I have been asked by one of our readers to take a look at Lesaka Technologies (LSAK) and provide my honest opinion about this South Africa based fintech company. Lesaka Technologies operates in a manner similar to Square (Block Inc (SQ)) in its early days. Targeting micro, small, and medium-sized enterprises in South Africa, Lesaka provides comprehensive financial services to both businesses and consumers through mobile handheld point of sale (POS) terminals, a mobile app, and payment cards. In a predominantly cash-based economy where about 60% of all transactions are conducted in cash, Lesaka sees an opportunity to capture a significant portion of the market, similar to the early days of Square.
Even though Lesaka Technologies’ stock chart spans a period of nearly 25 years, it is really a company that was reborn in April 2020 when Value Capital Partners acquired an activist stake in the company with the goal of transforming the company into PagSeguro (PAGS) or StoneCo (STNE) of South Africa. StoneCo (STNE) shares went from $40 at the beginning of 2020 to as high as $94 in early 2021, as investor interest towards fintech stocks was gaining steam around that time. Investors also responded to Value Capital Partners’ plans regarding Lesaka as they pushed the stock price from about $3.50 when Value Capital Partners revealed its activist stake to above $6 a year later.
At the time Lesaka Technologies’ name was Net 1 UEPS Technologies Inc. (UEPS) which operated in payment processing in both South Africa and the Republic of Korea providing a range of services, including debit, credit, and prepaid processing, along with issuing services for major payment networks. In South Africa, the company offered cost-effective financial inclusion products such as banking, lending, and insurance. Moreover, Net One was a prominent distributor of mobile subscriber services and held a 15% stake in a leading South African mobile network operator. It was a broken stock as UEPS declined more than 70% from its 2019 high because of the cancellation of contracts it had with the South African Social Security Agency (SASSA). Its revenue was around $150 million in 2020 and its net loss was more than $76 million.
Value Capital Partners installed a new management team which then announced the acquisition of Connect Group at an enterprise value of more than $300 million. The Connect Group was in the business of delivering financial technology solutions to nearly 44,000 micro, small, and medium enterprises (MSMEs) in South Africa. At the time Net 1 UEPS Technologies’ market cap was around $200 million, so this was really a transformative acquisition for the company and the new management. The acquisition was completed in April of 2022, the company changed its name to Lesaka Technologies, and its sales skyrocketed from around $130 million in 2021 to $539 million over the trailing twelve months.
Any idiot can spend $1.50 and generate $1 in revenues which is why strong revenue growth by itself isn’t sufficient to make a stock attractive. Net 1 UEPS had a total cost of $225 million to generate $150 million in revenues. Lesaka’s new management managed to shrink this loss down to $30 million over the trailing twelve months. More encouragingly though, last month the company revealed that it generated an operating income of $228 thousand in its 2024 Q1 vs. an operating loss of $4.7 million a year earlier. A positive operating income doesn’t mean that the company is profitable because Lesaka still had to pay nearly $5 million in interest expense, so its quarterly loss was still $5.6 million after accounting for tax expense and negative changes in its equity holdings.
It is a bit misleading to use the US dollar figures if we want to understand what is going on with emerging markets stocks that experience significant inflation and interest rates. Lesaka managed to grow its Q1 revenue by 19% in terms of local currency, but its USD revenue growth rate was only 9%. South Africa’s inflation rate is in the neighborhood of 5 to 6% right now, so exchange rate fluctuations have a significant impact on the perceived growth rate of the company. Lesaka’s inflation adjusted growth rate is around 13% which is a very respectable number for a company operating in a country that is generating only 1% GDP growth rate.
Lesaka’s cost of goods sold increased by 16% year over year whereas its selling, general and administrative expenses registered a year-over-year growth rate of only 7%. This is in line with annual inflation plus a small increase. Overall, the increase in LSAK’s operating expense was 14.2%. This is why the company was able to shrink its losses significantly over the last couple of years. Here is how the company explained the improvement in performance:
“As we previously reported, the Connect Group implied enterprise value to EBITDA multiple was approximately 12.8x at the time of the acquisition that’s using Connect’s February FY 2022 projected EBITDA. Notably, the Connect Group has surpassed the acquisition investment case, and this effective multiple, enterprise value to FY 2023 merchant segment adjusted EBITDA has become approximately 8x, with Connect contributing approximately 99% of the merchant segment adjusted EBITDA in FY 2023.
…Lesaka has undergone a remarkable transformation since 2021. Our discussions at the Board and operation level and with our investors and other stakeholders are vastly different now, with a clear focus on growth and opportunity rather than turnaround and integration. Lesaka has delivered on the strategy as communicated to investors and achieved several significant milestones. As a group, the Lesaka of today is ready for the exciting growth stage of our journey. The results for FY 2023 have been excellent. We’ve exceeded our revenue guidance for the year primarily due to the stronger than expected growth in our Kazang VAS and Card business.”
Lesaka’s merchant segment accounts for nearly 90% of its revenue and almost all of this segment’s EBITDA is generated by the Connect Group. That was indeed a very shrewd acquisition that keeps delivering even though the company’s debt load and interest expenses increased significantly.
I like Lesaka as a long-term investment at its current price of $3.50. Please keep in mind that this is the same price paid by activist Value Capital Partners when the company was generating only a quarter of its current revenue and losing 2.5 times more money. It is now on its way to profitability and growing at double digits. I think Lesaka has the potential to deliver triple digit returns over the next 2-3 years, however, I wouldn’t add it to our monthly newsletter’s portfolio at this moment for a number of reasons. First of all, we have only around 20 spots in our portfolio and there are already two profitable fintech companies in it. I would have to sell one of these to add Lesaka to our portfolio.
Secondly, the other two companies are profitable, so they are more resilient to unexpected internal or external shocks. Lesaka can become profitable towards the end of 2024 if it cuts down its interest expenses by selling non-core assets and paying down debt that has as high as 14% interest rates. Lesaka has around $143 million in debt (and $35 million in cash for a net of cash debt load of $108 million) but they also have other assets that the company values at $79 million (1.5 billion rand) which can be sold off to pay down this debt. LSAK is almost done selling its Finbond stake for 64 million rands ($3.4 million) which is expected to be done later this month (December 2023).
LSAK’s roughly 10% equity stake in Mobikwik, the largest asset, is one of the largest fintechs in India and files its financials publicly every quarter with the government as required by law. Large investors include Sequoia, American Express etc. Mobikwik already filed for an IPO in 2021, but it was pulled due to the fintech correction in 2022. LSAK has a board member on Mobikwik’s board and has a monthly conference call with management. Mobikwik continues to grow rapidly while generating positive EBITDA and hopes to go public soon per many articles like this one. The stock of the largest fintech in India, Paytm, has risen roughly 87% this year, however, LSAK’s management values the Mobikwik stake as of the value set in the last round of financing which was many years ago. The sale of the Mobikwik stake, and subsequent deleveraging, is a potential catalyst for this stock. A couple of weeks ago Bloomberg reported that Mobikwik’s IPO may happen in 2024.
Thirdly, I am concerned about South Africa’s macro outlook. It is an emerging country with a GDP of $406 billion in 2022. Right now it is expected to grow at an annual rate of around 1% which isn’t much. Moreover, the country’s GDP stood at $417 billion in 2010, $404 billion in 2018, and $419 billion in 2021. The country’s economy grew uninterrupted between 2010 and 2018 but its currency depreciated against the US dollar. This tells us that the country isn’t attracting enough foreign capital to fund its much-needed growth investments. South Africa doesn’t even generate enough electricity for its population and is forced to employ “load shedding” which is a series of rolling blackouts that last as much as 12 hours per day. Obviously these cuts affect the total output of the country and LSAK’s results. The good news is that LSAK’s current results already take into account these cuts.
The overnight repo rates in South Africa also stand at 8.25% vs. a headline inflation rate of 5.9%. This results in much higher interest rates for businesses and consumers who are looking to borrow funds to fund their investments or consumption. So, the current macro environment isn’t very stimulative for LSAK and other businesses in South Africa and things may get worse. The good news is that LSAK’s current results already reflect the effects of the restrictive high interest rate environment and if there is an improvement on this front Lesaka Technologies may reach to profitability much sooner than expected.
Last week the company named Ali Mazanderani as its Chairman. Mazanderani is or was an investor or director in several leading payments companies globally, including StoneCo (STNE), Network International (NETW in London, but does business in the middle east and africa and was just sold to a US PE firm for roughly $3 billion), PineLabs (Private, in India, last valued at roughly $4 billion), Thunes (Singapore based private fintech valued at roughly $900 million), and Lesaka (South Africa). Mazanderani was a partner for 9 years at Actis, a London-based global private equity firm (roughly $20 billion AUM), spearheading emerging markets fintech investments. Mazanderani also controls roughly 8 million shares (roughly 12%) of LSAK through various trusts and affiliated entities and was awarded a large number of options for part of his appointment as the Chairman of the company. His appointment is likely to catalyze Lesaka’s transformation into a profitable fintech company.
I believe Lesaka’s stock price is cheap at $3.50 because it already takes into account most of the risks and macro factors I listed above. That’s why I already added Lesaka Technologies to my watchlist and will be closely following its progress from a money losing growth stock to a profitable growth stock with triple digit upside potential. I know that I won’t be able to buy this stock for $3.50 after it reports profits or announces large asset sales, but I will be happy to buy it at $4.5 as the stock’s price can exceed $7 in the next 2-3 years if it continues to grow at double digit rates and divests non-core assets to pay down debt.
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