Price pop on a very short announcement that the Central Bank of Ireland directed that a nil% growth cap would apply to EML’s Irish subsidiary and EML confirms no change to FY23 guidance.

Full Announcement:

EML Payments Limited (ASX:EML) (“EML”), refers to its ASX announcement on 24 February 2023 and confirms that after close of trading on Thursday, 30 March 2023, the Central Bank of Ireland directed that a nil% growth cap will apply to EML’s Irish subsidiary, PFS Card Services Ireland Limited (‘PCSIL’), for the 12 months ending 31 March 2024.

EML confirms there is no change to its guidance for FY23, being Revenue of A$235m – A$245m, and underlying EBITDA of A$26m -- $34m as disclosed to the market on 22 February 2023.

EML and PCSIL remain focused on engaging constructively with the Central Bank of Ireland, working to complete the remediation program and ensuring all of the regulator’s concerns are addressed.

EML lowered guidance a few days ago (not by much) and got punished on top of an already negative view from the market. So, is this an over reaction or is EML in a downward spiral? I updated my valuation from a year ago for the new information and to get a view on this (detail below):

Some key insights/assumptions on the business:

·        Costs seem to be rising fast to address compliance issues and ensure they don’t happen again (above one-off PFS/CBI costs), this has lifted to underlying cost base of the business and slowed the move into profit and reduced operating leverage. I am treating most of this as a one-off step up in the cost base, so will be looking for cost control going forward.

·        Sales have also slowed due to Covid and economic conditions – no big surprise, but does impact valuation and provides some doubt for growth rates. I have modified FY22 sales to the new guidance and GDV balances to a little above double the half year results for the FY.

·        Interest rates increases provide a benefit to EML for it’s returns on the Stored Value Float (the cash held on General Purpose Reloadable cards). If a 1% increase in rates occurred globally this would add 14-15m to the bottom line based on the current 2.7bn stored float. I have added a gradual increase in interest rates to allow for this upside.

·        The large European business is at risk due to the Ukraine/Russia conflict and will be hit if it escalates, so I have upped the risk discount from 5 to 10%, still assuming only a short-term impact. I have also reduced the exit multiple down to EV/EBITDA of 12 but retained the discount rate at 10%.

·        Inflation I see as a positive tailwind for EML, the higher value of transactions and balances the higher the income for EML. The accompanying higher interest rates are also a plus as mentioned.

FY22 Guidance Adj: Apart from Operating Cashflow, only down a little – FX rate impacts and operational issue in Europe cited as key reason, but market may be concerned there is more.

·        GDV $79-$84bn (from $81-$88bn) up from $19.7bn in FY21 – mostly Sentinel addition

·        Overheads $106-$109m (from $103-112m) up from $76.8m in FY21

·        Revenue $225-235m (from $230-$250m) up from $194.2m in FY21

·        Underlying EBITDA $52-$55m (from $58-$65m) from $53.5m in FY21

·        Gross Profit Margin 69% (no change) from 67% in FY21.

·        Underlying NPATA $27-$30m (from $27-$34m)

·        Operating Cashflow 50%-60% (from 80%-90%) from 87% in FY21

EML Val.pdf

Conclusion: I have lowed my valuation from $9.71 to $6.71 with the adjustments so value has been impacted but assuming expansion and growth across the various business segments resumes and revenue can grow to 3.5x current revenue in 10 years, then it seems quite undervalued. 

Disc: I own EML

A rather vague update from EML this morning on Central Bank of Ireland (CBI) issues:

·        Potential directions from CBI are more limited than foreshadowed in May 2021.

·        However, the CBI sees PFS Card Services material growth policy as higher than they want to see.

It sounds like penalties and remediation costs are limited but controls going forward are going to limit growth rates for the Irish subsidiary.  The good news is that it’s only the PFS subsidiary, not the other entities. However there really isn’t enough detail to get excited or worried either way.

I hold EML

YTD unaudited EBITDA of $43.8, $15.7m in Q3, of that PFS has contributed around $34.4m in Gross Profit and $16m to EBITDA YTD.  PCP growth is very large, but not relevant given the impact of Covid and addition of PFS.

Regulatory Update: EML is working with CBI but it is confidential and they cannot disclose – so no news.  However, they note costs of up to $2m in FY21 are expected on legal and professional advice, with no indication at this stage on an FY22 financial impact.

They previously reiterated full year guidance except for regulatory issues, so it looks like we can knock 2m off the bottom line of the below guidance, but they look to be on track otherwise:

·         Rev 180-190m

·         EBITDA 50-54m

·         NPATA 30-33.5m

·         EBITDA per share 13.8-15.0c

EML has updated the market regarding the regulatory concerns that triggered the trading halt.  A very large drop in price on opening is indicative, details attached, but it leaves a lot of unanswered questions.

In essence it’s PFS Irish subsidiary which handles European operations has had Anti-Money Laundering / Counter Terrorism Financing issues

What is at stake:

“During the period from 1 January 2021 to 31 March 2021, EML estimates that approximately 27% of EML’s global consolidated revenue (unaudited) derived from programs operating under PCSIL’s Irish authorisation.”

Guidance outside of legal costs and possible fines to do with this remains unchanged.

If you own or are thinking of owning EML, the Ausbiz interview with the CEO is 13 minutes well spent on the Sentenial acquisition and the business in general:

Ausbiz EML CEO Tom Cregan Interview 13min

EML has just announce the acquisition of Sentenial group, for around $170m (A$110m upfront, A$60m earnout) which will add A$70b in GDV to the current A$20b but at much lower rates (around 16 basis points Vs 90 basis points for current EML business), but stronger gross margins at 90% Vs current 70%. By Fy23, assuming the full earn-out is achieved the total purchase price would be €110 million, representing a revenue multiple of less than 3 times at projected growth rates.

The Sentenial acquisition add’s two new business lines to EML, further expanding it’s offering and diversifying the business, setting it up for to be a full service international payments solution provider as open banking grows internationally. These business lines which add to the current General Purpose Reloadable (GPR), Gift & Incentive (G&I) and Virtual Account Numbers (VAN) are:

SENTENIAL: provides direct debit, credit transfers and instant payments for major European banks with annual volumes of more than €45 billion (A$70b) in Calendar Year (CY) 2020. Sentenial provides the software platform through a Software-as-a-Service (SaaS) revenue model with charges for access to the platform, as such the yield is low, at circa 1-2 basis points (bps).

NUAPAY: an Open Banking product with A2A capabilities which in CY20 processed volumes of more than €700 million. Nuapay typically provides regulated services using Payment Institution licences issued by the Financial Conduct Authority (FCA), UK and L'Autorité de contrôle prudentiel et de résolution (ACPR), France and generates higher yields of circa 10-50 bps.

I see this additional product and geographic expansion as a good deal at a good price, offering significant opportunities for EML to sell Sentenial product into markets EML is in but Sentenial isn’t and cross sell or offer a full solution to new and existing customers.  My current valuation of $9.71 will need updating, but I expect it to be a solid upward revision and the market response today of a 10% lift in price suggests the consensus is that this is a value accretive deal.

Valuation detail for EML, see report for full reasoning