Will the reinvention of PayPoint PLC sustain their business model?

For those who don’t what PayPoint PLC does, then take a look at this image:

Nowadays, PayPoint is more sophisticated as it handled the returns of delivery under the brand “Collect+”, which has over 6,000 retailers. They operate 4,200 LINK-branded ATMs and a leader in contactless payments technology (which they recently sold).

Despite all this, PayPoint’s share price remains static for four years. The main concern is the change in their business structure that cumulated towards the disposal of two assets:

  1. In 2016, it sold their online business consisting of PayPoint.net and Metacharge for £14m to Capita;
  2. In 2017, they sold their mobile payment services for £26.5m to Volkswagen Financial Services in a deal advised on by Mills & Reeve.

The sale of these businesses affected net profit, when they reported a net loss of £2m in 2016, as the result of goodwill write down by £50m. A look at their latest interim result shows the company made an operating profit close to £25m vs. £3.5m last year.

By tomorrow, profits should be back to normal.

 

Let’s talk about their valuation before moving onto their fundamentals.  

Valuation at PayPoint is at fair value

I’m going to ignore the usually market metric valuations to save time.  

A fairer way to value PayPoint is the use of enterprise value as your numerator, that’s why I choose to use EV/EBIT and EV/OCF (operating cash flow) ratios.

Using the Greenblatt’s EV/EBIT ratio, it shows that valuation is at their lowest since 2011 (without the writedown, the ratio is closer to 9 times). A similar valuation appears on EV/OCF.

The low valuation was a product of PayPoint’s shares trading at a range between £7.60 per share and £12 per share for the last four years.

 

Why is the valuation “fairly” low?

One reason is investors are “revenue-focused.” What I meant is, they placed a paramount importance on sales growth for tech businesses. 

For PayPoint, sales have gone nowhere for eight years, but profit margins grew.

Second, is the uncertainty around their business structure. Now, we know Paypoint has sold off their online and mobile payment division.

It can now move forward and look to build-up their brand recognition.

 

PayPoint’s Stagnating Revenue and rising margins  

Over the course of 11 years, revenue at PayPoint during the period from 2005 to 2008 grew. Afterwards, revenue has stood still and stagnated. While that was going on, gross profits and operating profits improved as the company found ways to lower operational costs. (Some people point to lower commission payout to retail agents for the costs savings)

Both the gross margins and operating margins saw tremendous improvement.

The fall in operating profits in 2016 was a blip (as described in the graph). How long could PayPoint keep increasing margins? I assume, not very long.   

PayPoint has high marks for asset allocation

Looking at their ROCE ratio, PayPoint returns are in the 40s or more. That means they have an advantage in their field of operation. 

PayPoint has good cash coverage

When we talk about operating cash profit or their cash balance, PayPoint has been performing well. Also, they have zero debt obligations.

It is clear they have improved their operating cash margins (“unsurprisingly”, when you study the gross and operating margins). One advantage PayPoint possesses is producing greater operating cash profit vs. operating profit, that’s an indication of proving their trustworthiness on earnings. More accurately, cash profits are 26% greater than their accounting profits in the last decade.

When it came to cash dividend coverage, PayPoint is clearly earning excess amounts to meet dividends obligation. Operating cash profits cover the dividend by 2.5 times.

People shouldn’t sleep on free cash flow generation. Combining the past eleven-year, PayPoint’s free cash flow totalled £255m, compared to dividends paid at £182m.

Below is a graph showing the accumulation of cash flow generated and dividends, along with the change in cash balance (shown on the right axis).

The steady growth in cash should give investors’ the confidences in meeting future dividends. Though, I suspect that cash balance is to be used for something else (read below).

 

The future of PayPoint

Having sold their mobile and online businesses, PayPoint can now concentrate on its retail, delivery returns and ATMs businesses. They recently upgraded the retail EPOS platform for the first time in 12 years called PayPoint One. (see below)

The full impact of the sales of their online and mobile payments businesses isn’t fully realised until tomorrow. But analysts’ consensus on earnings is at 63 pence per share, giving a forward P/E of 15 times.  

My concern with PayPoint is the retail agents/convenience stores would demand a higher commission because rents been increasing, this could hinder any margins improvement. However, do they have the bargaining power to voice their concerns? That remains to be seen. 

Though not accepting could mean loss sales, especially when customers find it convenience to pick up one or two items while paying their bill.  

When we look at the convenience stores landscape, they remain robust.

Then there are the costs of rolling out PayPoint One (see image above), but Paypoint got this covered by using these milestone payments criteria:

No upfront costs for installation. But, is priced at £20 per week over two years for new customers, £15 per week for upgrades to Epos core for existing customers and £10 per week for upgrades to till app for existing customers. It stated in the six months there has been 2,000 orders.

Basically, new retailers need to pay a total of about £2,200 for this new platform, whereas existing retailers are getting a 25% discount.

That is all great, but there needs to be some capital investment into manufacturing the new Epos system. Also, it looks very convenience that they sold some businesses to raise cash to soften their expenditure and pay dividends.

 

Now, PayPoint market value of £700m is fairly valued considering earnings back to normal and maintaining dividends payout.

Thanks for reading and remember to share and subscribe.

Are their new competitors looking to challenge or change the nature of PayPoint’s business model?

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.

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