PSFE - Paysafe: The Good Times For Fintech Have Ended

Summary

• Paysafe is off to a strong start in 2023 with its commons up 48% year-to-date in a rally that's offered a salvo to a flatlined business.
• The great wave of regulated sports betting legalization that was sweeping across the US has hit a wall with the current market still not being large enough to stimulate revenue.
• Reverse stock splits normally get followed up with more decline, but it's unlikely that Paysafe will need to engineer another one.

Inflation is falling, the economy is still robust, and the stock market is rallying. Hence, whilst we're only a few weeks into 2023, it's already looking to be Paysafe's ( PSFE ) best year on record with its common shares up 48% year-to-date. Zoom out over 12 months and the stock is down 51%, scroll further out to performance since it went public in March 2021 and the commons are down by 82%. Hence, the last few weeks have presented a salvo for one of the largest fintech companies that went public during the pandemic-era SPAC boom.

The London, England-based iGaming payments solutions provider still holds a lot of promise on the back of the growing North American market for regulated sports betting. This forms the core of the long-term investment thesis with bulls focused on the outsized opportunities the US iGaming total addressable market would pose to a company whose revenues have essentially flatlined from before the pandemic. There's a lot at stake here with the now $1.29 billion market cap company holding a total debt balance of $2.54 billion , partially offset by cash and equivalents of $220.2 million.

The recent defeat in California of Proposition 26 and Proposition 27, two measures to legalize sports betting in the state, has thrown this thesis partially into disarray. Further, whilst Paysafe is profitable and cash generative, the company generates the bulk of its revenues from relatively mature European markets that are now at risk from heavier iGaming regulations being considered by respective national governments. For example, the UK is set to launch a new gambling white paper that is expected to set out a more onerous regulatory environment than the existing regime.

Why The Reverse Stock Split Had To Happen

Paysafe's go-public valuation was perhaps too much on the top end of the valuation range and faced an intense markdown as soon as the Fed started hiking rates. The market essentially switched overnight from being characterized by euphoric animal spirits to a near visceral rejection of deSPACs and fintech companies.

Paysafe last reported earnings for its fiscal 2022 third quarter saw revenue come in at $366 million , an increase of 3.5% over the year-ago quarter and a beat by $13.56 million on consensus estimates. This growth came on the back of total payment volume that increased by 5% over its year-ago comp to reach $32.5 billion .

Revenue has not grown beyond pre-pandemic levels with figures for the first three months of fiscal 2020 only $6 million lower than the most recent numbers. Further, Paysafe's fiscal 2022 third quarter gross profit of $214.18 million was a sequential decline from the prior second quarter albeit up 2.6% from the year-ago comp.

This tepid almost meandering growth has driven a lot of the dearth of initial enthusiasm Paysafe saw when it went public. To be clear here, Paysafe was pitching itself as a pick-and-shovel play on the growing liberalization of iGaming and initially guided revenue to grow at an 11% compound annual growth rate from 2020 to 2023.

Hence, with Paysafe stating that full fiscal 2022 revenue will not be more than $1.49 billion, this would be an 11.56% underperformance versus the initial guidance provided when the company went public. Revenue miss for next year is likely to come in even worse with the rising specter of a recession likely to impact volume growth. Hence, whilst Paysafe counts large companies like DraftKings ( DKNG ) and cryptocurrency exchange Binance as customers, the overall trajectory of its revenue growth has been disappointing.

Have The Good Times Ended?

Adjusted net income for the third quarter came in at $29.2 million, a decline of 25.88% from the year-ago figure. Overall, net profit margins have been flat for the last few quarters, regularly dipping into negative territory. The company is broadly cash generative but is using this to pay down its debt balance whose interest expense during the third quarter came in at $34.6 million, an increase by $6 million in the prior second quarter.

Despite the near 50% rally, Paysafe is facing one of the greatest tests of its life as a public company. The reverse stock split was important as it offered a save face to the company and allowed them to remain solidly above the NYSE minimum listing requirements. And whilst the outlook for companies that engineer reverse split is normally quite poor, Paysafe's underlying issue does not stem from recurrent losses or stock dilution, it's from a lack of revenue traction and an almost managed nothingness against a broader mature TAM.

Ultimately, the performance of Paysafe has now come in at a far cry away from the positive vision spelt out by management during the pandemic. Whilst it's not exactly clear whether the stock price will retain and build on current gains, revenue will likely remain flat. Hence, I'm neutral on the stock.

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