WorldPay, the UK’s largest merchant acquirer, announced its 2016 results yesterday.
Group revenue and profit across all its businesses (UK, US and eCommerce) was up 15% on 2015, which is great for shareholders but what can we learn about its UK business and how the business is growing? Is WorldPay adding value by introducing new, genuinely valuable products and attracting new customers or are they just hiking prices? Let’s take a look.
Is Worldpay UK growing?
Worldpay UK is clearly growing based on several metrics. However, it’s not growing as quickly as the overall Worldpay Group. Considering how the US business is also struggling, it’s really Worldpay’s eCommerce division that is supporting the Group’s overall growth. The UK and US operations are dragging performance down.
WorldPay UK 2016 growth metrics:
- Net Revenue (gross profit): +8%
- EBITDA (net profit): +11%
- Transaction volume: +7%
- Transaction value (key driver of Net Revenue): +3%
- Net revenue/transaction value (take rate): +5%
Of the metrics above, Net Revenue is the most important measure and it has grown by 8.2% (£33.4m) in 2016 to a total of £438.6m. However, quality of growth is just as important as the rate of growth so what is causing the increase in Net Revenue?
WorldPay’s explanation is a picture of fantastic growth in customer numbers, who are all highly satisfied with Worldpay (through impressive Net Promoter Scores), who are buying a multitude of additional products (Worldpay Total, My Business Dashboard, eCommerce Gateways, etc) and who welcome and are converting to their more profitable “simplified“ pricing structures.
We would contend that, in fact, a material proportion of growth comes from customer rate increases and withholding of EU interchange benefits. Neither of these factors can be sustained in the medium term.
WorldPay UK growth vs. market growth
Card Turnover (or Transaction Value) is the key measure of market growth because it is this measure which actually drives volume growth within Net Revenue. This is because all card types are now priced by merchant acquirers as a percentage of Card Turnover rather than a fixed rate per transaction.
WorldPay UK hasn’t grown as quickly as the wider market in 2016 and hasn’t been matching market growth for some years as we can see below :
As you can see, WorldPay UK’s Card Turnover grew at 3.1% in 2016 compared to market growth of 4.3%. So, WordPay UK is performing ~30% worse than the market. The continual lagging of market growth has meant that Worldpay UK’s market share by Card Turnover has declined from 35% in 2012 to 32.3% in 2016, an 8% reduction.
Rick Medlock, CFO at WorldPay, revealed an interesting tidbit in yesterday’s results presentation, saying that 2016 is the first time in a number of years that WorldPay UK has gained customer numbers. This confirms what the market share data has been alluding to, but what WorldPay has hidden to date, ie that WordPay UK has been losing customers every year. However, this is hardly surprising given its recent aggressive repricing program and its struggling RBS referral channel.
Breakdown of Worldpay’s Net Revenue growth
To analyse the quality of WorldPay UK’s Net Revenue growth, we need to break it down to its constituent parts:
- Acquiring income: transaction fees paid by merchants less interchange and scheme fees
- Terminal Income: Terminal rental fees
- Ancillary Income: Gateway fees, PCI fees, fraud fees, interest income from holding merchants funds for 3 days
In the last few years, the elements of Net Revenue have grown as follows:
|Net Revenue (£m)||2013||2014||2015||2016|
WorldPay says that the majority of it’s Net Revenue increase in 2016 came from increases in acquiring income. In reality, acquiring income growth accounts for ALL of the growth in Net Revenue given that the terminal income and ancillary income streams are actually in decline.
According to WorldPay management, part of the reason for the decline in ancillary income is a “conscious decision” to remove some elements of charges — including invoicing and management charges — in favour of higher rates within acquiring income. It’s not clear what element of the £5m decline in 2016 this represents.
Terminal income has been in decline for four years now. WorldPay management contests that this nothing to worry about as terminal pricing is now sacrificed for higher transaction rates. This is true (to an extent) but the decline in customer numbers (which WorldPay management has finally admitted to) is as likely to be a factor.
What’s Growing Acquiring Income?
As we noted above, WorldPay management attributes its growth to increases in customer numbers, increases in transactions, cross-selling more product and enhanced customer satisfaction/loyalty. To validate the Worldpay UK growth story, we must dissect their acquiring income in more detail :
|Growth||£m (2015)||%||£m (2016)||%|
|Yield – ie rate increases (2)||18.6||51%||11.3||28%|
|EU Interchange (3)||12.0||33%||22.0||54%|
|Total Acquiring Income||36.4||100%||40.5||100%|
|Total Net Revenue||39.2||33.5|
(1) Acquiring Volume (18% of 2016 Growth)
As you can see, Worldpay’s 3% sub-market growth in Card Turnover processed during both 2015 and 2016 translates into a small element (<20%) of their total growth in acquiring income. This would be where we’d see the impact of higher customer numbers were it a material factor.
(2) Acquiring Yield (28% of 2016 Growth)
This is a bit of a balancing figure as we know what the volume growth element is and we can take a pretty good guess at the EU interchange benefit from management’s own disclosures. Acquiring yield represents the value of the rate/price increases that Worldpay merchants have suffered.
WorldPay management would undoubtedly contend that this is not entirely accurate and that this line also contains income from new products like My Business Dashboard, cross-selling payment gateways or removing invoicing and management fees for higher acquiring income. We estimate that their revenue contribution can only amount to a few million pounds and the remainder is from customer rate increases, which are either direct increases or improved profitability from persuading merchants to take one of Worldpay’s bundled pricing plans. These pricing plans will overall be more expensive for merchants.
The feedback we have previously received from WorldPay merchants with regards to rate increases which they have suffered validates our thinking that aggressive repricing is a material element. (For more information, click here or here.)
(3) EU Interchange (54% of 2016 Growth)
This is 54% of acquiring income growth in 2016 and represents the EU interchange reductions which WorldPay has not passed onto its SME merchants who are on blended pricing. In H1 2016, WorldPay announced its 6-month benefit from EU interchange reduction not passed-through as £13m. Rick Medlock bizarrely said:
“Given we’d already benefitted from the interchange cost reduction in H2 last year, I do not expect any material incremental benefit in the future”
This statement raised eyebrows amongst investment bank analysts because of course, the largest interchange benefit was the reduction in consumer credit card interchange of 0.5%, which didn’t happen until 9th December 2015, so it has to be a significant factor in H2 2016 comparative growth.
As noted, the H1 2016 benefit was £13m, which included 2 months where WorldPay retained the full interchange benefit of consumer credit cards and a further four months where they passed through some benefit to blended priced SME merchants. We believe that Worldpay only passed through approximately one-third of the full benefit they received. For more information, see our blog post.
So, H2 2016 should contain a further 6 months of “retained interchange benefit” which we conservatively estimate adds a further £9m to the £13m already realised in H1. This gives a total 2016 EU interchange benefit of £22m.
Its worth noting that this could easily be an underestimation. Our previous estimate was for £28m of additional benefit in 2016 (for more information, click here) and there have been other changes that WorldPay could easily have used for additional profit taking, for example September 2016’s abolition of the Visa debit interchange cap.
Conclusions and Takeaways
WorldPay UK underlying performance is questionable
We’d contend that the EU interchange benefits are the significant driver of Worldpay UK growth. These benefits are massive at an estimated ~£34m of 2016’s P&L (£22m from 2016 changes plus £12m carried forward from 2015 changes). To put in context, we estimate the benefits account for roughly 17% of WorldPay UK’s total EBITDA. WorldPay UK has been skilful in retaining such sizeable benefits but they are a one-off and cannot contribute to future growth.
Without the EU interchange benefits, we estimate Worldpay UK’s Net Revenue growth would have been around 2.8%. This is a truly a dismal performance and its no surprise that management never quantified 2016’s full year impact of EU interchange as it conveniently masks underlying performance.
Another reason to be circumspect is it does not look good to the EU, UK Payments Regulator or customers if such a material benefit is derived from legislation intended to lower costs for both businesses and consumers.
Further rate increases for SME customers in the future?
The stock market is a demanding mistress and, looking to the future, Worldpay UK will need to find more organic growth without EU interchange benefits to meet its relentless demand for growth.
The important question is: Where will it come from?
Yes, WorldPay can, and undoubtedly will, just hike some SME merchant’s transaction rates but this can only be done so many times.
More likely are further rate increases due to card scheme fee increases, where Worldpay will include additional profit alongside the card scheme fee pass-through. We’ve already seen an instance of this in January 2017 (for previous examples, see here) and we will undoubtedly see more.
Alternatively, Worldpay could get more ‘creative’ with its fee structure and introduce new fees or new mandatory products with corresponding fees. For example, they could remove the free Lite version of My Business Dashboard.
What’s certain is that Wordpay has a huge hole to plug if it is to meet the market’s growth expectations (mid-single digit percentage growth”) and we would expect an element of this to come from customer rate increases.