Shares digital

Chief executive Dominic Taylor on why the company’s business model is still relevant and can ride out the downturn

by Dan Coatsworth

I wouldn’t claim full responsibility for persuading the mobile operators to develop electronic pre-pay but we were certainly an early influence on their thinking,’ says Dominic Taylor, chief executive of bill payments-to-ATM group PayPoint (PAY).

He may speak modestly but deep down, you can tell he would really like to be credited with introducing an electronic method of topping up mobile phones. As a man with his foot in the door of 20,000 UK retailers, Taylor lives and breathes convenience services. Competition is fierce and with UK growth becoming harder to achieve, PayPoint is having to seek opportunities overseas. Being at the forefront of payments innovation is vital to maintain its premium rating.

Down the line

PayPoint was founded in 1997 as an alternative payments network for utility companies which had traditionally used white goods showrooms as a destination for customers to settle their bills. It placed payment terminals in corner shops, off-licences, garages and other convenience-type stores. It promised to be a cheaper service, both for utilities who were moving away from the showroom model and for consumers who could pay bills at local shops that were open longer hours.

Original investors included BT (BT.A) and London Electricity but the addition of mobile top-ups in 1999, cash machines in 2001 and launch of London’s Congestion Charge in 2003 prompted the utilities to question their involvement in a business diversifying from its core interests. PayPoint’s IPO in 2004 provided an exit for these seed investors.

The company has come a long way since its flotation, building up a strong brand on the high street and joining the FTSE 250. There are major concerns, however, that two of its activities are at serious risk of losing earnings growth momentum. Mobile operators are pushing for customers to register their debit or credit cards so balances can be topped up directly from the handset rather than having to visit a convenience store. Taylor insists the threat is manageable. ‘We are aware operators are seeking direct relationships with their customers on topping up. Their efforts have been quite successful and we have noticed this on our volumes, but industry data suggests the initiative has stopped growing. They have achieved 20% penetration.’

He claims the fundamental market, being teenagers, is still centred around cash transactions so over-the-counter mobile top-ups are still relevant to PayPoint’s future. Nevertheless, he does admit growth is now flat and only driven by the roll-out of its terminals to new retailers.

Taste the crunch

In the wake of the credit crunch and the weaker economy, consumers strapped for cash are going to become more savvy over their spending habits. I put it to Taylor the days of paying a £1.50 surcharge to use a PayPoint ATM could be numbered, given people can get money out free from bank machines.

In the year to March 2008, the average number of PayPoint’s ATM transactions fell from 630 to 620 per site, with average net revenue per transaction also falling. ‘These machines still work economically and consumers will still use them,’ retaliates Taylor, who insists ATMs have always been a niche proposition for PayPoint. While only modest growth is forecast by investment bank Citigroup for ATMs, there is some comfort in that the machines provide greater income than commission on bill payments, which accounts for around half of the group’s earnings.

Of the £1.50 ATM surcharge, £1 goes to the retailer and 50p to PayPoint. Balance enquiries also net the payments group 16p per transaction, which equates to an average income of 33p to 34p across ATM activities. In contrast, processing household bills earns PayPoint just 14p per transaction. Its clients include utilities British Gas, Scottish & Southern Energy (SSE), Severn Trent (SVT), Thames Water and the BBC for TV licence payments.

The company’s biggest battle is to lure custom away from the Post Office and banks, both of whom charge the consumer to pay a bill (unlike PayPoint) but still grab a large part of the market. Taylor says he cannot justify the costs of a national TV advertising campaign to promote the company, so it is down to brand strength, public relations and word of mouth to drum up new business.

There are a few obvious gaps in its client base, not least credit card providers. I point this out to Taylor, saying PayPoint should have secured this business years ago. ‘We have not got there yet,’ he replies. Why not? ‘We have had discussions with credit card companies but I suspect offering cash payments could persuade customers to then use cash more often on a general basis. The other obvious one is Sky. It has refused to acknowledge cash as a tender mechanism. It does not want to jeopardise their direct debits.’

Taking money for transport tickets is another market in which PayPoint has the potential to do more. Transport for London has raised the bar with its Oyster smart card ticketing system, but the rest of the country has been slow to catch up. PayPoint has suggested for several years a similar set-up could be rolled out across the country. Taylor argues it will take time to change consumers’ perception over not handing over physical cash onboard a bus or train and instead having an electronic wallet.

Promises, promises

Having interviewed Taylor at least every six months since 2006, recurring arguments have emerged. His justification behind the slow progress of transport ticketing has certainly been offered before, as is the repeated goal PayPoint will one day offer a way to pay in cash for goods ordered online. This is the big promise made several years ago, I remind him. ‘We have signed up one or two clients, it is beginning to happen but will take time. We are not in anyway less enthusiastic, but for now I can’t say exactly where we are.’

In PayPoint’s defence, it has been busy building an online processing platform through the acquisition of technology groups Metacharge and SECPay in November 2006 and February 2007 respectively. Integration is now complete and the company can move forward on the initiative.

PayPoint is positioning itself for a substantial new market. The proposition would involve a person ordering a book online, for example, and then going to the convenience store to pay in cash. Once the money has been received, an alert is sent to the retailer to release the book.

Given that there are probably hundreds of thousands of people who do not trust handing over their bank details online or do not have credit or debit cards, the rewards for PayPoint could be tremendous if it cracks this market before someone else.

It was appointed this month to process top-ups for a pre-paid card offered by PayPal, an online payment group. On paper it seems a straightforward deal, but if you consider that PayPal is owned by auction house Ebay, that means PayPoint has formed a relationship with one of the world’s largest online retailers.

So has PayPoint offered to provide cash payments for Ebay purchases? Taylor simply smiles. ‘I agree it would be nice. I can’t possibly comment on whether we’ve had talks,’ he says, laughing nervously.

Next-generation transport ticketing and internet payments offer considerable growth opportunities in the UK but achieving them will not be easy. That is why PayPoint has gone overseas to diversify its interests. It bought a Romanian mobile top-up distribution company in 2007 where it hopes to replicate the UK’s swift migration from paper vouchers to electronic top-ups. Earlier this summer it also made in-roads with bill payments in Romania, which is many years behind the UK market. Taylor tells a story of how Romanians take half a day off work each month to pay their bills into state utility offices. With the sector now being privatised, PayPoint hopes Romanians will prefer to use convenience stores to settle their accounts.

It will not stop at Romania. Further international expansion is on the cards, confirms the chief executive. Market speculation suggests PayPoint may snap up certain assets of Payzone (PAYZ:AIM), the troubled rival created from the merger of Alphyra and Cardpoint in 2007.

Taylor says a lack of published numbers for Payzone makes it difficult to say if the assets are worth pursuing. However, Payzone admitted to the stock market earlier this month it had received several approaches for its Spanish, Italian and French businesses, so someone is obviously interested.

Plenty more to do

Having been chief executive for the past 11 years, Taylor is still enthusiastic about the group’s prospects after all this time. It is a remarkably different business from his previous career, when he spent 12 years underwater on Royal Navy submarines, but this experience has obviously rubbed off as he runs a tight ship.

Concerns over a weaker economy threatening to make a chunk of its corner shop network go bust are not shared by Taylor. He says PayPoint should not see churn beyond current levels of 5% to 7% as the company is particularly selective over who it gives payment terminals to, only picking those in the best financial shape.

The market is not so certain, with the share price having fallen 12.5% to 581p since the start of August. If PayPoint can squeeze further growth out of the UK and make a good job of overseas expansion, its near 30% premium rating to the support services sector should be protected.

CONCLUSION: PAYPOINT (PAY)

Risk to earnings forecasts: 4 (5=upside risk, 1=downside risk)

Earnings predictability: 3 (5=very high, 1=very low)

Valuation: 2 (5=cheap, 1=expensive)

Balance sheet strength: 4 (5=cash rich, 1=heavily indebted)

Cashflow: 4 (5=very strong, 1=very weak)

Over-owned?: 2 (5=all brokers negative, 1=all positive)

TOTAL: 19/30

RATING: BUY