Lesaka Technologies, Inc. (LSAK) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Net1 to acquire the Connect Group conference call. [Operator Instructions] Please note that this call is being recorded. I would now like to turn the conference over to Dara Dierks. Please go ahead.

Thank you, operator. Welcome to a conference call to discuss Net1's announcement today that they will be acquiring the Connect Group, leader in merchant services and commerce enablement. With me today is Chris Meyer, Group CEO; and Alex Smith, Group CFO of Net1. As a reminder, during this call, we will be making forward-looking statements, and I ask you to look at the cautionary language, contained in our Form 10-K and today's press release, regarding the risks and uncertainties associated with forward-looking statements. The Connect Group prepares its financial information under International Financial Reporting Standard for Small and Medium Enterprises, and as such, they may differ materially from U.S. GAAP. The press release and presentation on our website includes non-GAAP measures, and those reconciliations can be found in the press release and presentation. On today's call, Chris will be -- will discuss the strategic rationale for the acquisition, Alex will discuss the acquisition price and other key metrics, then we will conclude with a Q&A session. So with that, let me turn the call over to Chris.

Thank you, Dara, and good morning, everybody, and thank you very much for joining us today as we announce the exciting and transformational combination of Net1 and the Connect Group. As we've mentioned many times, our vision is to transform Net1 into the leading South African fintech platform, offering payment processing and financial services to underserved merchants and consumers. Our core purpose is to improve people's lives by bringing financial inclusion to South Africa's underserved customers and helping small businesses access the financial services that they need to prosper. South Africa is primarily a cash-based economy, with approximately 60% of transactions still conducted in cash. And as you know, worldwide, there is a secular shift towards digital payment methods. South Africa and the wider African continent is part of this shift and is at a similar phase of transition as many other middle-income countries. Our vision and our core competency is aligned very well with this trend. And as we've explained on previous investor calls, we intend to build a full-service fintech platform across cash and digital, serving the needs of both, while also facilitating the secular shift to digital that is taking place. Our mission leads us to a total addressable market of more than ZAR 150 billion, which flips into 2 overlapping markets. First, a consumer financial services market of more than 26 million adults in LSMs 1 to 6 in South Africa, and second, a merchant financial services market of approximately 700,000 formal and 1.4 million informal micro, small and medium enterprises, or MSMEs as they're known in South Africa. On the consumer financial services side, we currently have the product offering, the distribution, the footprint and core competencies to serve the market very well. We are, therefore, addressing that opportunity, organically. On the merchant side, our offering serves large formal merchants very well. We operate one of the largest bank independent final switches in South Africa, with integrations to over 40,000 terminals for bill payments and value-added services for many of South Africa's largest retailers and build issuers. We also manage point-of-sale terminals for third parties and provide various cryptographic solutions. However, as I've said before, we are not currently addressing the 700,000 formal MSMEs or the 1.4 million informal MSMEs, which is a very large and growing opportunity. Specifically and from a product perspective, we do not have an offering in merchant acquiring, merchant lending or digitized cash management, all of which are key elements of the full-service financial technology platform we plan to build for South Africa's underserved consumers and MSME merchants. I mentioned in the last earnings call that we would address these opportunities, both organically and through acquisition, which brings me to today's exciting news that we will be acquiring the Connect Group, which is a profitable, high-growth and leading fintech company, serving over 44,000 MSMEs in Southern Africa. The Connect Group delivers 4 main product lines to its customer base, under well-established and respected brands. Firstly, a prepaid value-added services platform, branded Kazang. Secondly, a digitized cash management and supplier payment solution, branded Cash Connect. Thirdly, a digitized provider of growth capital to merchants, branded Capital Connect. And fourthly, a merchant-acquiring solutions platform, branded Card Connect and Kazang Pay. Taken together, the Connect Group is a unique full-service provider, across cash and digital, of financial and value-added services to formal and informal MSMEs in Southern Africa. The Connect Group offers these products in an integrated manner, leveraging the power of the technology and data. For instance, an MSME merchant can accept card payments using Kazang Pay's point-of-sale devices, sell value-added services like airtime and remittances, using the same POS device and receive much-needed capital to grow their businesses, based on the value of the card payments and sales that go through their POS device. This results in a win-win relationship with MSME merchants; the merchant gets better product and pricing, and the Connect Group gets to cater customers at a higher take rate. Therefore, the Connect Group uniquely fills the product -- customer segment and distribution opportunities that I have previously flagged and that were also previously flagged by our Nonexecutive Director, Ali Mazanderani, during the Q4 2020 earnings call, following our board's strategic review. Based on a thorough due diligence process that I've led with my management team, which has been supported by external professional services firms, I can conclude that the Connect Group is an established leader in our target market. And I want to expand on 5 points that illustrate this conclusion. Firstly, the Connect Group has reached substantial scale in the MSME market and continues to grow swiftly. Their customer base, as of 28 February 2021, includes more than 8,600 formal MSMEs and over 35,000 informal MSMEs. In their last financial year ended 28 February 2021, the Connect Group grew EBITDA by approximately 30% on the prior year, notwithstanding the significant impact of COVID first wave, Level 5 and second wave, Level 3 lockdowns on the South African economy and the MSME segments that the Connect Group serves. In the financial year to 28 February 2021, the Connect Group settled cash of ZAR 79.5 billion, which is $4.8 billion, through its retail cash vault infrastructure. It sold ZAR 13.2 billion or $799.4 million of value-added services through its point-of-sale terminals and digital wallets, and advanced over ZAR 280 million or $17 million in growth capital to SME businesses and processed ZAR 2.6 billion or $157.5 million in card transactions through its POS terminals. This resulted in net revenue for the year, of approximately ZAR 1.1 billion or $66.6 million, which represents a 3-year compound annual growth rate of just under 30%. Second, the Connect Group is highly profitable, with strong unit economics, delivering an historic 3-year compound annual growth rate, in earnings before interest, depreciation and amortization EBITDA, in excess of 40% for its financial year ended February 28, 2021. Further, underpinning the strong track record is an agreement between the parties that the purchase consideration will be reduced on a rand-for-rand basis by any amount by which the actual EBITDA, as defined in our transaction documents, is lower than ZAR 375 million, which is the targeted 2022 EBITDA for the 12 months, to 28th February '22. The Connect Group's EBITDA for the financial year ending February 28, 2023, is expected to grow in line with recent historic growth rates. Third, the Connect Group has a very long runway for continued profitable growth. While they serve 8,600 formal MSMEs and 35,000 informal MSMEs as of 28th February 2021, the addressable market includes approximately 700,000 formal MSMEs and, as I said, 1.4 million informal MSMEs. The growth of this market is supported by secular tailwinds due to MSME shifting from manual to digitized cash management, and from cash-to-digital payments. And we've seen these trends accelerate during the COVID-19 pandemic and during the recent civil unrest in parts of South Africa. Fourth, we have seen in similar emerging markets around the world that regional size and scale for financial technology platforms such as ours, is a definitive source of strategic advantage, given the operating leverage in the business. This acquisition allows Net1 to gain significant scale in Southern Africa across the payments value chain. And fifth, the Connect Group has an exceptional management team, who are highly aligned with us on our purpose of driving financial inclusion for those underserved by the traditional financial system. The current group CEO of the Connect Group is Steven Heilbron, he has led Cash Connect since 2013 and Capital Connect since its founding in 2018. He has also been at the helm of the Connect Group, including Kazang and Card Connect, since the acquisition in February 2020. Steven has made himself available to continue in an executive role for a year from transaction close, and to continue the Nonexecutive Director on the Net1 Board for a further 2 years beyond that. And pursuant to this acquisition, Steven has retained a beneficial interest in Net1 stock. The rest of the Connect Group's management team will join Net1, including Martin Wright, the CEO of Kazang, who has been with the business for 12 years, and many other highly-experienced executives with a proven track record will be coming across and joining us. They will be aligned with Net1 shareholders through a staff-incentive pool that includes Net1 stock, and I look forward to welcoming the Connect Group's management team to Net1 and working together to ensure that the whole is greater than the sum of the parts. So taken together, we believe these points demonstrate that Net1 is acquiring a unique asset that is highly complementary to Net1's corporate strategy, our core competencies, our customer segments, our distribution footprint and our product offering. It is one of the fastest growing and leading fintech companies in South Africa and has won numerous awards, including the South African Retail Business Fund of the Year title in the 2021 Wealth & Finance FinTech Awards. This acquisition represents a transformational leap forward in Net1's journey to becoming the leading fintech platform for underserved merchants and consumers in South Africa. And I will now turn the call over to Alex to review some of the financial details of the transaction. Alex?

Thank you, Chris, and good morning, everybody. We signed a share purchase agreement, or SPA, to acquire 100% of the Connect Group for approximately ZAR 3.7 billion, which is approximately $242 million, at the current exchange rate of ZAR 15.22 to the dollar. After adjusting for net debt and debt-like items, the implied enterprise value is ZAR 4.8 billion. The transaction is subject to regulatory approval and the finalization of debt facility agreements and the satisfaction of closing conditions that are customary for a transaction of this nature and size. As a result, the transaction is expected to close in the quarter ending 31 March 2022. The SPA also includes contractual undertakings, usual for a transaction of this nature and size, including those relating to representations, warranties and interim period undertakings. The transaction includes a reciprocal break fee of ZAR 50 million, payable, should Net1 or the sellers of the Connect Group reach any of their respective undertakings, and as a result of such breach, the conditions of the transaction are not met, then the transaction is consequently not implemented. We have agreed that the consideration will be reduced on a rand-for-rand basis by the amount by which the actual EBITDA, as defined in the transaction documents, is lower than the target 2022 EBITDA of ZAR 375 million. Should this be exceeded, no adjustment will be made. The final consideration payable is subject to adjustment for debt and cash-like items and payments of interest from 1 March 2021 until the closing date pursuant to a locked-box closing mechanism. The rights, benefits and advantages of the Connect Group accrued to Net1 from 1 March 2021, in terms of the locked-box mechanism. The acquisition enterprise value of ZAR 4.8 billion will be funded as follows: ZAR 2.35 billion in debt, consisting of a ZAR 1.1 billion 5-year term facility and ZAR 150 million general banking facility that replaces the Connect Group's existing debt facilities. On top of that, there is a ZAR 1.1 billion 18-month bridge facility, secured against Net1's assets. Then there is deferred consideration of ZAR 350 million, which will be satisfied through the issuance of approximately 3.1 million shares of Net1 common stock, at an issue price of $7.50 per share, and payable in 3 equal tranches on the first, second and third anniversaries of the transaction closing. Then there is ZAR 139 million that will be satisfied through the issuance of 1.3 million of Net1 restricted stock to the Connect Group employees. The shares are also to be issued at a price of $7.50, using an exchange rate of $1 to ZAR 14.7. This restricted stock will vest in 3 equal tranches on the first, second and third anniversaries of the closing of the acquisition. This issuance is in line with Net1's current stock plan and includes both good and bad leaver provisions as well as including a top-up mechanism. The remaining balance will be funded by existing Net1 cash resources. At closing, the net leverage ratio on the ZAR 1.1 billion term facility for Connect Group, is expected to be less than 3x. And the asset cover ratio on the ZAR 1.1 billion bridge facilities for Net1, is expected to be greater than 7x. At closing, the trailing 12-month EV/EBITDA multiple, as calculated from the target 2022 EBITDA for the financial year ending February 28, 2022, is expected to be approximately 12.8x. The Connect Group's EBITDA for the financial year ending February 28, 2023, is expected to grow in line with the recent historic growth rates, in which case, the forward 12-month EV/EBITDA multiple is expected to be significantly lower. We consider this an attractive value for this profitable, high-growth and high-quality business, with strategic importance to Net1's core strategy. It should be noted that the Connect Group currently prepares its financial results under IFRS for SMEs. And the numbers I've referred to, have been extracted from those financial results. The results, under U.S. GAAP, may be different to those, reported under IFRS for SMEs. As is normal for transactions of this nature, we will, in due course, publish detailed pro forma financials and expect to conduct a roadshow, closer to the transaction close. To wrap up, we're really excited about growing Net1, both organically and through acquisitions such as Connect Group. We believe this acquisition is incredibly attractive, fixed with our growth aspirations and positions us well to deliver on our commitment to financial inclusion. With that, we will be happy to take your questions. If I can hand it back to the operator. Thank you.

[Operator Instructions] We have a question from Raj Sharma of B. Riley.

That's a sizable, large acquisition. Is -- I just had a few questions, I haven't had that much time to digest this. Is the business limited to South Africa, and does it have any impact on your retail side of the business?

Thank you for your question. So the business is -- the majority of the business is South Africa, merchants in South Africa. It does have some presence, just outside of South Africa, in Botswana and Namibia, but very small, relative to the South African business. And then your second part -- and let me just say, we see those as growth markets but relatively early stage, relative to the South African business. So the second part of your question, just to make sure I understand, you asked if it has any -- did you say any overlap or any relevance to our consumer business?

Yes.

So we see potential synergy, in terms of bringing both the merchant and consumer offering together. We -- our target market, as you know, on the consumer side, is very much in what we call the LSM 1 to 5, the lower income groups in South Africa, and these are very much the target client base for the Connect Group, from a merchant perspective. So we see an opportunity -- a number of different opportunities, in terms of bringing this offering together, in a very complementary way. In many ways, it's our target consumer, who will be in the stores, the shops that the Connect Group serves, the merchants that the Connect Group serves, so there's a clear overlap there. We also have, in our minds, an opportunity, in terms of growing footprint of the Connect Group. If you look at their existing presence in South Africa, it's very strong in -- primarily, in the Western Cape and in the Gauteng regions, and is growing into some of the other provinces. We have a very strong reach already in places like the Eastern Cape, KwaZulu-Natal. So we feel, our ability to help grow the business in that way, leveraging our consumer footprint and our relationships in those markets, will be of benefit to the Connect Group.

Got it. And then just one -- just commenting on -- you said that you expect the EBITDA growth for the year ending 2023 to be in line. Is that in line -- what is that number, it's about 40%, you said, of year-on-year growth?

Yes. So we -- well, so the 3-year compound annual growth rate, in EBITDA, is 40%. That's the historic number, so -- and I think the growth, year-on-year, between FY '20 -- February '21 and the previous year, it was just under 30%.

And you've given the number for year ending February '21, and they -- did they -- are they expected to assume a similar growth rate for the year ended '22 as well?

So Raj, the expected EBITDA growth rate, in rand terms, based on the target EBITDA, is about 24% for the fiscal year ending February '22.

Got it. So it's 24%, but do you think -- for this year and that -- so the number that you gave was for fiscal '21, right? It's 20 -- I'm sorry, what is the number for '21 EBITDA? Was it around...

So Raj, what we gave was actually the target EBITDA for fiscal '22, so -- they're in a different fiscal year to us, they run to February '22, so that target EBITDA is ZAR 375 million.

Got it. So it's ZAR 375 million, and then that should grow at a historical rate of 40% for year ended '23. And that's what your target is based on, right? Based on whether you take back cash or you give them more cash?

Raj, the historical compound annual growth rate to February '21, was about 40%, at EBITDA level. The growth rate to February '22 is about 24%. And so we expect the -- that sort of level of growth rate to continue into the future. Okay?

Got it. And yes, okay, that's clear. So the -- there was a lower growth rate for '22 -- year ending '22, because of COVID impact? Or is that the -- Is that what is being implied here, COVID and certain unrest?

We were referring to -- the main COVID impact was in the calendar year 2020, so in the year to financial year February '21. Yes, so we talked about a year-on-year growth of 30%, approximately 30%. That was a COVID-impacted year, yes.

[Operator Instructions] Our next question is from Bill Gordon of Gordon Capital.

Do we see any connection here in the future, between our work in India and South Africa, with this new operation? This whole item here is very overwhelming at the [indiscernible] Monday morning. I got to tell you, wow.

Bill, thank you for your question. Are you referring to MobiKwik, to our investment in MobiKwik?

Yes. Yes.

Yes. So there's obviously, some similarities, in terms of MobiKwik's strategy and MobiKwik's focus in India to what we're building here, but it's very separate, very different. We're an investor, a minority investor in MobiKwik, whereas this is our primary focus. I'm sure, there's lots of learnings that we can glean from MobiKwik and vice versa, and we continue to stay close to them and talk to them and learn, but we see this as quite separate.

It seems we have no further questions on the lines. Would you like to make any closing comments?

Thank you. Thank you, operator. I think I'll just close by saying thank you to everybody for joining us on the call. A big news, first thing on a Monday morning. We're very excited about this transaction. We've been working on it for a long time. And we see this as a transformational move for Net1 as we move towards becoming the leading financial technology platform, serving both merchants and consumers in the underserved elements of the South African economy. So thank you for joining us and we appreciate your time. Thank you.

Ladies and gentlemen, that concludes this conference. Thank you for joining us. You may now disconnect your lines.