment plan. Park is the UK market leader in Christmas savings, and it also has a relatively small business in the Republic of Ireland, operating under the Park Ireland brand.

Christmas Savings sales have grown fairly steadily over a number of years, despite a tough consumer environment for much of the period. In our view, Christmas is the last thing that Park’s traditional customer base wants to cancel, and the savings discipline and the convenience of shopping that the programme brings are key attractions, generating strong customer loyalty. There have been just two setbacks in recent years. One was in 2009 in the wake of the financial and banking crisis as well as retail failures such as Woolworths; the other was in FY14 when a number of high-profile high street retailer failures such as HMV, at the peak of the Christmas Savings marketing campaign, had a negative impact on sentiment and created unwarranted fears about the security of store-branded gift cards.

For a number of years, consumer sales were dominated by gift vouchers but, since the introduction of flexecash in 2010, card sales have steadily increased as a share of the total. In FY17, the Love2shop voucher represented 58% of sales (FY16: 62%) and prepaid cards, driven by the flexecash card engine, represented 20% (FY16: 18%). The balance of sales represents third-party retailer gift cards, a small amount of hampers and other physical goods, and the recently introduced Mastercard product that adds further open-loop product flexibility options.

Distribution was traditionally catalogue based and significantly reliant on local agents who would each collect orders from multiple customers. Exhibit 6 shows the steady rise in the number of accounts over the years, with an increasing proportion of these representing individual customers coming directly to Park. Although the number of agents has declined over the years, they are still very important to Park. Although agent accounts represented c 25% of all accounts at the end of FY17, because each agent represents multiple customers, the agency customers still represent almost two-thirds of all customers. As Park continues to invest to improve its direct appeal to a wider group of customers, it is conscious of the need to similarly support its agency distribution.

As well as more customers choosing to deal with Park directly, more of them are choosing to do so online (approaching 90% of new customer orders are placed on line), and the vast majority of those customers (c 85%) are doing so with a mobile device. Park supports this through social media networks such as Facebook (where followers are growing rapidly, to more than 100,000), Twitter and LinkedIn, using these to promote products, post promotional competitions and seek ‘friend’ referrals. It has found the site a useful early indicator of customer issues and concerns, allowing it to plan a timely response. Park’s ‘Ask Wanda’ virtual assistant holds some 500 answers to possible customer questions and has been expanded to include ‘live chat’. So as to better satisfy the customer demand to interact with Park via mobile, a new smart device app was first introduced in a pilot scheme in January 2017 and was rolled out fully for the Christmas 2018 marketing campaign. The app makes the mobile experience significantly faster, simpler and more convenient, and management believes it has the potential to significantly enhance customer engagement, improving retention, winning new customers through positive recommendation and increasing sales value per customer. The app leads customers through a convenient sign-up process, allowing them to plan their savings targets and choose the most suitable payments method. Once orders are placed, the app allows for regular, positive communication with the clients through notification alerts, encouraging savings patterns and prompting orders.

The H118 growth in billings of 6.3% (7.6% in Christmas Savings, partly offset by lower other income from third-party utilisation of the group’s cold storage and packaging facilities) in part reflects the early despatch of Christmas Savings orders. The Christmas Savings order book is built in the early months of the calendar year and was c 4% ahead y-o-y at the time of the interims in September 2017. This c 4% is a better guide to billings growth for the year as a whole. The seasonal operating loss of £2.0m (FY17: £1.3m loss) increased during the period which, in addition to the c £330k y-o-y reduction in other income, is attributed by management to a number of timing issues, amounting to c £350k, which should unwind by year end. Mastercard processing costs related to Park becoming a licensed Mastercard issuer have been spread fairly evenly across H1 and H2 with a negative impact on H1 of more than £200k.

Management expects continuing product enhancement and customer service innovations to continue to drive growth.

The corporate business has a good track record of growth as digital investment has allowed it to create convenient and cost-effective solutions for customers, introduce innovative new products, and address new markets. In the UK it operates in a large and fragmented market, providing opportunities for market share gain. The UK Giftcard & Voucher Association estimates that around half of the £5.6bn annual UK sales are B2B, and that these have grown at a double-digit rate over the past five years. The launch of Love2shop Worldwide has given Park global capability for the first time.

The corporate business accounted for 46% of FY17 sales and 53% of operating profit before central costs. It supplies a range of products including Park’s own vouchers and prepaid cards as well as individual retailer-branded vouchers and travel services, mainly used by corporate customers for incentive and reward schemes as well as for on-sale to their own customers. Since October 2016, the corporate business also includes Fisher Moy International (FMI), a specialist in brand engagement consultancy. At a cost of just under £1m, the FMI acquisition was modest but strategic. It works with a number of larger, blue-chip clients and provides Park with the opportunity to engage with a much broader and larger pool of corporates. It also gives the group a physical presence in the south of England. Highstreetvouchers.com is the UK’s leading online gift card and voucher retailer. It has grown steadily and strongly since it was launched in 2004 with 80% of sales coming from corporate clients. Management looks for new innovations to maintain growth. Love2shop.co.uk is the online ordering, transaction and servicing site for the own-branded Love2shop product range.

Park has traditionally provided low-cost and flexible incentive and rewards schemes to the UK SME market. Unlike many competitors, it is not reliant on charging fees for these packages as it earns revenues through the use of its own voucher and card product. Additionally, Park has invested in online servicing capability that improves both the service offering and efficiency. Engage, launched in 2016, is an online digital platform for the corporate incentive and reward market that allows corporate users to create and control tailor-made modular web or smart device-based programmes for their customers or staff, providing real-time information to the customer on uptake and progress.

The Evolve platform, which was launched in the UK in June 2016, was well received by Park’s customer base and has recently been made available globally since May 2017 via the establishment of Love2shop Worldwide. It is a live online platform providing organisations with a quick, easy and reliable way to reward employees or customers who may be on the move. It can be fully branded to the organisation and delivers reward by way of digital rewards codes via email or SMS in a convenient and cost-effective way. At the time the interim results were released in November 2017, the number of businesses that had purchased codes since launch had reached 249, generating £3.6m in sales. An indication of growing momentum is that 192 clients purchased codes in H118. The global roll-out of Evolve has been made possible by a partnership with Carlton Group of Canada, an engagement and rewards specialist with a strong international footprint that allows it to deliver country-specific rewards in 150 countries utilising a catalogue of branded rewards that is available in 39 different languages. The ability to deliver product on an international basis is key and Love2shop Worldwide will now be able to offer a digitally based rewards programme, utilising the Evolve platform, on a worldwide basis. The new capabilities are initially being offered to Park’s existing UK corporate clients before being rolled out into new territories. Growing the sales of Evolve is a major focus for the group and management believes that there is a significant opportunity to be exploited.

FMI has had a slow start and generated a c £100k operating loss during H118. However, it is now fully integrated as the customer engagement arm of Love2shop Business Services, it has been profitable over recent months and, with the support of the Love2shop sales and marketing team, is showing early progress in broadening the take-up of Park’s incentive and reward offering to a broader and larger corporate universe. Among new business won is a multi-country online rewards programme for a major European car manufacturer and a rewards mandate with a UK trade programme, with a potential value of more than £2m pa and offering significant corporate communication and engagement opportunities.

The corporate business’ good track record of growth in recent years becomes more apparent if adjusted for the run-down in sales to home-collected credit (HCC) operators, and particularly to Provident Financial. Credit sales overall are now small and Park expects no impact from the ongoing problems experienced by Provident Financial. Management looks for growth to continue, with new products and services targeting new markets and larger businesses.

H118 billings growth was 7.7%, with a number of important new customers added in the period. Management reports that its online platforms are proving popular with corporates, and in particular the control that the self-service features provide. Operating profit was at a similar level to the prior year despite the negative FMI contribution in the period, some front-loading of promotional costs, and business mix effects (increased card sales, but deferring profit recognition, and more third-party product such as Amazon e-codes, where margins are lower).

The group is currently led and controlled by a board consisting of the non-executive chairman, three executive directors and two non-executive directors. The executive board includes the CEO, group finance director and the managing director of Park Retail. This team has been in place for many years, together managing Park through its transformation and development, but has begun a process of significant change. Ian O’Doherty became CEO and joined the board on 1 February 2018, replacing Chris Houghton, retiring from the group after more than 30 years of service, and who had held the position of CEO since 2012. The CFO, Martin Stewart, has also indicated that he will leave Park after 13 years in his position, although this will not take effect until August 2018, once a replacement has been found and an orderly handover completed.

Ian O’Doherty has 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. He spent 28 years at MBNA, most recently as chairman and CEO of MBNA Ltd in the UK, between 2008 and 2017. During this time he oversaw the re-engineering of MBNA’s digital capabilities and reorganised the business, leading it through the financial crisis and subsequent sale (for £1.9bn) to Lloyds Banking Group in 2017.

The non-executive chairman is Laura Carstensen, who was elected to the board in September 2013 and became chairman in June 2016. She is a former partner in City law firm Slaughter and May and a former member and deputy chairman of the UK Competition Commission (now the Competition and Markets Authority). The other two non-executive directors are Michael de Kare-Silver, who joined the board in September 2013, and John Gittins, who joined the board in September 2016 and has more than 20 years’ experience as a CFO across various sectors and territories. Brief biographies of the executive board members and chairman are on page 16.

Park reported its interim results for the six months ending 30 September 2017 in late November. Because of the highly seasonal nature of Park’s business, in our opinion these are best viewed as a guide to underlying business trends and direction, particularly in orders. We have covered the trends within the consumer and corporate businesses in the section above but note that they reveal the extent of the seasonality. More than 75% of sales, and all of the profits, are generated in the second half of the year, which includes the important Christmas trading period. The first half is significant in building the order book, but is traditionally loss making. Digitalisation of the business and changes in customer behaviour have seen the share of total annual sales (defined as billings) generated in H1 increase steadily, from less than c 15% in FY13 to more than 24% (we forecast 24.4% in the current year), while the seasonal H1 pre-tax loss has also trended down over time. However, the extent of remaining seasonality in the business continues to create volatility in first-half reported earnings and cash flow. H118 was no exception, with the normal seasonal pre-tax loss increasing to £1.6m (H117: £0.8m), although still well down on the £3.0m reported in H113.

In brief, the group highlights from H118 were:

No change to forecasts – timing impacts to unwind

We have made no material changes to our group forecast after the interim results, although within this we have slightly reduced our consumer business forecast with a corresponding uplift in corporate. The change was driven by a rebalancing of our billings forecast between the two. We do not yet incorporate the changes relating to the adoption of IFRS 15 applicable from FY19 (see section on page 11 re IFRS 15).

Forecasts for the consumer and corporate businesses are shown in detail in the sections above. At the group level and on the current basis of accounting, we are forecasting 7% billings growth for this year and next, and for similar growth in gross profit (gross margin on billings maintained at c 7.5%). Within this we look for card billings to continue to represent a larger share (growing c 35-40% pa) and limiting reported revenue growth (to c 2%), but continuing to lift gross profit as a share of revenues. Despite continuing investment, we look for operating profit to grow slightly faster than gross profit and for next year we anticipate some benefit to interest revenues from higher average cash balances.

Park is a highly cash-generative business with no debt. Historically, Park’s operational cash flow has been allocated between strengthening the balance sheet, investment in growing the business (partly capitalised but also expensed) and funding the progressive dividend payments shown in Exhibit 3. Exhibit 12 shows how the balance sheet has developed and strengthened over the years, with the equity position moving from a substantial negative to positive, and with a substantial net current liability position all but closing. Other than a £4.2m (net) equity issue in FY14 to fund growth, this has all been achieved out of retained earnings and positive cash flow.

Although in a positive equity position since 2016, for many years it funded its growing business from working capital with the balance sheet reporting negative equity. The latter reflected historical goodwill and other write-offs from the early 2000s, related to an unsuccessful diversification effort before the current, focused growth strategy was adopted, and captured none of the goodwill value inherent in the continuing business. The business model is based on cash being received from customers upfront, in return for prepaid cards and vouchers, and then being paid out, less service fees (Park’s margin), to the redeemers that accept the vouchers and prepaid cards at their outlets.

Customer prepayments are segregated, substantially so in the case of Christmas savings in the voluntary Park Prepayment Protection Trust (PPPT) or, in the case of prepaid cards, fully segregated as required by the regulator (the FCA) within the e-money Trust. The PPPT was set up in 2007 in the wake of the Farepak collapse to provide reassurance to customers. The trust deed allowed Park, under the supervision of the trustees, to access some of the accumulated balances on a limited basis to meet operating costs and working capital needs in the business period. Management indicates that it no longer accesses these funds for working capital.

As noted above, we expect the timing impacts on H118 cash flow to unwind during H2. Our forecast shows end-FY18 shareholder cash (net of overdraft) at £32.6m (FY17: £31.4m). Park typically distributes a little more than 50% of earnings and, with substantial balance sheet strengthening behind it, we would expect future dividend policy to be driven primarily by the prospects for organic investment and/or external acquisition opportunities. However, this strong and growing cash balance needs to be seen in the context of the provision for outstanding vouchers and, although the dividend policy is progressive, we do not believe that investors should anticipate any substantial change in the payout ratio over the near term. The provision represents the cash that is expected to be paid to retailers over time in respect of vouchers that have been issued to customers but are yet to be redeemed at retailer outlets. There is also a smaller provision for corporately issued (rather than individually issued) cards where there is no right of redemption for unspent balances. This will not happen overnight and the size of the provision balance cash is, among other things, driven by ongoing voucher sales. However, over time, we expect prepaid cards to continue to take sales share from vouchers.

Cards versus vouchers and IFRS 15 update

The introduction of IFRS 15 will see accounting treatment for prepaid cards and vouchers, currently very different, converge. Park will report under IFRS 15 for the first time in respect of the financial year ending 31 March 2019 and is likely to provide initial guidance on the impact with the current year (FY18) results in June 2018.

Currently, voucher revenue is recorded when the vouchers have been despatched to the customer, generating revenues that equal the amount paid by the customer for the voucher (typically the face value) and a gross profit margin that represents the service fees receivable from the retailers/redemption partners at the same time; a provision is made for the redemption liability arising. For cards, the revenue recognised is generally much lower, representing only the fees charged to cardholders and service fees receivable from retailers/redemption partners. There is also a timing difference, with card revenues and profits recognised later than similar voucher-based customer transactions. Where the cardholder has the right of redemption, revenue is recognised when amounts are deducted from values held on cards, ie when cards are redeemed at retailers/redemption partners or when charges are levied.

In short, card ‘sales’ to customers generate much lower reported revenues than vouchers, but are recorded as 100% gross profit margin, while profit recognition may be delayed. To provide greater clarity, the group reports the (non-statutory accounting) measure of billings. It represents the face value of voucher sales and the amount of value loaded onto prepaid cards, net of any discounts given to customers, and as such provides a consistent measure of customer sales activity in any period. The effect can be seen in the 4.9% pa compound growth in revenues in the three years to FY17 compared with 6.4% in billings, with the gross margin (on revenues) increasing from 8.3% to 9.7%.

Exhibit 13 shows how £100 of billings generates very different accounting revenues depending on whether it is a voucher or prepaid card, although assuming all card balances are spent in the same accounting period as the voucher sale, the gross profit contribution is the same. However, in reality, it is unlikely that all card balances will be spent in the same accounting period, deferring gross profit (and a similar amount of revenue). As card balances grow, so too does the deferral. Accumulated, unspent customer card balances are held on balance sheet within the segregated e-Money Trust, a regulatory requirement. The balance as at H118 was £29.5m, representing almost £2.5m of deferred gross profit (and revenue) that will be reported in future accounting periods.

IFRS 15 will move the accounting treatment for Park’s own prepaid vouchers (54% of FY17 billings) onto the same basis as cards (26%), although the treatment of third-party vouchers, hampers and gifts (19%) will remain the same. The impacts are mitigated by the fact that a high proportion of the vouchers sold/billed in any year, particularly when Christmas related, are in fact redeemed in that same year, triggering an IFRS 15 revenue recognition. We have not yet incorporated these changes into our forecast. In broad terms, the impacts on the reported numbers are likely to be:

Our approach to valuation is to consider both a potential absolute value based on a modified DCF analysis as well as a relative value based on a comparison with a selected group of listed stocks. The average of the two measures points to a fair value of 88p per share, unchanged from when we last published.

Our modified DCF valuation is unchanged at 86p. 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 generated by Park. 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 and accounted for in earnings but not yet redeemed. For now, our forecasts go out to March 2019, and beyond this we grow free cash flow at 5% until year 10, enhanced by an assumed normalisation of interest rates to 3% in FY20. The terminal cash flow is valued at 10x, and we use a discount rate of 10%. The terminal value represents 46% of the total 86p value. A 1% increase in the assumed discount rate, a reduction in the terminal multiple to 9.0x, or a 1% reduction in the long-term growth rate reduces the value by c 8%, 5%, or 5% respectively. We note that the current share price could be said to be assuming a long-term growth in free cash flow of just more than 3% pa.

Competitor employee benefits and service providers to Park are either private companies or relatively small parts of larger groups, complicating any attempt at a relative valuation approach. 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 a minor part of Sodexo Group. Because Park’s traditional Christmas prepayments customer base (c 50% of Park) has historically had some socioeconomic overlap with that of the HCC lenders, we also show valuation data for these. We would expect a premium rating for Park as it does not have similar credit risk, and we believe it has less regulatory risk. On this basis of a premium to the HCC companies but a discount to the larger incentive-related peers, our judgement is that a multiple of at least 15x prospective 2018e calendar earnings 31 March year-end), or 90p per share, is a fair objective.

As discussed in the Financials section, our forecasts are based on current accounting standards and do not allow for the potential impacts of IFRS 15, to be applied from the beginning of FY18. We note the following fundamental sensitivities to the performance of the business and our forecasts: