- Industry dynamics, outlook and ROC mean the price is fair
- Consoloditation of European payment industry could boost growth
- Risks include disruptive technology and payroll size
- Nets should outperform the overall equity market over the next 3 years
Nets' home market, Denmark, is a dynamic, digitised and innovative economy. Photo: iStock
By Peter Garnry
Nets upcoming IPO is an interesting opportunity for investors who want exposure to the growing adoption of payment processes in our expanding digitised economy. The valuation is fair at the mid price of DKK 145 given the industry dynamics, the outlook and return on capital.
Nets, the Danish-based payment solution provider, offer a wide range of solutions spanning merchant offerings, clearing, payments, card solutions and e-Security. The three main business segments (Merchants, Financial & Network Services, Corporate Services) are well balanced in terms of contribution to total revenue which is in general an attractive feature for any company.
Nets' industry is generally characterised by robust organic growth as retail sales grow and electronic payments penetrate a higher share of total purchasing. Although not a perfect peer group the Bloomberg North America Payment Index gives a good idea of the historical return to shareholders in companies related to payment processes. As the chart below shows, performance has been good. The total return including reinvesting dividends is 14.3% annualised compared to 7.6% annualised for the S&P 500 translating into 6.7% annualised alpha since August 2005.
Bloomberg North America Payment Index since August 2005
Past performance is not an indication of future performance.
The biggest risks for investors are...
- Increasing competition on payments with potential disruption coming from blockchain technology or a big technology player in Silicon Valley.
- Number of employees have been reduced ahead of the IPO without any prior evidence of this type of scaling resources. There is definitely a risk that EBITDA margin could come under short-term pressure the first year if the layoffs were only temporary.
In the IPO prospectus Nets is offering new and existing shares in the period September 13–26 with the expectation of first trading being on September 27. The shares are being offered in the price range DKK 130–160. At the mid price Nets is issuing 37,931,035 new shares taking the number of outstanding shares to 200,000,000 translating into a market value of DKK 29 billion at the mid price. Existing shareholders expect to offer 67,068,965 existing shares at the mid price. If the underwriters exercise their underwriter option of 15,750,000 the total free float in the secondary market will be around 60.4%
Over the last 12 months Nets has generated DKK 9.54 billion in revenue and DKK 1.86 billion in EBITDA (after one-off items). Despite management does everything it can to promote EBITDA before extraordinary items they are so recurring in nature that we go with the unadjusted EBITDA which is also most conservative from a valuation perspective.
The expected net debt at the mid price is expected to be around DKK 3.43 billion leading to an expected enterprise value of DKK 32.4 billion immediately after the IPO. This translates into a trailing EV/EBITDA of 17.5 compared to 10.4 for STOXX 600 or a 68% valuation premium to the general equity market. Is this steep valuation justified?
Nets generated 16.1% return on average equity over the past 12 months. Compared to our estimated cost of capital of around 5% the company delivers a solid profit spread justifying the price-to-book ratio around 3.3 on the IPO data based on the mid price. There are 155 companies in the STOXX 600 Index that generate between 12-20% return on equity. This universe of companies are priced with a median value on price-to-book ratio of 3.02, so the overall valuation at the mid price looks fair. Even at the high end of the price range the numbers add up.
The European payment industry is still fragmented so future consolidation could drive economies of scale and higher return on capital adding meaningful to stock performance going forward.
Based on the numbers we have seen and our view on the industry we believe investors have good industry visibility over the coming three years. Given the return on capital and fair valuation we believe Nets will outperform the overall equity market over the next three years. In addition we believe the stock has interesting downside features should be get a sizable setback in the economy and equity market because the industry is rather resilient to economic shocks.
– Edited by Clare MacCarthy
Peter Garnry is head of equity strategy at Saxo Bank