Wirecard WDI GY
April 01, 2010 - 11:11am EST by
cgnlm995
2010 2011
Price: 6.35 EPS $0.48 $0.59
Shares Out. (in M): 102 P/E 13.2x 10.8x
Market Cap (in $M): 635 P/FCF 12.8x 9.7x
Net Debt (in $M): -46 EBIT 57 71
TEV ($): 606 TEV/EBIT 10.6x 8.6x

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Description

Wirecard (WDI.GR - €6.35)

Wirecard offers an extremely compelling opportunity to purchase shares in the "Paypal of Europe", a 30%+ sustainable annual top-line grower in all economic climates, generating return on invested capital in excess of 40% per annum, with a seemingly endless runway for unfettered growth for just 8X forward year free cash flow (net cash balance sheet). We estimate Wirecard to be worth 300% more than where it is currently trading today.  Wirecard is led by a best-in-class and highly incentivized entrepreneurial management team which owns 10% of the shares, and has material incentive upon a change of control event, a fate which we deem highly likely in the medium term. We believe Wirecard is a sitting duck consolidation target for multiple large companies coveting its impressive position in the European e-commerce space. A recent dramatic sell-off of over 50% since unfounded legal concerns surfaced refocused us on the opportunity. After careful diligence, we concluded that the issue in question (described in detail below) had absolutely no bearing on the economic value of the company and therefore provides an exceptionally attractive entry point. Since its IPO, we have followed Wirecard closely given its strength of business model, phenomenal scope for growth, excellent market position and extraordinary returns profile, but our unwavering focus on valuation and lack of apparent market dislocation kept us on the sidelines until now. 

Business Description

Based in Germany, Wirecard is a provider of technology services for electronic payment and payment risk management. The Company is considered a Payment Service Provider (PSP), which provides software and support to online merchants for secure and instantaneous processing online payment transactions. Wirecard employs 400 people and has roughly 10,000 corporate customers largely from businesses that have a significant presence on the Internet like Tourism, Digital Goods and Consumer Goods. More than 90% of its revenues are generated in Europe. Wirecard has also started offering acquiring bank services to corporate customers and virtual credit cards to individual consumers through the banking license it acquired in 2006. 

Reasons for Dramatic Sell-Off

In mid-February, a criminal complaint was filed against a Michael Schuett, a German National with residence in Florida, for creating and managing an illegal site that enabled US citizens to play online poker in Europe. Schuett setup several hundred businesses in Florida and effectively used a handful of these businesses to wire money to and from the gaming participants. Wirecard is one of a dozen or so banks (he had 40 accounts with BofA, several with Wachovia, RBC, BB&T, etc.) mentioned in the complaint. NO charges have been filed against any of the institutions nor is Wirecard suspected of any wrongdoing (nor is any other bank). The CEO estimates that Wirecard received maybe €500 from this customer from wiring fees. However, rumors from 1-2 hedge funds rapidly circulated and a brief panic began with the shares falling 14% in less than two weeks. A couple large shareholders in Paris rapidly liquidated their positions in the market with volumes trading at 9x the daily average ($45mm vs. $5mm average), as the sellside community began to write about the issue. After speaking with the CEO, reading the complaint, discussing the issue at length with people who have been following the stock for years, and examining a similar situation that occurred in 2008, we took just over a 5% position.

 

Then the shares fell an incremental 22% in two days. On March 29, the stock traded higher throughout the day until about 15 minutes left in the session when the stock fell 4% immediately. Two hours later a website unbeknownst to the sellside community or management called GoMoPa.net alleged that Mr. Schütt claimed that he was instructed by Wirecard board member Rüdiger Trautmann and CEO Dr. Markus Braun to engage in his money laundering scheme, and cited the local Naples News - the Floridian paper reporting on the case. Despite zero incentive to do so (this was a small-time operation, Wirecard made <€500 on wiring fees, the CEO owns 8% of a high-quality business with multi-year visibility, etc.), French and UK investors panicked, and the stock sold off >30% intraday. We began purchasing at the lows after speaking with analysts, combing through the articles (ZERO mention of Wirecard in any Naples News article citing the case), and speaking with the CEO. We added ~4% to the position. The CEO explained that Wirecard lawyers spoke with Mr. Schütt's attorney who affirmed that Mr. Schütt had made no accusations against Wirecard. Wirecard lawyers spoke with the Naples News reporter assigned to the case, who was also oblivious to any accusations made against Wirecard. The Wirecard CEO believes that somebody was interested in creating a panic given the price action minutes before the close on March 29, the website rubbish hours later and then reports of an anonymous complaint filed with the Munich authorities that has not been made public hours after that. The Company is pursuing legal action against the website and intends to find and prosecute the libelous perpetrator. Unsurprisingly, the CEO explained that there had been no impact to the business from these rumors, and affirmed the strength in fundamentals for 2009 and 2010 (8x 2011 free cash flow for the Paypal of Europe in a less penetrated market!). By the end of the day, the CEO released a public statement aggressively repudiating the allegations.

 

This is not unprecedented for Wirecard. In mid-2008, the Company was subject to rumors concerning aggressive accounting practices, resulting from a lack of disclosure surrounding the Company's balance sheet, the Bank's sales revenue and the payment processing business. There were also rumors that the retired Chairman, Klaus Rehnig, was selling his shares. None of these rumors bore fruit, but the shares fell from €10.75 to €3.50 in just two months. The Company responded effectively by publicly addressing the rumors as false, affirming legal action against the perpetrators/manipulators, significantly improving disclosure in the following quarter, which included segmenting Bank revenues into three buckets, AND hiring Ernst & Young to complete a double audit. As a result, the shares began to rebound were trending quite well until February of this year (from €10.18 to €6.30). Meanwhile, cash earnings will have doubled from 2007 to 2009. 

Entry Barriers

Scale, reputation, operating history, switching costs and leading technology provide barriers to entry, and in particular, barriers to success in the PSP industry. Risk management and fraud detection for e-commerce payments are relatively sophisticated technical activities that have been mastered by Wirecard over seven years. Payment approval processes need to react within a fraction of a second and analyze the transaction for the probability of fraud. If a fraudulent transaction is let through, the payment can be charged back to the merchant. Hence, the payment service provider needs to have a reliable real-time solution that has been proven especially for large volumes. While a new software player could acquire the know-how to compete with an incumbent PSP, it would take material time and capital investment to achieve an important position in the market. The Company has made meaningful investments in R&D over the past ten years, which have made Wirecard capable of offering its clients the reliability, efficiency, and security, which have resulted in almost zero churn. Additionally, Wirecard is able to offer its customers a very sophisticated degree of functionality in number of forms of payment accepted, which is a key differentiator amongst its competitors and new entrants. The number of payment methods accepted by an online merchant has been shown to meaningfully enhance a retailers likelihood of making a sale. Therefore we believe Wirecard's technical and process know-how required for automated real-time order screening represent a major barrier to entry. 

Diversification

Wirecard has a relative small client base of over 7,000 mostly midsized merchants, although concentration risk appears low with the largest accounting for less than 2% of sales. The company appears to have limited dependence on any single client industry. Wirecard's exposure to (non-US) online gambling is reasonably balanced, estimated at 15-20% of transactions, or 5-10% of revenues (unlike other listed peers whose business models have been questioned and valuations punished for their high exposure to online gambling). 

Channel Sales

Wirecard employs both direct and indirect channels to grow its merchant customer base. Its sales force primarily targets key accounts in highly invoiced industries like Tourism and the Internet. One of the means of approaching customers is through trade fairs and industry events. Wirecard also works with various business partners (on both direct and indirect basis) to expand its network in Europe and Asia. Wirecard may engage with other firms as a processing partner or as an acquiring bank. Using its virtual credit card technology, Wirecard is able to offer a product that facilitates payments to partners, component suppliers and agents working on a commission basis. The product is primarily focused on the Travel & Tourism sector, and GE Capital is the main competitor in the space. 

Bank license

Wirecard's portfolio of services and products has been considerably enhanced by the acquisition in early 2006 of a full EEA banking license (via XCOM Bank). The deal allows the company to settle (acquiring bank) card transactions for which it earns a further fee, which it would have previously paid away. As merchant accounts do not pay interest, Wirecard is also able to earn interest revenue on client balances. The migration of existing and future PSP clients to the acquiring bank service has helped to offset fee pressure and maintain robust consolidated margins. Very few players are able to provide an integrated approach (offering both PSP and merchant account services). In a typical internet transaction, the merchant pays ~3% of transaction value for payment processing. Out of this, 125 to 150 bps go to the issuing bank, ~75 bps go to the acquiring bank and 75 to 100 bps are retained by the PSP. Hence, Wirecard now has the opportunity to keep the acquiring bank fee post the acquisition of XCOM. Wirecard has been pitching its services as an acquiring bank to its PSP customer base and it had recently achieved a penetration greater than 80% of its customer base. According to the company 90% of new customers are buying acquiring services as well. Apart from the additional revenue opportunity, the ability to serve as both PSP and acquiring bank makes Wirecard a one-stop internet payment solution, giving it competitive advantage and some degree of pricing protection, in our view. Further, Wirecard also generates some interest income on customer deposits. Note that Wirecard does not extend credit to its banking customers and hence has no credit risk. 

Margins

Despite concerns about processing fee margin pressure, the Company has a high degree of visibility on both revenues and costs. Fees are set using a sliding scale based on the client's transaction volumes. If the volumes subsequently fall below the agreed level, the fees are adjusted to compensate. The main cost positions are usually charged on a per-transaction basis, making the business model highly scaleable. Germany and Europe account for about 90% of revenues, meaning currency risk is negligible. The company is highly cash generative due to low capital intensity, negative working capital requirement (WCR), and holds net cash on the balance sheet. 

Market Size and Growth

Wirecard is a strong structural grower due to an increasing trend towards e-commerce especially in Europe where Wirecard sources the majority of its revenues (90%+). Market Research from various firms indicates that European online spending will continue to grow at 20%+ for the coming several years as broadband penetration expands and retailers continue to transition their business to the higher margin online channel. In addition, outsourcing provides a second overlay of growth; large online retailers are increasingly outsourcing their payment processing due to the growing internationality of technological standards and regulations. While market share data is hard to come by, the European PSP space is highly fragmented with a number of small players operating in each country. We believe that Wirecard's size makes it the industry leader in Europe; this strong customer portfolio provides a distinct edge over competition in winning new mandates, and we expect Wirecard to win the majority of incremental outsourcing business from online retailers. 

Long Merits

Valuation: Despite 2009 ROIC of 37%, 15-30% sustainable top-line and 20-30% bottom-line growth, Wirecard trades at <9x 2011 P/E. The shares trade at 8x EV/NOPAT and 8x 2011 free cash flow.

Clear Market Dislocation: The market misses two important factors that will drive significant share price appreciation in 2010 and beyond. As a result of the smear campaign described in detail above (Reasons for Dramatic Sell-off), we have the opportunity to buy the shares down 38% from their January highs. The second dislocation will prove itself out over the coming quarters.

     

  • Analysts incorrectly forecast that the margin pressure seen in the payment processing division will lead to structurally lower margins for the business going forward. As Wirecard grows, it continually adds larger and larger clients (merchants). These clients receive superior economics to their smaller peers, because of the scale they offer to Wirecard. There is no disputing that this has occurred as witnessed by PP&M margins declining by 19% to 16% over the past 9 quarters. However, over this time, consolidated margins have actually INCREASED by 60bps as a result of the positive mix-shift that is occurring in the business. Wirecard Bank EBIT grew by ~250% from 2007-2009 and will account for ~37% of total EBIT in 2009 versus 19% in 2007. With margins of ~30% vs. PP&M margins of 16.5%, it is fairly easy to see how margins will continue to expand as the positive mix shift continues and the bank achieves greater scale.
  •  

     

  • Management Quality: CEO Dr. Markus Braun has overseen Wirecard's development since early 2002 when the company generated <€3mm of sales and lost €5mm of net income. In 2009, Wirecard will generate >€30mm of sales and nearly €0mm of net income. Before joining Wirecard, Braun worked more than three years as a Project Manager with KPMG Consulting AG. Prior to this, he was senior consultant with Contrast Management Consulting GmbH. Braun owns 8% of the Company and receives a significant portion of a 3-installment 2% royalty if the Company is sold with an EV between €00mm-€bn.
  •  

     

  • Growth: Structural trends will provide 7-10 years of double-digit top-line growth for Wirecard. These drivers include:

       

    • Broadband penetration: 25-35% in developed Europe (OECD), 25% in the US (OECD) and 25% in China (CNNIC).
    •  

       

    • E-Commerce penetration: 33% of all Internet users in the EU purchased at least one item online (EU Commission). This being said, in Western Europe, just 5% of consumer spending occurs over the internet.
    •  

       

    • Credit card penetration: In Germany, just 26% of shoppers currently prefer to use credit cards. In China, the number is closer to 5% (Forrester).
    •  

       

    • Allocation of consumer resources: activities are moving increasingly towards the internet (gaming, gambling, music, video, dating, social networks, adult entertainment)
    •  

       

    • Outsourcing of payment processes: Payment processing is becoming increasingly complex due to the growing internationality of technological standards and regulations. As a result, companies will increasingly outsource payment processes to specialized providers.
    •  

       

    • Wirecard Bank will continue to drive significant growth for Wirecard as the subsidiary continues to effectively cross-sell its services to existing and new clients, issues credit cards and provides unique and innovative payment solutions (vouchers/prepaid cards).
    • Industry growth of 15-30% through 2012 and 20-30% long-term EBIT growth for Wirecard
  •  

  • Business Quality: This appears to be a very strong business with high barriers to entry reflected by 37% ROIC (and rapidly accreting) and 25% margins. Wirecard's PP&M systems partake in nearly every part of the transaction chain from P.O.S. to credit and risk management checks, reflecting high switching costs. Additionally, Wirecard owns a number of patents, protecting the importance of its technology and systems where R&D accounts for ~20% of staff. Clients value the reliability and efficiency of an automated order screening service, which helps cut fraudulent transactions and pushes down prevention costs (manual order review is costly for merchants). Functionality is also extremely important and with 85 different payment methods accepted, Wirecard continues to take share from single state focused, inflexible competitors. Additionally, with over 10,000 customers, a fragmented/diversified customer base provides a good degree of revenue stability (no customer accounts for even 2% of sales). Wirecard's bank license permits significant cross-selling to customers where there is no major European payment processor with such an integrated payment- product solution (one-stop-shop).
  •  

  • Inflation hedge: Wirecard benefits from rising rates as its deposit base grows. A combination of growing deposits and rising yields could greatly enhance earnings (est. €.2mm in 2009 versus €.4mm in 2008 despite 31% deposit growth, as the net interest margin declined to 0.9% from 3%).
  •  

  • Takeout Candidate: This Company would be a logical acquisition target for private equity (FDC purchase by KKR), Google, Amazon, or Ebay/Paypal. Wirecard is the Paypal of Europe trading at <11x 2011 P/E with >20% EBIT growth and >25% of its market cap in net cash (about 30% of that is completely free as the bank requires cash reserves). There have been dozens of deals in this space over the past 10 years with average EV/Sales multiples of 5x (implies 100% upside), EV/EBITDA of 16.5x (>75% upside) and 22x EBIT (>100% upside). Additionally, management is clearly incentivized to sell the company given the 2% royalty provision as well as significant insider ownership.
  •  

 Long Risks Catalysts

 

  • Competition

       

    • Direct: US based CyberSource and UK based DataCash are two notable competitors, but neither has a banking license. CyberSource is about 20% smaller than Wirecard with a much more significant focus in the US (<8% of sales in Europe). Margins are comparable. DataCash is <20% the size of Wirecard with higher margins and more of a UK focus.
    •  

    • New liberalization laws/regulations could push smaller, nationally-focused players to attempt to expand beyond their borders (SEPA - Single European Payments Area and PSD - Payment Service Directive).
    •  

    • Indirect: Disintermediation from alternative payment schemes like Ebay's PayPal, Amazon's FPS and Google's Checkout could occur.
    •  

    • Regulatory change: Online gambling accounts for >20% of Wirecard's sales. While some countries have moved towards liberalization (France and Italy recently passed laws legitimizing the practice), others could propose potentially damaging legislation or regulation on the industry.
    •  

  • Wirecard (WDI GR)

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    €in mm, FYE Dec-

    2007

    2008

    2009E

    2010E

    2011E

    2012E

     

     

     

     

     

     

     

    Revenues

     

    138

    201

    233

    285

    353

    442

     

     

     

     

     

    Organic Growth

    66.3%

    45.7%

    15.9%

    22.3%

    24.0%

    25.0%

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    EBITDA

     

    35

    52

    61

    75

    93

    118

     

     

     

     

     

     

     

    Margin

     

    25.4%

    25.9%

    26.2%

    26.2%

    26.4%

    26.6%

     

     

     

     

     

     

     

    D&A (excl. goodwill)

    (2)

    (3)

    (4)

    (4)

    (5)

    (5)

     

     

     

     

     

     

     

    Total EBIT

     

    33

    49

    57

    71

    88

    113

     

    Peer Multiples

    P/E

    EV/EBITDA

    Margin

     

    23.9%

    24.4%

    24.5%

    24.8%

    25.0%

    25.5%

     

     

     

    2010

    2011

    2010

    2011

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    EBITDA

     

    35

    52

    61

    75

    93

    118

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Interest Expense

    (3)

    (1)

    2

    3

    3

    5

     

    Cybersource

     

    19.2x

    17.5x

    17.4x

    14.6x

    EBT

     

    30

    48

    59

    74

    92

    118

     

    Datacash

     

    13.1x

    11.3x

    8.1x

    7.2x

    Taxes

     

    (5)

    (9)

    (11)

    (13)

    (17)

    (21)

     

    Visa

     

    19.8x

    17.2x

    11.5x

    9.8x

    Rate

     

    18%

    18%

    18%

    18%

    18%

    18%

     

    Mastercard

     

    18.8x

    15.7x

    10.6x

    9.0x

    Minority Interests

    0

    0

    0

    0

    0

    0

     

    Peer Average

     

    17.7x

    15.4x

    11.9x

    10.2x

    Norm. Net Income

    25

    39

    48

    60

    75

    97

     

     

     

     

     

     

     

    Average Shares Out.

    102

    102

    102

    102

    102

    103

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    WDI GR

     

     

     

     

     

    EPS

     

    0.24

    0.39

    0.48

    0.59

    0.74

    0.94

     

     

     

     

     

     

     

    Cash EPS

     

    0.24

    0.39

    0.48

    0.59

    0.74

    0.94

     

    Sellside

     

    10.7x

    9.1x

    8.1x

    6.9x

    Growth

     

    51.1%

    60.0%

    22.9%

    24.9%

    24.0%

    27.8%

     

    Internal

     

    10.8x

    8.7x

    8.1x

    6.5x

     

     

     

     

     

     

     

     

     

     

    NOPAT

     

    41

    61

    72

    88

    110

    139

     

     

     

     

     

     

     

    Total Debt

    7

    12

    (5)

    (46)

    (89)

    (143)

    (212)

     

     

     

     

     

     

     

    Total Equity

    108

    164

    207

    237

    285

    346

    423

     

     

     

     

     

     

     

    Capital Employed

    115

    176

    202

    191

    196

    203

    211

     

     

     

     

     

     

     

    ROCE

     

    28.4%

    32.5%

    36.6%

    45.5%

    55.1%

    67.1%

     

    Premium to Peers

    -39%

    -44%

    -32%

    -36%

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Cash Flow

     

    2007

    2008

    2009E

    2010E

    2011E

    2012E

     

    Market Stats

     

     

    Intrinsic Value

     

    Net Income

     

    25

    39

    48

    60

    75

    97

     

    Current Price

    6.40

    Incremental ROIC

    110%

    add: D&A (excl goodwill)

    2

    3

    4

    4

    5

    5

     

    Market Cap

     

    652

    Growth

     

    20.0%

    less: Capex

     

    (21)

    (13)

    (7)

    (8)

    (10)

    (12)

     

    Net Debt (Cash)

    (46)

    Norm. NOPAT

    92

    add: Other

     

    96

    (1)

    7

    9

    11

    13

     

    Enterprise Value

    606

    Fair Multiple

    20.0x

    Total FCF

     

    102

    28

    52

    65

    81

    103

     

    Dividend Yield

    1.9%

    Fair EV

     

    1,845

    Total FCFS

     

    1.00

    0.28

    0.51

    0.64

    0.79

    1.00

     

    Mgmt Ownership

    7.6%

    Fair Equity Value

    1,891

    Dividends

     

    0

    0

    (8)

    (12)

    (15)

    (19)

     

     

     

     

     

    Fair Value per Share

    18.58

    Acquisitions

    0

    (23)

    (2)

    (10)

    (12)

    (14)

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

     

    Catalyst

    Quarterly earnings - April 15

    Increased communication regarding irrelevant criminal complaint

    Takeout

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