Potential for Profits Out of Africa

 | Nov 22, 2013 | 9:00 AM EST
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The great thing about having a "cabal" is you are in regular touch with people feeding you great ideas. I was speaking with one of my very astute contacts the other day and he mentioned his new high priority name, one of which I had no knowledge -- and I suspect that neither does the market.

The company is Net 1 Ueps Technologies (UEPS), a South African payment processing company traded on the Nasdaq. The company offers a smart card-based system of secure payment cards to enable electronic transactions in regions with limited or no telecommunications infrastructure. The cards are fingerprint activated, and are "stored value"; they only require occasional communications back to central servers to square up the transactions. As you might surmise, the product is popular in very emerging markets where communications infrastructure is spotty, especially in Africa. They call it the Universal Electronic Payment System, hence the UEPS in the name.

As they describe themselves in the 10-K: "Our technology is widely used in South Africa today, where we distribute pension and welfare payments, using our UEPS/EMV technology, to over nine million recipient cardholders across the entire country." The company says they also "process debit and credit card payment transactions on behalf of a wide range of retailers through our EasyPay system, process value-added services such as bill payments and prepaid airtime and electricity for the major bill issuers and local councils in South Africa," Their filing says they also "provide mobile telephone top-up transactions for all of the South African mobile carriers."

Beyond this penetration in the home market of South Africa, they supply entitlement cards in Iraq, merchant processing in Korea and other hardware/software solutions. UEPS should do about $490 million this year in revenue, and analysts estimate they will earn $1.36. The $500 million market cap and $500 million of revenue indicate they are a real company, yet the stock trades at a paltry 8x earnings -- far below similar U.S. transaction processors such as Visa (V) or Mastercard (MA).

The issue overhanging the stock is that of the 50% of revenue that is derived from South African payment processing, 70% of which is from a welfare benefits program. The Justice Department and the Securities and Exchange Commission are investigating whether the company violated the Foreign Corrupt Practices Act in winning that contract. While those charges are serious, the company has already emerged victorious in two related court actions in South Africa. While "you never know", that data convinces me that the investigation will ultimately result in little damage to the company.

Meanwhile, the opportunities for future growth are substantial. As the Janney analyst that covers it notes: "Net 1 has enrolled a million users in its prepaid airtime business, Umoya Manje, in just two months of operation, with transactions nearing 250,000 per day during peak periods.

"Net 1 is also beginning to issue financial services in the form of micro-lending to its 10 million South African smart card holders. During the first quarter, the company began this rollout in the six provinces where this service was not offered in 2013. Outside of the country, Net 1 and MasterCard are evaluating opportunities that could be 'multiple times' larger than the SASSA rollout in South Africa."

The company offers a unique offline micropayment system that can address the banking needs of the "unbanked", which number in the billions. They are deploying systems into many new countries, including many in Africa and Southeast Asia.

The business model is solid, with recurring revenue and high visibility, since the South African welfare program is a five-year contract. My thesis is that as the legal overhang subsides, the company continues to grow and visibility extends beyond the two analysts that cover the company, the valuation can be re-rated higher. A market multiple on the near-term earnings of $1.36 puts the stock at $21. That is nearly twice its current trading level.

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