A higher risk-reward stock idea for 2017

Thursday, 5th January 2017 09:32 - by David Harbage

As promised in the previous article, which highlighted the volume national house builder Bellway, this blogs wishes to focus on a second company share which offers the prospect of being upwardly re-rated by investors in 2017: the financial online payments business Paysafe.

Last year was a turbulent one for this little known company which moved from the Alternative Investment market to a full listing on 23 December 2015, having completed the acquisition of a complimentary payments business - European-focused Skrill - before becoming a FTSE250 index constituent on the 21 March. Having begun 2016 at 370p, Paysafe shares progressed – encouraged by reports of positive trading, raised guidance and benefits of integrating Skrill - to 469p in mid-October, before falling to 304p (252p intra-day) on 13 December following publication of a piece of research alleging fraud and illegal behaviour. Management immediately denied any wrongdoing and, in response to the fall in its equity value (current market capitalisation is £1.8bn at 369p) as well as to evidence the firm’s strong cash generation, initiated a share buyback of up to £100m. 

Previously known as Optimal Payments and operating under various product brand names, (notably NETELLER, paysafecard and Skrill), the business has almost 20 years’ experience in digital payments. It operates a wide range of pre-paid, immediate and pay-later solutions through digital wallets, white label and merchants cards, payment processing, invoicing and other related services (including risk management) to move and manage money. Serving both merchants and consumers in over 200 countries, 100 often-localised payment types and 40 currencies, these services are particularly configured for use on mobile devices, which can be especially useful in emerging economies. This is a technology business which facilitates strong global demographic trends in e-commerce: to shop online ever more conveniently and in particular ‘on the move’. In addition, Paysafe often benefits from its merchants’ success, via revenue sharing agreements on transactions effected on its platform.   

Management have also endeavoured to add value, for instance via data analytics and fraud indemnity, to what can often be a low margin commoditised business, as well as deliberately diversifying away from the gaming industry and non-Europe & North America regions (both of which had represented over 50% of group revenue prior to the purchase of Skrill in March 2015). Paysafe has grown very quickly over the past five years and, remaining in growth mode, has yet to pay a dividend – choosing instead to reinvest profits in building its business via acquisition. Expansion by such a route makes sense – primarily to enhance the quality of its revenue and profits by reducing its dependence on any one industry (by reference to gambling), customer (one merchant provided 20% of group revenue in the first half of the year, down from 29% in H1 2015, with no other client accounting for more than 10%) or region (especially in countries viewed as being lightly or unregulated).

However, such corporate activity requires either premium rated (a high earnings multiple) equity, to be able to offer shares as consideration, or cash. As at 30 June 2016, the Balance Sheet showed net debt of US$385.9m (having fallen from $431.3m in the first six months of the year). The board, led by chairman and CEO Mr Joel Leonoff (who owns 2%, or £36m worth, of Paysafe shares), has shown itself to be bold and prepared to stretch itself to the extent of acquiring businesses as large as itself (Skrill was such a ‘reverse’ takeover).  Whether the most recent commitment to buy back its own shares – prompted by the sell-off in the share price on 13 December, which had resulted in the board saying it “believes the current share price significantly undervalues the performance of the business to date and our future prospects” - will inhibit its predatory appetite remains to be seen.

In the calendar year just ended, earnings per share (EPS) of 33p are expected by the broking community, rising to 38p for 2017. These forecasts have consistently been raised, guided by the company, over the course of the past six months and equate to a forward looking earnings multiple of 9.9x. This is cheap for a stock which appears capable of delivering growth of 15% per annum over the medium term (a PEG ratio of 0.7x), but reflects investor caution over the quality and sustainability of those profits. The Sell side appear universally positive (perhaps not surprising, given an expectation of takeover or merger activity), with 9 Buy recommendations published – featuring assessments of fair value or price targets around the £5 mark. The most recent analytical piece, on 14 December (albeit probably written before the defamatory Spotlight research) comes from Barclays, who have a price target of 610p. A move to sign Barclays to become house broker would enhance credibility, as mixed opinions of the magnitude of risks facing Paysafe prevails amongst fund managers.    

A trading update, covering the period since 8 November 2016, is due to be released on 12 January. Post the note from Spotlight Research, which has disclosed a ‘short’ position in Paysafe shares, the board are expected to issue an upbeat report on current trading and prospects. Countering concerns about involvement in any unlicensed or illegal practice, (the research paper referred to Chinese consumers using Bet365’s non-indigenous site), would also be helpful - given the opaque nature of this cash payments business and its customers. Meantime, with powers already in place to buy up to 10% of the company’s stock (equates to a £180m spend) in the current year, there is significant support to counter any investor unease. At the time of writing, there are three notable hedge funds who have ‘short’ positions (have sold the stock, typically by using derivatives, in the expectation of being able to profitably buy-back or close their exposure at a lower level) totalling 5.1% of the issued stock in Paysafe. They are AEK 2.6%, Public Equity Partners 1.9% and Oxford Asset Management 0.6%. In the month of December, AEK and Public Equity have been closing their positions (effectively buying shares) while Oxford AM increased their bearish stance (from 0.5%).

As can be appreciated, Paysafe is a very different company stock from our other selection for 2017, the house builder Bellway, and, in the author’s view, represents a higher risk-reward investment. While both are FTSE250 index constituents and currently stand on a significant discount to the wider UK equity market’s earnings multiple (based on both historic and forward looking numbers), the £3bn capitalised builder operates in a more obviously cyclical industry and its business model (in particular, how it makes money) is more transparent. ‘Widows & orphans’ as well as seekers of dividend income are unlikely to be attracted to Paysafe, but the more adventurous growth-oriented investor might view this stock as offering recovery potential and bolt it onto an existing diversified portfolio of stock exchange assets.      

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.