Description

Shva is the Visa and Mastercard of Israel. The company is the nation’s only payment switch but has not been run for profit - until now. Things are changing with a now mostly independent board bringing in new CEO Eitan Lev-Tov last month. Lev-Tov’s background is in tech and platforms and we believe he will take advantage of the large growth opportunities Shva has yet to capitalize on.

The stock trades for ILS 18/shr today and we think intrinsic value is ILS 50/shr in three years time, implying 175% upside. We see limited downside if we are wrong as even bearish assumptions result in a 6% FCF yield in three years for this unique asset. 

The opportunity exists because Shva went public in 2019 to limited fanfare, has no sell-side coverage today, and trades only US$300k/day.

Note: The USD/ILS exchange rate is 3.2. 

Situation Overview

Shva is Israel’s only card network switch.

The company processes transactions between customers, merchants, issuers, and acquirers. It charges 2-3 Israeli cents per transaction, around one-fifth of Visa or Mastercard in the US. Shva also charges merchants ILS 15/month for each payment terminal, and ILS 19/month for contactless EMV terminals. That works out at $70/terminal per year or $150/merchant. In contrast, First Data earned $300/merchant in Latam and APAC in 2017. That itself was growing at double-digit rates.

Shva’s sales in 2020 were ILS 85mm and have compounded at 10% p.a since 2012. Revenues are split 50% from terminals, 40% from collection and authorization of transactions, and 10% others. EBIT was ILS 34mm and margins have expanded to 40%. 

The company was founded by Israel’s largest banks in 1978 and continued to be owned by four of them until they were made to reduce their stakes to 10% each at the IPO in 2019. Those measures were part of reforms to encourage competition in the financial sector. 

Visa and Mastercard each bought a 10% stake pre-IPO. 

Both had been encouraged by the Bank of Israel to compete with Shva but concluded this was too hard. The Bank is no longer actively encouraging another network provider to enter. These show how strong the network effects Shva benefits from are.

Despite being a Rolls-Royce of a business, Shva’s ownership meant it was not run for profit or innovation. It only earns a 30% post-tax return on tangible capital. 

This is now changing with a board that is mostly independent and Eitan Lev-Tov joining as CEO in July. "Shva was stagnating. He will energize them to create new revenue”, one source told us, adding that “the feeling is that he is coming to Shva to increase its revenues and performance". We expect returns to improve to over 50% in three years and further beyond that. 

There is one speed bump up ahead. We expect Shva to be fully separated from its sister company, Masav, over three to five years. Masav is Israel’s clearing house, and the two share employees and infrastructure. The extent of separation will be decided towards the end of this year, with the Competition Authority pushing for a full split and the Bank of Israel less radical. 

A full separation would be a negative surprise for investors but is not something we see as serious. Shva has estimated it will add costs of ILS 15mm per year but would raise prices to offset it. For context, we expect EBIT to be ILS 70mm in three years.

Masav will then be a competitor by offering direct and immediate bank transfers.

We do not think that is a threat to Shva’s existing business, but it will bring minor competition in new areas such as fintech apps. The risk of disintermediation has not hurt Visa and Mastercard. 

Credit cards are deeply ingrained into Israeli culture, with nearly 90% of transactions in 2020 taking place on credit cards or deferred debit cards that only require you to make a single payment at the end of the month. An immediate payment through Masav would lose that working capital benefit. 

Above all, Shva is a unique asset that has been driven slowly - until now. With new owners, easing regulatory headwinds, and untapped growth ahead, we think new CEO Lev-Tov is about to press on the accelerator.

Growth Opportunities

Opportunity #1 - More transactions

Cashless payments make up 47% of spending in Israel compared to 80% in the US, which means there is still lots of room for transactions to keep growing at 9% p.a. We think that baseline will accelerate.

One reason is the growth in contactless EMV terminals, which became mandatory in July. Shva charges an extra ILS 4/month for these terminals. Across 230,000 terminals that equates to an extra ILS 11mm in sales, almost all of which will drop through to profits. That's nearly 30% of last year’s EBIT.

Another opportunity is tokenization. This is where a provider like Apple Pay sends your card details to a network like Shva instead of storing it on your phone. Shva then gives Apple a random set of numbers to use when you make a payment, thereby reducing the risk of fraud. Shva charges an extra 1.7 - 4.5 cents for these transactions, roughly doubling the normal 2-3 cents.

Tokenization can be used for all card-not-present transactions, but is currently most common for digital wallets. Those accounted for less than 0.5% of transactions until May, when Apple Pay entered and grew the market by over 700%. The entry of Google Pay later this year should provide an even bigger spark.

Digital wallets could account for 5-7% of transactions next year while continuing to grow rapidly. That equates to an extra 5-7% in group revenue that drops through to a higher percent of profits.

One more area for growth is in public transport. Israelis currently spend ILS 700mm in this area every year via cash or prepaid card, which means Shva only processes a transaction when a card is loaded. 

Much of the hardware and software to pay via credit card is already in place, but approval has been slow due to the Minister for Transport changing three times in the last two years. As transactions move over to credit cards, they will bring an extra ILS 15mm or 17% in sales.

Opportunity #2 - Higher prices

Shva currently charges one-fifth of what Visa or Mastercard charge in the US and has not raised prices since 2014. This is mostly because Israel’s largest banks owned the company pre-IPO and were not going to raise prices on themselves.

In addition, we believe that Shva is waiting for the split with Masav to be resolved and for a change in regulator. The company is overseen by both the Bank of Israel’s supervisor of banks and head of payments, but the supervisor’s oversight ends next May. We believe the supervisor focused on Shva not raising prices, whereas the head of payments is more interested in encouraging better services.

Once things settle down, we expect Shva to provide better services and raise prices either directly or through strategies like differential pricing, which Visa and Mastercard used effectively after their IPOs. 

Opportunity #3 - More services

Unlike most acquiring processors, Shva is yet to sell a range of services. When it does so we expect its infrastructure business - around half of group sales - to see growth substantially accelerate from its historic average of 11% p.a.

This is a large opportunity - around 40% of Visa and Mastercard’s revenues come from outside their traditional processing businesses. And prior to being acquired, First Data was earning around $300/merchant in APAC and Latam in 2017 and growing at double digits. 

We estimate that Shva earns just $150/merchant by charging a fee for processing transactions through payment terminals. 

The company is in a unique position as it is the only payment business in Israel with a connection and data on every merchant and customer. It should be offering point-of-sales software, analytics, loyalty and rewards programs, collective marketing initiatives, and risk management. Just look at how Clover became arguably First Data’s most valuable business by offering these services to see what Shva could do.

New CEO Eitan Lev-Tov

Most of Lev-Tov’s career has been in tech and platforms, rather than payments. He has a very different background to previous CEO Moshe Wolf, who had deep technical expertise from working in the technology and intelligence arms of Israel’s military for 26 years.

This change appears to be a signal from Shva’s board that they are steering the company in a different direction.

Lev-Tov was previously CEO of Cibus, a platform in Israel that connects over 3,000 companies and 350,000 employees to special offers and services from thousands of restaurants. Lev-Tov described it to us as a “platform of services to merchants and employees”, and Shva as a “base platform for many services”. 

Former colleagues at his three previous companies told us that Lev-Tov is someone of high integrity, strong customer focus, and work ethic. Everyone believes that he will bring new products, which is also something he has said publicly. 

One of his biggest challenges will be instilling a culture of innovation. Ex-employees said to us that Shva has grown sleepy from a lack of competition. 

To accelerate innovation, we think Lev-Tov will use some of the company’s ILS 85mm in excess cash to acquire or partner with fintechs and use their services to amplify Shva’s enormous data and connections. At Cibus, he launched partnerships with several food delivery companies.

One negative is that Lev-Tov does not own any equity in the company. But part of that is cultural and our references suggest he is ambitious and motivated. 

Why does this opportunity exist?

Shva trades just $300k/day, has no sell-side coverage today, and put very little effort into marketing to investors at its IPO in 2019 as it did not need to raise capital. It is happy to avoid coverage given the ongoing debate between the Competition Authority and Bank of Israel on how powerful it is and to what extent it should be split with Masav.

As Lev-Tov settles in and regulatory headwinds subside through next year, we expect the company to take the handbrake off and be more open to investors.

Valuation

Shva made ILS 85mm in sales and ILS 34mm in EBIT in 2020. Growth has averaged 10% p.a and we think it will accelerate to 15%. Including a one-off rebound post Covid - sales grew 25% in Q1 - we think the company will make ILS 140mm in sales three years from now.

Incremental EBIT margins have been almost 60% and so we expect EBIT margins to expand from 39% today to 50% in three years time. That is still some way below Visa and Mastercard, but above First Data and Global Payments, who operate in far more competitive markets. This implies an EBIT of ILS 70mm. 

Should Shva significantly expand into more competitive services, we see upside to our growth and downside to our margins. Net net, that would be a positive for both profits and merchants.

Comparable companies such as First Data (prior to acquisition), Fiserv, Global Payments, and Worldline trade at 20-27x EBIT, the Tel Aviv Stock Exchange at 30x, and Visa and Mastercard at 35x. Shva is arguably a better business than any of these. 

The market does not appear to apply a substantial discount for stocks trading in Israel, judging by the 30x multiple for the Tel Aviv Stock Exchange. Neither does the fact that Israel’s largest banks trade at 1.0x P/B for an 8.5% ROE, against 1.4x for a group of the largest US consumer banks that earns an 11% ROE.

We think 25x EBIT is reasonable for Shva, incorporating a discount for being an illiquid stock. Including accumulated earnings and excess cash, that puts intrinsic value at nearly ILS 2,000mm in three years, or ILS 50/shr. 

The stock today is at ILS 18/shr, implying 175% upside.

We see limited downside over a three year period if we are wrong, although the stock will likely have a negative reaction if a complete split with Masav is announced. Even if Shva were to see no rebound in growth post-Covid and continue growing at 10% it would make ILS 113mm of revenues in three years. Assuming margins stay at 40% results in ILS 45mm of EBIT, ILS 35mm in NOPAT, and a 6% yield after accounting for accumulated earnings and excess cash. That’s still not bad for a Rolls-Royce of a business growing at 10% per year.

Catalyst

No strong catalysts, but we expect the company to be more open to investors once Lev-Tov settles in, starting in September. The company will also introduce new products and should raise prices in the second half of next year.