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Bang on the money

For instance, the company has just extended its direct carrier billing (DCB) agreement for Microsoft Windows Store so that users in Finland, Norway and Hungary can make purchases from any Windows 10 device, including their Xbox One consoles, using their mobile phone account. This means that customers on Elisa, DNA and Telenor mobile networks in these countries now enjoy the convenience of 'one-click' billing when making purchases in the Windows Store with payment being charged directly to their pre and post-paid phone bills. This method of payment is available to PC, tablet, smartphone and Xbox One users.

Anil Malhotra, chief marketing officer at Bango, points out that "this will be particularly successful with Xbox One users, because there is a high correlation between games purchases in app stores and the use of DCB". He has a point as in established mobile markets DCB generates increased payment conversion rates of up to 10 times, given the convenience and flexibility it offers. It's no wonder that Bango has been signing up a host of MNOs to tap into the growth potential here. Indeed, having launched DCB into more than 140 mobile operator markets, the company now holds more than 1.7bn billable mobile identities. It's growing rapidly, and on a global basis, too.


Strong growth drivers

In March, Bango announced the use of DCB through its payment platform for Google Play with Idea Cellular, the third-largest MNO in India. It's an important breakthrough as Idea Cellular has 182m subscribers, making it the sixth-largest MNO in the world. The mobile handset market in India is vast, with over one million handsets sold every day including an increasing proportion of smartphones. The largest MNOs in India have around 1bn subscribers, with smartphone subscribers expected to surpass 200m this year.

And given the low levels of credit card penetration in India - only 3 per cent of transactions are charged to credit cards, Mr Anderson anticipates that the other major MNOs in India to introduce DCB for their customers and justifiably. Indeed, the commercial pressure on other MNOs to introduce DCB will undoubtedly increase given that it also enables digital content sales on a mass scale, something that was previously unavailable to many customers. By not offering DCB, rival MNOs are at a significant competitive disadvantage. Bango is well placed to tap into this opportunity, the scale of which is huge once end user spend (EUS) starts to accelerate even after factoring in a relatively low average revenue per user.

The acquisition of US carrier billing business BilltoMobile in May is significant as it provides Bango with connections to all the major MNOs in the US market and adds annualised EUS of $80m (£61.5m) to the Bango payment platform, moving the company closer to profitability. BilltoMobile is the only carrier billing services provider to have integrations with all the major MNOs in the US (Verizon, AT&T, Sprint and T-Mobile) and added 230m potential consumers to the Bango platform.

BilltoMobile currently processes payments for numerous digital merchants and app stores, including Google Play and Microsoft. Bango has been gradually migrating these operations to its own systems, the benefit of which is to create an opportunity to deploy Bango's sophisticated data analysis technology, Bango Boost, to improve end-user spend, and with it the transaction fees Bango earns on payments processed. I understand from my results call with Mr Anderson that in the past year technology such as Bango Boost has helped increase EUS on activated routes by between 20 and 80 per cent by analysing a vast amount of data including churn rates, new customer acquisitions, customer spend frequency, and spending limit optimisation, all of which can help to improve customer DCB spend for MNOs. It's a win-win situation as it benefits the stores, MNOs and Bango.

The agreement Bango announced last month with South Korean mobile commerce company Danal Korea Inc is interesting. Danal provides mobile payment solutions to some of Asia's largest digital content providers via a pan-Asia payment network focused on South Korea, Japan and Taiwan. This network is being integrated into the Bango payments platform, introducing more payment routes for existing Bango app store partners as well as offering Danal partners the opportunity to enter a much broader range of markets around the world. The two businesses will engage in joint marketing and sales activity and focus on enabling digital content sales in the Chinese market.


Growth potential

Bango's interim results revealed the explosive growth the business is now enjoying. EUS increased from £18.1m in the first half of 2015 to £46.1m in the first six months of this year, ending June at an annualised run rate of £159m including £58m of annualised spend from BilltoMobile. It has since increased to £167m, helped by the recent launch of the Pokémon Go phenomenon.

Pokémon Go combines smartphone capabilities and location technology to create a gaming platform where players are able to explore the game in the real world. Players travel to physical sites and use a mobile device to collect and harvest virtual creatures, called Pokémon, which appear on the screen as if they were in the same real-world location as the player. Pokémon Go has been an instant global phenomenon, having been downloaded more than 500 million times, and, significantly for Bango, the game supports in-app purchases for additional in-game items. This has had a noticeable impact on app store revenues and the numbers of new users using DCB for the first time. Adding new users to DCB adds additional revenue streams, but not at the expense of other activity, says Mr Anderson.

Taking Bango's current growth rate into consideration, and the commercial agreements in place with a host of MNOs and app stores, analyst Ian McInally at house broker Cenkos Securities believes that Bango is on course to end this year with annualised end-user activity of around £185m, up from £67m at the end of 2015, and predicts this will increase to around £350m by the end of 2017. Mr Anderson says that these forecasts should be achieved based on the existing agreements. So with a healthy pipeline of new activations to be added to Bango's DCB platform in the second half, and more than 200 opportunities being pursued, then it will only take a small number of new payment routes to open up to have a material impact on the levels of EUS and the fees Bango earns.


Operational gearing

I feel investors have underestimated this fact in their assessment of the company's prospects. That's because having made a capital investment upwards of £30m in its payment platform, which has been tested to handle $1bn (£769m) of transactions a year, Bango's operating costs are pretty stable at around £5m to £5.2m a year. So with minimal cost of sales, its gross profit is in effect transaction fees and platform fees earned from MNOs and app stores. The business is highly operationally geared to rising end-user spend.

To put this in perspective, Cenkos forecast a near doubling of gross profit this year to £2.5m which would lead to a cash loss of £2.5m, but based on EUS rising to £350m by the end of 2017 then gross profit surges again to £4.4m and cash loss falls to £800,000. And if Bango nails a small number of the deals it's currently pursuing then there is potential for a move into profitability earlier than 2018 when Cenkos predict it will make gross profits of £8.2m, cash profits of £3m, pre-tax profit of £1.5m and EPS of 2.6p, based on annualised EUS of £470m.

Importantly, the company is cashed up to cover losses until it hits cash profitability as it has net funds of £7.2m. Of course, even if Bango hits Cenkos' forecasts then its shares are hardly cheap on a forward PE ratio of 35. But it's the potential for Bango to continue to scale up the business which will lead to blue sky profits and shareholder returns.


Potential for high profitability

Research from technology consultancy Ovum suggests that the DCB market could generate transactional value in excess of $25bn (£19bn) by 2020. A realistic market share of 8 per cent would give Bango an annualised end-user-spend of $2bn in four years time.

Of course, the gross margin earned on that transaction value will reduce as the scale of activity increases, especially in more mature app stores and in more developed markets. However, if Bango continues to grow at its current heady rate then there will be some serious profits to be made. In fact, assuming its gross margin declines from 1.67 per cent in the first half this year to 1.4 per cent by 2020, on £1.5bn-worth of transactions its gross profits soar to around £20m and generate north of £10m of post-tax profits, a chunky sum relative to Bango's current market capitalisation of £61m. I would also point out that Bango has accumulated tax losses of £35m to offset against future profits, reflecting the substantial spend in its platform and marketing channels, so shareholders can expect a chunk of future profits to be tax free.

Mr McInally's financial models justify a share price four times the current level if this scenario pans out, and more than double using conservative assumptions. It's not often that you get the chance to buy into a small-cap company with potential to become a worldwide, large scale digital content payments infrastructure provider, but I feel that Bango has a realistic chance to fulfil that ambition.



Of course, all businesses carry risk and the obvious one is that the heady rates of growth in the DCB market slacken. That said, growth in app stores is rampant and in Apple's third quarter results the mobile phone giant noted that App Store revenue was the "highest level ever, as our installed base continues to grow and transacting customers hit an all-time record". The momentum in the end markets Bango services shows no sign of waning.

Technology is a risk as Bango's revenue is dependent on its technology keeping pace with developments in mobile phone technology. The company manages this risk by a commitment to research and development, combined with ongoing dialogue with trading partners and sector specialists to ensure that market developments are understood. Bango also has key trading agreements with payment providers and manages this risk by maintaining regular dialogue and investment in relationships with them.

Security of personal data is another issue given the risk that customer data could become public if there is a security breach. However, extensive testing of Bango by its major customers as part of ongoing customer audits, and the unique way Bango technology is used, mitigates this risk.

Target price

So, having considered all the risks, and the probability of Bango hitting cash profit break-even as early as next year, I feel it's worth buying into this growth story with the shares priced at 93p. My 18-month target price of 200p values Bango's equity at £130m, or 13 times its potential net profits in 2020. Buy.