I first mentioned EML Payments (ASX:EML) to you when I bought prior at a bit under $3 on August 13, prior to the results. It’s been a bit of lucky timing, because it then beat guidance and on August 21 I wrote that “Despite the stretched valuation, I would buy some shares in EML Payments at the current price of $3.40 if I did not already own shares.”
Over the last week, the company then announced the company making (or company breaking) acquisition of Irish company Prepaid Financial Services (PFS), to be funded by a combination of debt, and a significant issue of shares at a price of $3.55, some of which will be paid directly to the vendors.
The acquisition is expensive on traditional measures, at 17.5x EBITDA. However, PFS has grown its revenue at over 30% for the last few years, so it is certainly possible that future organic growth will justify the price. In any event, at a share price of $3.55, the standalone EML Payments had an enterprise value over around $870 million and EBITDA of $29.1 million, putting it on a price of around 30 times EBITDA. So even at the expensive price, the move should create value for shareholders.
The capital raising will offer retail shareholders 1 new EML share for every 5 existing EML shares they hold, at a price of $3.55 per share. Hypothetically, one could fund participation by selling some shares at the current price of $4.30, and buying back the same number (or even more) at a cheaper price under the offer. I may do that.
At the AGM (and in the acquisition material) the company highlighted that its newer VANS business did revenue of $3.1 million in the first quarter of 2020, which compares favourably to $6.4 million in the entirety of FY 2019. Meanwhile general purpose reloadable (GPR) growth was less impressive at $6.4 million in quarterly revenue against $23.9m for last year. The first quarter of gift and incentive (GI) isn’t really indicative because that’s a seasonal business.
The company gave some pro forma guidance for FY 2020, assuming the acquisition had already occurred last year. In that case, they say the combined company would do $65 million in EBITDA. At the current share price, EML Payments has a market capitalisation of about $1.5 billion (after all the new shares are issued), and debt of around $130 million, for an enterprise value of around $1.63 billion, or about 25 times EBITDA.
The Qualitative Perspective
If this acquisition performs as expected, then arguably it is a real win for the company (and shareholders), because it will transform the company into one that has a longer runway of organic growth. I’ll explain my reasons for thinking this below, but first, let me remind you that I have not considered your individual circumstances, and this is not a recommendation. Rather, this is my reading of recent developments at the company.
One interesting fact about the acquisition is that the two companies have complementary regulatory licenses, with PFS stronger in Europe and EML stronger in Australia and the US. Second, PFS has a greater proportion of GPR business than EML. Now, I actually think that the GI business is an enviable one, but the problem with it is that growth is harder to come by (and seems to be largely achieved through acquisitions). On the other hand, the GPR business actually hooks into a long term tailwind.
One 2015 study found that “The GPR prepaid card quickly became widely used as an important product for lower-income, underbanked, and unbanked consumers. In some instances, prepaid cards have become necessities for these consumers.” To give a specific example, PFS boasted in a 2018 press release that — thanks to their partnership with the Spanish post office — “any citizen can enjoy all of the mobile payment advantages with Google Pay using the Correos prepaid Mastercard card without the necessity to be a client of a classic financial institution”.
Now, some research has noted that millennials are more likely to use these kind of services than the generations before them, which may well be true, simply because millennials are more likely to use “neo-banking” services like rebellionpay.com (another PFS customer). To my mind, in fact, these services more aimed at Gen Z.
Suffice it to say the tailwinds are probably longer and stronger in GPR than in GI. All up, my gut instinct is that a big acquisition like this is very risky, and it makes me nervous. Simply put, I have a bias against acquisitions. At the moment the main question on my mind is whether to put more money into the stock through the capital raising, or if I should sell some shares to fund my participation in the capital raising. As for the sellers, it sounds like they have some serious spending to fund — and they will own over 6% of EML after the acquisition. While one founder said “We wanted to stay part of it for at least the next three years, there’s still a lot of growth in it,” I am still a bit nervous about the big swing, given that the people on the other side of the trade (from EML) are clearly intelligent and talented.
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