The ongoing slump at PAX Global Technology (OTCPK:PXGYF) recall a semi-famous quote (often misattributed to Mark Twain or Winston Churchill) that “a lie can travel halfway around the world while the truth puts on its boots”. Reports of a serious security breach of corporate endpoints, including their use in cyberattacks, and an FBI investigation (among others) drew a lot of negative attention…but virtually none of the sites reporting the sensational accusations only reported the follow-up which Palo Alto Networks (PANW) found nothing wrong or abnormal with these terminals.
It remains to be seen what impact this has had on PAX’s global business, but investors will see later this month when the company reports its results for the second half of 2021. I expect to see healthy growth in Latin America , but what management has to say about near-term growth prospects will clearly be important for the stock. At this point, although the stocks look pretty undervalued on what I think are conservative assumptions, liquidity and lack of transparency are major issues for me when considering a potential investment.
Old news… but it still seems important
PAX shares were hammered in October 2021 on reports that PAX point-of-sale (or POS) terminals had serious security vulnerabilities that were being exploited by criminals to launch cyberattacks and/or steal data. Additionally, reports have indicated that agencies like the FBI and Homeland Security, as well as MI5 are investigating the company and reported vulnerabilities. Many of these reports were also quick to note that Fidelity National Information ServicesThe Worldpay business of (FIS) removed the systems from PAX due to these vulnerabilities.
It’s funny, then, that those sources didn’t also report the tracking. Namely, that PAX instructed Palo Alto Networks Unit 42 to investigate the manner, and they (Palo Alto) found no evidence that the information was transmitted to any destination other than the payment processor, nor that the systems acted in a way other than that which would be expected for their normal function. Likewise, these sources did not report that Worldpay was a tiny part of PAX’s business and that at least some of Worldpay’s customers continued to use PAX’s systems.
I would expect management to have more to say on this issue with the next earnings report, as the shares clearly haven’t rallied since the report. Given the seriousness of the accusations, I can understand if some customers have taken a “better safe than sorry” approach and switched to other providers, but PAX has built the share it has (or had.. .) for valid performance and value-for-money reasons, and those reasons are still in play.
In any case, I don’t know if this is the final word on the matter, but I would be surprised if there were any vulnerabilities that remained hidden from Palo Alto analysts while they were intentionally looking for them.
From one problem to another… How important is PAX’s activities in Russia?
While I don’t think this had a significant impact on stocks (stocks have hovered between HKD 5.00 around HKD 6.50 since the security vulnerability report), I will be very interested to hear the comments , if necessary, management on the company’s activity in Russia. Management, as is the norm here, never gave much clear information about its business in Russia, but did note that it had “significant sales” in Russia during its first-half report for the exercise 21.
Russia isn’t talked about much in the global point-of-sale market, but it’s a big potential market for companies like PAX. There are about 1.5 “payment cards” per person in Russia, but the majority of them are debit cards and there has been considerable growth in recent years in the use of digital wallets and technologies. mobile payment. With this, there is a growing demand for terminals capable of handling traditional card transactions as well as contactless transactions, and this fits well into the PAX wheelhouse.
To that end, I’m hoping to hear something from PAX management about the size of their business in Russia and how the company is responding to Russian aggression in Ukraine amid growing boycotts and ending companies. to their activities in Russia.
Continued growth opportunities in key markets
As has been the case for some time, PAX’s future does not lie in the US market, the developed markets of Western Europe, or its home market of China.
Sales to China have continued to decline, falling another 7% in the first half of 2021 and now representing less than 10% of total sales (compared to more than 50% in 2015). While the European and North American markets saw significant growth in the first half, these combined markets contribute less to PAX revenue than Latin America and Russia (and other former Soviet states). Sharing growth with established competitors like VeriFone and Ingenico is still possible, and you’ll see PAX terminals from time to time if you pay attention, but these are slow-growing markets and PAX has struggled to establish itself. even despite events like the EMV transition and a move towards digital/contactless payments meant to create new opportunities.
Instead, PAX’s best opportunities remain in markets like Argentina, Brazil, India, Indonesia, Mexico and Vietnam, where companies like VeriFone and Ingenico don’t have the same standing. rooted and where PAX’s more compact, cost-effective and flexible smart Android systems have real appeal for merchants and merchant acquirers.
In addition to hardware, I believe the company’s PAXSTORE ecosystem remains an important competitive offering, with customers able to access a 3 hostrdcustom software offerings for functions such as inventory, accounting, customer rewards programs, etc. By relying on third-party developers, PAX not only avoids the need for costly and time-consuming market-specific app development, but also positions itself as a high-margin toll taker that doesn’t have to pick/predict the winners”. ”, and they have no incentive to coax (or coerce) customers into using a particular software stack. Unsurprisingly, this isn’t a particularly popular feature with merchant acquirers in the US who want to offer their own software offerings as value-added services.
Getting only two data points per year (two semi-annual revenue reports) makes modeling difficult, especially when you have such a big event that could drive away customers. At a minimum, I’d like to see PAX release its sales figures on a quarterly basis, as many large European companies do (companies that still only publish full financial statements twice a year). To that end, I certainly see significant model risk not only for future earnings, but for 2022 and 2023 as well. Similarly, PAX isn’t particularly well hedged and doesn’t go into detail when it comes to orientation.
I think my model is quite conservative and I’m only looking for high single-digit long-term revenue growth from PAX, as I expect the business momentum to slow in the coming years. This is partly due to market saturation in markets like Brazil and what I believe is continued downward pressure on equipment selling prices and margins. I think PAXSTORE can provide a high margin revenue stream, but the value per transaction for PAX seems to be quite low (another area where more clarity/disclosure would be nice), and the “service” revenue was less than 3 % of turnover for 1H’21.
I expect material margins to come under pressure over time, and again, it will be some time before revenue from high-margin services is strong enough to significantly offset this. At this point, I expect PAX’s FCF margins to erode from historic low double digits to high single digits, but still sufficient to drive mid to high single digit FCF growth .
If PAX can grow FCF even in the low single digits from reported 12-month levels, the stocks are significantly undervalued, such is the pessimism surrounding these stocks. Unfortunately, even with this potentially extreme undervaluation, I don’t see myself buying – I insist on better disclosure and communication from the companies in my portfolio and over the years I have found that situations like this These were more trouble than they were worth. . They can sometimes pay off big, but it’s all too common for stocks to languish, especially when there’s little institutional support. With that in mind, I would advise readers intrigued by the valuation, desirability, and negative sentiment here to do at least thorough due diligence before making any substantial investment.