By Elie Rosenberg
Net 1 UEPS Technologies (UEPS) is a South Africa based provider of a variety of payment processing services. Their business outlook and stock price are clouded by the overhang of the potential loss of a large government contract that accounts for nearly half of their revenues.
UEPS is in a wide array of different businesses related to payments processing (they have no less than 5 operating segments for a $350 million company!), which leverage their core payments hardware and software technology in a variety of ways. The material business lines include:
- The administration of social welfare payments on behalf of the South African government- UEPS does this through a biometric smart card system, which provides security and the benefits of banking to an unbanked or underbanked population. UEPS also derives revenue through the use of these smart cards in the UEPS merchant network (similar to a credit card processing company).
- EasyPay- A processor of credit, debit, and pre-paid payments for South African retailers
- Payroll processing for South African businesses
- KSNet- A South Korean payments processor acquired last year
With the stock at $7.42 a share the company has a market cap of $343 million. They have $102 million in cash and $111 million in debt for an enterprise value of $343 million. In the last twelve months, which is the first full year following the KSNet acquisition, UEPS has done $379 million in revenues and $136 million in adjusted EBITDA (backing out impairment charges and KSNET transaction expense). Free cash flow was $44.5 in the trailing 12 months, which was hit by KSNet transaction expense, some swings in working capital, and higher than normal capex. It should be around $90 million on a normalized basis:
For perspective UEPS did $102 million in FCF in FY09 on lower EBITDA. Based on these numbers UEPS is trading at 2.5X EBITDA and a 28% normalized FCF yield.
Of course the stock is cheap for a reason. The SA government payments contract constituted 47% of UEPS revenue in FY11. The South African Social Services Agency (SASSA) is bidding out the welfare payment processing contract, which will certainly result in lower economics to the winners and perhaps result in provider consolidation (currently two other companies aside from UEPS provide electronic payment solutions to SASSA). In 2007 SASSA initially indicated that they wished to rebid the contract. The RFP has been continually pushed off and UEPS has been operating on one year contracts. In 2010, UEPS provided revenue concessions to SASSA in return for extending the contract, but the RFP process is now finally complete. A decision was supposed to be announced in October, but SASSA has extended the existing contracts until March 2012 and it appears we will finally have a decision by then.
I don’t have any special insight into the odds of UEPS winning the bid. But it is worth noting that the RFP specifically calls for a biometric smart card based model, which plays to UEPS’ strength. Additionally, UEPS claims the competitive advantage of being able to process transactions “offline” when there is no network connection to connect back to a central database. The transactions can take place securely between two smart cards and a portable POS card reader with the data being loaded to the central database at a later time. This enables processing in remote rural areas, which account for a large percentage of welfare recipients. My guess is that the odds are good that UEPS at least retains their share of the business, but nothing is ever certain with government contracts. But even if UEPS does win at least part of the bid, SASSA is looking for significant cost savings with the new contract- on the order of a 35% reduction in payment provider expense from current levels based on their public estimates for the FY12 and FY13 budget.
To determine the value of UEPS stock, we can look at three scenarios- losing all of the SASSA business, retaining their current share, and winning the entire business.
What happens if UEPS loses the entire SASSA business? UEPS accounts for SASSA related revenues in two operating segments- South African transaction-related and smart cards. The entire smart card segment is SASSA related, but the SA transaction segment also includes other revenues, most notably EasyPay. It is possible to come to a rough estimate for SASSA revenues and margins in the SA segment (I’ll spare you the gory details) and I estimate that total SASSA related EBITDA in TTM is about $75 million. That leaves $62 million of non-SASSA EBITDA.
The non-SASSA business is predominately payment processing, which should at least be stable, and historically has grown at a steady clip. Management has a 10% annual growth estimate for their mature payments businesses. So I think it is fairly safe to assume a steady state EBITDA of $62 million. Payment processing businesses are high quality due to their sticky customer base, recurring revenues, and low capex. Comps trade in the 8-10X EBITDA range (and UEPS paid about 9X for the Korean business last year). But even if we assign a 6X EBITDA multiple we get a UEPS equity value of $7.80, or about the current stock price. So it appears the market is pricing in a complete loss of the SASSA contract and for the rest of the business to trade at a discount to peers.
What if UEPS maintains their current share of the SASSA contract? I assume SASSA related revenues will take a 35% haircut from $166 million in the TTM to $108 million and that EBITDA margins will drop from an estimated 45% to 35% on the lower revenue base. That yields company wide EBITDA (assuming the other business remain flat) of $99 million. I assume the market will continue to assign a discount to the company due to the government exposure (although the new contract will be a 5 year deal). So let’s say it trades at 6X EBITDA. That would equate to a $13 stock.
If the downside is $8 and the upside is $20 then UEPS seems interesting at $7.50. But it is hard to envision what will provide a catalyst to the stock between now and the resolution of the SASSA contract issue in March. If they win all or some of the contract the stock will spike, but a full loss will likely be hard on the stock notwithstanding the analysis above. And it would take some time for the market to realize the value of the remaining businesses. There is also some risk that management will throw away capital at