Mobile Payments promise rich rewards

Mobile devices were used for 34 per cent of the UK’s online retail sales in the first quarter of this year, up from 20 per cent a year earlier, says e-retail research outfit IMRG Capgemini. That trend is set to continue - smartphones could account for £14.2bn in purchases of goods and services in 2018, up from £4.8bn in 2013, according to the Centre for Economic and Business Research.

Other catalysts are fuelling the UK’s mobile revolution. IMRG research reveals that more than two-thirds of 4G users say that faster Internet access encourages them to shop using their smartphones. Unsurprisingly, that has ignited interest from telecoms in the sector. Potential entrants include Vodafone (VOD), Telefónica's O2 and EE, which have already drawn on their combined database of 22m customers to launch targeted-marketing venture 'Weve' last year.

Banks have been unable to resist either. HSBC (HSBA), Lloyds (LLOY) and several others have invested £110m in joint-venture Paym, which will allow 30m UK current account holders to send money to each other simply by utilising the recipient's mobile phone number. And Barclays’ (BARC) Pingit app drove a 150 per cent rise in its mobile banking usage to 2.3m customers last year. But shareholders may have other concerns - the bank's adjusted pre-tax profits fell 5 per cent in its first quarter and 32 per cent last year, reflecting weakness in its investment banking arm as well as restructuring costs.

Mention payments and many people’s first thought is PayPal, online auctioneer eBay’s payment platform. Its growth has outstripped its parent’s to such an extent that activist investor Carl Icahn clamoured for a spin off this year. He believes the stock is “very undervalued”, and given that eBay’s shares trade at 16 times consensus forecast earnings, that's not unreasonable. PayPal's finances support his claim. It achieved record mobile volumes of $27bn (£15.9bn) last year and helped attract 14m mobile customers to eBay. And it recently launched 'PayPal Here' - a mobile payment solution for small businesses - in the UK.

As a whole, eBay's net sales rose 14 per cent to $4.3bn in its first quarter, while adjusted earnings climbed 11 per cent to $899m. One concern for investors - that also hints at the buzz surrounding mobile payments - is that Facebook poached PayPal president David Marcus to lead its messaging products.

Monitise (MONI) might be described as a “pure-play” mobile payments company. Its payment platform is used by banks, retailers, mobile networks and over 28m consumers to securely transfer money. Its first-half sales rose two-thirds to £46.5m, and it reduced its cash losses by 31 per cent to £10.2m. It has also partnered with computing powerhouse IBM, and over 30 Visa Europe banks have signed up to its payment solutions, enabling Visa cardholders to send money to each other using their mobile phones.

But the narrative seems to be changing - Monitise recently raised £109m to fund its shift from a licensing model to a subscription-based one. The strategy should lower its upfront costs and the technical barriers facing clients interested in joining its network, but the downside is slower short-term sales growth and higher capital spending. What has really wrong-footed investors is its purchase of Markco Media - owner of MyVoucherCodes.co.uk - for up to £55m. Monitise bought it to enhance its network and access its partners such as Amazon and Tesco (TSCO), while gaining access to a readymade marketing content platform. But shareholders aren't entirely convinced of the benefits of it owning discount websites.

An alternative exists in the form of Bango (BGO), whose technology is used by mobile operators, retailers and app stores to collect payments. Its customers include Amazon, Google and Facebook, and it recently partnered with telecoms giant Etisalat Group, which should boost its exposure to Asia, the Middle East and Africa. Bango’s end user spend – a measure of interest in its platform – climbed 150 per cent last year as a deal with Google’s app store paid off. However, its pre-tax losses soared 88 per cent to £4.9m as it expanded its operational teams and data centres to meet the demands of new major customers.

A safer option could be Optimal Payments (OPAY), which charges gamblers to store their money in its mobile wallet and also processes payments for online gambling companies. Its sales climbed 41 per cent to $253m last year, as sales rose by more than half at its Neteller stored value segment and by 39 per cent at its Netbanx processing division. That helped cash profits rise 89 per cent to just over $52m. Most importantly, Optimal was granted principal membership with Visa and MasterCard in Europe, allowing it to offer commercial services to EU merchants beginning this year. That will benefit the company through more competitive rates and a broadening of its market base. Changing attitudes towards online gambling in the US provide another tailwind, as the likes of New York and California may follow New Jersey and Nevada in making it legal. And just this week the company agreed to acquire two US payment companies for up to $225m, which should spur significant expansion.

These various mobile payment businesses threaten to blur together – “Investors are quite confused by the activity going on in this market,” says eServGlobal (ESG) chief executive Paolo Montessori. But his Sydney-based business specifically targets the 2.5bn people worldwide that own mobile phones but lack access to financial services as well as the $400bn global remittance market. It offers users features such as mobile wallets, saving them the trouble of venturing out to a bank to receive funds. eServGlobal returned to positive cash profits last year and widened its gross margin by 6 percentage points to 62 per cent. Those gains have continued with sales up 24 per cent to £9.3m last quarter, driving core adjusted cash profits of £0.5m. But potentially its most lucrative move was the spin-off of its international remittance hub, HomeSend, to MasterCard. Revenues from its remaining 35 per cent stake could well exceed those from its core business in the future, management tells us. eServGlobal also signed a 3-year deal with international operator Zain Group and remittance-specialist MoneyGram joined the HomeSend network.

Favourites:

Shares in cross-border payment specialist Earthport (EPO) have doubled since our buy tip last summer, and we expect them to rise further. The company recently signed a multi-year contract with HSBC, and has also recruited the likes of Bank of America Merrill Lynch, PNC Bank and State Street. Earthport's sales and gross profits soared by around four-fifths in the second half of last year, while cash losses fell by 11 per cent to £3.3m.

Outsiders:

International payment-processor Planet Payment (PPT) looks less attractive than its sector peers. Its net sales slipped 7 per cent to $11.2m in its first quarter, and adjusted cash profits slipped 36 per cent to $0.9m. Although it grew its merchant base and transaction volumes, its shares trade at a lofty 31 times consensus forecast earnings.

THE BROKER'S VIEW

There's money in mobile

The mobile payments sector is still evolving. I’m often asked which company will be the winner in five years, but we haven’t even determined who the players are yet. There was a lot of excitement over the concept of mobile payments in the market a year ago, whereas now investors are looking for clear evidence of commercial traction. Companies that can deliver over the next year should be able to track the sector’s strong long-term growth.

We see tremendous potential in eServGlobal’s domestic mobile money business. It targets emerging markets, which offer some of the best growth rates in mobile money because they’re skipping a generation – traditional bank branch network – and using mobile to more effectively and efficiently deliver financial services to the large unbanked population. We see the company moving from a 5 per cent cash profit margin to a 20 or 25 per cent margin, in line with other business software providers.

Banks may feel threatened by emerging mobile ventures that can potentially circumvent their systems. That fear factor has at times led banks to invest in Monitise’s mobile money infrastructure. We see Monitise as a well-positioned, broad-based play on mobile money. It does mobile banking, payments and commerce and is good at all three. It has great partners and investors such as Visa, IBM and MasterCard too.

Optimal Payments is one of our top picks in the sector. It manages e-wallets and processes electronic payments – mobile or online – for e-commerce merchants. The company is taking market share in several high growth areas, and has turned around its Neteller division after two years of rebuilding its platform, expanding its product offering and investing in marketing. Optimal is also expanding exposure to e-commerce through highly accretive acquisitions and is benefiting from strong Asian online gambling growth. Nearer term, we believe it could see a significant boost from the World Cup.

We have buy ratings on Monitise, eServGlobal and Optimal Payments, and price targets of 80p, 58p and 575p respectively.

Bob Liao is a technology analyst at Canaccord Genuity.