Paypoint: where's the growth?

PayPoint was started in 1996 as a branded retail network for the payment of household bills. It was intended as an alternative to the Post Office – and it's grabbed market share ever since then, adding mobile top-ups and private ATMs to its repertory.

Flotation in 2004 saw the company expanding fast – it was a top tip for growth investors. By 2006 it was growing at 30% a year. Now, it has businesses in the UK, Ireland, and Romania – the latter business having been acquired for £10.5m in 2007.

Is the growth still there? Results for the year to March 2009 show an 8% rise in transaction volumes, with pretax profit up 19% and an increase in the final dividend. But the interim management statement issued in August 2009 makes less impressive reading [ref] Interim management statement: http://www.paypoint.com/PayPoint%20plc%20Interim%20Management%20Statement%20August%202009.aspx [/ref] . Transactions rose only 2% in the period – and revenues declined 11% as the mobile top-ups business declined. That's partly due to the economic downturn, and partly to the fact that mobile operators have been offering more airtime for less money. Fortunately, since mobile is the lowest margin product, net revenues (that is, after paying the cost of airtime and agents' fees) actually increased by 3%. None the less, it has to be said that 3% revenue growth is not the sign of a go-go stock.

PayPoint aims to grow by expanding the terminal estate. This year it said it would add 1500 terminals in the UK and 900 in Romania [ref] Preliminary statement: http://www.stockopedia.com/news/announcement/PAY/090528pay000977.htm [/ref] – that should enable the company to migrate further market share away from the Post Office. It's been particularly successful in signing up multiple retailers like Costcutter and Londis – though a large part of the estate is still represented by small independent convenience stores.

PayPoint claims over 24,000 terminals in the UK and Ireland, with more than 6,000 clients and merchants. That compares with 14,500 Post Offices – a good market positioning. In ATMs, where PayPoint has 2,300 machines, it's a smaller player – Payzone has about 6,000.

Although it's the terminals network that gives the company its market reach, though, its long term growth is more affected by the deals it can strike with major utilities. For instance, in 2006 it managed to convince the BBC to switch the TV licence payments contract from the Post Office, which had handled these payments for 60 years, to PayPoint. British Gas allows customers to pay at either the Post Office or PayPoint – for many customers, PayPoint will be more convenient.

This also helps to create a barrier to entry. PayPoint has spent time and money on supporting equipment such as magnetic swipe cards, smart keys for prepaid meters, and contactless rechargable smart cards for local transport [ref] European CEO: http://www.europeanceo.com/news/finance/payments/article193.html [/ref] . Without the technological investment, other payment companies aren't going to be able to access this business.

PayPoint has improved the diversity of its product offering. The original bill payment network has been joined by mobile top-ups, and the company now has a network of private LINK-branded ATMs.

However, PayPoint doesn't seem to have done so well in online services. Back in 2007 it bought online payment processor SecPay for £12m, which seems expensive for a company that was only making £0.3m in profit. Its internet services don't have anything like the dominance of its 'bricks' side – and in particular, its cash payments for internet shopping service seems rather odd. If you've got internet access, chances are you have a credit card and a bank account – so this presumably is a service to appeal to 13 year olds trying to order booze over the web, or the terminally paranoid who think the internet will steal their credit card number? I'm not really convinced – and the results statements never seem to say very much about this area of the business, so it can't be very big. In fact, the one thing that the interim statement tells us is that gaming merchants are migrating en masse to the lower margin of Paypoint.net's two services – bad news for the P&L.

So, we have a company which appears to be competing in a relatively mature UK market, and has a Romanian business which ought to provide some growth, but is currently making losses [ref] Investors Chronicle, 29 May 2009: http://www.investorschronicle.co.uk/Companies/ByEvent/Results/Analysis/article/20090529/efde7a16-4b6b-11de-832a-0015171400aa/Paypoint-shows-resilience.jsp [/ref] . Let's look at the current trends and forecasts.

PayPoint has probably been helped by high energy prices – household fuel bills have been high, and that boosts its commission – and as utilities bill start to fall again, that could hurt transaction values. At the same time, falling airtime prices seem set to continue. The company is also losing money on a parcels joint venture with Home Delivery Network, called Collect+. These negative trends lead broker WH Ireland to forecast 33.3p earnings, down from 35.6p last year, returning to growth in 2011 [ref] Growth Company Investor, 20 May 2009: http://www.growthcompany.co.uk/recommendations/1048677/paypoint.thtml [/ref] . That puts the company on a PER of 14.2, a tad above the support services sector average of 13x.

It's worth noting that the company pays a dividend, and currently offers a 3.6% yield. It's managed to increase the dividend every year for five years, and it seems likely that management will try to continue that record this year. There was £27m net cash in the balance sheet at the end of Q1 – though £7m of this is client cash, which PayPoint can't touch – and though this is down from £36m at the start of the year, it still gives the company room to pay an increased dividend this year. (In fact one reason for the lower cash total is that the £8m final dividend payment was made during the quarter.)

There are a few rivals to look at – though there are no forecasts publicly available for either of them. E-pay Asia is involved in different markets – mainly mobile top-ups in the Far East. It made a thumping great loss last year; though most of this was due to a goodwill writedown, it's worth noting that the company made a small operating loss, too.

Payzone is another company in trouble. It made a EUR 208m loss last year (to September 2008) and interims showed it still loss-making, though at a reduced level. This company is heavily indebted, and you can get some idea of the shambles it's in from the fact that last year, its shares were suspended as its ex-directors went to court against the new board. PayPoint has said it's not interested in making a bid for the company, which I think has to be good news for PayPoint shareholders – though tough luck for Payzone holders, who saw the shares fall 13% after a bid was ruled out[http://www.independent.ie/business/irish/payzone-shares-tumble-after-takeover-hopes-dismissed-1859810.html [/ref] .

Then there's Cashbox, which looks very similar – it's made a loss for every one of the last four years. It has won a few contracts this year, including managing the Tattershalls and M&B ATM estates – but it looks as if it will take more than a few deals to perk up its performance.

Compared to this bunch of loss-makers, PayPoint looks pretty good. But it still has that premium rating, and it's difficult to see where the growth is going to come from. Currently, it's forecast to bounce back strongly in 2011 – 14x earnings might not be expensive if you're locking in 15% or better growth in earnings that year. But most of that earnings growth, I suspect, is forecast to come from the absence of losses (in Romania and the parcels network) rather than from significant revenue growth. Longer term, getting sustainable growth could be a problem – and if it is, and PayPoint turns out to be a cash cow, 14x is too high. That's certainly what Hoodless Brennan's analysts think [ref] Hoodless Brennan notes: http://proactiveinvestors.co.uk/companies/news/7314/hoodless-brennan-comments-on-paypoint-7314.html [/ref] .

There's another thing has me puzzled, too. Transaction processing ought to be a no-brainer for making money. You set up the terminal network, which does of course have a cost, but once you've done that, your cost of sales should actually be pretty small. The incremental cost of each transaction is minute – so as traffic grows, your profitability should increase dramatically.

That's what the economic theory says – and up till 2007, PayPoint seemed to be putting it into practice. No reason that it couldn't make it work in future, either. But if that's the case, why are all the other payment processors in such a shambles? How come, in a sector that ought to be as cash generative as the Royal Mint, they're all losing money? Until I get an answer to that question that makes sense, I'm going to stay clear of these companies – and that, I think, will include PayPoint.