Riding the wave of consolidation: Private Equity and the Payment Industry

By Florian Kramer & Konstantin Brandt

Over the past two decades, the global payments industry has been subject to significant changes in both its underlying market drivers, and also in its competitive landscape. Driven by rising e-commerce volumes, an increasing demand for digital payment solutions and the trend towards cashless payment, global payments revenues experienced 6% annual growth over the past decade. Furthermore, waves of consolidation are shifting the competitive landscape with M&A volumes reaching record highs in 2019 cemented by landmark transactions creating regional and global market leaders.

Before the rise of the internet in the 1990s, payment companies were chiefly viewed as necessary technical facilitators for card payments: an unglamorous business with only limited growth opportunities. It wasn’t until the 90s gave birth to soon-to-be internet giants such as eBay and Amazon that a necessity for a new form of payment and payment processing emerged. Firstly, this makeover facilitated the inception of specialized players in the market, and secondly, it fostered the development of the payment businesses in established banks. Previously, the payment industry was comprised primarily of the enabling and processing of credit card transactions via physical POS (point of sale) systems: the issuing institutions, providing customers with a card of a certain scheme (e.g. Visa, Mastercard), and the acquiring institutions, providing merchants with the acceptance of card payments. Online payment methods eventually paved the way for a new type of institutions: payment gateways, offering payment services for e-commerce. With digital payments gaining importance over the last two decades, these players have gained traction and were able to build an outstanding growth story within the financial services industry. Both being megatrends, cashless societies and e-commerce are far from tired opportunities; there is still ample untapped potential for significant organic growth. Today, the payment industry primarily consists of four types of players:

Banks: Traditional financial institutions have pulled out of or spun off both the payment processing and the acquiring business to a large extent with many recent acquisition targets being formerly owned by banks (e.g. Concardis, Six Payment Services, Worldpay, Nexi). Only a few are still operating acquiring services while card issuance remains part of a traditional commercial bank’s portfolio.

Legacy payment players: Specialists which formed during the first wave of digitization which focus solely on payment services. Key European players include Worldline and Ingenico, which merged in February 2020.

Specialized Fintechs:  Fintechs have profited off their lean organizational structures and strong customer focus to dominate the market for online payments. This has led them to become highly economically attractive and resulted in IPOs including Adyen and German provider Wirecard, which propelled the latter to the highest German index DAX30.

Cross-industry players: In recent years, the field of payments has also attracted players from other industries attempting to gain traction and move closer to the customer they serve by also offering payment solutions. This includes Amazon, Apple, Google, Facebook, WeChat, and Alibaba.

The business models among these players are extremely diverse. Common denominators amongst payment specialists are strong scalability, high technological advancement and grown complexity. Traditional players struggle with their legacy systems in a similar manner to banks. Key differences include companies focusing on directly addressing customer needs, both at the Point of Sale and online, and companies focusing on technical aspects of the business and facilitation such as payment processors. With the steady rise of e-commerce, all payment companies seek to gain traction in the field, whereas previously mainly attacker banks were active and remain so today due to a strong first-mover advantage.

Having presented this brief industry overview, because of the scope of our student association, what follows will include the potential of financial investor involvement as opposed to a more detailed market breakdown. It becomes clear that, compared to the early years of the payment industry, the competitive landscape is now divided among a large number of player types, with new entrants and traditional agents battling for market share.

1 Deal volume in the payment industry

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(Source: Dealogic, EY)

While the payment industry has changed significantly and gained importance in recent years, M&A activity developed accordingly. Industry experts commonly define three phases of M&A activity within the payment industry. While the three phases follow a chronological order, they are overlapping to a certain extent and may vary from country to country and region to region.

The first phase is represented by banks’ disposal of national assets and the respective national consolidation. As mentioned above, many payment-related services were previously operated by banks which decided to spin off this unit of their operations. Examples include Deutsche Bank’s disposal of EasyCash, the spin-off of Italian Nexi as well as Danish Nets and German Concardis.

The second phase is represented by regional consolidation. During this phase, payment companies have sought national and regional assets to complement previous acquisitions from the first phase. The underlying goal is to become a national or regional market leader to be able to leverage synergies and exploit economies of scale. A good example of this is the recent €7.8bn merger between the two France-based companies Worldline SA and Ingenico SA. This represents the most recent landmark transaction for the payment industry consolidation in Europe, creating a payments leader with global reach and with enhanced operating leverage and economies of scale.

The third phase is represented by global consolidation or transcontinental M&A and the entry of private equity. It is the phase many countries and regions are currently transitioning towards. As the pressure to consolidate increases, M&A volumes and deal sizes increase accordingly. 2019 marked a record year in M&A volume for the industry with $116.6bn in the first six months alone compared to $31.8bn in the first half of 2018. This development was primarily attributable to multiple mega-deals which candidly display the characteristics of this third wave.

These mega deals include the $35bn transcontinental acquisition of UK-based Worldpay Group plc by US-based Fidelity National Information Services Inc (FIS) – the largest deal to date within the payments industry. The deal comes only about a year after Worldpay was initially acquired by US-based credit card processing company Vantiv for $10.4bn, after being listed by private equity investors Bain Capital and Advent in 2015. The short time frame between the transactions and the increased valuation for Worldpay exhibit the intense competition between large players over high-quality assets that can complement portfolios and establish global leadership positions. A further example of the aforementioned megadeals from the first half of 2019 is the $22bn merger between First Data Corporation and Fiserv, Inc.

These deals show how industry players were the driving force behind the waves of consolidation. But especially in the third wave, private equity investors have played an increasingly significant role, led by a handful of firms which began to accumulate assets early-on during the rise of the industry.

Two financial investors have become juggernauts driving the trend of PE-backed consolidation within the payment industry over the last years: Bain Capital and Advent International. Up to today, each has completed around 20 payment deals in Europe, North America, and South America. After the two companies successfully took over the US-based payment company Worldpay in 2010 and subsequently listed the shares in 2015, they allocated capital more heavily in the European market, being involved in one of the most impactful PE-backed transactions within the payment industry, the takeover of Danish payment provider Nets A/S. Nets was acquired by a consortium of Hellman & Friedman, Advent International, and Bain Capital in mid-2017. The consortium took Nets private for $5.3bn at a premium of roughly 30%, representing one of the largest European LBOs since the financial crisis. Bain and Advent had previously bought shares in the company from a consortium of Danish banks in 2014 and listed the company in 2016, still holding a minority stake at the time. The 2017 takeover was followed by a strategic repositioning, targeting a strengthening of the core businesses and an expansion of the geographical footprint.

Following the LBO, Nets merged with the second largest German payment provider Concardis in 2018. Concardis was previously acquired by Bain and Advent, which bought the company from a consortium of German banks in 2017 for €770m. The takeover of Concardis marked the entry of private equity investors into the German payment landscape, which is characterized by fragmented competition and strong growth. The combined entities increased the opportunities for the private equity consortium to immediately lift scale effects and leverage their two assets to the best possible extent. Together with the merger, Nets disposed of its account-to-account and instant payments businesses to Mastercard for $3.15bn, further focusing on core business areas.

In what followed, the newly formed group, backed and steered by its PE-owners, acquired several German payment specialists including Fintechs focusing on online payments as well as two technical processors, strengthening its position in the German market. In 2019, Bain, Advent and Hellman & Friedman were also said to be amongst the interested parties to acquire German payment provider Heidelpay from AnaCap, which would have further pushed the positioning of the combined Nets and Concardis in Germany. The bidding race, which was eventually won by KKR, bestowed Heidelpay with a valuation of €1bn.

The initial merger and the following influx of acquisition activity paired with the strong home market position in the Nordics and Germany led to the group becoming one of the key European players. This also laid the foundation for further geographical expansion. Through this, the merger of Nets and Concardis clearly demonstrates the possibilities for financial investors to combine different entities to leverage economies of scale and add further acquisitions, creating cross-border payment platforms.  Nevertheless, the acquisition of Concardis also shows the significant risks single payment players and thus private equity firms might face: due to Concardis’ losses in the acquiring business, where for example travel company Thomas Cook were amongst its customers causing write-offs after its bankruptcy, and high costs both from interest payments and transformative measures, Concardis had large consolidated losses in both 2018 and 2019.

Overall, these case studies display both the opportunities and the challenges of the payment industry from an investor’s perspective. Financial sponsors have the opportunity to participate in a high-growth industry with stable cash flows, scalable business models and remaining growth potential in developed economies. The companies operating in the industry promise two key components: strong top-line growth and the potential for further consolidation. As mentioned before, due to an increasing share of cashless payments at the point of sale and growing e-commerce revenues, payment companies are expected to maintain the high level of revenue growth over upcoming years. Additionally, the business models of payment companies are highly scalable and cost structures feature relatively few variable costs, implying access to untapped market potential also indicates bottom line growth. Valuation for early spin-offs of non-core business as well as expected exit multiples are high due both to the aforementioned growth potential and the high demand for payment assets from industry players.

At the same time, the pressure to consolidate requires investors to leverage existing investments as platforms to participate in the wave of consolidations. That being said, competition for assets is high which increases valuations and leaves a smaller number of potential targets, making it more difficult to expand on the foundation of existing assets, as was also shown in the bidding war for Heidelpay. In addition, especially for traditional players such as Concardis which have been under bank ownership for a long time, the transformation towards the digital business is costly and the current acquiring business in parts very risky, driving the cost base for these companies.

To conclude, the rise of the payment industry is likely to continue with annual growth in payment revenues expected to remain at 6%. There remains untapped potential in cashless payment at the point-of-sales and the global pandemic is only likely to contribute further to a shift in consumer behavior towards this in the long run. Also, with many retail stores remaining closed into the foreseeable future and some consumers likely to make online purchase behavior permanent, e-commerce is likely to benefit which also increases the demand for digital payment solutions. The trend of rapid consolidation which, in some cases, creates global market leaders is likely to remain as most countries transition from phase 2 of regional consolidation to phase 3 of global consolidation. As discussed above, the development of the industry bears both opportunities and challenges for private equity firms. Firms that already have payment companies in their portfolio are likely to either sell, considering that there are many willing buyers, or acquire further assets to leverage synergies and create regional or even global market leaders under their watch.

 

Editor: Eric Peghini

Authors: Konstantin Brandt, Florian Kramer