Paysafe Group — Niche payments focus drives growth

Paysafe reported revenues of $1bn in FY16, in line with its January trading update. Gross margin increased 594bp to 54.3% in FY16, mainly due to mix. The company increased headcount by 538 over the year to 2,116, resulting in an increase in operating expenses (excluding depreciation and amortisation) of 68% on a reported basis. Much of the headcount increase was to build up the company’s risk management and compliance function to ensure the business is prepared for new regulations relating to money laundering. In addition, the company hired more product developers and scaled up operations and customer support ahead of expected growth of the business. Despite this, the company expanded its EBITDA margin from 24.9% to 30.1% y-o-y. The adjusted operating margin also expanded y-o-y, from 21.7% to 26.8%. The company reported exceptional items totalling $8.2m, consisting of $5.6m of restructuring charges (the majority taken in H116), $2.2m of acquisition costs, FX losses of $6.8m, loss on disposal of assets of $0.8m and a fair value gain on share consideration payable of $7.2m. The effective tax rate increased to 11.9% from 8.5% a year ago – the company had guided that the rate would increase as profits are generated in higher tax regions. Normalised EPS came in 2.7% ahead of our forecast and showed 65% growth y-o-y.

The company reduced its net debt position by $151m (35%) from the end of FY15 and at year-end had reduced the net debt/EBITDA ratio to 0.9x (2.1x a year ago). Adjusted cash conversion before payments working capital as a percentage of adjusted EBIT was 101% in FY16, up from 92% a year ago.

The company outlined the progress it has made against its five strategic pillars over the last year:

Exhibit 2 shows the reported and organic revenue growth rates by division and for the group over the last three years. Clearly, strong organic growth has been achieved by the group while expanding gross margins.

Reported revenue growth benefited from $13.5m revenues from the MeritCard acquisition (February 2016). Constant currency organic growth accelerated to 21% in FY16, up from 16% in FY15. Over the year, growth slowed (H1 28%, H2 15%), and if the major merchant is excluded, this is more evident (H1 32%, H2 10%). H2 growth reflects the tougher y-o-y comparison; in addition, the company took action to reduce the merchant risk profile, throttling volumes for merchants with high chargeback rates. The major merchant generated revenues of $3-4m from the 2016 UEFA championships which will not be repeated in 2017.

Volumes processed increased 30% y-o-y to $22.4bn; the take rate reduced to 2.1% from 2.2% last year, owing to the addition of MeritCard volumes which tend to have a lower risk profile and hence lower pricing.

Divisional gross margin increased from 36.9% in FY15 to 40.6% in FY16. 1% of this increase came from a change in the calculation of intercompany cost of sales. Otherwise, the division saw lower processing costs, and although bad debt costs were higher than a year ago, the rate fell h-o-h (H1 2.2%, H2 1.0%). We note that as a consumer facing company, payolution has a higher rate of bad debt – and this was the first full year of inclusion.

The recently launched acquiring business makes up a small percentage of revenues. Since the launch of its multi-currency cross border European acquiring service in 2016, the company has seen a good level of sign-ups by North American merchants and the first new European merchants.

Online gambling made up 29% of revenues in FY16, with online gaming making up 2%. The bulk (69%) of revenues is generated from e-commerce merchants, particularly in medium and high risk industries eg direct marketing, e-tail, professional services. The company is focused on developing its expertise in additional verticals.

Constant currency organic growth accelerated from 17% in FY15 to 30% in FY16. The business was strong through the year (H1 +28%, H2 +33%), including a c $4m (c 2%) boost from the UEFA championships. Reported revenues benefited from the $3.1m contribution from Income Access (acquired August 2016). The company increased volumes with existing merchants (partly through helping them expand into new territories and offering new payment options) as well as signing up new merchants and users.

Fees from online gambling merchants made up 61% of revenues with a further 5% from online gaming merchants. The remaining 34% of revenues was made up of fees from consumers (mainly linked to online gambling) as well as merchants operating in e-commerce.

The division processed volumes worth $22.9bn in FY16, 15% ahead of FY15 on a pro forma basis. The take rate increased from 1.2% in FY15 to 1.4% in FY16. This was boosted by fee rebasing across the two wallets as well as the initiation of fees for money transfers on NETELLER.

Gross margins grew from 72.9% in FY15 to 74.9% in FY16. Mix, the positive impact from fee rebasing and money transfer fees, and lower bad debt costs more than offset the 2.8% negative effect of reallocating intercompany costs of sale.

The Prepaid division reported revenue growth of 180% in FY16 and organic constant currency growth of 10% (FY15 5%). When Ukash was acquired, Skrill took the decision to discontinue the service in certain geographies. Excluding this, organic constant currency growth was 14%, up from 11% in FY15. The division successfully managed to restart its Greek business after capital controls were introduced in 2015, which explains some of the growth in H216 (H116 0%, H216 19%). Volumes in Greece are now equivalent to the level before the controls were introduced, and the division is now able to remove funds from Greece.

The division processed volumes of $2.8bn (+4% y-o-y) with a take rate of 7.7%, up from 7.5% in FY15 (pro forma). In FY16, the division benefited from the application of maintenance fees on unredeemed voucher balances from the Ukash business – as these balances decline, so will the fees generated.

61% of FY16 revenues were generated from online gambling, 18% from online gaming and the remainder from e-commerce and consumer fees.

Gross margins increased to 52.6% from 51.3% a year ago, benefiting from the maintenance fees on unredeemed balances.

The business is continuing to focus on expanding its geographic coverage, particularly in Latin America and MENA.

The company continues to work on developing a single platform. Its next-generation global data platform is being designed to enable analysis of data from all parts of the business for the benefit of the company and its merchants. It will also provide unified APIs and SDKs for developers so the platform can act as a single point of integration to the existing processing and digital wallet platforms. The new platform should make it easier for customers to connect to the full range of Paysafe’s services as well as make it easier to cross-sell. The company expects to start rolling out modules through the course of FY17.

The company launched its self-service developer portal in December 2016 to simplify on-boarding.

Both precursor companies to Paysafe grew by providing services for niche areas of the payments market, including identifying the need for digital wallets in the online gambling space, providing payment processing for medium to high risk merchants (an area neglected by the banks and larger payment processors), and providing a means for consumers without bank accounts or credit cards to spend online. The company is keen to continue developing solutions to serve niche applications and will also consider acquisitions. In 2016, Paysafe soft launched its GOLO mobile pick-up and delivery product aimed at local merchants.

The company bolstered the management team with the hires of Tim Thurman as Chief Digital Officer and Oscar Nieboer as Chief Marketing Officer.

Paysafe acquired two companies in 2016 (MeritCard and Income Access) for a total consideration of $50.7m. The company continues to consider acquiring companies that fit with its strategy. With rapidly declining net debt (we expect the company to reach a net cash position in FY18), the company should be able to borrow a significant amount if necessary. Based on 3x FY17 forecast EBITDA of $332m, the net debt ceiling would be c $1bn, $920m above our forecast net debt position at end FY17 and before taking into account the target company’s EBITDA.

The company maintained its outlook for 2017, supported by trading year-to-date: low double-digit organic revenue growth and EBITDA margins of at least 30.1%.

As the share price is now trading consistently above £4.00, we have assumed that the company halts the share buyback programme. We had previously assumed it would use the entire £100m to buy back c 25m shares. If the share price drops materially, we believe the company may resume the programme. It has c £75m remaining of the £100m to spend.

FY17: Our group revenue forecast is substantially unchanged. We reduce EBITDA by 0.9% to reflect higher opex (mainly for legal and compliance). We increase the tax rate by 1% to 16%. This combined with slightly higher depreciation and amortisation and reversing the bulk of the share buyback reduces normalised EPS by 3.0%.

FY18: Again, our revenue forecast is substantially unchanged with a 0.8% cut to EBITDA reflecting higher opex. We increase the tax rate by 2% to 17%. Our normalised EPS forecast reduces by 5.8%.

FY19: We introduce a forecast for revenue growth of 7.9% and an EBITDA margin of 30.7%. This results in normalised EPS growth of 8.5%.

Our net debt reduction increases now that we are not factoring in the remaining £75m potential share buyback. We forecast the company to return to a net cash position in FY18.

The company noted that it would consider ways to return cash to shareholders (assuming no large acquisitions are undertaken), either via buybacks or initiating the payment of a dividend.

Paysafe continues to trade at a discount to its peer group on all metrics. Some discount is justified to reflect the risk relating to its largest merchant’s activities in China, but in our view, the current discount is overdone. The major merchant reduced its contribution to revenues from 23% in FY15 to 20% in FY16 and we expect this to gradually reduce (by c 1% pa) as we expect faster growth from the remainder of the Paysafe business. The major merchant generates revenues across all three divisions - we estimate that the total loss of the Asia gateway business (reported in Payment Processing) would reduce FY17 EPS by c 20%.