September 21, 2020

Priority Technology Holdings: Prioritizing Shareholder Value (NASDAQ:PRTH)

Our initiating coverage of Priority Technology Holdings, INC (Nasdaq: PRTH) (“Priority”), a FinTech company, checks all the boxes of profitability, growth and a misunderstood story disguising hidden opportunity.

We will provide an overview reflecting our interviews with Thomas Priore, CEO of Priority Technology Holdings & Patrick Ghilani, CEO of MRI Software, that will explore Priority’s business segments, delivery platform, distribution channels, financial performance, cost reduction initiatives, leverage issues, recent transactions, growth opportunities, and general valuation.

Company Overview

Priority is much more than an ISO Platform

Source: Author Interview with Thomas Priore, Priority CEO

Priority is a growth technology platform that hosts a breadth of payment operating assets in consumer, commercial and integrated market segments specifically designed to acquire, serve, and retain Merchant SMB members with open architecture software-based payment tools.

Its merchant acquiring and commercial payment solutions are ranked 13th in the nation and 5th among non-bank providers and climbing in an industry fraught with acquisitions and consolidation.

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Unlike the majority of its peers, Priority has the advantage of having built its business when cloud-based infrastructure was nascent and not hamstrung by the deficiencies of mainframe infrastructure allowing them to leapfrog their competition by prioritizing speed and innovation with far less resources. Priority’s virtualized infrastructure and shared services operating model has also enabled the firm to adapt to remote working environments without missing a beat. Its merchant adoption and financial performance through the Covid-19 pandemic bear this out.

The firm’s proprietary platform of micro-services is efficiently designed to monetize and adapt merchant networks across multiple vertical specialties.

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Source: July 2020 Investor Presentation

Business Segments

Priority categorizes its customers into three business segments:

1. Consumer Payments

Priority’s largest segment, founded in 2005, provides full-service payment processing and enabled solutions for B2C transactions. It supports over 209k SMB Merchant Accounts which average $210K+ in annualized volume per account (i.e., ~$42Bn).

Priority’s modern CRM supports largely variable-cost, nationwide sales channels consisting of Integrated Software Vendors (ISV’s), Financial Institutions and Community Banks (FI’s), and Independent Sales Organizations (ISO’s), that consistently produce 4,5000 to 5,000 merchant signings each month. Its robust reseller support and merchant tools produce industry-leading revenue attrition rates of 10%-12% historically.

Importantly, Priority’s comprehensive CRM and payment software products allow its resellers to operate like mini-ISV’s. The company’s product suite is completely configurable to fit all individual merchants’ needs, giving them the flexibility necessary in today’s evolving diverse marketplace.

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Source: July 2020 Investor Presentation

Market forecasts predict that electronic consumer payment volumes are expected to grow at a 7% 10-year CAGR, as consumers increasingly use cards over paper-based payments and global eCommerce continues to accelerate as a result of Covid-19.

2. Commercial Payments

Founded in 2012, the Commercial Payments segment, provides accounts payable automation software, payment processing and managed services to industry leading financial institutions (including Citi, MasterCard, and AMEX) and corporations. Priority currently supports 1,000+ Enterprise clients with virtual and physical credit cards processing $300M+ in accounts payable volume (i.e., $280k+ of spend per client) and generating ~$22M in managed services fees annually (i.e., ~7%+).

Digital B2B payments volume is expected to grow at an 11% 7-year CAGR driven by an increase in AP automation and card payment adoption.

3. Integrated Partners

Founded in 2019, Priority’s fastest growing segment provides vertical-specific payment-enabled software solutions linked together by the Vortex API and Cloud in high-growth markets for emerging companies early in the cycle of digital adoption. The segment has 3,200+ accounts and $6Bn+ in volume yielding 80%+ gross profit margins.

Within the segment, there are four primary industry verticals:

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Source: July 2020 Investor Presentation

Of note, the hospitality segment, consisting of the e|tab technology platform for restaurant carryout/delivery service (offering a free 60-day trial, with comprehensive functionality, such as menu build, setup, and training on the system) has recently demonstrated triple digit growth. Management expects ongoing double-digit to triple-digit growth continuing into the new year with E|tab’s new dine-in features that are under beta test providing restaurant patrons safe and secure, contactless table-side ordering and payments functionality from a merchant’s mobile phone that are needed in a Covid-19 and Post-Covid environment.

Delivery Platforms

Solutions are delivered via Priority’s internally-developed cloud-based infrastructure and product platforms. The platform is an open architecture environment allowing for third parties to establish immediate turnkey access to Priority’s solutions reducing on-boarding and ramp-up times.

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Source: July 2020 Investor Presentation

Q2 Financial Review – Covid Resistant

Like most Merchant Acquirers, overall Q2 YoY volume metrics were hard hit reflecting the shutdown and shelter-in-place orders, with Salons and Hospitality businesses bearing the brunt of the decline. Despite these headwinds, full quarter revenues of $92.4 million were above the $92.1 million posted in 2019 and gross profits remained essentially flat YoY attesting to the resiliency of the model. One of the primary reasons for increased revenues in a declining volume environment resulted from an improved product mix with a larger proportion of higher margin e-commerce transactions.

A further dive into the month-to-month breakdown of the quarter reveals a significant recovery and growth trend throughout Q2 demonstrating a strong rebound in Volumes, Revenues and Gross Profits normalizing and exceeding prior year results by quarter end.

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Source: July 2020 Investor Presentation

Management, on its Q2 earnings call, announced that processing volumes in July improved 1.4% YoY and 10% compared to June to $4.35Bn and revenue increased 19% YoY in July and 8% compared to June to $36.5MM.

This translates into consistent growth in Revenues, Profits and EBITDA as the economy re-opens.

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Source: July 2020 Investor Presentation

Q3-to-Date

Management expects to achieve Adjusted EBITDA of $6.6 million to $6.8 million for July representing a 60%+ increase in Adjusted EBITDA YoY.

This is not “pent up demand”. Through the middle of August, total processing volume trended to exceed $4 billion, signaling a high likelihood of revenue and adjusted EBITDA results in-line with July’s run rates and setting the stage for $11Bn+ for Q3.

Management notes that there has been a partial reversion in Q3 back to historical norms in terms of average ticket size and product mix where average ticket sizes for online orders in the hospitality space (e.g., curbside-pickup & deliveries) are traditionally 15% higher vs. on-premise orders. As premises reopen, that mix will shift but be offset by increased ticket volumes and reactivation of merchant accounts. Management sees this as a “systemic change in the hospitality environment that is here to stay”.

Business Segment Analysis

From a business segment perspective, most revenues and gross profits performed at or above prior year levels.

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Source: July 2020 Investor Presentation

The under-performer, Managed Services, is a small cash cow of the Commercial Payments segment that declined while the overall Commercial Payments segment grew (driven by the high growth payables business in CPX). Managed Services is a “contract for hire” segment (e.g., American Express and other large institutions) that backed up because of the Covid-19 pandemic and is expected to recover during the second half of the year.

Cost of Revenues

Priority’s high variable cost structure as well as a shift in the product mix during the course of the pandemic in Q2 helped maintain strong gross profits across most business segments and verticals despite declines in processing volumes.

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Source: July 2020 Investor Presentation

Pipeline

Priority has a pipeline in payment volumes of $30Bn+ that is in the process of activating throughout Q3. Management noted some commercial banks have been slower to roll out their programs due to remote activation issues and may extend onboarding into Q4.

The business model has held strong in the worst of the crisis with new merchant onboarding historically averaging between 4,500 – 5,000 new accounts per month and continuing to exhibit similar results throughout a tumultuous Q2 (averaging 4,389) as merchants raced towards cashless payment mechanisms to facilitate business in the new world order.

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Source: July 2020 Investor Presentation

With the reopening of the economy, management indicated that Q3 will likely be closer to the higher-end of the historical on-boarding range as more of their existing resellers regain consistency in the re-opening and a new higher base growth/adoption rate for e-commerce (Contactless/curbside) becomes the systematic norm in hospitality (particularly in distribution channels in the Southeast, Northeast, and Texas).

Cost Reduction

In the last two quarters, the company implemented many significant and permanent cost reductions, reflecting automation-driven initiatives launched in Q4 2019 optimizing payment operations to positively impact Adjusted EBITDA. The expense initiatives drove a permanent 7.7% decline in salaries and employee benefits and a 20.8% decline in SG&A improving EBITDA margins across all segments.

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Source: July 2020 Investor Presentation

Management believes there are further savings to come as a result of these automation initiatives over the next several quarters which will further improve margins. “Everything we do is super-efficient at taking and making payments.” (Source: Author Interview with Thomas Priore, Priority CEO)

“Perceived” Headwinds

  • Historic Reduction in Consumer Payments

In 2019, due to regulatory changes surrounding the subscription e-commerce segment in the Card Network industry, Priority experienced a wind-down of a significant portion of its e-Commerce merchants within the Consumer Payments segment. This forced the closure of core merchants in 2019 and delayed the ability to re-board which again became impaired due to mega-mergers and changes Priority needed to implement in the processing platform. This drove down financial metrics throughout 2019, until the transition was completed by the end of 2019. Since then, the firm has returned to growth in the e-commerce segment in 2020 and is now benefitting from significant tailwinds from Covid-19.

The amount of revenue lost from the e-Commerce market shift and to fight our way through that and turn it around in the timeline we did says a lot about us organizationally. That’s in someone’s DNA and is not just the industry or economy bailing you out. Past performance is a predictor of future results. That’s where the Alpha comes from.

Source: Author Interview with Thomas Priore, Priority CEO

  • Historic Leverage Concerns & The MRI Solution

The largest concern confronting investors has been a historically high leverage ratio of ~7.5x Adjusted EBITDA (TTM) resulting from the aforementioned regulatory changes. In comparison, Priority’s peer group’s leverage ratios range between 3x-4x.

On September 1st, 2020, Priority announced a Definitive Agreement with MRI Software to sell RentPayment platform assets (i.e., RentPayment, DuesPayment, and StorageRentPayment brands but excluding Radpad & LandlordStation). These assets provide payment solutions to ~2,900 clients across the U.S. multi-family, single-family, storage and HOA markets.

The cash transaction is expected to close in Q3 2020 with net proceeds of ~$127MM of which management will use ~$112MM to reduce the existing Net Debt balance of $494MM yielding a reduced leverage ratio closer to 5.5x while simultaneously increasing annual free cash flows from reduced interest expense. Priority will continue to remain laser-focused in targeting a leverage ratio of between 3.5x – 5x to bring Adjusted EBITDA in line with its industry peers through a combination of natural growth and debt paydown.

MRI Solves More Than Leverage

A Marriage Made in Heaven

Source: Author Interview with Thomas Priore, Priority CEO in reference to the MRI & Priority Strategic Relationship

Rentpayment had been one of MRI’s largest payment solution partners for well-over a decade.

However, based on MRI’s own research:

The #1 cross-sellable solution to MRI’s installed base is payments. It is the most needed, necessary and likely add-on solution that a client of MRI would be likely or willing to buy.

Source: Author Interview with Patrick Ghilani, MRI CEO

Therefore, in Q1 2020, MRI began to roll out its own branded payments offering to their US based conventional multifamily clients, before learning about the Rentpayment platform acquisition opportunity.

It would give us immediate scale and capabilities further in the space than we already had… plus the fact that we already knew them and had integration with them. It really was a good marriage, and during Covid it bolstered our excitement for the payments’ arena. Clearly paying fees online, whether it is rent, storage, associations… had become hugely popular anyway, but in a contactless world it is paramount. If anything, Covid made us more bullish on the opportunity.

Source: Author Interview with Patrick Ghilani, CEO

Priority’s Rentpayment solution stood out because of its specialization in the rent payments sector and allowed MRI to continue to work with Priority by leveraging Priority’s resident payment servicing and electronic payment processing infrastructure.

The MRI partnership is a realization of Priority’s payment infrastructure as a platform offering for enterprise ISVs. This is a proof of concept for our infrastructure as a service offering.

Source: Author Interview with Thomas Priore, Priority CEO

MRI does not anticipate any hurdles and plans to immediately scale North American adoption in 2020 initially with their US conventional multifamily client base and penetrating other areas of MRI’s US portfolio which have a concentration in underserved government owned housing (public, affordable, social housing) that have a Covid-based need for online payments.

In 2021, MRI anticipates expanding the solution into European and Australian/New Zealand markets where they have a large concentration of residential units (i.e., conventional housing, social housing, and home-owners associations).

In terms of hurdles, winning new clients is more challenging as clients do not want to switch payment providers in the middle of a pandemic. Although MRI expects growth with new clients, MRI will be focused on penetrating the installed based as the lowest hanging opportunity by growing a team to target existing customer communities using communication, training, marketing and incentives.

At the same time, they will grow a sales & account management channel that will continue to build the Rentpayment portfolio for non-MRI clients since MRI and Priority fundamentally developed Rentpayment around the concept of an open ecosystem platform for all.

Why is this important?

In the most recent Form 8-k filing, Section 4.18 on Page 41 reads as follows:

Processing Agreement. From and after the date of this Agreement, Buyer and Seller will engage in good faith conversations regarding Seller or one of its Affiliates providing payment processing services (in addition to those contemplated by the Services Agreement and including international payment processing and using ‘Priority CPX’ for its vendor payments and automated payments) for Buyer’s and its Affiliate’s payment business and similar lines of business on terms mutually agreeable to the Parties.

The MRI transaction underscores two big wins: “Monetizing a Strategic Asset” and “Forming a Partnership with a Global Leader in Real Estate Technology”.

Rentpayment will become the payment platform for the original Rentpayment base (~2,900 customers with ~1MM users) as well as the MRI base (9,500+ customers with over 12MM users in 170 countries) as both continue to grow and also for third parties.

Priority will reap the benefits earning an estimated ~$200k in monthly revenues for every 1MM users (or, in other words, an annualized potential of $30MM+ straight to the bottom line). Many of those customers will choose alternative competitive solutions, or refrain from adopting a solution, but as the ‘#1 cross-sellable add-on solution’, a large portion will see the benefits of adopting a MRI/Rentpayment payments solution supported by Priority.

I believe the upside in the MRI partnership is greater than the base business that we had.

Source: Author Interview with Thomas Priore, Priority CEO

Priority is essentially exchanging ~$11MM in LTM Adjusted EBITDA from the Rentpayment assets in return for net cash proceeds of $127MM (i.e., ~12x Adjusted EBITDA) and exclusive access to a leading global strategic partner customer base to which Priority can provide payment processing and servicing earning >$2MM EBITDA annually from the start and significant growth potential thereafter.

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­­­­­­­Source: Mike Vollkommer, Priority CFO

We took an asset that, at the time of the acquisition, was declining in revenue by 10%, and grew it 30% within a year and had more of that hitting the bottom-line as a % of EBITDA. The Priority platform is uniquely positioned to optimize integrated software assets for payments. This transaction validates it.

Source: Author Interview with Thomas Priore, Priority CEO

Capital Allocation

Priority runs a Capex-lite operation and generates FCF, after Capex, at a conversion rate of 80%+ of Adjusted EBITDA. This combined with the anticipated ~$10MM in FCF from reduced interest payments post the MRI transaction and debt paydown will create the opportunity for double-digit FCF yields going forward into 2021.

The choice of Capital Allocation strategies will be based on maximizing shareholder value:

  1. Debt Paydown

Priority will continue to focus on debt reduction to ensure leverage ratios fall to and remain within 3.5x-5.0x.

2. Shareholder Buyback

Given depressed stock prices, management has noted that this may be a limited opportunity given the thin trading float (e.g., historically Priority engaged in $5MM Repurchase Program for the first half of 2019).

3. Technology Asset Acquisitions

Management is opportunistic, but focused on core acquisitions in healthcare and consumer finance.

4. Merchant Portfolio Asset Acquisitions

Merchant portfolio assets may offer discounted opportunities (e.g., historical acquisitions from Direct Connect and Blue Parasol in 2018).

International Expansion

Priority, over the last several months, entered into three global strategic relationships:

  • MRI (Real Estate Technology)
  • Akerna (Cannabis ERP technology)
  • Citigroup (Diversified Financial Services Bank)

It is no coincidence that all three have broad global customer bases and supply chains. Priority is building partnerships with an international footprint by design and aligning itself to monetize payment processing across partners’ respective businesses, supply chains, customer bases and geographies. Priority will remain a lucrative card issuer for two of these relationships (i.e., MRI & Akerna). While every country has unique processes required to “move money”, all markets that MRI and Akerna serve have some form of payment technologies already in place which will aid in obtaining requisite approvals to accelerate adoption.

While the partnership with MRI is important, the platform remains an open architecture with connections to all of the large property management software companies (like RealPage and Yardi). This is not just for the MRI customer base; it will support all property management software for rent payments.

Source: Author Interview with Thomas Priore, Priority CEO

Valuation

Although up 90%+ above its March lows of $1.33, Priority remains severely discounted relative to its Peers: Fidelity National Information Services (FIS), Fiserv (FIS), Global Payments (GPN) and EVO Payments (EVOP). In the Peer Group Analysis below, the estimated forward EV/Adjusted EBITDA multiple range is between ~14x–18x (representing a ~200%+ premium over Priority’s current valuation). This discount stems primarily from leverage concerns and the historical unwinding of the e-commerce subscription business. I expect the markets to take time to absorb and process the resolution of these issues, but with time, valuations will likely fall in-line with its peers reflecting a target valuation between ~$6-$8 per share.

Source: Analysis by Author

Conclusions

Priority has proven to be a resilient and low-risk undervalued FinTech company with “growth” characteristics even in the worst of times. Recent transactions address historic leverage concerns while establishing strategic relationships to drive double-digit EBITDA growth and FCF yields with global partners who have established inroads throughout Europe, South America, and Asia. As the economy stabilizes and investors turn their gaze forward to the next twelve months, the discount that the company faces will likely erode as investors re-prioritize their portfolios with an emphasis on Priority to harvest triple-digit returns.

Disclosure: I am/we are long PRTH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We pride ourselves on conducting extensive primary & secondary research, analyses, and/or interviews with Senior Management, Partners, and/or Customers in order to identify and vet undervalued investment opportunities. That said, we aren’t always right and these are just our humble opinions. Don’t get us wrong, we would love for you to follow us to show you the “hidden” gems we find, but we also always encourage everyone to do their own homework and research and as the saying goes….BUYER BEWARE. Happy investing!

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