Disclaimer: The information provided in this post is not to be considered as any form of investment advice. I might buy or sell shares in any companies discussed in the post without notifying readers of the blog. I currently own shares in Points International.
My latest position is in Points International, a Canadian company providing e-commerce and technology solutions to the loyalty industry headquartered in Toronto, trading both on the Toronto Stock Exchange (ticker PTS) and on the NASDAQ stock exchange in the US (ticker PCOM). Over 90% of the daily trading volume happens in the US. Market cap is around 200MUSD and the annual share turnover is roughly 80%. It is a small/micro-cap company that is fairly illiquid, and thus might have potential to be overlooked by the overall market.
It is not entirely straightforward to figure out exactly what it is Points does exactly. Citing the companies filings, they are the “..global leader in providing loyalty e-commerce and technology solutions to the loyalty industry, connecting loyalty programs, 3rd party brands and end consumers across a global transaction platform.” Points do not run their own loyalty programs, and they do not provide the technology to operate such a program. Instead, they have build a “Loyalty Commerce Platform” (LCP) that loyalty programs and third parties can use for transaction capabilities, program integration, analytics, reporting, security and fraud detection. The products and services offered by Points are designed to increase loyalty programs revenue and profits by selling loyalty program currency or related services to end consumers or third parties, drive efficient cost management by offering “non-core redemptions” and to enhance loyalty program member engagement. In short, Points partner up with loyalty programs and help them make more money through the use of their platform. Points have direct integrations with over 60 loyalty programs, with the majority belonging to the airline or hospitality space. The total number of loyalty program member accounts in the network of loyalty programs integrated with Points is over 1 billion. The loyalty industry as a whole is growing rapidly with the number of annual memberships up 15% a year (according to Points investors presentation). 60% of points/miles acquired in a year is estimated to be bought by 3rd parties such as Points. Below is a snippet from the annual report showing some of the major loyalty partners.
The company operates three different business segments. The, by far, biggest contributor of revenue (and pretty much entire contributor to profits) is the “Loyalty Currency Retailing” (LCR) segment. This segment consists of products and services to buy loyalty program currency for personal use or to give away as a gift, purchase status points to reach a tier status, transfer points to another member etc. In this segment, Points has 30 loyalty program partners that use at least one of the solutions within this segment, all within airline or hospitality. In this segment, Points primarily compete with the internal technology departments of the loyalty programs, but claims to have been successful in acquiring customers that previously provided the same services in house. Two thirds of the revenue within this segment comes from deals where Points technically acts as a “principal”, selling loyalty points at a retail price that they purchase at wholesale price from their partners. However, an important distinction needs to be made. Points do not load up on loyalty program points and keep them on the balance sheet. On the contrary, using the LCP, Points can buy the loyalty points in real time from their partner as they sell them to the end consumer. Importantly, Points get paid by the end consumer immediately and will have the money in their account within a few days, whereas the payments to loyalty partners are done on a monthly basis, usually 30 days after the end of the month in which a transaction was made. This leads to Points having “float”, usually with 1.5-2 months of revenue sitting on the balance sheet in cash at most times in payables to loyalty partners. Since Points seem to have very stable revenue streams from this segment, this float is essentially a free loan from the loyalty partners that pretty much funds Points operations and has enabled Points to grow without requiring any additional capital. Growth is essentially free for Points thanks to this.
The revenue where Points acts as a “principal” is booked on a gross basis. If someone buys 10 000 loyalty points through Points for 300$, but Points then passes 250$ along to the loyalty partner, the entire purchase amount of 300$ is booked as revenue, and 50$ becomes the gross profit on the transaction. For most other revenue within the business, what is booked as revenue is actually the commission that Points charges on transactions where they act as an agent or platform provider, on a net basis. Because of this, revenue isn´t a great measure to use when evaluating the company as a large chunk of that revenue is being passed along to loyalty partners and doesn´t belong to Points, though it is still crucial in generating the float that funds the operation. Gross profit is a better number as it is more indicative of the money earned by Points that will actually stay with the company permanently, it is essentially the “real” revenue for the business. Because of the way revenue is booked in this segment, the gross margin is quite low at around 12%.
In 2018, almost 98% of total revenue was generated in the LCR segment, and over 100% of operating profits. In the LCR segment, Points actually guarantees annual revenue to some of their major partners. For instance, in 2020, Points has guarantees to various partners to sell at least 150 MUSD worth of loyalty points in total. If they do not manage to do this, they will have to buy the loyalty points themselves from the partners, creating a potential liquidity risk. Revenue in this segment is likely to end up somewhere between 350-400 MUSD in 2019, so the total liability isn´t that great in comparison to total revenue. These liabilities are very likely to be spread out over several partners, so even though Points revenue in total is likely to stay way above the guaranteed 150 MUSD, they may still miss the guaranteed revenue targets for a particular partner and be forced to buy loyalty points from this particular partner by the end of the year. As far as I can tell from the annual reports, this has only happened once in the last ten years or so.
The other two segments are “Platform partners” and “Points Travel”. In the “Platform partners” segment, Points allows loyalty programs, merchants and other consumer service applications to use the LCP to distribute loyalty currency and loyalty commerce through multiple channels. Several third party applications are enabled by the LCP. They range from redemption based services that offer cost management solutions to loyalty partners, to earn-based services where merchants can partner with Points to buy loyalty currency to offer to their customers as awards. The revenue in this segment comes from commission fees, a set fee per transaction, revenue sharing or monthly recurring revenues, and gross margins are generally very high. In 2018 the segment generated revenues of just under 8 MUSD and a gross profit of 7.4 MUSD, with an operating result around 3.8 MUSD. I expect similar numbers in 2019.
The “Points Travel” segment is a white-label online travel service specifically designed for loyalty programs. Here, Points partner up with loyalty programs to enable members of the loyalty program to easily earn and redeem loyalty points by making hotel or car reservations online. By year end 2018, Points had 12 partners using at least one of their services in this segment generating a total of 1.8 MUSD in revenue (mostly from commissions) and an operating loss of 3.8 MUSD. The competition is fierce within this segment, as major online travel agencies are among the competitors. The development of this segment has been slower than anticipated by management, but according to a recent earnings call, the economics for the partners are great in this segment, as well as the unit economics for Points.
The contribution of “Platform partners” and “Points Travel” to the bottom line is very close to 0 for the time being, but even if they aren´t adding profits on their own, they might still be very useful. As mentioned, Points have a total of 60 loyalty partners, and offers a wide range of products and services within each segment. Whenever a new partner is signed, they usually just sign up for one or a few of the products that Points offers. Points then works on up-selling and cross-selling additional products and services to partners over time. If I´m reading correctly between the lines, both these segments, and maybe “Points Travel” in particular, is a great way to establish a relationship with a new partner that can be expanded over time. According the investor presentation, the current “opportunity matrix” within existing partners is only 30% penetrated, leaving ample space to grow with existing partners as well as new ones.
In December 2018, Points signed a strategic partnership with Amadeus IT, a giant IT provider for the global travel and tourism industry. Amadeus offers pretty much everything you can image, including loyalty programs, to airlines, airports, tour operators, insurers, ferry and cruise lines, travel agencies etc, and had revenues of almost 5 billion Euros in 2018. Citing the press release, the partnership “… will enable airlines to integrate Points’ solutions within existing Amadeus Loyalty Management and Awards solutions at the click of a button.” Amadeus have relationships with over 150 airlines across the globe, so if things turn out well, this could be a major driver of growth in the future, as Points look leverage Amadeus’ global presence and co-develop new services with them.
The financial results of the business has been pretty spectacular in the past. Revenue has gone up every single year since at least 2008 (this is the earliest year I have gathered data on), indicating that more and more loyalty points are being sold through the company every year. Adjusting for a one-time non-cash write down on a JV investment in China, gross profit has increased every year as well. EBITDA increased every year up until 2016 and 2017 when it decreased for two years straight, before increasing rapidly to record levels in 2018 with the company on track for another record year in 2019.
Looking back over the five year period of 2013-2018, gross profit has compounded at an annual growth rate of 10%, EBITDA at 14% and the companies favourite measure, Adjusted EBITDA at 16%. However, the company has bought back shares consistently since 2014, generating even greater growth rates per share with gross profit per share compounding at 21% annually for the period, EBITDA at 27% per share, and Adjusted EBITDA at 33%. If we look the period 2015-2018 instead, growth has been quite a bit slower with gross profit per share compounding at 11% annually, EBITDA 11% and Adjusted EBITDA 17%.
The business is generating a lot cash. In fact, it is one of the rare type of businesses that consistently generate more cash flow than earnings. Average after tax profit in 2013-2018 was 4.9MUSD. Average free cash flow (defined as operating free cash flow – all cash expenses for acquisitions of property & equipment and additions to intangible assets, as well as cash costs for the Restricted Share Unit-program) over the same period was 11.9MUSD. For the period 2015-2018, average after tax profit was 4.9 MUSD, and average FCF 11 MUSD. For the period 2013-2018, total after tax profits were 28.1 MUSD, total FCF was almost 60 MUSD.
The company achieved all of the above without carrying any interest bearing debt at all during any of the years I have data on, and they still don´t.
2019 is on track to become a record year in terms of both gross profit and adjusted EBITDA. Management has guided for gross profit to be between 58.5-64.5 MUSD which would mean 9-20% growth YoY, and adjusted EBITDA between 20.5-23.5 MUSD which would equal somewhere between 10-26% growth YoY. Additionally, during the year, the company announced long term goals of generating gross profits in the high-90 million dollar range by 2022, as well as more than doubling adjusted EBITDA to the mid 40-million dollar range. This is the first time that management has gone public with long term goals as far as I can tell.
The financial performance of the company certainly seems to indicate some sort of moat. On a recent earnings call, one of the few analysts covering the call asked whether the company experienced any change in the competitive client regarding the LCR segment. Management reiterated that they did not, and that they mainly compete with the internal technology departments of their loyalty partners. For some reason, Points has managed to increase profits pretty much for 10 years straight, without seeing their returns competed away. Why is this?
If we consider the situation from an airlines point of view, they want to sell as many points as possible as rewarding and selling points has turned out to be a very lucrative business. Loyalty programs increases customer retention rates, which leads to a higher Lifetime Value (LTV) per customer. The more you can engage your customer, the higher the LTV over time. This has triggered loyalty programs to come up with new ways to generate revenue, for instance by offering members the opportunity to rent cars or make hotel reservations using their loyalty currency. So airlines wants to drive revenue in this segment, and they are faced with the choice of either building a product in-house and do all of the marketing themselves, or they could hire Points to do it for them. If they choose to build their own products to try and drive revenue, they are going to have to employ both capital and man hours to do so, with no guaranteed return on the investment. If they instead hire Points, they have no costs associated with this, and are instead guaranteed a steady stream of revenue as well as access to Points growing network of loyalty partners in other industries, primarily in hospitality.
Additionally, Points have access to transactional data and anonymized customer data from many different loyalty programs in the same industry. Without knowing for sure, I think it is reasonable to assume that this is an advantage when it comes to marketing as they should have more information to use to optimize any marketing efforts and generate a higher return on the investment than a single airline would on its own.
There´s also a scale component. An airline would have to spend X dollars to develop the products on their and market them. Points probably have to spend a similar amount, though I´m assuming the number is bigger for Points due to the fact that their customers might have different needs and requests, but they can then derive revenue from many different clients using the same technology, whereas the airlines would only derive revenue within their own loyalty program.
Lastly, there´s probably some network effects going on here. Points have established relationships with many partners in different sectors that an airline (or any other loyalty program) will get access to by partnering up with Points, meaning they don´t have to spend any time or money developing those relationships themselves. Developing new ways to earn or redeem loyalty currency is crucial to drive customer engagement, and getting access to Points network of merchants is a quick way of doing this. As an example of how this can work in practice, during the year Points signed a deal with Home Chef, one of the largest meal kit delivery companies in the U.S, that enables United Airlines loyalty program members to earn frequent flyer miles when they sign up for Home Chef. This way, Points benefits from any additional engagement from United’s loyalty members by selling more loyalty currency, as well as a commission from Home Chef whenever someone signs up using United miles.
Another example is the possibility for members of the Hilton Honors loyalty program to use their loyalty currency to pay for their Lyft rides, by leveraging Points LCP platform.
I am not sure quite how wide Points moat is. In theory, airlines and other loyalty programs might certainly in-house this type of products, but since Points generate more revenue and sign up more partners year after year, the trend seems to be the exact opposite. In theory, companies such as Amadeus with a massive network of partners in the airline industry and lots of resources that already run loyalty programs could easily build their own product to compete, but they didn´t. Instead they signed a partnership with Points. Other marketing businesses or transaction platforms could also be a potential threat, but the type of relationships Points has would probably take some time and resources to replicate, and it might not be worth it to an outside competitor as it is a very niche business. Really, it´s more like a part of the business of running a loyalty program, that Points has specialized in running on behalf of loyalty programs. Overall, it´s probably not the widest moat I´ve ever seen, but there are no signs at all that it is eroding at the moment.
MANAGEMENT & CAPITAL ALLOCATION
Management has generally been with the company for a long time. President Christopher Barnard and CEO Robert MacLean are both co-founders and have been in charge throughout the very successful history of the company, or at least as far back as I have gone in my research. While it is very nice to see continuity and a founder-led company by seemingly competent people, this makes the fact that insider ownership is quite low all the more puzzling. Barnard and MacLean owns just over 200 000 shares each, or approximately 1.5% each of the shares outstanding and are still the biggest shareholders of the board or management.
Since 2017, executives no longer gets cash bonuses. Instead, their entire bonus is paid out in stocks in a “Restricted Share Unit”-program. Rather than diluting shareholders, the company has decided to appoint a trustee to administer the program and purchase shares from the open market that are then passed on to management as bonuses. This creates a very real and recurring cash expense but keeps the number of outstanding shares lower, and should increase insider ownership over time. If you look at recent insider transactions, you see a lot of selling and not much buying. This probably is partly due to the fact that no one is given cash bonuses, so if you want any cash other than the base salary as an executive, you need to sell shares. With that said, if the company truly is reaching an inflection as management has said, it would be very comforting to see them load up on stock and put their money where their mouth is, or at least not sell any of the stock that is handed to them in bonuses.
Management is not exactly conservative in their communication. The adjusted EBITDA used definitely include some things I consider real expenses that impacts cash flow, particularly equity-settled share-based payments, and the language in general is very bullish. The company gives guidance for each fiscal year, and the measures used in guidance have varied a little from year to year in the past, though they have remained the same since 2017 at this point (gross profit and adjusted EBITDA). The definition for adjusted EBITDA was changed in 2016 in a way that, surprise surprise, rendered a larger number, as the equity-settled share-based payments has been added back to net income (along with all the usual EBITDA adjustments) since. Since 2013, they have had to revise their guidance of adjusted EBITDA downwards once (in 2016) and up twice (in 2018 and 2019). The combination of very bullish commentary alongside low insider ownership is a bit weird to me, if they truly believed in what they are communicating, why wouldn´t the executives (especially the co-founders) want to own more stock?
With regards to capital allocation, the company has never paid a dividend, and they don´t intend to in the near future. Instead, they have been aggressively buying back stock through a “Normal-Course Issuer Bid”, a Canadian term for a company repurchasing its own stock from the public in order to cancel it. The NCIB needs to be approved by the TSX yearly, and the company has the authority to buy back up to 5% of the shares outstanding in 2019, and did so in 2018 as well. Since 2014, shares outstanding has gone from 15.4 million to 13.5 million, a total reduction of 12%, or -2.6% compounded annually, with the pace of the buybacks picking up in recent years. The buybacks are perhaps a bit too automatic for my liking, as I like to see management being very opportunistic in their allocation of capital, but given how cheap the stocks been historically, I think buybacks have been a fine option. At the very least, it is perfectly in line with management being bullish on the future of the company.
The company has made two acquisitions in the last five years, the most notable one being the acquisition of Accruity Inc, the operator of the PointsHound hotel booking service in 2014 that seems to have cost 16MUSD judging by the cash flow statement. The services in the “Points Travel” segment has been built upon the PointsHound technology, and with the segment still showing negative earnings, this investment isn´t looking to hot today.
Overall, any concerns I might have regarding management is more of a gut feel regarding low ownership and non-conservative commentary, rather than anything that is evident in the quality of the business, that by all measures, seems very high.
Compounded annual growth rates are lower across the board if you look at the 2015-2018 period vs the 2013-2018 period, and even lower still compared to the 2008-2018 period. So growth has slowed down, but it seems like it could be picking up again in 2019, and for managements long term goals to be met, it has to pick up quite a bit. The company has identified three core growth drivers going forward:
- Sign new partnerships
- Up/Cross-Sell Existing Partnerships
- Drive growth in existing partnerships
These are all self-explanatory. Furthermore, the company has also identified three growth accelerators:
- Geographic expansion
- New verticals (financial services and retail mentioned in investor presentation)
- Corporate development (by acquisitions and strategic partnerships).
The majority of revenue is coming from North America and Europe today. Here, growth is expected to mainly come from cross-selling existing partners and moving into new verticals, with financial services (the company has existing partnerships with Chase & Citibank) and retail being the primary targets. According to the investor presentation, the company has a growing footprint in the Middle East and are targeting large carriers and financial services in that area. The same is true for South America and the APAC region, and in H2 2019 Points has opened a new office in Singapore to better serve this region.
Regarding acquisitions, the investor presentation states that the historical approach has been opportunistic, but that the company is moving to a more proactive approach given balance sheet strength. Personally, I´m not sure I´d like to see any acquisitions at all given the history with PointsHound and how well the core business is doing.
The strategic partnership with Amadeus could present a great opportunity for growth as it should enable Points to establish relationships with new potential partners that are currently customers of Amadeus. During 2019 Points have added a couple of new partners through the partnership with Amadeus, but the extent to which this had affected overall gross profit is unclear.
So we have a seemingly very predictable, profitable business carrying no debt that throws off a lot of cash. Market cap as I´m writing this is 199MUSD and the company had 54MUSD in cash at the end of Q3, with another 6MUSD expected to be paid back from the tax authorities in Q4, rendering an EV of 139MUSD. If we expect that adjusted EBITDA for 2019 will be in the middle of guidance at 21.5MUSD, and that my definition of EBITDA will be 16.5MUSD (subtracting equity-settled share based payments) we get an EV/EBITDA of 8.4. The company has actually generated more cash flow than EBITDA historically, but that does not seem to be the case in 2019. Using my definition of FCF and looking at the average for 2015-2018 to even the lumpiness of free cash flow out a bit, we get 11MUSD in FCF and an EV/FCF multiple of 12.6 or a FCF yield of 8%.
Using enterprise value might be a bit optimistic, as an outside buyer of the company wouldn´t be able to just pocket the cash that is sitting on the balance sheet as it is going to be paid to partners. If we look at P/FCF instead (adjusting for the 6MUSD tax rebate), we get a multiple of 17.5 and a 6% FCF yield. This is very conservative measure as I exclude the expected record year of 2019 in the calculation of free cash flow, and give no value to the cash on hand. To exceed the average market return over time, we need growth to be over 4% annually. Given that the company has grown gross profit with a CAGR of 10% over the last five years, that the loyalty industry is growing at a double digit rate as a whole, and that management has guided for faster growth in the years to come, a long-term growth rate of over 4% seems very doable.
The long term financial goals are gross profit in the high-90 MUSD range by the end of 2022, accompanied by an adjusted EBITDA in the mid-40 MUSD range. To achieve this, gross profit needs to grow at a CAGR of around 15%, and adjusted EBITDA needs to grow at 25-30% annually. So the gross profit needs to grow faster than it has been for the last couple of years (10% CAGR over the last five years), adjusted EBITDA needs to grow even faster (16% CAGR over the last five years), indicating that management expects considerable operating leverage working in a positive direction going forward. Indeed, the company targets an “effective margin”, defined as adjusted EBITDA / Gross profit of 45% in 2022. The 3 and 5-year average “effective margin” are both 30%. These are, in my opinion, quite aggressive targets, and I would not like to depend on them for an investment to be profitable, but let´s pretend for a second that management is spot on and that we end 2022 with an adjusted EBITDA of 45 MUSD. EBITDA would be more like 40 MUSD, and if we slap a generic 8 times EBITDA multiple on that (if the company would reach these ambitious goals the real multiple will likely be quite a bit higher, but let’s be really conservative), we get a value of 320 MUSD (and remember, FCF is likely to be at least the same as EBITDA or higher). Comparing this to today’s 199M market cap we get a CAGR of 17% in capital gain. If we assume that the company keeps reducing the share count with 3% a year, you´re looking at an annual return of 20%, not counting any cash that has piled up on the balance sheet or potential dividend. If management meets the long term financial goals, the stock is very cheap. To make a market beating return of 10-12% a year, the company can miss the long term financial goals by some margin provided an average market multiple to EBITDA or cash flows.
I can see how this is not a particularly exciting stock to own for a lot of people. The business is pretty boring and niche, there´s no catalyst, and it is not incredibly cheap. I just think it is a very nice and solid business that is being overlooked and undervalued due to it being small and fairly illiquid.
With a large exposure to travelling in general and airlines in particular, a downturn in the economy would likely be negative for the business, and any event that has an adverse effect on how much people fly would likely be very negative as well. Carbon emissions are certainly a real thing, and if the environmental movement will gain traction worldwide and make people fly less, that could pose a long term risk. This has certainly happened to some extent in Sweden with “flight shame” actually becoming a thing in 2019, and was probably one of the reasons that the number of passengers who flew through Swedish airports decreased 4% YoY. A terrorist attack including planes is also very likely to make people fly less, at least for some time.
Customer concentration is also a risk. The top three partners make up 70% of revenue, but as discussed earlier, revenue is a bit misleading due to how it is booked. Management does not disclose how much these three partners contribute to gross profit, but 80% of gross profit comes from 14 different partners, at least indicating that gross profit is a bit more spread out over several partners. Still, it would be nice to get a number on how much the three largest partners contribute to gross profit to further evaluate the customer concentration risk.
I can´t help but feel that management is a bit of a risk as well. To be clear, there really isn´t anything in the way the business has been run to cause any concern at all as far as I can tell, but the combination of a very bullish outlook for the company, combined with very low insider ownership makes me cringe a little. It is very possible that management is overly optimistic with their long term financial goals, we have no history of them making these type of long term forecasts to compare with, so I really do not want to rely on these goals to make a market beating return on my investment. This is why I´m being very conservative in my valuations and future growth prospects of the business. I am also going to be weary of any acquisitions going forward. The existence of the float that funds the company is crucial to my investment, and any move on managements part that would eliminate the float would be an immediate sell decision for me.
Then there is the very significant risk of me misjudging things. I might be underestimating the level of competition in the LCR segment going forward. The lack of historical competition is in no way a guarantee of low competition in the future, neither is company commentary on the subject. I might also overestimate how predictable and safe the business really is. The development since 2008 has been outstanding, but so has the economy as a whole, and the company has certainly been riding a secular tail wind with the overall loyalty market growing faster than the economy. There really is no telling how the company will do in a shakier general economic environment.
I am very grateful for the feedback I received on my post mortem-post on Aspire Global. Thank you all who contributed! I welcome any critique or feedback on this post as well, both regarding the way it is written, but more importantly, the actual analysis of the business and its valuation.