- This "payments" company has been unfairly pressured year to date due to negative news, but its market potential is vast.
- It has exposure to fast growing emerging markets, including South Africa and Korea, with both countries being heavily under-banked.
- Despite a recent pop in the stock, the upside is over 35% as the company embarks on expansion to other fast growing markets.
Net 1 UEPS Technologies (UEPS) fell off a cliff toward the end of last year, with the stock tumbling some 30% in a single day after its South African contract was deemed invalid. However, Net 1 has exposure to emerging and developing markets that make the selloff a great buying opportunity. Net 1 regained some of its share price loss last week after posting fourth quarter earnings that beat consensus by 29%.
The recent overhang makes for a great buying opportunity
Back in August the company beat EPS consensus by $0.09, posting earnings per share of $0.37. This gave the stock a big boost as investors became confident in Net 1's business model. However, all those gains were wiped out toward the end of last year after its South African unit, Cash Paymaster Services, was stripped of its South African Social Security Agency (SASSA) contract.
This goes back to 2012, when Net 1 landed a $984 million five year contract to manage welfare payments for the SASSA. Then, just last year, the contract was ruled invalid after it was found that Net 1 made corrupt payments to South African government officials in order to win the contract. Even without the SASSA contract, Net 1 still has some impressive sales growth ahead. Fiscal 2013 revenues were around $450 million, 2014 should come in around $490 million and $516 million for 2015.
This will put revenues at decade highs. As well, Net 1 is generating a free cash flow yield of over 8.5%. Thus, the 30% pull back in the stock appears to be more than over-exaggerated. This is especially true when you consider the growth opportunities the company has in other emerging markets. Despite the fact that the stock jumped over 18% after a positive December quarter earnings report, there's room to move higher.
An under the radar payments company
Most residents of emerging countries don't have access to conventional bank accounts. Net 1 provides payment solutions and transaction processing services. Net 1 has a universal electronic payment system, or UEPS, that doesn't require access to a centralized computer. It has offline capabilities that allow its users to conduct transactions anytime and anywhere. What's unique about Net 1 is that it is able to biometrically identify users, which is a first in the industry. Furthermore, Net 1's solution is integrated with Mastercard (MA).
One positive is that over 80% of revenue is generated by recurring transaction-based businesses. In South Africa alone, the company processes over 600,000 transactions per hour with response times under of one-third of a second.
Net 1 is uniquely positioned to cater to the unbanked and underbanked populations. The company is a broader play on emerging and developing economies and the rising trend of mobile-based transactions. CEO Serge Belamant said of the potential on the company's earnings call:
"Our MasterCard issuing platform, together with our fully-integrated banking platform, as well as a myriad of advanced secure mobile solutions, we now believe that the potential to change the way banking is performed today in South Africa and in many other developing countries of the world."
The unbanked and underbanked offer a large opportunity
The World Bank has noted that there is a marked rise in the popularity of using mobile phones to transfer money and banking. The funny thing is that in the U.S., mobile banking is considered being able to view balances, transfer funds, and deposit checks; however, with Net 1's UEPS, emerging markets are ahead of developed markets when it comes to being able to use the mobile device as an actual banking instrument to make everyday payments.
The World Bank believes that about half the entire global population doesn't have a bank account. Although these emerging populations are grossly underbanked, the majority have mobile phone access.
South Africa continues to be the workhorse
South Africa remains the company's biggest revenue generator. During fiscal 2013, South Africa accounted for over 70% of company wide revenues. Net 1 distributes pension and welfare payments, using its EMV technology, to over nine million cardholders across South Africa.
In South Africa, Net 1 is the largest third-party processor of retail merchant transactions and leading processor of third-party payroll payments. It's also the leading processor of health care claims.
Beyond South Africa, one of Net 1's big opportunities is to expand throughout the continent. Africa as a whole remains the world's most underbanked continent. Only about 20% of families in Africa have a bank account.
A number of markets to tap
One of the beauties of Net 1 is that it has leveraged its technology for a number of uses, uses that are valuable across all the emerging markets. Net 1's cash paymaster service distributes social welfare grants. This business doubled from 2012 to 2013.
Net 1 also has a presence in payroll and healthcare transaction management. FIHRST is the company's payroll processing service. Net 1 offers employers an easy way to make payments to employees. Its FIHRST and EasyPay combo provide employees with the ability to pay bills and purchase prepaid airtime and utilities directly as a payroll deduction.
Net 1 has also introduced its XeoRules healthcare management system in the U.S., with plans to expand into Western Europe. Its payroll services allows employers the ability to make payments to creditors. Meanwhile, Net 1's XeoRules covers all aspects of healthcare claims processing and managed care services.
Net 1 is also looking to tap into the India market with over 1.2 billion people. There, Net 1 has partnered with Axis Bank (OTC:AXBKY), the third largest banking group, and Visa (V). While it's too early to tell the potential for Net 1, we are excited by the fact that Net 1 is signing partnerships with the right groups in such a large market.
Risk v/s reward
The biggest risks for Net 1 include:
- The level of competition from banks in South Africa continues to rise.
- It's had one contract nullified recently, more of this would continue pressuring the stock. There are also a number of class action lawsuits and inquiries from the SEC and DOJ.
- Margins could continue compressing, notably, as SG&A rises.
The greatest rewards should be driven by:
- South Africa is an underbanked population and has limited access to financial services that most developed markets are used to.
- Expanding into other markets outside of South Africa, including other African countries.
- Tapping other markets, including payroll, healthcare and additional mobile payments.
Cheap valuation, suggests impressive upside
We think the case can be made for the stock getting back to the near $13 the stock was trading at near the end of 2013, versus its current $9.60. Net 1 turned in $0.73 per share in free cash flow last year. If we assume a 7% growth in free cash flow, and a 10% discount rate, intrinsic value for Net 1 is close to $17. Using its historical average price/earnings multiple and fair value is right at $16.
Although Net 1 does trade at 16x earnings, it trades at less than 7x forward earnings. Net 1's five year average p/e is over 20x. There are only two analysts following the stock. We see the lack of street coverage causing many investors to overlook Net 1.
Net 1 trades at 5.8x EV/EBITDA, well below major competitors Heartland Payment (HPY) and Global Payments (GPN), trading at 11.0x and 9.98x, respectively. Given the uncertainty of emerging markets, Net 1 will likely continue to trade at discount to peers, yet, a 7x multiple for Net1 is excessively low for a company with the growth expectations that Net 1 has.
While there remains some uncertainty with Net 1's operations in South Africa, there will be another hearing this month to determine what the South African Constitutional Court deems a "just and equitable remedy" concerning the situation. The contract in question represents only a portion of Net 1's total business in South Africa.
The fact remains that Net 1 operates in volatile territories, South Africa and Korea, however these are also a couple of the most underbanked countries in the world. Net 1 has a stronghold in these markets, but still has a large market to tap. As well, we think the company's move to get a presence in more developed markets will help add some stability to margins. We see interim upside of 35% as the market realizes the low multiples, but strong growth potential and high margins.