A tale of transformation, (rather than evolution).

Friday, 27th March 2015 11:46 - by David Harbage

For every twenty sensible small ‘bolt on’ purchase made by a typical company’s management, who seek to steadily evolve into a stronger more sustainable business, there’s typically only one transformational corporate deal. But when one of the latter does come along – such as AIM listed payment processor Optimal Payments’ (OPAY) Eu1.2 billion acquisition of the privately owned Skrill this week – it makes the pulse of both Sell side analysts and existing investors beat faster.

That OPAY had an enterprise value of just £710 million (£683m market capitalisation of its equity plus £26m net debt), when announcing its intent, makes this a relatively rare reverse take-over as the ‘prey’ is a more valuable asset than the ‘predator’ business. Always a bold move, this is being funded by a hefty £451m cash-raising exercise (5 new shares for every 3 held at 166p per share), approximately £360m of new debt and £95m worth of new shares (offered to Skrill shareholders).

Existing OPAY investors who choose to take up their entitlement to the deeply discounted rights issue in full will be making a major additional financial investment, as a holder of 300 shares pre-announcement (worth £1,257 at the 419p prevailing price) would be investing a further 66% of value (as the allotted 500 new shares would cost £830) to subsequently own 800 shares.

Such a commitment could only be made after considering the merit and risks of the proposed deal which, if approved by shareholders on 16 April, is due to complete in the third quarter of 2015. Amongst the prime considerations, the price paid for the CVC-owned Skrill business is circa 10% lower than the listed market’s valuation of OPAY (based on respective enterprise value and earnings) and should therefore add significant value, being earnings accretive in year 1 (by 20% - 25%, as a one-off $26m integration charge delivering $40m of annual cost savings is enhanced by greater debt leverage).

The ‘fit’, by reference to products/services and geographic location, is highly complimentary: Skrill was OPAY’s prime competitor in its e-wallet stored value service (the merged entity becomes a global leader), offers a major boost via its pre-paid card proposition (enables consumers without bank accounts to make online purchases, branded paysafecard and Ukash), a high European bias (92% of Skrill’s turnover) takes the resultant enlarged group to a more balanced sales mix (52% Europe, 16% USA & 32% rest of the world), as well as halving the largest individual merchant risk (to 15% of turnover). In addition, OPAY management flagged their intent to move to the LSE’s main market upon completion of the acquisition – which would attract FTSE250 index tracking institutions and wider coverage by the broking community.

What’s there not to like? Certainly the market responded positively as Optimal Payments stock jumped 31% (from 419p to 550p), in response to the perceived benefits of the acquisition, and now stand at a premium rating - based on a theoretical ex-rights (post the rights issue) price of 260p – to the wider UK equity market. The prospect of above average earnings growth (which history suggests is the best metric for determining equity value over the longer term) over the next three years appeals, but value-focused investors (noting the lack of any dividend support and higher financial gearing) might decide to look elsewhere in the technology sector for businesses which have yet to enjoy the transformation-induced limelight enjoyed by OPAY shareholders this week.