Ingenico,
Pax,
and the payments industry.
By Manuel Maurício
December 18, 2020
Introduction
As you know, I bought Pax Global for the Portfolio cognizant that I still had a lot to learn about the industry. I’m usually not fond of this strategy because I like to know what I own, but the price was so compelling that I reckoned I should shoot first and ask questions later. That’s what I’ve been doing this week.
The payments industry is a complex one, and it’s rapidly evolving. The number of fin-techs and payment solutions is growing by the day and the risk of technological obsolescence is high. This is clearly not the pond where I usually fish in.
To understand the competitive landscape I decided to look at Ingenico, but then I learned so many things and these companies are so intertwined that I ended up writing an hybrid on Pax, Ingenico, and the Payments Industry.
If you’re new to the Pax Global story, I recommend you to read my previous articles on HERE.
Let’s start with a brief explanation of who does what in the payments ecosystem.
What happens when you pay with your card!
I’ll explain this as if you were 3 years old. I’m not suggesting that you’re a slow learner. I’m the slow learner here! That’s why I want to explain it slowly so I can cement the knowledge that I’ve just gathered.
The first thing we’ve got to understand is the Point-of-Sales device (POS) or Terminal. This is the machine that reads the card when you pay at a store or restaurant. This is what Pax and Ingenico and Verifone (the 3 largest players) do.
These terminals come in all shapes and forms, some are wireless, others are bulky, and others look like a smartphone. In recent years the Android powered terminals have been highly sought after due to the easiness of usage and integration with other software. With the pandemic, the shift to contactless terminals has also been accelerated.
Now, for what happens when someone pays via one of these terminals. When a customer – the CARDHOLDER – enters a store…
..he pays the MERCHANT with his debit or credit card. The MERCHANT is the business, the shop, the restaurant, the retailer…
That MERCHANT has an agreement with its bank, the ACQUIRER. The Bank is called the Acquirer because it’s the bank that usually acquires the merchants.
Through that agreement, the ACQUIRER leases, (or gives away for free) the actual terminal.
That terminal is bought by the ACQUIRER from companies like PAX, Ingenico or Verifone.
The payment request then goes through the Card Association (Visa, Mastercard)…
Until it reaches the CARD ISSUER, the customers bank.
The CARD ISSUER will then give the OK or NO OK depending on the funds available to the customer. That information will then go all the way back until it reaches the terminal again.
All of this happens in an instant. Just think about how this was done before the internet. Merchants would literally pick up the phone to call their banks who would then call the CARD ISSUER BANK to see if the customer had the money. This could take hours.
*Note that, in some cases, because of the scale of some MERCHANTS (think big retail chains), there might not be an Acquirer mediating the payments. Those Merchants can go directly to PAX or Ingenico looking for custom made solutions.
Pax Global vs Ingenico
With an installed base of 30 Million terminals around the world and a global market share of 37%, Ingenico is the world leader in the sale of the terminals.
Now let’s look at both and see what we can find.
Note that because Ingenico earns revenue from businesses other than the sale and maintenance of terminals, ideally we should be looking at the metrics for the terminals business alone.
Unfortunately the company doesn’t separate all the metrics on a segmented basis, so some of the metrics below may not be completely comparable, but I’ll do my best to be comparing apples to apples.
The first thing that I’ll want to know is the relative size of both companies. If we measure it by revenue, it’s clear that Ingenico is almost three times the size of Pax.
But it’s also clear that Pax has been growing much faster.
It’s astonishing how Pax has been able to grow its revenue during the pandemic while Ingenico has seen its revenue drop by 12%.
A little bit of history is deserved at this stage:
Around 2016, due to lax regulation in China, the Chinese market became overflown by cheap terminals. This can be seen very well in the image below where the yellow bars, representing the revenue from China for Pax, start to go down.
This is also when the CFO had a nervous attack and expelled the only analyst that had given the company a Sell rating. Not a pleasant episode.
The company was growing pretty rapidly and expectations were high. And we know what happens to the share price when high expectations are unmet.
All of this was also reflected in the margins…
Margin Analysis
For starters, the gross margin that had been going up nicely started to come down right about that time. Today, the company has overcome that burden and the business coming from China (with low margins) represents just a tiny fraction of the total sales, (meaning higher margins).
Going forward, I believe that we’ll see even higher margins. You see, first the company has been investing heavily in R&D (new terminals and Android based software) which will slowly decrease as a percentage of revenue. And second, those new products are higher margin.
The next thing I’ll want to be looking at is the Expense Ratio. The Expense Ratio is the ratio obtained by dividing the operating costs by the revenue. This will tell us which company runs its business in the most optimized way. The lower the ratio, the better. (I could be looking at the Operating Margin, but I think that the Expense Ratio is probably a purer metric).
And as we can see, Pax has been running its operations in the leanest manner. It’s also apparent that when Pax decided to focus on the overseas market after the China debacle, it had to ramp up its costs, especially the R&D expenses and personnel.
This all leads to the Net Margin. Here, Pax clearly stands out, not only because it runs its operations better, but also because it has no debt, thus no interest expense.
Efficiency Ratios
We’ve looked at the margins to see the profitability of the businesses, but now let’s look at a different set of metrics.
If we look at the Efficiency Ratios for both companies, we notice that Ingenico is much more efficient than Pax. Ingenico’s Cash-Conversion-Cycle will be 50 days in 2020 whereas for Pax it will be 94 days. This means that Pax takes about twice the time to transform its cash in new cash.
This happens due to a combination of 3 factors (see table above), the most important one, I would say, is the difference between the inventory carried be each company. While Pax holds inventory that it could sell in 142 days, Ingenico holds inventory for 31 days.
This isn’t a problem per se. It could become a problem if Pax had to raise debt to fund all that inventory and if, while the inventory sits in the warehouses, it became obsolete. This hasn’t been the case. The company has no debt whatsoever and there have been no material inventory write-offs.
So why the difference? First of all, Pax’s customers are concentrated in developing countries, mostly Brasil. The payment terms there are more relaxed. But this doesn’t explain the high inventories. Some analysts say that this happens because of the specificity of developing countries, but I’m not entirely convinced.
I’ve emailed the company asking about this.
3 Players and industry consolidation
Ok, so we’ve seen what goes on when we pay something with our cards, and we have compared the most relevant financial metrics for both companies. But this tells us very little about the business and the industry.
My first assessment when I looked at Pax Global was that the business was condemned to vanish just like Blockbuster or Kodak. I still believe that if the company doesn’t evolve, that’s the most likely outcome.
But what exactly do I know about the industry and the competitive landscape? I’ve been researching it for the entire week and I feel I’ve just scratched the surface.
You see, with the advent of e-commerce, could computing, and other technological progress, the payments industry is rapidly evolving.
For instance, we’ve seen high consolidation with companies merging and acquiring other companies in order to gain scale, clients, and technical know-how.
Ingenico itself was bought this year by one of its clients, an acquirer called Worldline, for €7.8 billion, or a 14x times EBITDA.
In 2018, the private equity firm Francisco Partners bought Verifone for $3.4 billion, or 9x EBITDA.
Immediately after the acquisition, it cut costs, lowering the R&D spend, and reduced its focus on non-core geographies. The result? Some of its former clients are now Pax clients.
The Payments Industry
I was watching one video with the three companies, and the spokeswoman for Pax said that she doesn’t see the terminals vanishing any time soon (at least, not in the US) and she gave the example of how long Americans took to adopt the debit card (20 years).
My opinion is a little different. Some devices will always be needed (think those Mcdonald’s bulky ones), but there’s no doubt in my mind that we’ll be paying directly with our phones through apps in the future. It’s already happening, and it will be more frequent going forward.
And this is exactly what Ingenico understood when it decided to expand into other verticals such as the acquisition and e-commerce.
Until now, Pax has had the foresight to develop the new technologies that are now in demand, contacless, android, and the most recent one is the facial recognition.
The facial recognition still presents some challenges, namely data protection compliance, but there is also no doubt in my mind that it will be the future. Or at least part of it.
Ingenico is further ahead than Pax in relation to services. It understood early on that it had to cover the full payment value chain so it has been acquiring companies on other verticals and it has also understood that it has to invest in software to mitigate the hardware commoditization.
The services is the name of the game to get the clients to stick to the company. If the software is fully integrated with the client’s business and other software (such as CRM), it will be less likely that the client will switch provider.
Ingenico’s service segment already accounts for 20% of the revenue whereas for Pax, it’s just 2%.
Pax seems to have come late to the game, but by sheer luck, it probably isn’t so. Pax couldn’t compete with Ingenico because it didn’t have all the software ecosystem that Ingenico had. It couldn’t offer similar services to Ingenico’s clients.
Pax’s store is still taking the first baby steps, but it’s promissing. You see, Ingenico’s software ecosystem is a closed one just like Apple.
Pax took another route. By opening it to other developers to create new API’s Pax should be able to ramp up API’s much faster than if it were doing it in house.
Today, it seems that the stars are aligned. Because Ingenico was recently bought out by an ACQUIRER, from the banks perspective, Ingenico is becoming a competitor.
Pax’s management team believes that after this move some of Ingenico’s clients will flow to Pax. And now Pax has the software to welcome Ingenico’s clients.
Conclusion
If you ask me if I expect to be holding Pax for many years, the answer is No. At least that’s my current opinion.
Who knows if I’ll change my mind as I learn more about the industry and as the company evolves? If Pax is able to switch to a Software-as-a-Service (SaaS) platform, the current price is just ludicrous.
It’s obvious to me that Pax has to keep evolving if it wants to be around 10 years from now. It’s moat is shallow and narrow. But the management has proven that it has what it takes to do so.
It has made many wise choices in the past, even when that meant enduring some short-term pain. Recently, it has announced that it’s looking for acquisition targets focusing on software so I believe they’re not sleeping at the wheel.
Right now, as the company keeps growing its profits as I expect it to, given all the tailwinds, and as its market cap approaches the $1 Billion mark, more analysts will be able to follow the company and more institutions will be able to buy it. Pax will be kept in the Portfolio.
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