Wirecard: Why Patience Could Finally Pay Off In 2020

Summary

• While investors had assumed that the uncertainties had been finally removed, new (old) accusations from short seller circles were reheated, which led to a renewed drop in share price.
• The uncertainties caused due to the recent allegations even led to the fact that the short ratio has now risen to a record high, which bears risks and opportunities.
• Nevertheless, there are several potential positive catalysts, which tend to fall behind in the event of negative stock performance, so that investors may miss the highest upside potential.
• The updated fair value calculation indicates an upside potential of at least 79%.
• In addition, for the sake of a balanced view, I will also address potential risks and weaknesses that could burden the company.

1. Introduction

As promised in my most recent article "Amazon - Why Corporate America's Future 'King Of Revenue' Is A Must-Have In The Decade Ahead", I would like to provide an update on Wirecard (OTC:WRCDF) (OTCPK:WCAGY) with this article, before I focus again on my favorite (US) tech stocks in my upcoming articles.

I had already published three articles on Wirecard on Seeking Alpha in 2019, in which I intensively dealt with the business model, the financial situation, future prospects, balance sheet allegations and the strategic partnership with Softbank (OTCPK:SFTBY) (OTCPK:SFTBF). You can find these articles in my profile.

While investors had assumed that with the publication of the positive results of the Rajah & Tann audit and the unqualified audit opinion from Ernst & Young in the 2018 annual financial statements, the uncertainties had been finally removed and the share now had a clear path, new allegations from short seller circles were reheated, which led to a renewed burden on the stock. This even led to the fact that the short ratio has now risen to a record high.

Since my contributor colleagues from Seeking Alpha have already addressed these allegations, I am not inclined to repeat them and therefore refer to their contributions, which can be found in Wirecard's profile on Seeking Alpha.

Rather, I would like to focus on potential positive catalysts. These tend to fall behind in the event of negative stock performance, so that investors may miss the highest upside potential.

In addition, for the sake of a balanced view, I will also address some potential risks that could burden the company.

Finally, I would like to present an update on my fair value based on the latest developments and news flow.

But, before I discuss the potential positive catalysts, I would like to take a look at last year's stock performance. Compared to Wirecard's growth rates, it is rather sobering. While Wirecard is the fastest-growing company in the Dax 30 index with top- and bottom-line growth of over 30%, it was the worst performer among the stocks included in the index last year with a 20% decline in share price. By comparison, the Dax 30 Index has risen by 19% over the same period (see following chart).

(Wirecard vs. Dax 30 index in 2019, in USD. Source. YCharts)

When looking at the share price development of the last three years, it is noticeable that Wirecard's growth rates are better reflected in the share price. Thus, the Wirecard shares almost tripled in the three-year period with a stock performance of 172% - despite all the allegations, short attacks and the resulting price setbacks - while the Dax 30 index gained about 12% (excluding dividend payments).

(Wirecard vs. Dax 30 index from 2017 to 2019, in USD. Source: YCharts)

Furthermore, the above mentioned chart illustrates that a stock price correction was not surprising after a steep performance since the beginning of 2017. Additionally, larger share price corrections of 30% or more are not unusual for growth stocks.

So, what factors could drive the Wirecard stock up for a potential outperformance in 2020 and beyond?

2. Potential positive catalysts for the upside in 2020

a) Positive results of the independent review by KPMG and ongoing investigations by Singapore authorities

First, as ironic as it may sound, but after the report is before the report in this case. While investors had been waiting for the Rajah & Tann report and the unqualified audit opinion from the auditors Ernst & Young in 2019 in order to disprove the allegations regarding the accounting practices at the Singapore office, they are now waiting for the audit report from KPMG.

In this context, Wirecard board commissioned an independent review conducted by KPMG due to further allegations raised by the British newspaper Financial Times in relation with Wirecard's third party acquiring business, particularly Al Alam, and certain aspects of Wirecard's merchant cash advance business. In the meantime, the same source also questioned Wirecard's accounting of cash position.

The company has already commented on the allegations through its investor relations department and denied all allegations based on internal audit results. Nevertheless, the independent review by KPMG is intended to confirm this from an independent source and shall serve as an additional service to the capital market.

While the result of the KPMG review is expected by the end of the first quarter of 2020, the publication of CEO Dr. Markus Braun on Twitter may be interpreted as a potential positive audit result which could be published earlier than expected.

(Wirecard CEO Dr. Markus Braun spreads optimism via twitter.)

Additional optimism is spread by an article published on January 11, 2020, in the German newspaper Handelsblatt, which refers to the company's environment, according to which so far no evidence of accounting irregularities have been found.

Furthermore, there is an ongoing investigation by the Singapore authorities concerning the allegations already examined by Rajah & Tann. In the conference call regarding the results of the most recent quarter, CEO Dr. Markus Braun told analysts that he is "very optimistic that the investigation can be resolved in the next couple of months". Positive news from the authorities in Singapore should remove additional uncertainties and drive up the share price.

Finally, in response to the above mentioned allegations and the demands of market participants, Wirecard also strengthened its corporate governance structure (see following figure).

(Implementation of revised corporate governance structure. Source: Wirecard)

b) Potential covering of record high short interest

Second, short interest has risen to a record high as a result of the above-mentioned allegations. According to Ihor Dusaniwsky from S3 Partners, 24.68 million shares are currently shorted. Based on the total number of outstanding shares of 123.6 million as of Q3 2019, the short ratio represents approximately 20% of the free float (see following figure).

(Price vs. Short Interest. Source: Ihor Dusaniwsky, S3 Partners).

If the investigations in Singapore and the independent review by KPMG should disprove the above mentioned allegations against the company, the short-interest should decline, which in turn could create additional buying pressure and fuel the rebound of the stock - as it has happened after the audit results of Rajah & Tann and Ernst & Young mid 2019.

c) Potential increase of the share buyback program

Third, the company launched a share buyback program of up to €200 million on October 18, 2019. Based on the Xetra closing price of €111.65 and market capitalization of €13.8 billion on October 18, 2019, this corresponded to approximately 1.5% of the market capitalization.

In my article published on May 9, 2019, I assumed that the company would launch a share buyback program of up to €600 million based on the net cash position as of Q1 2019. Considering my assumption, the level of the share buyback program is rather disappointing. The market seems to have shared my view. Based on the closing price of €110.90 on January 10, 2020, it can be observed that the share buyback program has not had a sustainable impact on the share price so far.

Nevertheless, I assume that the €200 million share buyback program had more of a symbolic character and was only the first step. I further assume that the buyback program will be increased by at least another €200 million in the next step if the share price does not start a recovery rally soon. Considering Wirecard's net cash holdings of €870 million as of Q3 2019, an increase of the buyback program is not unlikely.

(Wirecard's net cash position as of Q3 2019. Source: Wirecard)

Meanwhile, the share buyback program reduced the number of outstanding shares by 303,378 as of January 3, 2020. According to my calculations, Wirecard has so far spent a total of €32.82 million within the share buyback program, leaving approximately €167 million remaining.

Assuming a conservative average share buyback price of €120, the company could still buy back about 1.4 million shares. If these are added to the shares already bought back, the total number of shares bought back would amount to 1.7 million. According to my calculations based on Q3 2019 earnings, the current buyback program would have no substantial impact on earnings per share. It would have increased earnings per share in Q3 2019 by 4 cents from €3.13 to €3.17, an increase of approximately 1.3%.

d) Guidance update for "Vision 2025" and market entry into China

Fourth, there was an event that hardly received any attention in the media or at least I didn't encounter it. Wirecard updated its "Vision 2025" at the Capital Markets Day in New York on October 8, 2019. The company now sees transaction volumes of more than €810 billion (up 14% from €710 billion previously), revenues of more than €12 billion (up 20% from € 10 billion previously) and EBITDA of more than €3.8 billion (up 15% from €3.3 billion previously).

Consequently, I have also updated my previous calculation for the sake of traceability. According to my calculation, this corresponds to an annual growth rate of around 31% in terms of the transaction volume (up from 28% previously), 29% in terms of revenues (up from 25% previously) and 32% in terms of EBITDA (up from 29% previously; see following figure).

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

According to the company, the guidance update is based on three pillars: i) the increased focus on large companies will lead to a significant growth in transaction volumes and at the same time realizing economies of scale (e. g. strategic partnership with Softbank and its holdings); ii) the ongoing development of the payment ecosystem and its expansion to include digital financial services as well as data-driven value-added services which leads to improved conversion rates and revenue increases, while at the same time reducing customer acquisition costs; iii) geographic expansion.

With regard to the geographic expansion it is noteworthy that Wirecard announced on November 5, 2019, that it would acquire all shares in the Beijing-based AllScore Payment Services for a maximum amount of €109.3 million.

According to the company statement, AllScore Payment Services' license portfolio will enable Wirecard to offer internationally oriented Chinese merchants local acquiring services, cross-border acquiring including settlement in their local currency and digital value added services. Furthermore, the international merchants of Wirecard gain access to Chinese consumers and are enabled to accept digital mobile payments methods and receive settlements in their respective local currency. Additionally, the license portfolio provides Wirecard with the capability to issue payment cards to consumers and companies in China.

Wirecard projects a low single-digit EBITDA contribution after integration costs in fiscal year 2020, more than €35 million of EBITDA in 2021 and more than €50 million in 2022. For comparison, Wirecard had a group EBITDA amounting to €553 million in the nine months ended September 30, 2019.

The following figure provided by Wirecard illustrates some potential and trends of the Chinese market.

(Overview of the Chinese market. Source: Wirecard)

In summary, if the market focuses again on the company's fundamentals, the guidance update and the market entry into China could serve as additional catalysts for the share price.

e) Increased stakes of US investment banks with unclear intentions

Fifth, while ordinary market participants and the general public were only barely aware of the events surrounding the "Vision 2025" and the expansion into the Chinese market, probably due to the weakening stock, it is worth noting that three US (investment) banks in particular have built up or increased their stakes in Wirecard after announcement of these events.

The biggest surprise was that on December 11, 2019, Bank of America initiated a position in Wirecard of up to 5.7% of outstanding shares including derivatives.

Furthermore, Goldman Sachs seems to have taken advantage of the price drop of the Wirecard shares and increased its stake including derivatives to just under 11% as of December 10, 2019, up from less than 10% previously.

Additionally, Morgan Stanley significantly increased its stake in Wirecard to more than 10%, whereby the portion of equity swaps amounting to more than 4% is particularly noteworthy here. Equity swaps can, but do not have to occur in the context of a takeover attempt.

Another interesting aspect would be to know whether these (investment) banks act in their own names or on behalf of clients, so that a hidden investor instructed these investments.

Given the current valuation and growth prospects, it would not be surprising if a (strategic) investor had instructed these banks to build up shares. The leakage of such intentions could result in a significant price gain, so that it is intended to avoid disclosure for the time being.

By the way, equity swaps were used in connection with Schaeffler’s (OTC:SFFLY) (OTCPK:SCFLF) hostile bid for rival Continental (OTCPK:CTTAF) in 2008 and LVMH's (OTCPK:LVMHF) (OTCPK:LVMUY) stake build-up in rival Hermès International in 2010.

3. Potential risks and weaknesses weighing on the company

First, in the context of the various allegations against the company, there is regular reference to so-called "whistleblowers". What worries me is that this could be due, among other things, to a poor corporate climate. This may have various reasons, such as improvable salaries, high workload, monotonous tasks, too loose employee management, rivalries between employees or disagreements with superiors. I have to admit that this is based purely on speculation. Nevertheless, the constant leaking of (confidential) information out of the company worries me. So, in addition to improved corporate governance, an increase of employee satisfaction and loyalty to the company could also be favorable.

Second, apart from the (short-term) volatility of the share price in connection with the regularly occurring allegations from always the same sources, the hiring of special audits leads to significant additional costs, which destroys (long-term) shareholder value.

Not only can these reduce the company's capital, but they can also impede growth through permanent distraction from operating business and reduce employee satisfaction through constant additional workloads due to special audits. Furthermore, they can adversely affect the corporate climate and damage the company's public image, resulting in considerable financial and non-financial damage.

As the earnings report of Q3 2019 reveals, there was a substantial increase in legal and financial statement costs as well as consulting expenses and consulting-related expenses. While the legal costs increased to €30.1 million, up from €9.7 million in the same period of previous year, the consulting expenses and consulting-related expenses increased to €34.1 million, up from €20.7 million. Consequently, additional costs amounting to €33.8 million incurred which could have alternatively been invested in growth. By comparison, the company paid a total of €24.7 million in dividends in 2019. This means that the additional legal expenses even exceed the dividend payments for one year (see following figure).

(Other operating expenses as of Q3 2019. Source: Wirecard)

Based on a per share basis with a share count of 123.6 million and earnings per share of €3.13 in the nine months ended September 30, 2019, the additional legal and consulting expenses reduced earnings per share (before tax etc.) by approximately €0.27 or 8.6%. Thus, these additional expenses have a material impact on earnings, shareholder value and shareholders' equity (see following figure).

(Quarterly results as of September 30, 2019. Source: Wirecard)

Third, as already mentioned in my article dated March 21, 2019, one of the biggest disadvantages for a technology company like Wirecard, in my view, is the fact that it is not domiciled in the US. Considering the valuations in the US technology sector, I am pretty sure that the valuation and investor demand would be much higher if Wirecard were domiciled in the US, and the stock would not be so vulnerable to such allegations as well as short attacks.

By the way, on Friday the company announced that the long-time chairman Wulf Matthias is resigning from his position with immediate effect and will be succeeded by Thomas Eichelmann. This short-term appointment could again be used for speculative purposes by certain market participants. The fact is that Thomas Eichelmann was elected to the Supervisory Board at the annual shareholder meeting in June 2019 and has already been considered as the chairman's successor. At the same time, Thomas Eichelmann is responsible in the Supervisory Board for the currently ongoing KPMG review. In order to apparently eliminate any speculation, CEO Dr. Markus Braun also reacted via his Twitter account and issued a statement on this matter (see following figure).

(CEO Dr. Markus Braun twitters on personnel changes in Wirecard's supervisory board.)

4. Updated fair value calculation i

ndicates upside potential of at least 79%

Factoring in the following developments, I have decided to update my fair value from April 29, 2019:

• management's guidance update for "Vision 2025" which sees accelerating growth rates;
• strategic partnership with Softbank in connection with deals relating to Softbank's holdings (such as the US-based carrier Sprint (S));
• increased focus on gaining cooperations with large-sized companies which should increase economies of scale;
• potential implementation of further buyback programs which should reduce share count due to solid financials and free cash flows;
• reduced uncertainty and creation of a much stronger corporate structure once KPMG review is finished with a positive result and the new corporate governance structure is fully implemented.

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: € 7,827.41) and the value of the FCF of the tenth year (here: €17,907.14) are then added together and added with the net cash position (here: cash on hand amounting to €3,287 minus debt and liabilities amounting to € 2,417). 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 22% per year in terms of the free cash flow, increased by 10% from a growth rate of 20% per year compared to my previous calculation. This calculation is still conservative since management expected an organic long-term growth of 25% per year related to its previous "Vision 2025".

Furthermore, I have chosen a multiple of 15 for the last FCF, which is in line with my previous calculation.

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, which is also in line with my previous fair value calculation. Additionally, I have chosen an EPS growth rate of 27,5%, also increased by 10% from a growth rate of 25% per year compared to my previous calculation.

Based on the first valuation method, the fair value is €214.55, which corresponds to an undervaluation of the stock of 93% (see figure below).Fair value calculation, method I. Source: Author's calculation.

Based on the second valuation method, the fair value is €198.72, which corresponds to an undervaluation of the stock of 79% (see figure below).

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 €182.00 which corresponds to an upside potential of 64.56% (see following figure).

Compared to me, the analysts have lowered their price targets due to the uncertainties associated with the accusations. As of April 29, the average target price of the analysts was €199.79.

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

5. Conclusion

"The stock market is a device for transferring money from the impatient to the patient."

- Warren Buffett.

Over the last year, investors have been through a rollercoaster ride with Wirecard shares. In the short term, it looks like share price performance will be determined by whether the bulls or the bears are stronger.

Nevertheless, in addition to the short-term uncertainties and volatility that weigh on the stock price, my goal was to highlight the positive factors once the uncertainties surrounding the allegations had been removed. Potentially positive factors include a positive outcome of the KPMG review and investigations in Singapore, the update of "Vision 2025", the global expansion and market entry into China, the share buyback program and a potential increase in the share buyback program due to the company's solid financials, and the increase of stakes by US investment banks.

Furthermore, the updated fair values based on DCF and EPS calculations indicate an upside potential of at least 79% provided, of course, that the company's figures are accurate.

From the negative point of view, it is worth mentioning that, as detailed in the article, these allegations in connection with legal costs have a material financial and non-financial (long-term) impact on earnings, shareholder value, shareholders' equity and corporate reputation which is not acceptable from a shareholder's point of view.

In my view, management should make a clear statement to the market after the KPMG review is finished that it will in future ignore such allegations since the balance sheets and business activities are examined by independent auditors as part of the audits.

Beyond that, I think that it is the responsibility of German authorities and financial supervisors (e. g. Bafin) to prevent such misleading allegations and increase shareholder protection by imposing appropriate and dissuasive sanctions. At regular intervals, old allegations are reheated or new allegations are made by the same old sources. The exact background to these allegations is unknown, but meanwhile it appears that they are more than just fundamentally justified.

Finally, as already mentioned in my previous articles, while I see currently no reason to overweight a particular stock for any particular reason (which, in my opinion, would ultimately fall under "timing the market," and stock price developments are difficult to predict, as we all know), I think that Wirecard offers a good risk/reward ratio for investors ("time in the market") for the reasons outlined above and under the condition that the ongoing KPMG review as well as investigations by the Singapore authorities once more disproves the current allegations.

P.S.: I intend to publish more about my favorite tech stocks in future. If you are interested in finding out my (from an emotional point of view) favorite technology stocks, just follow me on Seeking Alpha or my personal blog.

Disclosure: I am/we are long WRCDF, WCAGY, CTTAF, LVMHF, LVMUY. 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.