Pax Global - 2nd Largest Payment Terminal Producer Trading Cheaply, But Questions Remain
Historically resilient business with opportunities in MaxStore, ECR and unattended solutions. However, I question future value creation. I met the management to find out.
Pax Global has been my top holding for my portfolio since 2019. But the business is testing my patience.
This write-up is pertinent to investors of Pax Global and anyone interested in capital allocation in Asia (also check out my 10K+ word deep dive in Shimano).
I was very bullish on Pax Global in 2019 because it felt like a no-brainer investment.
At HKD $3/share purchase price (HKD 4.5B market cap, equivalent to USD 600M), I owned 70% of the market cap in cash and equivalents. The remaining 30% of the market cap was a resilient 3rd largest point-of-sales terminal (POS) producer (number of terminals ex-China), valued at 3x P/E (ex-cash), earning 15% EBIT margin, which was growing at 15%+ forward growth, and 5%+ FCF per share growth. It was also paying a 4% dividend yield.
It felt like a resilient, medium-growth business and a great deal, even though there were problems. Its China business was crashing. It had a mediocre IR team trying to clear the IR mess from 2015. It was listed in Hong Kong with a 40% insider ownership with some related transactions (nothing fishy, though) and questions around the capital allocation of the massive war chest.
Between 2020-2022, I continued to hold shares because the company kept delivering top-line and earnings growth, becoming the second largest POS producer (behind Ingenico and overtaking Verifone), eliminating the flagging issues in the China segment. The IR team has improved considerably, and capital allocation has improved with more frequent opportunistic buybacks (1-2% buyback yield annually) and fast-growing dividend payments (6-7% dividend yield). It also handled a false allegation of a security breach in 2021, hiring Palo Alto Networks, a top cyber security company, to close the case. Meanwhile, Pax was still preserving a healthy cash war chest of HKD 3B, or about half of the market cap as I am writing today.
But that lies the dilemma as a long-term investor. I have held the stock for four years and consider myself a long-term one.
The questions around capital allocation remain, and unfortunately, the only way for a business to grow, create further value for stakeholders, and earn a higher valuation multiple is to allocate excess resources in the order of:
+Reinvest to grow organically
+Acquire if they can’t grow themselves
+Buy back shares if there isn’t a good reinvestment opportunity
+Pay out dividends if they can’t reinvest or buy back shares at a good price
I give credit where it’s due. Pax Global has been generous with paying out dividends, currently at around 7.5% dividend yield.
Pax Global has also invested circa HKD 500M or 17% of the HKD 3B war chest on a new industrial plant, expected to be completed by the end of FY2023 and production commencing FY2024 or 2025. It also kept up with R&D spending at around 7% of sales, expanding between 15%-20% annually between 2019-2022. That’s great!
However, to keep this simple and to the point. Free cash flow per share has not improved; if not, the prospect of it growing is grimmer. In other words, it has not created value.
Pax Global has grown revenue by nearly 20% CAGR since 2009 (IPOed in 2010) - impressive for a boring industry!
It benefits little from operating leverage, so EBIT and NOPAT growth and margin haven’t improved since 2009, if not diseconomies of scale - meh.
And as we go down to cash flows, the picture is more apparent. Pax has not converted the seemingly strong growth and profitability into cash!
Free cash flow has shrunk -3% a year CAGR since 2009! 😨
Ok, that’s not entirely fair. Due to stocking chips and logistical issues, the 2020-2022 cash flow has been lumpy. So if we normalize free cash flow to HKD 400M (5-year rolling), then -
Free cash flow per share would have grown by 4% CAGR since 2009. 😐 - the last emoji.
That is significantly lower than the 20% revenue and EBIT growth rates. And it puts Pax’s cash conversion at around 25%.
This is why I spoke with management earlier this year and met them again in person yesterday.
Meeting the management
I had a list of questions and also asked fellow FinTwits to contribute:
Following is the summary of my discussion with the CFO - Ethan Cheung, one by one:
Market share - outside of the US and China, Pax’s internal opinion is they are in 2nd place, behind Ingenico, and above Verifone. Nilson's report confirms his answer, but it’s a voluntary survey. A dongle also counts as one unit, skewing the results to lower-tech POS producers in China. In the US, it’s firmly the third largest.
Key product differentiations - Pax has a reputation for good reliability and service and the strongest app platform - MaxStore, which should increase stickiness as it grows the install base. Pax is focusing on building this moat.
Customer profile - most acquired customers reorder at the end of the replacement cycle, which is 3-5 years. Bank of America is a new client that took two years to onboard, the longest yet. It has done one of the most stringent tests and piloting on Pax’s device, so it speaks volumes about the quality of the product and has room to become one of the most prominent clients.
Supplier profile - Pax does its procurements and has staff at the outsourced manufacturing plants to help control quality (which it claims to be a key differentiator to other Chinese producers’ supply chains).
Distributor vs. going direct - can conflict with existing customers, so it’s not doing it now but has options in certain regions and segments (software).
Reinvestment goals and expected outcomes -