EML or Tyro: Who's the better payments player?

Not all payments companies are created equal. And there are perhaps few better illustrations of this than the contrasting fortunes of EML Payments and Tyro Payments. Following their recent results, I spoke with Shane Fitzgerald from Monash Investors Limited to get a deeper understanding of these two small-cap payments firms. 

Despite appearing similar at the surface, these two companies have vastly different competitive positions. 

While EML (ASX:EML) is the leader in a complex niche where relationships matter, Tyro (ASX:TYR) is a niche player in a fully saturated market, competing against the likes of Australia’s big banks.

In this Q&A, Shane tells us why he’s never owned Tyro, why he believes EML’s regulatory challenges will be overcome, and he shares his outlook for the years ahead. He also answers
these other key questions:

What is Tyro Payments’ competitive advantage? Or do they have one?

Tyro's business is in a market that is already fully saturated.

Every business has an EFT terminal of some description. Tyro would say their dongle's better than the next guy’s. And that may well be true. But these are fully saturated commodity markets, and it's a race to the bottom. 

 Every now and then a company will stick its head up and start making some money. And then a competitor will come in with a cheaper offering and away we go.

Tyro has about a three and a half of a percent market share and that's commendable. 

But if I think about that a little bit more deeply, in a big market, which is already fully saturated, three and a half percent is just a disgruntled customer base of existing players to some extent. 

Getting a three and a half percent market share is great, but I don't think that's a ringing endorsement that this is a superior product. It’s understandable how they could get to that level. I think getting to six, nine or 10 percent market share – which is what the share price implies at a $1.8 billion market cap – that's a whole different question.

The results seem to be reasonably well regarded by the market. 

For the first time, they posted positive EBITDA. But as usual, with all EBITDA these days, it’s been adjusted for a range of items. EBITDA used to be a hallmark because it was reflective of cash. Everyone could calculate EBITDA to operating cashflow. And that would typically be around 100% for the average company. 

Now EBITDA has absolutely no relevance to cash in any way, shape or form.

Because of these concerns, we've never really been on the company register. If you look at the share price, it's really been a trading range for its history. It's had blips and recoveries; the COVID crash, then its connectivity issue. But it's always been trading in that $3.00 - $3.50 band. 

I think that reflects the fact that the market has already valued this as a success story, that it will achieve a much higher market share. Maybe it will, maybe it won't. But I do question if one of the big boys comes out and crushes it at some point in time. 

For those reasons, it's not one that we're really that enamoured with.

What were some of the key lessons were from the recent result?

The overarching thing that came out of the result was a deeper and better understanding about the regulatory issues with the Irish Central Bank (ICB). 

It's starting to look a bit like a storm in a teacup, although "storm in a teacup's" underplaying it somewhat.

As it turned out, the regulator didn’t know that EML was a listed entity. They were regulating the Irish entity. And they put out this letter about we're going to take regulatory action. EML said, “we're going to disclose this.” But if EML was listed in Ireland, they wouldn't have done it the way they did. 

Regulatory interactions between companies are ongoing, they happen all the time. If you look at the regulatory fines that have occurred in Ireland, they range from around one million to 15 million euro. When this action was announced, the market cap of EML fell around $300 million - $400 million.

The result itself was a fairly normal one for EML. 

The overall businesses doing very nicely. Obviously, the gift and incentives business has stabilised and is coming back again, but it's not fully back. That's really where the growth will come over the next year or 18 months when the world starts to open fully.

But it did underscore that the regulatory issue is something that can be dealt with. And it can be dealt with in two ways, they're going to pay a fine, but it's not going to be a stupid number. They have to put in some more staff to manage the compliance that the Irish regulator has requested.

They want an Irish board, with a company secretary, with a proper process of board. Well, what EML had was just a cursory board. They didn't have a company. So why would you have a company secretary for a subsidiary board? They’re going to have to hire a couple of new bodies to sit on the board, they’ll have to hire a company secretary, and a compliance team.

The other thing that was noteworthy, was they said that they put a handbrake on the growth of the PFS (Prepaid Financial Services) operation. 

This was more about playing nice with the regulator. The way it works is when you have a new client, you on-board the client and you then need to get a regulatory approval for that client to start to transact over the platform. They didn't want to be in a discussion with the ICB, while on the other hand, they’re new clients into the pipeline. 

So, they put a hold on new client onboarding for a three-month period. There's a long lead time for all their new customers coming on, it can be nine to 18 months from the initial discussion with a client before they start transacting and making money for EML. So that flywheel has been stopped for a period of time.

When they first announced the regulatory issue, they said it would have a material impact on the business. It's 24% of revenues, and the share price fell 40%. So, the market effectively wrote off the entire value of the PFS. That was over the top. 

I think the market is now seeing that and the share price is re-rating. The regulatory issues are not catastrophic to the business in any way, shape or form, but the share price tanked when they made that first announcement.

How did the EML result look compared to your expectations and analyst expectations?

It was in line with analyst expectations. I think it was a little bit above, slightly above, pretty much all the levels, but the guidance was below for the reasons just discussed.

One important thing to note is the acquisition of Sentinel. When the Sentinel acquisition was announced, there wasn’t a lot of data to go with it. The announcement stated that it was expected to be EPS-neutral, so the market largely ignored it.

Sentinel is an on-ramp payment system for neo-banks. The Neobank market is just exploding at the moment. 

EML generates an average revenue margin of around 100bps on its existing business. However, for Sentinel, it’s more like 1 bps. As such the market needs to recalibrate their forecasts for this product mix change.

This has always been a dynamic in EML. In something like gifts and incentives, they get about a five or six percent margin on that. On the re-loadable cards it’s anywhere from 70 basis points to 2%, and on what they call the VANs (virtual account numbers) business, it's typically been around 15 basis points. But then there's Sentinel at more like one basis point.

But very high transaction volumes?

Lots and lots of volumes going through. Sentinel also has an add on neo-banking-style service, which I understand can be priced more like 20 or 30 basis points.

Part of the argument is the $90-odd billion of transactions; what proportion of that customer base can they shift onto these new value-added products? 

Now, this is something I'm not going to get overly excited by because I've covered financial services for 30-odd years. The one thing that is always talked about in the financial services, and Tyro included, is cross-sell. We've got a customer base, we're going to cross-sell to it. It doesn't work most of the time.

And part of the reason for that is that everybody has the financial services they need. People's inertia to their providers is very, very high - partly because financial services are viewed to be complex and hard. 

Chances are whoever you have your transactional bank account, is where are you going to get your mortgage from. It's where you going to go and get your personal loan from.

You see churn ratios of customer bases across financial services. Be it Tyro, be it ANZ Bank on its transactional bank account, it's in the low single digit range. Any SAAS business would be ecstatic if they got those sort of ratios, but that's common in financial services.

What’s your outlook for EML looking ahead a few years, beyond the guidance that the management has already provided?

We’ve got a very positive outlook for EML. It comes from a range of different factors.

First, which is often overlooked, is EML's very broad customer base. There are 1500 different customers around the world, and they're high-growth businesses in their own right. So EML will get above-system, organic growth, purely because the customers that they're serving are in that growth phase themselves. So that's a good source of organic growth.

Second, we will see a very sharp comeback in the gift and incentive business as a re-opening trade. That's going to be added to the growth.

Another area that will be added to the growth is the interest rate environment. Right now, we've got significantly negative interest rates in Europe. I don't think interest rates are going to go up a long way. But will it stay negative? Probably not. 

So I don't think EML is going to make money from its float, but at the moment it's costing them a couple million bucks. When you only got $55 million of EBITDA, a couple million bucks is additive.

The final area, and this is the area that we all know about with EML, is the pipeline they have of new customers coming on. With EML, this is a fairly certain pipeline. They talk about $10 billion of gross volume load by those customers once they're fully onboarded, but it'll take three to four years for them to be fully onboarded. So you've got good visibility of what the pipeline is like.

All things considered, I think you'll get 10 to 15% organic growth in this company, just because their clients are growing their own businesses.

 I think you'll get probably a 10 to $15 million uplift in EBITDA as the gift and incentive business returns to 2019 levels. You'll get the negative drag from interest rates drop off, and then you're going to get new product launches. So you put it together, this is a high growth business.

Do you think that the turnaround in the company's earnings has been priced into the stock yet?

EML got beaten up in COVID because of the concern for the gifts and incentives – that shopping centres were going to close. And when they realised that wasn't the case, you saw the share price rally. And the share price was on a great run prior to this regulatory issue. So, I don't believe it's in the share price. We saw good value in EML prior to the fall from the regulatory concern. So, we're now looking at a share price well below that level with and outstanding growth story.

We think there's a lot of upside still in EML. But I think it's going to take a year or more for the valuation multiple to rerate.

Would you Buy, Hold, or Sell EML Payments and Tyro Payments?

Tyro for us would be a hold. We think the valuation is very full. It is encouraging to see them moving into positive EBITDA territory, but we’re concerned about the long-term growth. We think it's pretty fully valued.

For EML it's a buy, we believe that the de-rating that was seen in the share price was well and truly over the top. So, it's got a lot of head room for the share price to expand.

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