Is anybody home? The public markets are sure a lonely place to try and find a payments company these days. The combination of 2007's LBO frenzy, industry consolidation and the lack of an active IPO market for the past 16 months have taken a substantial amount of investor focus away from the industry.
You may say "who cares?" The answer is that everyone in the payments industry should. The metrics of publicly-traded payments companies drive valuation comparisons for private companies in capital raising, M&A and even debt discussions.
In early 2008, the market capitalization of companies in payment processing (including financial outsourcers such as Fidelity National and Fiserv) was nearly $100 billion. As of mid-April, the market capitalization of the industry was just over $30 billion. These numbers do not include MasterCard or Visa as investors look at them very differently than the payment processing market.
Such a dramatic decline in market value for the industry has multiple effects. Wall Street, institutional in- vestors (mutual and hedge funds) and strategic buyers for payments assets all use public market valuations for benchmarks. These issues show up in a lack of attention from investors and research analysts, uncorrelated trading patterns and difficult valuation negotiations.
Lack of Attention
As a result of the shrinking size of the payments industry in the public markets, there is less attention on the segment by the mutual funds and investment banks that once followed it aggressively. Mutual funds who once invested in every company of size in the segment employed analysts devoted to the sector. Each investment bank had research analysts who covered every public company in
the industry and specialized bankers who knew the intricacies of the payments business. With the decline of the size of the segment in the public markets, the research analysts have taken on other market segments and have dropped coverage of many of the companies they used to cover. The bankers that focused on payments exclusively were either handed pink slips or reassigned to cover broader financial services or technology companies. The end result is a lack of detailed understanding of the industry by the investor, research and banking communities.
No Correlation
In order for a market segment to trade with any correlation (i.e., semiconductors, mid-cap banks, power generators, etc.), the comparable group must have what is known as "investible size." There is no magic number that indicates when this has been achieved; however, it results from a combination of the number of companies with substantial market caps and the overall market capitalization of the industry. Institutional investors want to own a large block of shares in each company in a given sector. In an industry with many large companies, you typically see the same funds in every shareholder registry. Since there is commonality of ownership, there is a trend in the trading activity across the entire sector.
As of April, only six companies in the group referenced above had market values greater than $1 billion each, which is a magic number for many institutions. As such, you see very little similarity in the investor bases of today's public companies. This infers that the investors are solely looking at companies on an independent basis as opposed to a strategic view on the payments market in general. This results in the trend we have seen of payments companies trading at very different valuations and at varying levels of volatility over the same period.
Value Uncertainty
The public markets are of great importance to setting valuation. For example, a bank with a large payments business should trade at a higher valuation multiple than other banks assuming their core banking businesses are performing equally as well. The reason is that currently the earnings stream from the payments business is valued higher by the market. Without a large payments sector, the ability to value the payments assets independently is more difficult and subjective. The same circumstances hold true for privately-held payments companies. M&A transactions use the publicly-traded comparable company valuations as much as they do past transactions in the industry when evaluating the appropriate value for a business.
If the public companies don't trade in a correlated manner, private businesses tend to get tied to one particular public company. If something goes horribly wrong at that public company, the impact on valuation for the private business is substantial.
You can try to mitigate the impact of a smaller public market for payments companies on your own business. When talking to people about the value of your business, expand the comparison group for your company to businesses outside of the payments industry that attack a similar target market or utilize similar core competencies. The public market has always liked the payments industry and there are many sizeable companies in the industry that could come to market when the IPO environment improves. What the reception will be like, however, is more uncertain than it used to be.  |
