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The rise of the payment processors

Technological innovation has encouraged investment in the payments space, sparking significant competition and frenzied M&A activity
December 28, 2017

It seems that cash is no longer king. Prompted by the rise of global e-commerce and internet-connected mobile devices, we are spurning physical money in favour of cards and other digital payment options. Indeed, according to Capgemini, global non-cash transactions grew 11.2 per cent during 2014-15, reaching 433.1bn: the highest growth of the past decade.

This shift towards digital transactions has been excellent news for payment specialists. McKinsey says global payment revenues will average a 7 per cent growth rate over the five years from 2016, reaching $2.2 trillion (£1.6 trillion) by 2021.

This huge market opportunity helps to explain the M&A activity seen over the past year. And payments is a crowded space, occupied by various types of business. Scaling up can improve competitive advantage. Banks must compete with huge dedicated payments processors such as Worldpay (WPG), and tech-driven start-ups offering alternative payment methods. Indeed, ‘fintech’ has been particularly transformative in emerging markets, where more people are ‘unbanked’ and where mobile payments can enable financial inclusion. Where mobile goes, social media follows; hence, various messaging platforms now also offer payment services.

 

The payments cycle explained

First, an insight into how payments are processed. The cardholder decides to buy something. Their card enters the merchant’s payments terminal. These details are transferred to the merchant’s designated acquirer, also known as a payment processor – for example, Worldpay. The processor transfers this information to the relevant card scheme, such as Visa or MasterCard. The card scheme liaises with the card issuer – for example, a bank. The issuer debits the cardholder’s account, and confirmation of payment flows back through to the merchant. In some instances, one organisation plays two roles in the cycle: Barclaycard is a card issuer and an acquirer, while American Express is both issuer and card scheme. Naturally, the greater role one plays in the cycle, the greater the potential rewards.

 

Payments giants are scaling up

For companies trying to take advantage of the growing demand for online transactions, M&A presents an obvious solution. In July, Worldpay agreed a merger with US-listed Vantiv (US:VNTV). These two payments behemoths expect to complete their £9bn deal by mid-January 2018. The combined company will process enormous volumes of transactions; Worldpay processed 15bn in 2016, compared with Vantiv’s 25bn. Worldpay investors will retain 43 per cent of the group, and it will maintain a London listing. Vantiv agreed to pay 55p in cash along with 0.0672 of a new Vantiv share for each share held. Including dividends this is equal to 30 times Worldpay’s expected 2017 full-year earnings, putting it beyond the valuations of other major rivals.

Vantiv agreed to pay 55p in cash along with 0.0672 of a new Vantiv share for each share held. Including dividends, this was equal to 30 times Worldpay’s expected 2017 full-year earnings, putting it beyond the valuations of other major rivals.

Vantiv’s bid was made more interesting by the brief interest shown by JPMorgan (US:JPM). While the bank’s initial approach did not lead to an offer for Worldpay, we were reminded that financial services institutions are seeking new ways to enhance their payments offerings. In fact, JPMorgan more recently agreed to purchase WePay – a FinTech start-up.

Meanwhile, the heads of some European banks recently told the Financial Times that they are in discussions to collectively establish a cross-border instant payments service.

The EU’s Second Payment Services Directive (PSD2) perhaps presents another challenge; one of its aims is to open the EU payments market to new services and providers, with a view to enhancing competition. Banks will need to provide third parties – including FinTech entities – with access to customers’ payments data (with customers’ consent).

 

Deal flow has continued

Deal momentum continued elsewhere, with the acquisition of Digital River Payments by Paris-listed Worldline (WLN), Ingenico’s (ING) takeover of Bambora, and private equity house Permira’s purchase of a 10 per cent stake in Swedish payments processor Klarna. In September, private equity firm Hellman & Friedman bought Denmark-based payment processor Nets for a cool $5.3bn.

Not to mention the offer made to Paysafe (PAYS) by a consortium of funds managed by CVC and Blackstone in July. This coincided with Paysafe’s own acquisition of Texas-based Merchants’ Choice Payments Solutions. The former deal, agreed by the respective parties’ boards on 4 August, valued Paysafe at around £2.96bn or 590p a share. We previously noted that the offer price for Paysafe is equal to 15 times forecast earnings – less than the value attributed to Worldpay. 

 

Smaller players

Smaller businesses operating in the payments space might represent a more attractive entry point. There’s always the chance that these could attract M&A activity themselves.

Safecharge (SCH) has a relatively small market capitalisation of around £430m. But transaction volumes have continued to rise, up 30 per cent to 75.6m in the six months to 30 June – supported by growth in volumes from its dedicated acquiring platform.

Meanwhile, small cap Earthport (EPO) offers cross-border payments service. That said, its shares have fallen by more than a tenth after a £25m share placing on 4 October 2017.

 

Security is key

Aim-traded Eckoh (ECK) is a secure payments specialist. It may not be substantial in size (its market cap is a mere £120m), but recent trading looks impressive. In the first half to 30 September, it swung to a pre-tax profit of £1.5m from a loss of £0.2m a year earlier. The group has also expanded its footprint in the US.

 

Alternative payment methods

Contactless cards have garnered huge popularity. And, today, many people use contactless mobile wallets such as Apple’s (US:AAPL) ApplePay to pay with the tap of a phone on a card reader. Moreover, ‘boon.’ – an app created by German-listed payments giant Wirecard – is a pre-paid digital credit card, designed for devices with ApplePay capabilities.

China’s enormous e-commerce group Alibaba (US:BABA) has also created its own ‘eWallet’: Alipay. PayPal (US:PYPL) has an app called Venmo, allowing users to share payment messages on social media. Facebook’s (US:FB) Messenger service also supports transactions, and the same is true of WeChat, owned by China’s Tencent. Wirecard has demonstrated its prowess here, too, announcing in July that it will enable European retailers to accept WeChat Pay. Wirecard plays the role of acquiring bank during the payment process.

 

Direct carrier billing

We’ve also witnessed the emergence of another specialist area within mobile payments: direct carrier billing. While mobile payments business Bango (BGO) has existed for years, bosses have said they expect it to fund itself through to operating profitability by the end of 2017. Bango allows people to charge purchases on their mobile devices to their phone bills, and has a deal with Amazon Japan – Amazon’s third-biggest global market. Management notes there are many more mobile phones in the world than there are credit cards, reflecting a significant addressable market.

On 20 November, direct carrier billing specialist Boku (BOKU) also listed on Aim. Boku works with Apple, Facebook and Spotify among others. We reckon a healthy dose of competition is healthy in this scenario.

 

Crypto-currencies

It’s hard to avoid headlines about Bitcoin. Despite the wide-ranging views on crypto-currencies, they may present an opportunity for payments players. Indeed, private FinTech business Revolut now enables customers to trade bitcoin on its mobile platform.

That said, Reuters recently reported that a representative of the European Central Bank has called for banks to accelerate the introduction of instant payments, dampening the appeal of digital currencies.