NASDAQ: LSAK - A Cash to Digital FinTech in the Emerging Market of South Africa

Like emerging market fintechs such as Fawry in Egypt, NuBank (NYSE: NU), and PagSeguro (NYSE: PAGS) in Brazil, could Lesaka Technologies be the Square of South Africa? Like early Square (now called Block, Inc. / NYSE: SQ), Lesaka is a fintech that serves both businesses and consumers and targets micro, small, and medium-sized enterprises (MSME). It provides a full range of financial services to merchants and consumers through mobile handheld point of sale (POS) terminals, a mobile app, and payment cards. South Africa has lagged behind the first world in electronic commerce and is still primarily a cash-based economy; about 60% of all commerce in South Africa is done in cash. Here there is still the opportunity to capture a vast portion of the economy like during the early days of Square when there were few mobile banking and payment offerings and increasing usage.

Lesaka offers several services under various brand names that target different markets. Consumers can receive government payments as well as pay for services, while merchants can take card payments and make money processing payments for electricity, water, mobile minutes, and other goods and services. The company also provides small loans and insurance policies. MSMEs are where one finds much of what is called the “informal” economy which comprises almost 30% of South Africa’s GDP or $126 billion of economic activity according to World Economics. The “informal economy” is defined as commerce done by people or entities with no business ID that is neither taxed nor monitored by any form of government. While in the US we cannot imagine that the government would not come knocking on the door, this practice is widespread and gets no pushback from the authorities. The informal economy includes street vendors, farmers selling at markets, barbers, restaurants, and small stores. In contrast, the “formal” economy only includes entities such as large chains of gas stations, supermarkets, and businesses in urban settings. One benefit of servicing the informal economy is that it is less affected by fluctuations in the South African economy, as most of the transactions are for household goods and services needed daily. Another benefit is there is less competition. Lesaka is well-positioned to serve the informal market and take market share from banks as they provide services primarily on mobile phone apps and mobile POS devices. Phones also provide information such as payments, deposits, and location allowing fintechs to collect data for lending criteria much less expensively than can banks.

Lesaka is a turnaround story. A new CEO was appointed in 2021, and he in turn appointed new management who cut costs dramatically and embarked on the current strategy. Lesaka made a transformative acquisition by buying the Connect Group in April of 2022, more than doubling revenues. Through this acquisition and organic growth, Lesaka is expected to grow revenues 134% in its FY2023 ending June 30th to $521 million. It currently trades at an enterprise value of approximately $380 million or 0.7 times its revenue run rate which is a lot lower than similar public companies. Lesaka paid $264 million for Connect, funded through $147 million in cash, debt of $93 million, and deferred equity consideration of $24 million. Since the acquisition, Lesaka has been right-sizing operations, honing offerings, and working toward cash flow breakeven with the objective to pay ultimately down debt. It has now been cash flow positive for the last two quarters and can focus on building and eventually paying off debt which currently stands at $205 million ($166 million on a net debt basis). In addition to using excess cash flow to bring down debt, the company owns four large positions in non-strategic entities that are available to be sold and are valued at between $40 million (by analysts) and $76 million (by the company) combined. The largest of these is its 10% equity position in Mobikwik, one of the largest mobile wallets and Buy Now Pay Later (BNPL) players in India.

Management guidance for the year ending June 2023 is for adjusted EBITDA to be between $25.6 million and $28.0 million. In addition, it will pay approximately $17.3 million in cash interest and taxes during the fiscal year. For FY2024 some analysts expect the company to grow revenues by approximately 20%, all organically, to more than $600 million.

EBITDA should increase faster than that due to cost-cutting and operating leverage. Based on EBITDA forecasts, analysts have price targets ranging from $5 to $8 per share. At the midpoint, this is 83% higher than its current price.

Merchant and Consumer Revenue Segments

Lesaka has two divisions: one with B2B offerings and the other a B2C business targeting lower-income earners and welfare and social security recipients. The B2B merchant business is dominated by its informal market product, "Kazang.”

Merchant Business

Most of Lesaka’s revenues (88% in FYQ3 2023) come from its B2B offering targeting MSMEs. Lesaka has multiple brands targeting businesses. Its Kazang offering contributes over 90% of revenues in the merchant group and targets the informal economy. Kazang has very compelling unit economics, specifically the low customer acquisition cost (CAC) compared to the lifetime value of a customer. The center of its offering comes from a small mobile battery-operated POS device given to merchants to conduct business. Approximately 72,000 of these MPOS devices are currently being used by merchants, and that number grew roughly 50% year over year in the latest reported quarter. Kazang processes roughly 1.5 million transactions a day. Larger stores may be provided with automated cash vaults, again connected to an app, enabling the merchant to accept payments in cash in addition to payment cards. The merchant is the only one that can access the vault, deposit the cash, and enter the payment information into the phone app. Lesaka also may offer working capital loans to its merchants as the company knows how much cash is in the merchant’s vault. Lesaka has approximately 4,400 vaults in merchant locations.

Merchants using a Kazang MPOS device, first must download an app, and create an account/ wallet. Merchants can accept credit and debit card payments and can sell a range of common prepaid products and services called “value-added services” (VAS) to consumers. Merchants earn a small fee for each transaction processed. All payments are stored in the merchant’s wallet, like with a Square or PayPal account, but the wallet does not require the merchant to have a bank account. Lesaka also owns the biggest non-bank payments switch in South Africa, so it is both a payment processor and aggregator.

Customers can buy mobile top-up minutes, travel tickets, lottery tickets, credits for online gambling, and send international money transfers. In contrast to consumers in the United States who are billed monthly in arrears for services like electricity or internet service, in South Africa consumers buy electricity in small prepaid amounts ahead of time, and then top up their account when needed. The Kazang VAS offering is well diversified by product with more than 100 individual products across categories such as gaming, airtime, electricity, supplier payments, and others. No single product category contributes more than 30% on a throughput basis. Kazang Pay allows merchants to accept all major debit and credit cards including Visa, Mastercard, and SASSA (social security grants) cards. It can sell prepaid airtime for use on Vodacom, MTN, Cell C, Telkom, and Kazang Load (an airtime voucher that can be used across all networks). Other payments include water, electricity, Wi-Fi, online gambling and lotto, TV, traffic fines, gift cards for international airtime and electricity and some stores, and international money transfers.

We believe the Kazang business is Lesaka’s fastest growing. Kazang currently has operations in South Africa, Namibia, and Botswana, and a licensee operating under the Kazang brand in Zambia.

Consumer Business

Using a payment card and an app called EasyPay Everywhere, Lesaka also provides financial services to consumers (social grant recipients) in the market. In FYQ3 the consumer business contributed 12% of revenues and has turned around to be EBITDA positive for the last two quarters. In addition to typical consumer banking and payment offerings, Lesaka’s B2C business targets “grant beneficiaries” who are primarily people receiving social security or welfare. It provides a payment card and an app for those with phones and cross-sells EasyPay Everywhere life insurance and small loans to these customers. The insurance sold is for funeral expenses while the small loans are from one to six months in duration and can be for R400 to R2,000 (or approximately US$20 to $115.)

Of the 61.5 million people living in South Africa, 18 million beneficiaries rely on permanent grants of some sort which are paid to a total of 12 million grant recipients (e.g., a child support grant is paid to a parent or another 3rd party who takes care of the child). 18 million of this number are already permanent beneficiaries of state welfare and receive social security (old age,) child support, and disability grants. Lesaka provides them (and others) with transactional banking capabilities, payment processing, the ability to purchase value-added service products (airtime and electricity), and access to capital and financial services. Lesaka places its services in branded service points at appropriate and convenient locations.

The additional COVID-induced R350 social relief of distress grant caused the number of welfare recipients in South Africa to skyrocket to nearly half the population or 29 million people. The temporary payments are only $20 per month and the government is looking to possibly make them permanent.

Lesaka currently has 1.1 million of these 12 million grant recipients as customers an increase of 16% year over year in the last quarter. The South African government’s Postbank, distributing the majority of Source: Lesaka Technologies grant payments since 2018, is undergoing challengesand performing poorly (with long lines, few open hours, and technology snafus) in this regard. Given much dissatisfaction with service levels and their ability to receive their grants, grant recipients are switching to new distributors. Lesaka is working with the South African Social Security Agency and hopes to capture a portion of this newly available market. The company’s current ARPU for these customers is 78 ZAR per month, whichis currently US$4.16. On an annual basis that is approximately $50 in revenue. If EasyPay Everywhere signed one million new customers, and they took additional products at the same rate and same profitability, that could add $50 million in revenues annually). Lesaka is well-positioned to be a possible solution as it was the payment distributor for the government back in September 2018 before the expiry of the SASSA grant distribution contract. With entirely new management and a new name, Lesaka has been successfully working to turn around after having lost 90% of its revenues from the loss of this contract.

EasyPay Everywhere consumer offerings:

The consumer division also owns roughly 650 legacy ATMs down from 1,500 last year, a business that management is managing for cash, not growth. The company expects that number to be reduced to 360 in the future.

So, could Lesaka Technologies (Nasdaq: LSAK) be the Square of South Africa? Insiders seem to be optimistic, as current shareholders and management have recently been buying the stock on the open market. Given that it is the early days of fintech in South Africa and it is still a cash-based economy, we believe there is an opportunity for investors to profit from the secular shift. Lesaka as a pure play in this market could be an easy way to invest in this shift as the economy transforms driven by a young population keen to adopt technology. New management is showing evidence it has righted the ship, and analysts expect the turnaround to continue, and for profit margins to improve. The company has already hit cash flow and EBITDA positive. In its last earnings call management said it expected to hit positive monthly pretax income by the September quarter excluding amortization for the acquisition (which we believe runs about $3.8 million a quarter) and changes in non-core investments. We expect EBITDA should increase faster than revenues due to operating leverage. Analysts’ EBITDA forecasts for FY2024 range from $36.7 million to $39.2 million, the midpoint of which puts Lesaka’s current valuation at 10.0 times EV/EBITDA. Near-term upsides to valuations would include the paydown of debt as well as better-than-expected success in capturing Postbank customers.

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