Lesaka - Fair value considering trading illiquidity
Lesaka is a South African financial technology company focused on delivering financial services to consumers (B2C) and merchants (B2B) in Southern Africa, through proprietary banking and payment technologies. Lesaka offers banking, lending, and insurance solutions to consumers as well as cash management solutions, bill payment technology, value-added services, business funding and card acquiring solutions to formal and informal retail merchants.
The company started its journey as Net1 in 1997, but was best known through its subsidiary, Cash Paymaster Services (CPS), the company behind South Africa's social welfare grant payment system. CPS was appointed as the contractor for the payment of social grants in 2012 for a duration of five years. In 2013, the contract was ruled invalid by the Constitutional Court of South Africa due to the way in which it was awarded. During 2012 and 2013, the group derived approximately 41% and 42% of its revenues respectively, from the CPS social welfare grant distribution business. Following an extension of the contract, it was eventually terminated 2018. The cancellation of the contract had a severe impact on the company, with some legal proceedings still ongoing and CPS currently in liquidation.
Net1 had a primary listing on the NASDAQ (NasdaqGS: UEPS) and a secondary listing on the Johannesburg Stock Exchange (JSE: NT1). The company commenced an extensive brand renewal plan in South Africa to articulate its vision and purpose to the market. Led by a new leadership team, and following a comprehensive strategic review, the company embarked on a new era with a new name, Lesaka Technologies (NasdaqGS: LSAK; JSE: LSK) in 2022.
The company now operates through two segments - Merchant and Consumer. Merchant accounts for ~89% of total group revenue. Through Capital Connect, the Merchant business delivers solutions across the formal and informal market, from micro businesses to large enterprises. Consumer (11% of revenue) focuses on low-cost transactional banking solutions that are structured for underserved consumers in a lower-income market through EasyPay Everywhere.
Merchant
The Merchant Segment services MSME (micro, small and medium enterprise) customers. At this level, Lesaka offers cash management and digitisation, card acquiring, growth capital, Value Added Services (VAS) and bill and supplier payments. At a larger enterprise level, the group offers bill and supplier payments and VAS through proprietary financial switch, as well as point of sale devices and maintenance, bank and SIM card production, and other specialised technology products.
Informal sector merchants are smaller and operate in rural or informal urban areas and without access to traditional banking products. Formal merchants are mostly in urban areas, have larger turnovers and have better access to different service providers. Lesaka operates different brands within each sub-segment.
According to Lesaka, there are ~2.1 million MSMEs in South Africa, of which around 1.4 million operate in the informal market. It is estimated that only 4% of these can accept digital payments and therefore the group believes that the market is highly unpenetrated.
In April 2022, the company acquired Connect Group in South Africa for R3.8 billion. Connect is a profitable, high-growth, and leading South African fintech company, bringing with it sizable access to informal merchants for Lesaka of over ~51 000 MSMEs into the Merchant business segment. The group currently services around 52 000 MSME's.
Consumer
In the B2C Consumer segment, Lesaka's focus remains on the lower-income end of the market (Living Standards Measures (LSM) of 1 to 6), which it estimates consists of ~26 million people.
Products include transactional banking, short-term loans, a digital wallet, as well as insurance and various VAS to underserved consumers in South Africa.
The EasyPay Everywhere banking solution is available through bank cards, USSD, internet banking and a mobile app. EasyPay Everywhere is available and serviced through a widespread network of EasyPay Everywhere branches, in-store retailer branches, and ATMs.
EasyPay Insurance (previously named SmartLife), which holds a long-term insurance license, offers consumers access to the Smart 1 and the Pensioners Plan insurance plans.
Lesaka also offers EasyPay Loans (previously named Moneyline) to consumers through the EasyPay Everywhere distribution network. Loans are either fixed or variable in amount and repayment tenure, up to a maximum of R2 000 over six months. Device lending for mobile phones is another service offering.
The company has over 1.1 million active consumers - predominantly social welfare grant recipients.
The payments landscape in South Africa
According to the World Bank's latest report, ~1.4 billion adults are unbanked globally, meaning that they do not hold an account at a financial institution. The unbanked population mostly represents women, poor adults and the less educated. Almost half of the unbanked population are concentrated in only seven economies of the world, with China and India making up the majority of the unbanked population.
PWC's Payments and Open Banking Survey 2022 found that South Africa has a banked population of ~84%. While this points to relatively high banking penetration and a substantial improvement from 2013 (~62%), 25% of South Africans still prefer to withdraw all their money and transact in cash. This highlights that having a bank account is only used to receive comparatively large payments, giving rise to the “mailbox” trend, which is particularly prevalent among social grant recipients.
According to a 2019 report from SASSA, more than 85% of all grant money received by recipients was withdrawn within the first five days of the month. Putting this into perspective, National Treasury budgeted R227 billion for social grant assistance in 2023/2024, this could have equated to a potential opportunity to digitise almost R193 billion cash in the market. As such, Lesaka's transactional banking offering through the EasyPay Everywhere solution can bridge this holistic banking gap in the Consumer market space. This specific target market needs streamlined, simple and easily accessible banking solutions, which provides good tailwinds for Lesaka's core service offering. Through investor education and brand familiarity, we think that Lesaka could aid in successfully digitising the informal cash market.
The informal business space in South Africa is complex yet thriving, and its size and significance on the economy is likely underestimated. There are ~2.6 million micro, small, and medium enterprises (SMEs) in South Africa, according to the OECD iLibrary. A 2021 study by Mastercard revealed that only 38% of SME respondents held a business bank account and are also heavily focused on cash. The study further found that as merchants, the payment options offered to its customers are either cash, EFTs, or e-Wallet. None of the respondents offered card machine, contactless e-card, mobile card, contactless PoS machine, card machine with app for phone, QR codes, contactless QR codes or tap on phone. A report by SME South Africa, found that access to funding was also a major stumbling block. Only 6% of SME owners indicated that they received funding from the government, which is alarmingly low. Through the Connect platform, Lesaka is ideally placed to offer banking solutions to unlock growth and opportunity for these businesses, through its transactional and funding offerings, a market which traditional banks have typically avoided.
Lesaka has a footprint of over 58 000 points of presence across Merchant and Consumer, making the company well-positioned to capture and retain market share through its service offerings.
Cross-sell opportunities
Loan penetration by FY22 was at 36% of active EPE customer base, while funeral insurance had penetration levels around 19% of the active account base. This suggests that there is still a substantial cross-sell opportunity. Targeted marketing and rewards programmes could further solidify stakeholder relationships. Implementation of pro-active sales growth strategies would also be supportive of penetration numbers.
We see marketing and point-of-presence opportunities for consumers utilising the existing merchant footprint.
Limited liquidity and tolerance towards share price volatility
Thinly traded shares often come with extreme volatility, driven by an over-reaction by a relatively small number of shareholders to company announcements (variations in operating results, litigation developments, market conditions) or because of other company market trades. Relatively illiquid shares can also be difficult to buy and sell at quoted market prices.
While Lesaka has a reasonably high market capitalisation, its free float is very low. According to Bloomberg, Lesaka's free float is at 58.9% but we think it could be even lower - particularly on the JSE since most of the shares are held and traded in the US.
Latest financial results
For the third quarter ended 31 March 2023:
The company is scheduled to release 4Q23 results on 12 September 2023.
What we like about this company
What we don't like about this company
SPM Valuation and View
Revenue is expected to step up substantially in FY23 following the conclusion of the Connect group acquisition.
The company is expected to report a profit in FY23, and we anticipate that margins will improve over the medium term.
We considered several valuation models in determining our fair value for Lesaka. Our discounted cash flow valuation offered the most upside. The PE and PB valuations offered the most conservative upside levels. We place a 12-month target price of $4.99 on the stock or $4.24 taking a 15% liquidity discount. This translates to a rand value of R79.54 at spot, or 7.1% upside from current levels.
