It’s been a while and for that I apologize. Truth be told, I had gotten my portfolio almost fully invested by mid-last year. And, as the stock intense rally we’ve seen in stocks through 2009 has turned flat since the new year, I’ve been much less aggressive with my personal portfolio and as such have had a lot less to say. Though, for those of you who follow my Covestor account, you’ll know that I have not been completely out of the markets. I’m increasingly interested in companies which do the bulk of their business internationally as I believe this is a good way to capitalize on foreign growth while being constrained with access only to U.S. exchanges. (By the way, does anyone know any good online brokerages which allow you to trade stocks internationally?)
Universal Electronic Payment System (UEPS)
UEPS is a financial transaction system offered by Net1 which utilizes its patented Funds Transfer System and secure smart cards to provide real-time but offline payment solutions for un-banked/under-banked populations. These cards store all necessary information – available funds, user identity, etc. – and allows for transactions to take place without a connection to a host mainframe. As such, the cards are particularly useful to countries with under developed infrastructure.
As you may have guessed, Net1 does most of its business in developing countries, primarily South Africa, where it provides cards and point of sale equipment to governments which use the cards as a medium to distribute grants and other social welfare payments.
Proven, cost effective technology serving a large niche – Unlike traditional debit cards or credit cards, UEPS offers a proprietary technology which does not require always on connection to a primary host or even a bank account. Data is stored on the card and information transferred at the point of sale.
Adoption reaching critical mass – The Company has long been used by the South African Social Security Administration to distribute entitlement payments to citizens and Net1 has recently leveraged this success into a national contract with Ghana as well as a roll out of its technology in Iraq.
Operating leverage and free cash flow generation – The Company’s equipment and cards are generally paid for by national governments which have chosen its system. Further, as additional customers are enrolled and begin using their cards for payments, the Company generates incremental transaction fees without significant incremental investment. Operating margins in the transaction processing segment are near 60%.
Exposure to South African Social Security Administration Contract – 65% of revenues are currently generated through five provincal contracts with the SASSA. This contract has been on one-year renewal terms for the last three years as SASSA attempts to bid the contract through a formal RFP process. The last RFP process ended almost a year ago without a resolution and Net1’s current contract in South Africa is set to expire on March 31, 2010.
Exposure to South African Rand – The majority of the Company’s costs and revenues are denominated in South African Rands. While exchange rate fluctuations will not have a major impact on cash flow or liquidity, it can have a significant impact on valuation for USD investors. The Rand is currently trading at 7.65 per USD and has traded in a range from 6 to 12 historically.
Political Risk – The Company’s growth plan relies on entering developing nations with sometimes tenuous governmental structures.
Technological Risk – While the Company’s smart cards and other payment technologies appear to be quite forward thinking, the increasing availability of wireless communications infrastructure and cell phones poses a potential disruptive threat for a motivated competitor.
Quick and Dirty Valuation
Despite guidance of 20% yoy growth in EPS (constant currency) and long term catalysts for significant growth through new market entry internationally, the Company trades at 12.0x P/E and, in fact, represents a significant discount based on my analysis of PEG which has traditionally approached 1-1.2.
Further, for a smaller, growing company, UEPS generates significant free cash flow. As defined as operating cash flow minus capital expenditures and investments, the Company has averaged approximately $110 million in free cash flow over its 2008 and 2009 fiscal years good for a 13.75% free cash flow yield. Put differently, at no growth and a 10% discount rate this would justify a stock price of ~$24.00/share vs. its current price of $17.65/share. Obviously, with significant headline risk involved in the Company’s 65% concentration in South African Social Security payments, this discount rate may not be appropriate.
The Company, however, currently has ~$2.00/share in net net working capital and $3.35/share in cash on hand. Management has shown a willingness to redistribute value to shareholders having recently approved a $50 million share buyback to be funded entirely from cash on hand. Netting the entire value of cash out of the shares, the Company’s cash yield would actually be closer to 17%, enough to pay back shareholders in less than 6 years if fully redistributed. Is this worth the risk of annual renewals of the South African contracts? I believe so.
Full disclosure: Author is long shares of UEPS at the time of writing.