James Faulkner’s Small Cap of the Week: Optimal Payments

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In its earlier incarnation as NETELLER, Optimal Payments (OPAY) was forced to withdraw from the US eWallet market, to the ire of shareholders. However, it has repositioned itself as a provider of online payment services, with a particularly strong presence in the fast growing Asian markets and a recently established bridgehead back into the US. I first tipped Optimal Payments (OPAY) back on the old WatsHot site when the shares were trading at just 87p, but a lot has happened since then and it is time to reappraise the investment case.

Optimal Payments

The company was originally founded in 1999 as NETELLER, when the advent of internet commerce prompted it to launch its eWallet, a secure online payment service for consumers that also offers 100% payment indemnification to merchants. A listing on AIM followed in April 2004, and in October 2005 NETELLER bought Netbanx, a UK payment service provider (PSP). In 2006, the company entered the Asian market with the launch of NETBANX Asia payment processing services. However, NETELLER was caught with its pants down in 2006 when the US introduced the Unlawful Internet Gambling Enforcement Act (UIGEA), which banned processing of payments related to illegal online gambling; the firm’s withdrawal from the US eWallet market followed in 2007.

To reflect the new focus of the group (and to distract attention from a bombed-out share price), the company changed its name to NEOVIA in 2008. In January 2011, NEOVIA acquired Optimal Payments, a Canadian-based PSP, and in February 2011 changed the company’s name to Optimal Payments.

The group currently operates through two business segments – Stored Value, which comprises the NETELLER eWallet and the Net+ prepaid Mastercard; and STP (straight through processing) which comprises the NETBANX gateway and bureau services.

In STP, revenue growth depends on winning new customers while retaining the existing customer base. In Stored Value, the focus is on stimulating higher levels of customer activity, while extending the use of the eWallet outside of the online gaming market by offering a white label version to retailers. Stored Value also holds the wildcard of a potential re-entry into the US online gaming market, depending on the regulatory climate. Aside from volume-related processing and bad debt costs, now that integration is complete the group has a relatively fixed cost base, meaning that any material growth in revenues should have a significant impact on the bottom line.

* forecasts prior to acquisitions.

One of the reasons I was initially attracted to Optimal was its scalability. One obvious way that scale can be built quickly is through acquisitions, so I was interested to see what the company had up its sleeve when it announced the acquisition of Meritus Payment Solutions on Tuesday. Meritus is a payments platform provider for US based merchants, so this is clearly a move to help diversify the group away from the online gambling market.

Founded in 2008 and based in California, Meritus currently processes more than $3 billion+ annually in transaction volumes, mostly focused on small & medium sized merchants and the card not present (CNP) market. It also brings with it a streamlined merchant boarding process and strong partnerships with leading US acquiring banks, giving Optimal a strong base to build from in the US. So the overall strategic view looks great. What about the numbers?

At first impressions, this is a very expensive deal. Meritus only made a pre-tax profit of $1.1 million in 2013, versus a takeout price of $210 million. Even working on an EBITDA multiple the deal still looks expensive at 16.1x EBITDA. However, I wasn’t concerned for long, as it became clear that the potential upside from this deal is huge.

Meritus almost doubled revenues in 2013 and more than doubled EBITDA. Moreover, reported profits were artificially subdued during Meritus’ time as a private company as the majority of profits were paid out as cash bonuses. Throw in the prospect of synergies and cost reductions through integrating Meritus with Optimal’s existing US business, along with the inherent operational gearing of this type of business, and I think that this deal could start to look a lot cheaper rather quickly. In any case, one of the attractions of Optimal has always been that it is a highly cash generative business, with net operating cashflow of more than $93 million having been thrown off in 2013. In this context, the deal looks easily digestible from a financial point of view.

The fact that Optimal chose to step up its US presence in California is particularly interesting, as that largest, wealthiest and most populous of all US states could be about to legalise online poker. Estimates vary widely, but the Senate committee believes there are an estimated 750,000 to 1 million online poker players in California, and the number is likely to increase with legalisation. Time will tell whether or not this move will prove prescient, but the opening up of such a huge market for Optimal’s products surely wouldn’t do the share price any harm.


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