Pepkor Holdings Limited (PPH) Earnings Call Transcript & Summary

Good morning, and thank you for joining us. I welcome you today as Acting Chair and Lead Independent Director of Pepkor to present as we announced a transformative transaction for the group, Pepkor combining its Flash fintech business with Shop2Shop. As a Board, we are entrusted with safeguarding the long-term strategy and performance of the company and ensuring that value is both created and ultimately realized for shareholders. That mandate extends to capital allocation decisions and corporate actions of this nature, where scale and capability and strategic positioning can materially accelerate the trajectory of value creation for shareholders. And today, we are presenting such a transaction that aligns with that responsibility. Let me go through the agenda. So I'm making a few introductory remarks. Garth Napier will talk us through the transaction rationale. Then we'll hand over to Peter Berry. Peter is the Founder of Shop2Shop, and Peter will provide an overview of the journey and the success he has built in the informal market, including the Shop2Shop business and what the transformation from the formation of FintechCo will bring. Riaan Hanekom will then share more detail on the structure of the transaction, the financial metrics, and then I'll conclude on a few closing comments before we deal with questions. In terms of this transaction, Pepkor will be combining its flash Fintech business with Shop2Shop. This is a transformative transaction for the group and has taken substantial effort to negotiate and construct. We are moving from a commercial relationship with Shop2Shop to a combination of the 2 businesses with Pepkor in control. As a Board, we conducted a rigorous process to evaluate the transaction, which I'll cover in more detail later in the presentation, ultimately concluding that the combination of Flash and Shop2Shop is a logical next step for Pepkor. It firstly strengthens our position in one of South Africa's fastest-growing markets and secondly, allows us to integrate the group's capability across retail and financial services in the informal market. Lastly, it creates a clear pathway to unlocking shareholder value in the medium term through the planned listing of the combined business. We also anticipate that FintechCo will play a significant role in the group's banking strategy. And I'll now hand you over to Garth to unpack this further.

Thank you, Ian. As we've mentioned previously, we see Pepkor as a retail-powered consumer platform. Our primary focus is on meeting customer needs, and we believe that we can serve customers throughout their lifetime with offering them everything from baby wear to banking. We already have significant scale with over 6,600 stores across the country. We process in excess of 2 billion transactions. We have 32 million known customers. And more importantly, in the informal market, we serve over 170,000 traders and have throughputs of in excess of ZAR 66 billion. We've been operating in the informal market for over 20 years. We continue to believe that this market offers significant growth potential for us. The market size has been estimated at between ZAR 900 million to ZAR 1.5 trillion, and we continue to believe there's an opportunity for us to expand in this market. Through this transaction, by combining Flash and Shop2Shop, we believe we can expand our offering across the full value chain. We think there are 4 reasons to drive this transaction. Firstly, it allows us to build on long-standing relationships between Flash and Shop2Shop. Secondly, it expands our reach across the informal market value chain. Thirdly, we believe it can unlock meaningful synergies and operational benefits for both businesses. And lastly, we believe it can allow us to unlock value for our shareholders through a future listing. If we look at the Flash business very quickly, as highlighted, we've been in the informal market for over 20 years. We have over 170,000 traders. We conclude 5.5 million transactions daily, and we have over 80,000 acquiring devices. We have operations in Southern Africa as well as in Europe. And through this transaction, we think we can continue to expand our business. The Flash business model is focused on serving customers across a couple of key focus areas. Firstly, we want to provide customers with access to digital products. Secondly, we want to enable payments in the informal market. Thirdly, we want to link the informal market with the formal economy. And lastly, we want to provide a tailored digital platform that allows for an integrated fintech ecosystem across both the informal and the formal market. The Flash business has 3 segments to it: the trader or the business segment; secondly, the aggregation or the platforms business; and thirdly, the consumer business, which serves consumers directly. Our product set is wide ranging with everything from VAS, vouchering, cellular and SIMs, including merchant acquiring, Flash Advance as well as our platform from the aggregation business. The Flash ecosystem has already delivered strong financial performance. As you can see, we've grown our revenue at a 9% CAGR over the last 3 years with revenue at the end of September at ZAR 11.2 billion. From an EBITDA point of view, as at September last year, we've managed to grow our EBITDA at 28% over the last 3 years and delivered in excess of ZAR 900 billion -- million in EBITDA. We've got a strong trader business with over 170,000 traders in excess of ZAR 24 billion in tapped value. The cellular business distributes 30 million SIMs a year and has 3.1 million customers on its SIM base. And our aggregation business has over ZAR 28 billion in throughput and has over 85 partners. Our voucher business processes over 420 million voucher a year and in excess of ZAR 31 billion in throughput. We believe with our significant scale, combining that with Shop2Shop provides a unique opportunity for both our customers and our shareholders. I'll hand over to Peter Berry to take you through the presentation.

Thank you, Garth. Over the next few minutes, I'll introduce Shop2Shop, how we've built the business, what sets us apart, why combining with Flash creates a unique fintech platform for both formal and informal businesses. Our focus has always been to solve problems for small business owners. In so doing, we have built a platform that enables small businesses to grow, and we are not just another payment company. This strategy has driven consistent growth and combining with Flash is a strong strategic fit. We didn't start with a grand ambition to become a fintech platform. We needed to make cash handling safer for township traders. Our first safe was installed in Khayelitsha and our first payment was made to Coke. Once cash was secured, merchants needed an efficient way to move money, pay suppliers and grow their business. Every capability added has been a logical extension to that of the customer journey. Supplier payments, digital vouchers, card acquiring, retail management tools, SME funding, international remittance, rewards and money transfer. We have secured the necessary regulatory licenses along the way to help us expand, acquiring license directly from the SARB and ADLA license Category 1 FSP license. All our growth has been organic, responding directly to what our customers' needs have been. Combining with Flash accelerates us to the next chapter. This slide summarizes the ecosystem we've built. Think of it as a cash management system for small businesses, replacing the need for payment administrators, debtors clerk and creditors clerk, a simple app the owner can run, giving him security, one place to manage his working capital and the ability to move faster. On the left side, the business sales activities, digitalizing and securing cash sales via the Smart Safe and card sales via the card machines. Other payment methods, bank vouchers and SASSA payments, stock advances and working capital for small businesses. Once sales are secured, funds can go straight to work. Order stock and paying suppliers is by far the greatest activity. Loading a VAS wallet to sell digital products is next. Currently, a small share is used for international remittance with significant room for growth. Suppliers settle to their bank accounts and the cycle starts again. The majority of brands are on board, Coca-Cola, PepsiCo, SAB, Unilever, Tiger Brands and the major distributors. Revenue is earned through fees on acquiring transactions, stock advance, supplier payments and cash processing. Most activities stay within the ecosystem, resulting in a faster settlement, lower friction and better customer experience. The ecosystem strength is shown clearly in the growth of the digitalized transactions. Throughput over the last 3 years has grown from ZAR 58 billion to ZAR 172 billion, a 44% compounded annual growth. Cash saves remain an important foundation. A growing share of inflows is now via Tap to Pay and card acquiring. As you can see, the mix has grown from 30% in 2023 to over 40% in 2026. Every digital payment captured is an opportunity for future growth. Operational performance has translated directly into strong financial outcomes. Today, we service 177,000 traders through 114,000 acquiring devices and 2,900 cash counting safes. Those businesses processed ZAR 131 billion in supplier payments, ZAR 770 million in international remittances and the balance into VAS. Of the ZAR 172 billion throughput, ZAR 131 billion, roughly ZAR 3 in every ZAR 4 flowed straight back to supplier payments. Not cash sitting still. The informal economy money is moving fast, creating better access to working capital, which in turn has created more jobs and more opportunities in communities. Over the past few years, our financials have shown revenue growth of 28% annually and EBITDA growth of 85% compounded. The more services and products our existing clients adopt, the more earnings we generate without a proportionate rising costs. This business has both the scale and profitability to be a key component of the combined FintechCo. The 2 businesses together create one integrated solution rather than isolated products with complicated onboarding processes. A merchant can order stock, make supplier payments, accept card payments, digitalize his cash, access working capital and transfer money and sell an even larger growing range of digital products. An owner can scale his business, open more stores and grow on one single platform. The advantage is simplicity. Shop2Shop brings business management and payments. Flash brings a strong digital product and a vending switch, able to add hundreds more products as customers' digital demands grow. Together, a complete platform neither of us could build alone. Okay. This slide captures why we're excited about the transaction. Flash has built exceptional scale in value-added services, digital vouchers, consumer reach, supplier aggregation and deep relationships across hundreds of thousands of traders and an extensive distribution footprint. Shop2Shop has built complementary strengths in digital cash, card acquiring, supplier payments, lending and cash management infrastructure. Individually, both businesses are highly successful and together, significantly more valuable. Every trader gains access to a broader suite of services through one integrated platform. Together, we'll move more than ZAR 200 billion a year of working capital to help small businesses thrive and prosper. We believe we could become South Africa's leading merchant commerce platform uniquely positioned to serve the ever-growing informal market. Riaan, I'll hand it over to you to show the transaction structure.

Thanks, Pete. As he said, I'll take you through a high-level transaction structure and some other detail to follow up that. So just to start off with, high level, these are the numbers that most of you are already aware of, and you know from a flash perspective, obviously, the Shop2Shop numbers are all new to you. To confirm the numbers that you see on the screen from a flash perspective as at the end of September, so our financial year, exactly as we reported to the market. The Shop2Shop numbers are as at the end of June because that's their current financial year-end. When we did the valuation on both entities, we did use September numbers for both entities to obviously compare apples with apples. Needless to say, we went through a very extensive process to do the valuation of both entities. As you can see there, obviously, from a flash perspective, the revenue growth the last 3 years from a compounded annual growth rate is 9% is just known to you. From an EBITDA perspective, it's 28%. As Peter has already communicated from a Shop2Shop perspective, really phenomenal numbers over the last couple of years at a compounded annual growth rate of 28% on the revenue side and 85% on an EBITDA side, really phenomenal numbers. As I said, when we did the valuation, we used, as always, different valuation methodology, either 10-year DCF looking at multiples across different industries, comparing it to other likewise companies, but we also looked at the multiples of individual components within the 2 operating entities. So what are the different product sets, and we try to do a sum-of-the part valuation on both of these businesses to make sure that we end up with a very accurate final valuation, which was obviously being checked as well by 2 outside independent advisers. And also, we've got a fair reasonable opinion that Ian Kirk will comment on later. So needless to say, because of the high growth rate you see on the revenue side and also on an EBITDA side means that the multiple that's been allocated to Shop2Shop is, therefore, slightly higher than the multiple that's been allocated to the Flash side, meaning that from a valuation perspective, although there's a higher EBITDA for Flash, the value comes out at ZAR 10.6 billion. And although the Shop2Shop's current EBITDA is slightly lower than Flash because of that slightly higher multiple, it comes out at a very similar valuation of ZAR 10.7 billion. Therefore, if you combine the 2 entities, you end up with a ZAR 21.3 billion. Hence, the reason, as you'll see, taking Monday's closing share price of Pepkor, which was ZAR 21.8 this is classified as per the JSE as a Category 2 transaction. So the swap ratio, and that's why this is really seen as a merger, not as a takeover, means that it's 49.7% on the flash side, and it is just over 50% on the Shop2Shop side. However, Pepkor decided that as we've always indicated, we want to maintain a shareholding in this new FintechCo of close to 60%. So we always want to be around about the 55% to 60%. That's why we made the conscious decision to invest another ZAR 1.57 billion in cash to acquire that further stake that takes us up to the 57.1%. So just to confirm, as I will communicate to you at the Capital Markets Day, when we look at acquisitions and we do DCFs, we always want to get a minimum of twice our WACC rate, which is currently about 25%, 26% as an IRR return. In this case, on our base case, our IRR, I can tell you is in excess of 30%. And if we take the synergies into account, it's even higher. So what does this all mean for Pepkor? And what is the impact on this for Pepkor from accretive or dilutive effect? As you can obviously see with the lower EBITDA currently of Shop2Shop versus Flash, it does mean in year 1, it will be dilutive for Pepkor. But because of the higher -- very high growth rate in EBITDA that you've seen in the past, and we foresee that to continue into the future, means it is accretive already for Pepkor from year 2 onwards. It does mean because this is really a merger and we're not doing an acquisition and the cash outflow is the ZAR 1.57 billion does mean that I will maintain my gearing ratio of less than a 1x net debt to EBITDA, as I've communicated to you at the Capital Markets Day, which is still our view for the next 3 years. It also means that in the short term, our dividend policy won't change. But again, as indicated later on around about 2029, we want to increase the dividend payout. So it does not materially affect the key KPIs that you always look at. So just some key matters to take note of in the agreement that we've reached. Obviously, there's 2 key agreements that we're in the process of signing with the Shop2Shop shareholders. The one is the shareholder agreement. The other one is the share swap, the Section 42, which from a shareholder agreement perspective, that obviously manages how we will interact, how the Board construct will work, what the minority protections are with the Board composition and also the approval framework will be. One key item to take note of out of that is we have agreed with the Shop2Shop shareholders that over the next 5 years, that current 42% that they have in the business can't drop below 15% to make sure that management stays and the founder stays invested in this business at least for the next 5 years. Also 2 different put and call agreements. The first one is around being -- either party being able to exit after 5 years. That's if we don't come to an agreement on listing and both parties see there is no future listing possible after 5 to 8 years or between 5 and 8 years, either party can do a put and call. There's also certain material trigger events around about that period that if we don't come to an agreement or see eye to eye on that, both parties can exit. Then the Flash cellular business, at this stage, we don't foresee that being a long-term part of the business. We might change our mind over time, depending how the cellular business develop. But for now, we said before we list, we really want to have the opportunity to exit that business out of this Fintech, which is currently an integral part of the business. So there is a put and call agreement on that, that can be exercised over the next 5 years. Both of these will obviously fall away when this entity list. So there's some certain key CCs in this agreement. As always, competition commission approval will be critical. This is a CAT 1 transaction from a Competition Commission approval is a large merger. So as always, we'll have to go through that process. There is some other regulatory approvals that we require, specifically one example being that Shop2Shop got an acquiring license, and we need to get approval to transfer that acquiring license into the new entity. As ever, lots of uncertainty around time line. We do think our current indication is around about a 9-month time line, meaning around about March, April next year for this to be executed and implemented. However, we do hope it won't take longer than 12 months at this stage, taking everything into account. So just from a high-level process look going forward in the next couple of years, looking at the integration road map. As we all know by now, we've recently gone through quite a few M&A transactions. The first part is absolutely critical is integrating these 2 businesses as quickly as possible to make sure that we get the optimal synergies out of them. First step is, however, because we want to list this entity, we need to set up the FintechCo that will ultimately be the listing entity. There are certain leverages and expansion that needs to happen, as I already said, we've learned from that in the last couple of M&A and acquisitions that we've done. that's critical to get that in place as quickly as possible. But one of the key points really because this is really a tech business, both of them is the integration of the systems on both sides into one will be a key aspect that we need to deliver in the next year. And then because of, as I already said, they have got this acquiring business in place being Shop2Shop. Flash is currently making use of that service already. But to get the full benefit out of it, we really need to make it a key part of the total business going forward. That we sort of see happening in the first couple of months to a year. In year 2 will really be, when we really extract the synergies between Flash and Shop2Shop. So that means, as we've always communicated to you, it's critical that you continuously offer more and more products to the trade as an example, that you lock in. So that's why we must expand this offer now using the Flash products in Shop2Shop and also using the Shop2Shop products in Flash and really combining those 2 into one. That's why cross-selling is critical and obviously, also utilizing this combined footprint that we've got. So in other words, where previously we did not have a Flash trader, but we had a Shop2Shop trader, making sure that all those services are also now available to the full set of traders we've got on both sides. So that we see as another year to really extract those key synergies. And then Phase 3 is then really looking at the bigger Pepkor Group, where are there benefits and opportunities that this FintechCo can utilize in the bigger Pepkor Group. Some examples of that is really insurance, the Abacus business, where we think definitely the traders, but also their customers can make use of that service. The bank -- new bank that we're in the process of forming, Plus B, we do think there's a huge upside in utilizing that bank in this environment as well. Similarly, on the Fone side, not only on payments, but also some of the services and products that we offer via Fone can also be rolled out to some of these traders. So huge upside. Peter already touched on this. We've really touched only on some of them. We think there's still a lot more. Ultimately, the plan is currently, as we communicated last year already that we really want to list this entity. We've been talking about medium term. So currently, we see that period being about 3 years' time. It's purely 3 years because that's how we currently see it's going to pan out. It might happen faster. It might be after 2 years. It might take us slightly longer. It might be 4 years. But we do want to ultimately list this entity. We'll unpack a lot more detail around that once this deal is completed on why the real reason is. But needless to say, there is benefit on both a Pepkor shareholder, but also on a Shop2Shop shareholder and stakeholder for us to list. And as I previously communicated, it's really for us around unlocking the sum of the parts in the Pepkor business and not only being seen as a retail business, but also being seen as a financial services and fintech and investors can then invest directly into that, which will ultimately unlock shareholder value to Pepkor shareholders as well. One key thing to take note of, as I mentioned, long term, Pepkor do want to hold around the 55% to 60%. So the current agreement is whatever that free float is when we list being at 20% or 30% will come from minority shareholders and minority partners. So Pepkor really want to maintain long-term a majority stake in this business. So on that note, I'll hand over to Ian Kirk for some closing comments and remarks. Thank you.

Thank you, Riaan, for taking us through the detail on the transaction. Now as I mentioned at the outset, the Board approached this transaction with a strong focus on governance, independence and shareholder value. A comprehensive evaluation process was undertaken, which incorporated independent valuations, extensive due diligence and a voluntary external fair and reasonable opinion from reputable advisers. And you see all the detail on the slide there. Against this backdrop, let me now turn to the ownership structure of FintechCo and how it aligns all stakeholders around future growth and value creation. Post the transaction, as Riaan mentioned in his presentation, Pepkor will hold a 57.1% controlling stake. while the Shop2Shop founders and the shareholders retain the remaining 42.9%. And this comprises indirect interests held by Peter Berry-related entities of 24% and Peter Erasmus-related entities of 13.2%. The balance will be held by Shop2Shop management and employees. This structure ensures the continued founder alignment while establishing Pepkor as the controlling shareholder in the entity. Now as we have disclosed previously in our annual reports, our Group CEO, Peter Erasmus, holds an indirect minority interest in Shop2Shop that predates his appointment as CEO of Pepkor. And therefore, in line with strict governance protocols, he was recused from all discussions and decisions relating to the transaction, which was conducted under independent Board oversight throughout. And on the Shop2Shop side, Peter Berry and his team handled all of the discussions with appropriate corporate finance support. And this approach over a 2-year period or more ensured a transparent, robust and independent process, safeguarding the integrity of the outcome for Pepkor shareholders. And following implementation of the transaction, government protocols will remain in place with regard to FintechCo, and this is supported by FintechCo shareholders agreement, which protects all shareholder interests. So to conclude, we believe that this transaction advances Pepkor's growth strategy, expands its participation across attractive market adjacencies and creates a scale platform at the intersection of retail, financial services and the informal market. We believe that the combined business is exceptionally well positioned to drive sustained growth, deepen customer engagement and unlocks significant value for shareholders over time. We will now go into Q&A session.

Okay. Morning, everyone. Thanks for the questions submitted. Just to note, in addition to the presenters, we have the full Pepkor management team present for the Q&A, and we'll get through as many of the questions that have been submitted in the time that we have available. I think starting with Peter Berry, who just had some questions pertaining to Shop2Shop specifically. So FintechCo as a company putting together Flash and Shop2Shop, how do you view that in terms of the informal market opportunities in that sector? And how does that look versus peers, players in the market?

Okay. Thanks, Ian. Yes, look, we built Shop2Shop effectively as a payments business to digitalize cash in the informal sector, help traders trade. So Shop2Shop at heart is a payments business. Flash at heart is a vending business, sells digital products to end consumers. Once you put these 2 businesses together, the product offering at a store level is far, far greater than us as individual companies. So going forward, I think the opportunity for the companies to work together is enormous. Another question that might come up later is the overlap, which you wanted to address. There's an overlap in our trader base with Flash of about 20% to 30%. So there's a lot of room for growth in that market. In terms of our sales forces and how we approach the market, the 2 companies together will give a far greater service to our consumers. And that's what I'm really excited about. The informal market itself is a fascinating and tremendous space to play in. So what you'll see, I think, over the next 5 years is a more formalization of the informal market. So yes, it's been very informal. Yes, you've seen massive growth. And I think that growth will continue because of the formalization of the informal market. So what you'll start to see is more and more shop owners owning more shops. As opposed to running one individual shop, our platform gives them the opportunity to scale these shops, to scale these businesses. And that's what I'm really excited about. To have 2 businesses with the same mindset running at the same goal, I think, is going to be very, very powerful going forward. And that's not to say that the digital market in the informal economy is going to grow. The cash is going to slowly disappear over time, although cash is still a big component of our business. It will slowly disappear over time. What's holding the cash element back is really the taxis, not taking cash. So you're starting to see what we have done is we've enabled the whole informal market to take digital payments, but the cash element still exists because of the taxi. So I think whoever solves that last element, and we're working hard at it, is going to be ahead of the game. And we have -- we already have a great established footprint and great teams on the ground collectively.

Thanks, Pete. Next one for you. So we've disclosed some of the performance measures for Shop2Shop revenue, EBITDA, et cetera. So there's just a few questions on what does performance look like post some of those periods that we've disclosed.

I mean, look, going forward, payments is a commodity product. So we're not going to try and gloss it over and say, look, you've got to get scale. You can't come into the payments business with no scale. So price is important. And that's why we have a great ecosystem because we allow our shop owners and traders and small businesses that are trying to make ends meet the opportunity to pay their suppliers at no cost. And we created more working capital for them in their businesses and in their ecosystem. So going forward, I think the projections are very good because I think the market is going to scale. What -- how we scaled was we got the massive tailwinds from COVID, which digitalized cash in the informal sector. It ramped up by like 100%, 200% just because of COVID. And we rode that wave. But I think the next wave will be a wave of independent entrepreneurs growing their own businesses because now they've got the technology to run it. Because prior to that, what you needed to run a small business, you need a debtors clerk, accountant, bookkeeping, all that functionality is built into our app. And with the advent of AI, we can formalize that and process a lot more transactions for these guys. And then to say like the consumer payment play is going to be a big one. I think this market ends up looking similar to the Chinese market or to the African market where most of the payment transactions are digitalized. And we're well positioned to look to take advantage of that.