You might know Pep for its affordable homeware and clothes. But do you know it for its prepaid electricity and tap-to-pay machines? Probably not — and Pepkor is betting big that you soon will.
The retailer has been in the value-added services game for years now, with the founding of its financial services company, Flash, in 2009. “Fintech” has since become a crucial element in its growth, along with everyone else in retail and banking.
“What retailers have all discovered is that consumer wallets are going to be under pressure for longer than expected,” says Aeon Investment Management head of research Shaakir Salie. “[Pepkor] is realising that if it wants to continue to grow, it needs to think outside of the box, and I think fintech is a decent strategy to go about solving that issue.”
Fintech can be hugely profitable, and fintech for the informal sector is an especially lucrative and underserviced area, say analysts.
“It is a lot more complicated to capture the informal market than the formal market, but I think that is where the opportunity is,” says Rand Swiss’s Gary Booysen. “Through technology you can vastly reduce the costs of a product or a type of transaction, and you can suddenly make a market that wasn’t obviously viable 10 or 20 years ago a lot more viable.”
Practical solution
Which explains the creation of FintechCo — a merger of Pepkor’s Flash with cash management company Shop2Shop.
Shop2Shop didn’t start out with the lofty idea of “being a fintech”.
“It started with one very practical problem: helping a township trader handle cash more safely,” says CEO Peter Berry. “Our first job, in 2018, was installing a cash-counting safe for a trader in Khayelitsha.”
Today the company provides a raft of services and trading infrastructure, from safes to card machines to money lending and supplier payment services. This is precisely why Pepkor sought it out: Shop2Shop is more of a merchant-facing business, while Flash is mostly a consumer-forward one.
Put together, a trader gets one platform that does what used to take several separate providers: “digitalise cash safely, accept cards, pay suppliers, borrow against their own sales history and sell airtime, electricity and a growing basket of digital products”, says Berry.
The plan is to have the two companies running in parallel, with the offering from the Shop2Shop stable available to Flash customers and vice versa.
The rationale behind the decision to merge was that neither company “could build what we’re building together this fast, alone”, Berry says. “Combined, we reach a substantially larger base of traders and move meaningfully more volume through the platform than either business could on its own, which is what lets us keep investing in the informal economy rather than just defending a position in it.”
Money on the margins
“While their competitors are going overseas to try to find growth, they [see] growth on their doorstep in rural areas and townships,” says Salie, in an oblique swipe at rival Mr Price’s recent German foray.
“It already looks like a far less costly endeavour,” he argues.
That’s because, despite its size, the informal sector is largely underserved in terms of financial services. This, then, is Pepkor’s opportunity.
Keagan Higgins, an investment analyst at Anchor Capital, explains: “The goal is to keep each rand recycling inside your own ecosystem rather than leaking to competitors, so you earn on it more than once.”
As Salie says: “We’ve seen it with Discovery and Capitec, where there is a lot of value in being able to cross-sell products and have clients pay all [their] monthly expenses through one app.”
Higgins notes that retailers like Pep have an advantage on this front, thanks to the “enormous repository of client data” they can leverage. Knowing what Pep consumers buy and how they spend means that fintech products can be designed at the right price and size for customers.
Crucially, though, FintechCo has to get the price right.
“If it wants to get to the scale that will ultimately be profitable, it will have to lower the cost of transactions for merchants and for consumers. And that is what is going to get people to choose it [over a competitor],” says Salie.
Crunching the multiples
Still, many analysts believe Pepkor is paying top dollar for this next avenue of growth. The newly minted FintechCo is to be valued at a whopping R21.3bn, with valuations of Shop2Shop and Flash coming in at R10.7bn and R10.6bn respectively, despite Shop2Shop having a lower earnings multiple.
Consider that against the valuations of listed fintechs Weaver Fintech (R5.8bn) and Lesaka Technologies (R6.6bn).
“There’s no question that it’s not cheap, but you can defend it based on the metrics of Shop2Shop and Flash,” argues Booysen. The idea is that with Shop2Shop’s higher growth trajectory, it will eventually have earnings equal to Flash’s.
“I thought that the explanations they gave were valid,” Salie says of the valuation. “But the Shop2Shop multiple is much harder to get your head around.”
“You have to really be confident that you can extrapolate that growth that they’ve seen in the past three years,” he says – and anything could happen during that time.
As Higgins puts it: “At face value it can look quite rich, but then you start arguing: is the peer group undervalued or is FintechCo overvalued? And you’ll probably find the answer somewhere in the middle.”
The related-party wrinkle
The other snag is that Shop2Shop’s lower ebitda margin means it will be value-reducing for FintechCo for the first year at least. “You can’t expect a deal like that to be earnings-accretive from day one,” argues Booysen, who expects growth to be slow but steady.
Pepkor itself expects the deal to be accretive in its second year, but for investors, “it’s about whether you buy the story or not”, says Anchor Capital’s Stephan Erasmus.
The valuation is not the only eyebrow-raising aspect of the deal: Pepkor CEO Pieter Erasmus holds an indirect minority interest in Shop2Shop, though Berry points out that his stake “reduces as a percentage once the transaction completes”.
Salie says of the issue: “That’s probably the asterisk that everyone has in their minds. Without that wrinkle, the deal would probably look a lot better.”
For Anchor’s Erasmus, “optically, it’s not ideal, but I think the way they’ve handled it, there’s not much more they could do. And the fact is, Pieter Erasmus owned these shares before he took the helm [at Pepkor] for the second time.”
Pepkor has said Erasmus recused himself from all dealings related to the merger and was not a part of the negotiating team. But Salie notes: “Would we have wanted the CEO of the business to remove themselves from such an important deal? He is ultimately responsible for their strategy, and this seems like a big part of that strategy, so it is very difficult to understand how he could have been recused from these discussions.”
Though market reaction has been cool initially, it is still an exciting time for local fintechs. And perhaps, when FintechCo eventually lists, as has been suggested, the market might be singing a different tune.
