Johannesburg-based Net 1 UEPS Technologies (UEPS.US and NT1.SJ) reported its third quarter 2012 earnings earlier this month.
Let’s get acquainted with the stock and see whether it represents a compelling opportunity for Africa investors.
Why Should You Care About UEPS?
Net1 trades on the Nasdaq, making it one of the most accessible South African stocks for US-based investors.
What Do They Do?
Net1 facilitates payments between institutions and individuals who don’t have easy access to banking services. It does this via its patented Universal Electronic Payment System (UEPS).
I’m technologically challenged and thus not entirely clear on how the UEPS works, but I’ll give my best shot at explaining it.
Suppose Thabiso lives in a remote village in South Africa. He is 63-years-old and qualifies for monthly financial assistance from South Africa’s social security agency. The nearest town does not have a bank branch, so it is difficult for him to make the long trek to a bank to cash his grant check each month.
Fortunately for Thabiso, Net1 developed a solution to this problem. Instead of mailing a check, the social security agency issues Thabiso a smart-card. This card accumulates his monthly assistance amount. Now Thabiso need only visit a conveniently located UEPS paypoint, provide his fingerprint to verify his identity, swipe his smart card, and receive his payment in cash. No bank account is needed.
Where Do They Do It?
Net1 operates globally, but it does most of its business at home in South Africa. Nearly 80% of its revenue came from South Africa during the 2011 fiscal year. Almost all of the remaining sales were made in South Korea.
How Did They Perform?
[table id=45 /]Profitability: As you can see in the above chart, Net1 enjoyed a very fat profit margin until 2010. At the end of that year, management wrote down the value of hardware and software assets by $37.8 million due to obsolescence and decreased demand. This took a huge bite out of earnings and squeezed the net margin.
Write downs of this sort are par for the course for a technology company like Net1. They add turbulence to earnings figures, but so long as the company devotes sufficient capital to research and development, it should not cause investors too much worry.
Far more worrisome is the $41.8 m write down that occurred in 2011. This resulted from the loss of a major customer that defected to an alternative payment platform.
Most disturbing of all is Net1’s dependence on its largest customer, the South African Social Security Agency (SASSA). In 2010, the agency announced that it would put its payment delivery service contract, which had previously been awarded to Net1, up for bid. This was a very bad thing for Net1. The company slashed its fees in an effort to retain the SASSA relationship, and profitability suffered. The net margin came in at 15.6% over the past twelve months — less than half its 2009 margin.
[table id=46 /]Growth: In spite of reduced profitability, Net1 has done a reasonable job of growing its revenue base — increasing it at a nearly 12% clip over the past five years. The most recent quarterly results are not as bad as they appear. The loss is due almost entirely to currency fluctuations. Because most of Net1’s sales are done in South African rand, sales figures will suffer when the rand loses strength against the dollar — the currency that Net1 reports its earnings figures in. So, while Net1’s revenue declined 2.3% quarter over quarter, it actually increased 10% in constant rand terms.
[table id=47 /]Balance Sheet: Net1’s balance sheet looks significantly more stable today than it did one year ago. Nine months ago, the company’s total liabilities stood at 1.4x its equity. Management had financed the acquisition of its Korean subsidiary with a $130 million five-year loan. It has since paid off nearly 20% of this debt.
Value: Net1 shares presently trade for 6.5x trailing earnings on the Nasdaq and a P/E of 8.7 on the Johannesburg Stock Exchange.
Dividend Yield: Perhaps ironically for a company that’s in the business of facilitating payments, Net1 does not pay its shareholders a dividend. It reinvests all profit into growing the business. So, income investors best look elsewhere.
Is UEPS a Bargain?
In a word, no. Although, the stock trades at an undemanding earnings multiple, the struggle it had in retaining the SASSA contract suggests that its technology is no longer as unique as it needs to be to prevent further erosion of its profit margin. I’ll be reducing my personal portfolio’s exposure to the stock.
[Disclosure: I am long UEPS.]