Paysafe Group — Update 21 April 2016

Paysafe reported FY15 revenue 2% ahead of the upwardly revised guidance from its January trading update. On a pro forma, constant currency basis revenues grew 13% y-o-y (see Exhibit 2 for definitions). Taking into account the fact that payolution revenues were included in the Payment Processing division (whereas we had included them in the Digital Wallet division), we estimate that most of the remaining upside in the Payment Processing division was due to stronger trading in the US. The Pre-paid business was ahead by 5% and investment income was significantly higher, driven by the interest earned on Skrill customer balances.

The group gross margin came in below our forecast, partly as a result of the higher contribution from Payment Processing, which has a lower gross margin than both other divisions, and partly due to a change in the accounting for Neteller gross margins (see below for further detail). As indicated in January, the company achieved integration cost synergies of $10m in H215 (earlier than originally targeted) and is on track to reach total cost synergies of $40m in 2016. The integration of Skrill should be substantially complete during Q316.

EBITDA was 2% ahead of our forecast to generate a 24.9% margin. With net interest expense higher than forecast (mainly due to the amortisation of financing fees), normalised net income was 1% higher than forecast and normalised EPS 2% ahead.

The company reduced net debt significantly below our forecast. We note that net debt per the balance sheet is slightly lower than the net debt quoted by the company of $431m – this is because the company has adjusted the net debt to reflect financing fees that are being amortised over the lives of the two loans. Looking at the cash flow in detail, the main variance was around the amount paid for Skrill: $1,097m including expenses compared to our $1,197m forecast. The difference was made up of the cash available in the business at the acquisition date ($67m), and lower than expected acquisition costs and debt offset by slightly higher cash paid.

The Payment Processing division saw a small impact from the Skrill acquisition with the addition of the payolution business. We estimate that this made a less than $5m revenue contribution in H215. On a pro forma constant currency basis, the business saw slower growth in H115, mainly reflecting the strong performance of its largest merchant in H114. Excluding the revenues generated by the largest merchant, the remainder of the business saw very strong double-digit growth. The gross margin in H215 decline slightly from H115 reflecting the higher contribution of revenues from the lower margin US business and the lower proportion of major merchant revenues. We estimate that major merchant revenues increased 17% h-o-h in H215 to $76m, but with the addition of Skrill revenues, its revenue contribution declined from 29% of group revenues in H115 to 20%.

Post year-end, the company agreed to acquire substantially all the assets of MeritCard Solutions LP for initial cash consideration of $16m, plus up to $4m in contingent consideration over the next two years. MeritCard is a Dallas-based company that specialises in building relationships with small and medium-sized independent sales organisations (ISOs), sales and bank agents and third party vendors. MeritCard is also a wholesale ISO working with Wells Fargo Bank, Deutsche Bank, Merrick Bank and TSYS. The business will retain the MeritCard brand.

This division saw strong reported revenue growth in H115, despite currency issues. The pro forma constant currency growth rate was similarly strong. The company noted that Skrill benefited from a one-off programme in H115 worth several million dollars, which partially explains the slower growth rate in H215 (albeit still double digit). The company has restated gross margins for Neteller to reflect the same cost allocation as Skrill. This reduces the H115 Digital Wallet gross margin to 73.2% compared to the previously reported 87.3%, although as it is a cost reallocation, it has no impact at the EBITDA level.

The Pre-paid business was acquired with the Skrill acquisition, so reported growth analysis is not meaningful. On a pro forma basis, the business grew 12% in H115 but declined 2% in H215, resulting in growth of 5% for FY15. The pro forma H2 decline was mainly due to paysafecard’s strategy to withdraw the Ukash business from certain markets as well as its issues in the Greek market. On an ongoing basis, we believe that growth should revert to levels more like those achieved in H115. The gross margin has remained stable at 51.3%.

At the end of FY15, paysafecard was available in 42 countries, in 24 languages and 23 currencies, and had 2.5 million active users/month. During the year, paysafecard started operations in New Zealand, Kuwait and Saudi Arabia, and is planning to enter new countries in 2016.

The company noted that the positive momentum seen in 2015 has continued into 2016.

We forecast a small decline in the Payment Processing margin, reflecting the declining influence of higher margin business from the major merchant. We have factored in the new basis of reporting gross margin for the Neteller side of the Wallet business, but as we expect the bad-debt cost to fall for the Skrill business, we forecast overall divisional gross margin expansion. We maintain the Pre-paid margin broadly in line with the FY15 level.

While the company is making good progress in achieving cost synergies from the integration of Skrill, it repeated the comments it made at the November Capital Markets day that it would be increasing investment in the following areas:

We have therefore been relatively conservative in our operating expenditure assumptions. We would expect that if the company continues to beat expectations and generate strong revenue growth, it will consider reinvesting a proportion of this upside to maintain its growth trajectory.

We have increased our capex forecasts to take account of the company’s comments regarding R&D. We assume that the company will continue to capitalise development costs at the rate of 2-3% of sales per year, with total capex including tangible assets at 4-5% of sales.

On our forecasts, the company should be able to pay down debt at a rapid pace. The net debt (reported)/adjusted EBITDA at the end of FY15 stood at 2.1x and we calculate that this will reduce to 1.1x by the end of FY16 and 0.2x by the end of FY17. We would expect the company to consider several uses for excess cash: share buybacks, a dividend, or further M&A. In fact, the company has said it will continue to consider bolt-on acquisition opportunities.