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05/25/17 05:00:14 PM


Digitization continues to prompt a shift away from physical credit and/or debit cards, towards "virtual" methods of corporate payments. Given a largely completed EMV implementation, industry trend data suggests fraud has now rotated from the point-of-sale (POS) to transactions with no physical card present. Virtual methods of payment have seen a boost in overall spend. While still in an embryonic stage, virtual payments remain a key component of growth for select companies. We think first movers offering virtual payment optionality could be rewarded with incremental share gains.

As the installment of chip-based (Europay, MasterCard, and Visa or EMV) compatible terminals at physical locations now remains largely behind most cardholders and vendors, card present fraud reflects this, as Aite Group (an independent consulting firm) expects compromised data losses to rapidly diminish from $4.5B in 2016 to less than $1B by 2020. However, as digital trends fully hit stride, we think card not present (CNP) fraud could see a dramatic uptick. Aite Group expects losses to swell from $4B in 2016, to nearly $7.2B by 2020, as fraudsters look for fresh opportunities to capitalize on.

Virtual payments (also known as ePayables), have emerged as a viable and secure alternative to traditional methods, such as check, plastic card or automated clearing house (ACH) transfers, primarily in a business-to-business (B2B) setting. Virtual cards, which are randomly generated 16-digit numbers that are tied to your tangible card number/account for single-use transactions, can be used to pay vendors for hotels, car rental, fuel, and airline reservations. Valuable, as this enables an extra layer of security when executing transactions via desktop or mobile, without having to ever reveal your private card information (including both your expiration date and card verification value). It also provides greater accuracy (eliminates human error), as it generates automated reconciliation of transactions. Sabre estimates this reduces up to 40 hours of reconciling expense on a monthly basis. Further, interchange (e.g. transaction fees) for the data processors remain attractive for facilitating transactions with the enterprise buyer (typically around 250 basis points split between the issuer, processor, enterprise buyer). We also note savings/rebates at the customer level, which help incentivize the usage of this payment method. In many cases, value added to customers is material. For example, Fleetcor stated savings and discounts amounted to more than $1B for its customers in 2016.

While the notion of plastic cards or checks being superseded by virtual methods is unrealistic near term, CFRA expects card spend to drift towards virtual accounts going forward. According to First Annapolis Consulting (acquired by Accenture in March 2017), virtual accounts comprised roughly 35% of spend in 2015, but are expected to rise to 53% by 2021 (17.5% CAGR). Further, when digging into travel vendors specifically, the Global Business Travel Association (GBTA) estimates that 20% of travel bookings are now made virtually, while 53% of vendors now accept virtual payment.

As virtual payment options continue to manifest, the market still remains largely under-penetrated (only 10% according to Fleetcor). With the payment landscape increasingly displaying intentions to migrate towards a paperless vendor environment, we think select companies continue to establish solid growth trends, but interestingly, have supplanted leading positions in vastly different outlets, including hospitality, airlines, and/or fleet/fuel cards. Given this versatility, we think a long runway of growth lies ahead, as digital trends continue to drive pronounced demand.

FleetCor Technologies (FLT 139 ****) is global leader in corporate payment solutions, including purchasing cards, travel and expense, fleet, and virtual payments. In 2016, FLT processed 2.2B transactions through its own and third party networks. FLT operates across a broad number of industry verticals, including retail, health care, construction, and hospitality. FLT acquired Comdata in August 2014 for around $3.4B in cash and stock, which greatly enhanced inroads into virtual payments, as it enabled $54B+ in payments across 48 countries. More recently, its Cambridge acquisition for $675M further enhances virtual payments (estimated $145B opportunity). Despite recent share price volatility given news surrounding customer fee practices, we note only 6% of 2016 revenues were comprised from "miscellaneous" fees. Further, of FLT's 700,000 active customers, customer retention rates are resilient, at 90%. Of the remaining 10% attrition, 40% of those client exits stem from involuntary removal (bankruptcy). We think its solid double-digit organic revenue growth rate and potential synergies from its recent Cambridge acquisition remain key catalysts for the stock.

Sabre Corporation (SABR 24 ****) is a leading technology solutions provider for the global travel and hospitality industry. It operates through two reportable segments, Travel Networks (70% of 2016 revenues) and Airline/Hospitality (30%). Through its B2B global distribution system (GDS), and its software-as-a-service (SaaS) cloud solution, it offers virtual payment optionality with its Sabre Red Workspace, which is currently used by more than 425,000 agents worldwide. We believe SABR virtual payments remain a key component for its overall travel platform, as it continues to see strong uptake from travel agencies and corporations, with 130% year-over-year virtual card issuance growth. We positively view recent efforts to reinvest in its already competitive cloud-based platforms (data centers, hardware, software), particularly in Hospitality, which we think could set the stage for sustainable long-term top- and bottom-line growth as end-markets look to execute product refreshes of, in some cases, severely outdated technology. We note favorable booking trends have carried over to 2017 (+5.8% in Q1), suggesting strong demand remains.

Total System Services, Incorporated (TSS 58 ****) is a global payment solutions provider for payment processing services, merchant services and related payment services to financial and non-financial institutions. In addition, TSS also supplies general purpose reloadable prepaid and payroll cards. On May 23, 2016, TSS announced the launch of a new commercial payment solution for B2B virtual payments, dubbed Virtual Payment Precept (VPP), to help stem fraud risk, and increase efficiencies around payable/accounts receivable payment and reconciliation. TSS stated that according to the Association for Financial Professionals, nearly 80% of companies are in the process, or have already transitioned to electronic payments for B2B transactions. While much of recent growth has been fueled by acquisitions (TransFirst), we think this was vital for branching out away from mature Issuing segment growth and shifted focus to higher Merchant segment channel growth (expecting 7%-9% organic segment growth in 2017).

Key risks to our thesis include a slower rate of adoption than expected and the potential for emerging alternatives with a more favorable cost profile or overall economics. Regulatory or legislative conflicts could also cause delays.


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