Wirecard: A Gift Served On A Silver Platter?

Summary

• First, based on my last article dated March 21, 2019, I will briefly discuss the latest developments in the case of Wirecard.
• Secondly, I will present the results for fiscal year 2018 as well as the traceability of Wirecard's "Vision 2025."
• Third, I will present my fair value based on a discounted cash flow and earnings per share calculation.

Be greedy when others are fearful, and fearful when others are greedy - Warren Buffett

A Short Review

Most recently, on March 21, 2019, I published an article about Wirecard (OTCPK:WRCDF;OTCPK:WCAGY) on Seeking Alpha, "Ignore The Noise And Focus On Fundamentals?"

In the aforementioned article I presented the current allegations, the business model, the growth rates, the fundamental situation, the valuation (compared to the peer group), the opportunities and strengths and the risks and weaknesses in connection with Wirecard.

In the conclusion, I wrote that "considering the high growth rate, solid balance sheet, competitive advantage based on global footprint and broad technological base, Wirecard seems to be one of the best (European) growth stocks at the moment. I would say that wirecard is a conviction buy at the current level. In addition, the share should have significant upside potential if allegations can be disproved."

Second, I wrote that "while I do not believe that Wirecard has committed any intentional misconduct, it is difficult to rule out whether individual employees have committed any misconduct. Nevertheless, history tells us that in the past all accusations have proven to be unfounded. Furthermore, CEO Braun sounds very optimistic in his tweet, which could suggest that at least no serious findings should arise."

Third, I explained that "there were two main factors for my investment in Wirecard. First, the growth potential in Asia and (Eastern) Europe. Second, the skills and vision of CEO Markus Braun. If the allegations prove to be true and there is a real threat of a license withdrawal in parts of the Asian business, I would be forced to reconsider my investment thesis."

In this article I would like to briefly discuss the latest developments and - now that the allegations have been disproved for the most part - use my fair value calculation to illustrate why Wirecard is a "Conviction Buy" from my point of view.

What happened recently?

In this section, I would like to briefly discuss the latest developments. I will provide the individual points with relevant sources, so that you can get further information from the linked sites, if you are interested.

There were five key developments recently according to my view:

1. Relief from the allegations of round-tripping and corruption by the publication of the investigation results of the independent law firm Rajah & Tann.
2. Issuance of the auditor's certificate in the Annual Report.
3. German market regulator files complaint against a dozen journalists, funds and investors on suspicion of market manipulation in Wirecard shares.
4. Announcement of new business relations with companies from India and Singapore, which created trust for Wirecard's Asia business.
5. Announcement of SoftBank's (OTCPK:SFTBF) (OTCPK:SFTBY) (potential) investment in Wirecard as proof of Wirecard's strong positioning in the area of digital payments (in Asia) and its future-oriented business model.

1) Results of the investigations of Rajah & Tann

On March 26, 2019, a summary of Rajah & Tann's findings were published. Based on the investigation results, Wirecard was relieved of the accusations of "round tripping" and corruption. No finding would have a material impact on the financial results and financial positions of the company.

The following statement from the investigation results is the most important for me:

The review has not revealed findings of criminal liability under Singapore law in respect of the headquarters of Wirecard in Munich/Aschheim.

Nevertheless, in the previous paragraph it is stated that employees in Singapore may have made themselves liable to prosecution under local law:

Criminal liability may be attributable to a few local employees in Singapore according to local law in relation to some of the above mentioned circumstances. Investigations by the Singapore authorities are currently ongoing.

To summarize, there were inconsistencies - regardless of whether they will be prosecuted under criminal law or not - and these inconsistencies were not made in the knowledge or with the consent of management, so that Wirecard as a group should not be held responsible.

Furthermore, it has become public that Wirecard has separated from the employee at the center of the allegations and that a compliance manager has left the company.

Thus, the results of the investigation broadly corresponded to my expectations mentioned in my Seeking Alpha article dated March 21, 2019.

Meanwhile, at the annual press conference on May 25, CEO Markus Braun admitted accounting deficiencies and pledged improvement of accounting quality.

2) Issuance of the auditor's certificate

In the context of the publication of the results of the Rajah & Tann investigation, Wirecard announced that the management decided to postpone the publication of the annual report from April 4 to April 25. This was justified by the fact that the results of the above-mentioned investigations were to be taken into account in the annual report.

Nevertheless, rumors were spread (intentionally or unintentionally) in various publications and forums that the auditors of Ernst & Young could refuse an unqualified audit opinion and that the postponement of the annual report was due to this.

With the publication of the annual report on April 25, this assertion was also refuted. At the same time, Ernst & Young has detailed the points which were examined in the course of the above-mentioned allegations in its statement in the annual report.

3) German market regulator files complaint on suspicion of market manipulation in Wirecard shares

Another key development happened on April 16, i.e. two days before the expiry of the short-selling ban, when it was announced that Germany's market regulator, so-called "Bafin," has filed a complaint against a dozen journalists, funds and investors suspected of market manipulation in the Wirecard shares.

This action by Bafin intensifies the suspicion of a targeted short-selling attack on Wirecard (it should be noted that in the case of Wirecard the Bafin had for the first time ever prohibited short selling of an individual stock).

4) Announcement of new business relations with companies from India and Singapore

While market participants were speculating about a potential refusal of the auditor's unqualified audit opinion and even a potential license withdrawal for the Asian business, Wirecard announced further cooperation with the Elush Retail Group from Singapore and India's RBL Bank a few days after the publication of Rajah & Tann's investigation results.

In my opinion, these developments were a further sign of the exaggerated media presentation in the context of the allegations, which only caused uncertainty among shareholders in order to put the stock price under pressure.

5) Announcement of SoftBank's potential investment in Wirecard

While the public was worried about a potential accounting scandal at Wirecard, management was apparently busy negotiating a deal with SoftBank besides clearing out the allegations.

On April 24, Wirecard announced that Wirecard and SoftBank have signed a binding term sheet under which an affiliate of SoftBank shall invest approximately €900 million in Wirecard via a convertible bond mechanism.

For this purpose, Wirecard shall issue convertible bonds with a term of five years exclusively to SoftBank, convertible to 6,923,076 ordinary Wirecard shares (currently corresponding to approximately 5.6% of common stock) at €130 per Wirecard share. The intended issuance of convertible bonds is subject to the approval of Wirecard's annual shareholders meeting to be held on June 18, 2019.

In connection with the investment, the parties have also signed a memorandum of understanding (MOU) on a strategic partnership for digital payment solutions. Under the MoU, SoftBank Group will seek to support Wirecard's geographic expansion into Japan and South Korea, as well as provide collaboration opportunities within SoftBank Group's global portfolio in digital payments, data-analytics, artificial intelligence and other innovative digital financial services.

It is anticipated that the partnership will also extend to joint exploration of new product and service offers in digital lending in order to leverage from high-quality customer portfolios, strong liquidity and other innovative financing solutions.

I intend to discuss the significance of this deal in a further article, since it would go beyond the scope of the current article.

The most important message, however, is that Wirecard is no empty vessel (as it was recently presented again in a German stock market magazine) and an indication that in the current case a large part of the allegations should be unfounded. SoftBank's investment will increase confidence in Wirecard on the capital market, so that (hopefully) Wirecard should no longer be an easy target for speculators and short sellers in future. In this context, Wirecard announced that SoftBank had taken a detailed look at the books before considering an investment.

Furthermore, Wirecard could use the €900 million cash injection to implement the new products and goals, which I mentioned in my last article.

Next, I would like to discuss the results for fiscal 2018 and the valuation of Wirecard.

Results for FY 2018

In FY 2018, Wirecard increased its revenue by 35.4% to €2.02 billion (previous year: €1.49 billion). The transaction volume processed through the Wirecard platform grew by 37.3% to €124.9 billion (previous year: €91.0 billion).

EBITDA increased by 36.6% to €560.5 million compared to the previous year (€ 410.3 million). Interestingly, the EBITDA margin increased, confirming management's target for further scalability of the business. EBITDA margin increased to 27.8% (previous year: 27.6%).

While the EBITDA was within the guidance range of €550 to 570 million, EBITDA and revenues were lower than the preliminary results announced on January 30, 2019, prior to the negative news reports. According to the preliminary results, revenues increased by approximately 40% to €2.1 billion in 2018 and EBITDA grew about 38% to €568.3 million. This results in a deviation of €80 million corresponding to 3.8% in revenues and €7.8 million corresponding to 1.4% in EBITDA. According to the CEO's statements in the earnings call, these deviations are attributable to the transition to IAS 15 on the revenue side and on the EBITDA side, there was a €6-7 million effect additional costs by lawyers, audits and consultants. So these would be the two main onetime effects causing the deviations.

Free cash flow increased by impressive 50% to €423.9 million (previous year: €282.6 million). In the previous year, free cash flow increased by 35% from €209.9 million to €282.6 million. Thus, free cash flow growth has also accelerated in FY 2018. Here it would also be interesting to know the reason for this acceleration.

Meanwhile, the net cash position nearly doubled year-on-year to €521 million (previous year: €264 million; see following chart).

Net cash position. Source: Investor Presentation, results FY 2018, April 2019.

Earnings after tax increased by 35.7% to €347.4 million (previous year: €256.1 million), which corresponds to earnings per share of €2.81 (previous year: €2.07).

With regard to the dividend, management will propose a dividend increase to this year's annual general meeting to €0.20 per share (previous year: €0.18), corresponding to a double-digit dividend growth rate of 11%.

Nevertheless, the dividend yield of 0.15% is very low with an Xetra closing price of €133.75 on Friday. Unless you invested in 2008 when the price was around 3€; then you are currently collecting a dividend yield of more than 6%.

The following figure summarizes the results for fiscal year 2018.

Key figures of FY 2018 and guidance for FY 2019. Source: Investor Presentation, results FY 2018, April 2019.

Furthermore, as you can see in the figure above, Wirecard reiterated the EBITDA guidance of €740–800 million for fiscal year 2019. This would correspond to an EBITDA growth rate of 32-43% compared to the previous year.

I could imagine that management will increase the EBITDA guidance for the fiscal year 2019 during the course of the year, perhaps even to the publication of the quarterly figures for Q1 2019 on May 8. Management may want to have an ace up its sleeve if another negative article is published or another short attack is undertaken in the meantime.

With regard to the future development, Wirecard published the "Vision 2025" last year. Accordingly, the transaction volume shall increase to a total of €710 billion, revenues to €10 billion and EBITDA to €3.3 billion until 2025.

Wirecard's Vision 2020 vs. Vision 2025. Source: Investor Presentation, results FY 2018, April 2019.

According to my calculation, this corresponds to an annual growth rate of around 30% in terms of the transaction volume, 25% in terms of revenues and 29% in terms of EBITDA (see following figure).

Wirecard's Vision 2025 - Calculation for the purpose of traceability. Source: Author's calculation according to Wirecard's forecast.

Based on the company's growth rates outlined above and the growth rates in payment services in general, these figures appear achievable from today's perspective.

At this point it is worth mentioning that PayPal (PYPL), for example, had revenues of €15.45 billion in FY 2018, simply to understand the dimensions in the area of payment services.

Fair Value Calculation

I have prepared two valuation models for the fair value calculation. In the first valuation model, the free cash flows for the next ten years are discounted at 10% and the result of the tenth year is multiplied by 15. The present value of the sum of the FCF of the first ten years (here: € 7,056.32) and the value of the FCF of the tenth year (here: €15,178.90) are then added together and added with the net cash position (here: cash on hand amounting to €2,720 minus debt and liabilities amounting to € 2,199). On this basis, the enterprise value is determined. After dividing the enterprise value by the number of shares, the fair value per share is determined.

In order to choose a conservative approach, I have chosen a growth rate of 20% per year in terms of the free cash flow. As already stated in my last article and presented in the calculation of Wirecard's "Vision 2025," management expects an organic long-term growth of 25% per year.

Furthermore, I have chosen a multiple of 15 for the last FCF, which represents half of the average price/cash flow valuation over the last five years. The average valuation of the price/cash flow for the last five years was 31.27 according to Morningstar (see red mark in the following figure).

Wirecard's valuation as of April 26, 2019. Source: Morningstar.

In the second valuation model, earnings per share for the next five years are also discounted at 10% and a terminal value is calculated. Finally, the fair value is determined on the basis of earnings per share for the next five years and the terminal value. In order to choose a conservative approach, I have chosen a P/E multiple of 30. The average P/E ratio of the last five years was 41.37 according to Morningstar (see green mark in the figure above).

Based on the first valuation method, the fair value is €183.52, which corresponds to an undervaluation of the stock of 37% (see figure below).

Fair value calculation, method I. Source: Author's calculation.

Based on the second valuation method, the fair value is €180.70, which corresponds to an undervaluation of the stock of 35% (see figure below).

Alternatively, the result of the fifth year could be multiplied by the average P/E ratio of the last five years (here: 41.37 according to Morningstar) or a conservatively chosen P/E ratio (here: 30). Based on a P/E multiple of 30, the fair value would be €159,60, which represents an undervaluation of the stock of 19% (€5,32 x 30 = €159,60).

Fair value calculation, method II. Source: Author's calculation.

In addition, it is interesting to know the price targets of analysts covering Wirecard shares.

According to the German website "Finanzen.net," the analysts have an average price target of €199.79 which corresponds to an upside potential of 50.67% (see following figure).

Price targets of analysts for Wirecard shares. Source: Finanzen.net

While most analysts recommend buying the stock, only two analysts from Independent Research (price target: €115) and Citi (C) (price target: €100) give a sell recommendation.

After publication of the annual report, Goldman Sachs raised its valuation again to "Conviction Buy" with a price target of 230.

HSBC raised its price target to €190 from €170 with a "Buy" rating.

The British investment bank Barclays (BCS) maintained Wirecard's "Overweight" rating with a price target of EUR 200.

Conclusion

Price is what you pay. Value is what you get - Warren Buffett

While I do not have a crystal ball regarding the investigations of the public prosecutor's office in Singapore, I interpret the results of the investigation by the independent law firm of Rajah & Tann, the new cooperation with partners from India and Singapore, the Bafin complaint and a potential investment of SoftBank as positive for Wirecard.

Nevertheless, there is still a residual uncertainty as long as the investigations of the public prosecutor's office in Singapore continue. This could hamper the dynamic development of the share and potential demand from investors, so that the price development could still be somewhat bumpy.

After (positive) completion of the investigations by the public prosecutor's office in Singapore, the share should have a cleared path. Nevertheless, a rise in the share price along a "wall of worry" is, in my view, more sustainable than rapid and strong price jumps.

Furthermore, the fair value based on my conservative discounted cash flow calculation is €184, resulting in an upside potential of around 37%. In my opinion, this offers a sufficient margin of safety.

Since Wirecard is a growth share, I believe it is more appropriate to make a valuation based on free cash flow since earnings per share can be influenced by investments in growth. Nevertheless, Wirecard has an impressive track record in terms of earnings growth.

Nevertheless, based on an earnings per share calculation, my conservative fair value equals €180, which also corresponds to an upside potential of at least 35%.

From a qualitative point of view, Wirecard has a visionary management, great growth prospects, solid fundamentals and is potentially cooperating with SoftBank, which could open up additional markets and enable synergy effects with SoftBank's global and innovative investment portfolio.

Wirecard will release its quarterly figures for Q1 2019 on May 8. The CEO has already announced in the earnings call that the first quarter was strong. This could also have a positive effect on the stock price. In this context, it is also worth mentioning that Wirecard raised its guidance three times last year. This year could also bring some positive surprises.

Finally, it can be mentioned that the current stock price could be a good starting point for short and long-term oriented investors. I just can repeat myself with the following quote:

You can lead a horse to water, but you can't make it drink.

Wish you much success with your investments!

Disclosure: I am/we are long WRCDF, WCAGY, PYPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.