Though there was a time when we could say “cash rules everything around me”, a la the Wu-Tang Clan, electronic payments are killing cash. SafeCharge International Group (SCH:LN) is in a prime position to take advantage of the rise of electronic payments through its innovative technology platform. From an investment perspective, it rates highly in these key areas we evaluate:
- Valuation – significantly undervalued relative to its history and its competitors.
- Growth potential – organic growth in new verticals, with potential for further complementary acquisitions.
- Quality – strong conversion of net income to free cash flow, no debt, and net cash equal to 30% of market cap.
- Entrepreneurial management is incentivized to create shareholder value – self-made technology billionaire owns 67% of the company.
- Payment industry is ripe for consolidation and attracting attention from renowned venture capitalists and tech legends like Mark Zuckerberg.
- 136% upside potential over a three-year time horizon through continued EPS growth and multiple expansion towards peer group and private market values.
Industry Trends and Competitive Position
Much ink has been spilled on the rise of ecommerce, so it really goes without saying that companies like SafeCharge, which are an integral part of a company’s ecommerce offering, have a secular tailwind. Globally, retail ecommerce is expected to grow at a CAGR of over 20% through 2019, with aggregate sales of approximately $3.6 trillion. Per a study by McKinsey, global payment revenues are projected to be $2.3 trillion by 2019.
SafeCharge’s roots are in the Payment Processing business, where it provides a proprietary platform as well as fraud prevention. The company has been able to leverage its core payment processing platform to serve other parts of the payment ecosystem. These organic initiatives, combined with two strategic acquisitions, have enabled the company to expand its product offering, and it now touches almost every part of a transaction. Additionally, the company is part of the Card Scheme with both Visa and MasterCard, which provides a competitive advantage.
n addition to increasing revenue per transaction, these efforts should allow SafeCharge to maintain its high customer retention levels. The company has developed relatively sticky customer relationships as its technology becomes enmeshed with the merchant’s accounting and inventory systems, increasing switching costs. Additionally, in some cases, the company develops bespoke solutions for the merchant, increasing the work load associated with switching providers. This functionality is especially critical as retailers move toward an omni-channel distribution approach.
SafeCharge International Group – Valuation
The company trades at an all-time low valuation in terms of forward P/E, nearly 50% below its average multiple. On a trailing basis, the company is half as expensive as its publicly traded peers, on average. We’ll get to private market valuations later.
Despite superior returns on capital, the company trades at a substantial discount to peers. A simple reversion to its own average would yield around 50% appreciation, while a move toward public market peers would more than double the share price.
By analyzing the company’s 2015 Annual Report, as well as its 2016 update, we see growth is at the top of the agenda. As we saw in our analysis of the company’s competitive position, it is expanding revenue with existing customers, which are predominantly in the sports betting vertical, by touching more parts of each transaction. Additionally, through its acquisitions, it is increasing its reach both geographically, as well as by entering new verticals. The company mentions airlines, travel, and retail in the 2015 Annual Report, though retail forex, other financial services, and online applications are other potential verticals that have been mentioned.
As we see in the 2016 Interim Update, revenue, gross profit, and EBITDA are all increasing at impressive rates despite many of these initiatives being in the relatively early stages of development.
Importantly, top line growth has not come at the expense of margins, with EBIT margins stable at around 27% and net income margins improving from 19% in 2014 to 23% in 2015 and over 25% for the first half of 2016.
The company’s ability to convert net income to free cash flow is impressive. This is a function of the company’s disciplined capital allocation, as often management decides to build functionality internally as opposed to paying for an acquisition. The aggregate value paid for the company’s two acquisitions was a mere $25M.
Year-over year, per the interim 2016 report, cash conversion remains above 80%.
Additionally, the company is debt free, and has significant net cash and investments, $124M (as of 12/31/2016) on a market cap of $426M (as of March 21, 2017).
The company is serious about returning capital to shareholders, targeting a payout ratio of 50% of Adjusted EBITDA. However, when times are good, this amount may increase, and the company is targeting a payout of 75% for 2016.
We always feel good when we are invested alongside the founder, and for SafeCharge that is the case. From the 2015 Annual Report, “The Company’s largest shareholder is Northenstar Investments Limited (“Northenstar”), which is wholly-owned by a trust, the ultimate beneficiary of which is Mr. Teddy Sagi.” Sagi’s effective ownership is approximately 67% per FactSet.
While Sagi certainly has an interesting personal background and social life, there is no doubting his work as a technology entrepreneur, building a $3 billion fortune from scratch.
His greatest success has been Playtech plc, which he founded and has built to over $3 billion in market cap. Playtech, along with many of his other on-line businesses help feed SafeCharge, though account for only about 15% of its total revenues.
Payment Processing Industry Garnering Attention
Though many smaller players operate in various parts of the payment ecosystem, the company that is probably the closest proxy for SafeCharge is Adyen, which is privately held. Adyen is owned by a who’s who of PE and VC firms, including General Atlantic, whose portfolio includes Snapchat, Airbnb, and Uber, not to mention the secretive Iconiq Capital, which counts among its clients tech legends such as Mark Zuckerberg and Jack Dorsey.
While Adyen is more of a known quantity, given its Silicon Valley ties, SafeCharge’s initiative to move into additional verticals has the potential to boost its profile, as well as its valuation, into Adyen’s stratosphere. Adyen’s $2.3 billion valuation in 2015 occurred in a year when its CEO was targeting profits of $45 million. By way of comparison, SafeCharge earned approximately $23 million in 2015. Whether applying this sort of private market multiple or looking at publicly traded peers, SafeCharge appears severely undervalued, and its growth initiatives could help push it beyond a $1 billion market cap, more than double its current capitalization.
About Opus Capital Management
Opus Capital Management, based in Cincinnati, Ohio, is a 100% employee-owned registered investment advisory