EML Payments — Turning the ship around

Exhibit 1 summarises performance in FY23.

EML reported revenue, underlying EBITDA and underlying NPATA ahead of guidance (revenue A$235–245m, underlying EBITDA A$26–34m, underlying NPATA -A$4m to A$4m). The company noted that revenue was higher than expected due to a combination of customer contract improvements and renegotiation of treasury arrangements resulting in higher interest income on float. Reported and underlying gross profit were 7% ahead of our forecast and the underlying gross margin improved 0.6pp y-o-y. As we wrote after the H123 results, underlying gross profit excludes an A$8.5m cost relating to one-off fraud events in the Sentenial and GPR businesses (A$6.2m and A$2.3m, respectively). Underlying operating costs of A$137.4m were 27% higher year-on-year and resulted in underlying EBITDA of A$37.1m, 40% ahead of our forecast and 9% above the top end of the guidance range. As well as reflecting cost and salary inflation, underlying overheads include increased headcount to meet higher ongoing regulatory requirements, a full 12-month contribution from Sentenial, higher bad debt provisions reflecting slower payers in GPR and increased post-COVID travel.

We show below the adjustments made to arrive at underlying EBITDA and NPATA. The class action suit against EML, brought in the Supreme Court of Victoria, is ongoing. As at the end of FY23, the company had a A$15.1m litigation provision, up from A$9.7m at the end of FY22, reflecting an increase in the provision of A$7.6m and usage of the provision of A$2.2m. We discuss the regulatory remediation process below.

As a result of the ongoing issues in the PFS business and the slower progress of the Sentenial business, the company reassessed the value of intangible assets related to both businesses, resulting in a total impairment charge in FY23 of A$262.9m (goodwill A$230.6m, other intangibles A$32.3m). EML had already written down goodwill for PFS and Sentenial in H123 by a total of A$121.3m; in H223 it reassessed the value of intangibles and wrote PFS goodwill down to zero, wrote Sentenial goodwill down by a further A$28.6m to A$22.8m and wrote other acquired intangibles down by A$32.3m. The company also reassessed the contingent consideration owing to Sentenial, reducing it from A$28.9m at the end of FY22 to A$7.0m at the end of FY23. The total reduction in contingent consideration in FY23 was A$23.4m, which has been treated as a one-off credit to profit before tax.

The group had cash of A$71.4m at the end of FY23 and, taking account of bank debt of A$50m and loan notes owing to PFS vendors worth A$41.8m, net debt was A$20.4m.

The group consumed A$2.6m cash from operating activities, spent A$0.4m on tangible fixed assets, capitalised development costs of A$11.3m and made lease payments totalling A$2.2m. To offset this, the company sold its stake in Interchecks in August 2022 for A$10.9m. We note that operating cash flow included c A$32.2m expenditure relating to remediation, litigation and restructuring, which implies underlying cash generation of A$29.6m.

Net interest income earned in FY23 was A$33.1m (H123: A$9.4m, H223: A$23.7m), making up 13% of group revenue, compared to A$5.1m/2% of revenue in FY22.

At the end of FY23, EML held a total float of A$2.6bn, of which A$2.0bn was held in cash and A$0.6bn in bonds. With rising central bank interest rates across the globe, the value to EML of this float has risen significantly, and management has focused on optimising the returns it can earn on these funds. It has renegotiated the margin it can earn with some of its existing banks and expects to continue to optimise treasury management in FY24, whether from existing or new banks.

Divisional performance is summarised in Exhibit 3.

The Gifting division reported gross debit volume (GDV) 13% ahead of our forecasts, equating to growth of 24% year-on-year. Mall GDV increased 13%, partially reflecting improved footfall post-COVID but also reflecting the launch of its cards in 56 new malls in Europe. Incentives GDV increased 41%, benefiting from strong demand for EML’s Perx product for employee incentives. In Ireland, the annual tax-free threshold for employee incentive vouchers increased from €500 to €1,000, driving demand. The company noted that in H223 it streamlined the management of this division, and going forward, it is focused on rebuilding the commercial team and deepening relationships with its existing customers.

Divisional revenue grew 9% y-o-y (mall revenue +6%, incentives revenue +14%). Breaking down the revenue in FY23, transaction-based revenue increased 5.0% y-o-y to A$32.0m, service-based revenue (account management fees (AMFs), breakage) increased 17.5% y-o-y to A$33.0m, establishment fees declined 49% y-o-y to A$4.9m (a one-off project fee of A$4.5m was reported in FY22) and interest income increased 13-fold to A$4.7m, reflecting the increase in central bank interest rates over the last year. Gross margin of 81.1% was ahead of our 79.5% forecast and 1.3pp higher year-on-year.

The GPR business grew GDV 3% y-o-y, despite growth caps in place in PFS Card Services Ireland Limited (PCSIL) imposed by the CBI (no growth in payment volumes for the period 31 March 2023 to 30 March 2024 compared to the volume processed in the period January to December 2022) and PFS Limited imposed by the Financial Conduct Authority (FCA - no onboarding of new customers), as the Australian salary packaging business grew 12% y-o-y. This translated to revenue growth of 7% and a yield of 1.24%, up 4bp y-o-y. This breaks down as: transaction-based revenue up 10.2% y-o-y to A$108.9m, service-based revenue (AMFs, dormant account fees) down 63.4% yoy to A$9.2m (one-off AMFs of A$14.8m were reported in FY22), establishment fees down 33.7% y-o-y to A$12.9m as the growth caps prevented new customer onboarding and interest income up 488% to A$27.5m. Gross profit increased 4% y-o-y and excluding the impact of a one-off fraud, underlying gross profit increased 9% y-o-y to generate an underlying gross margin of 60.4%.

In FY23, Digital Payments (DP) saw GDV rise 73% y-o-y to A$115.1bn, with a A$104.1bn contribution from Sentenial (acquired in September 2021, contributed for nine months of FY22). The original virtual account numbers (VANs) business generated GDV of A$11.0bn, up 13% y-o-y. Sentenial contributed significantly more GDV in H223 than we expected. However, the revenue model for Sentential is different to the rest of EML’s businesses, which tend to earn revenue based on the value of transactions processed. Sentential typically earns a per transaction fee for direct debits or open banking payments, regardless of the size of the transaction. The business also generates some monthly or annual service fees that similarly are not linked to GDV. Consequently, DP revenue only increased 23% y-o-y and yield declined 1bp to 0.02%. Most divisional revenue (91%) is generated from transaction-based revenue, which increased 18% y-o-y. Gross profit declined 21%, but adjusting for the one-off fraud in Sentenial, underlying gross profit increased 21% y-o-y with an underlying gross margin of 83.4%.

The company provided an update on its four strategic priorities:

As announced in April, a board sub-committee was created to oversee remediation activities, headed by director Peter Lang.

Irish-regulated PCSIL continues to work on its remediation programme. Additional resources have been provided to ensure it can work through this programme on a timely basis. The company expects to resolve the final sequence of events and timeline with the CBI in the near term. On 11 September, the PCSIL directors indicated their intention to resign their directorships. They will remain on the subsidiary board for a transition period and management is working with the regulator through this change.

PFS Limited (PFSL), the UK-regulated part of PFS, is currently operating under a growth cap imposed by the FCA and is undertaking a similar remediation programme to that in Ireland. It has made progress and is moving to the ‘embed phase’; it expects a-third party assessment to start in September.

The provision for remediation increased from A$8.1m at the end of FY22 to A$14.5m at the end of FY23, reflecting an increase in the provision of A$10.6m and usage of the provision of A$4.3m.

Management has undertaken a comprehensive cost analysis and has identified A$10m of cost savings that could be made in FY24. It has paused further investment in the long-term strategy to focus on short-term priorities.

Management is keen to protect and grow the core profitable businesses, particularly Gifting and the Australian GPR business (which includes salary packaging). It focused on performance in Q4, which drove upside to guidance. The rebuild of the commercial teams has started for both the Gifting and GPR businesses.

The company has strengthened its executive and leadership teams. A new CFO, James Georgeson, has been appointed (effective 1 September) and the interim CFO, Jonathon Gatt, has returned to his position as European CFO. Peter Lang (previously a non-executive director) has been appointed chief corporate development officer and will remain on the board as an executive director. An outcomes-based incentives plan has been put in place for key personnel.

In April, the company announced that a strategic review had been launched to consider all options available to the board, including a potential sale of all or parts of the business to maximise shareholder value. Since then, the company has received numerous approaches and continues to work with Barrenjoey to assess interest and determine the next steps.

As well as the focus on growing the core businesses, management is working with loss-making entities to determine whether they still fit into the group strategically and to return them to profitability. With a view to strengthening and simplifying the business, the board has decided to operationally split the PFS Group into independent stand-alone units (ie separating the UK and European businesses). The two businesses serve different markets and customer bases (UK: corporate and government focus; Europe: retail consumer loaded cards) and there are no scale benefits to keeping them combined.

While PCSIL generates higher GDV than PFSL (A$5.1bn versus A$3.6bn) it has significantly higher headcount (236 vs 72) reflecting the extra staff needed to manage the remediation process with the CBI and meet ongoing regulatory requirements. Management noted that PFSL is already EBITDA positive while PCSIL is loss-making at the EBITDA level, with underlying overheads of A$35m in FY23. The split should allow better accountability for the business performance of each unit.

While the company has not provided specific guidance for FY24, it expects to be able to achieve cost savings of A$10m in the year and has identified further opportunities to improve operating margins from FY25. We have applied these cost savings to temper the growth of underlying overheads. We also assume that there will be further one-off costs incurred in FY24, relating to restructuring and remediation, and we have factored in A$12m for this. Reflecting the better-than-expected performance in H223, we have upgraded our revenue and gross profit forecasts which results in an upgrade to our underlying EBITDA forecast in FY24.