When EML Payments (ASX:EML) presents its full-year results this week, investors should prepare for what might be a bit of a “mixed bag”, fund manager Ron Shamgar says.

The company will present in the wake of a tumultuous Q4, highlighted by regulatory concerns flagged by the Central Bank of Ireland (CBI) regarding EML’s subsidiary, PFS Card Services.

EML – ‘shoot first, ask questions later’

When EML disclosed its regulatory issue on May 19, investors were quick to sell out of the stock, sending shares in the company below $3 from their previous range above $5.50.

The move was indicative of market twitchiness around regulatory risk in the fast-growing digital payments space, where a number of ASX players are looking to build market share.

It’s an issue that’s been flagged in the high-growth BNPL sector, which so far has avoided stricter regulatory oversight around credit and merchant surcharges.

In EML’s case, Shamgar said its run-in with Irish regulators was actually a by-product of rule changes stemming from Brexit.

PFS, which EML acquired in March 2020, was “essentially always regulated for all of their payment programs in the UK”, Shamgar said.

Due to post-Brexit rule changes, it had to transfer those licences to an EU-based jurisdiction. And one of the reasons it chose Ireland was because its regulatory networks were considered stronger and more credible than other EU jurisdictions, Shamgar said.

Once approved, “it transitioned many of those programs over throughout 2020”, he said.

Then earlier this year, the Irish regulator saw some large transactions going through those programs, so they carried out an audit on PFS to get greater clarity on the business.

“PFS run programs which include transactions such as asylum seeker payments and UN (United Nations) payments, which the regulators weren’t as familiar with,” Shamgar said.

In response to the payments it deemed unusual, the Central Bank of Ireland issued its notice of concerns about the company’s AML (anti-money laundering) practices.

At the time, Shamgar said Irish regulators weren’t aware PFS was the subsidiary of an ASX-listed company. And from there, a bit of hell broke loose.

“Obviously as a listed company they had a duty to disclose that notice. And I think there was some panic in the market because if EML were to lose that licence, it would wipe out around 25% of its earnings,” he said.

In that environment, most investors took a “shoot first, ask questions later” approach, Shamgar said.

But for TAMIM, the selloff marked an opportunity to up its stake in the company.

EML — Assessing risk

Shamgar said TAMIM held extensive discussions with EML’s management team, and became satisfied a worst-case scenario was unlikely to eventuate.

“Looking at recent history, no one’s lost their licence over issues with the Irish regulator,” he said.

“We didn’t view that as a major risk, but there was definitely an overhang on the stock because it highlighted some regulatory risk.”

“So we took the opportunity to buy more when the market was selling. And in the months since I think they’ve helped reassure the market that the risk of losing their licence is no longer there.”

However, Shamgar said there’s still compliance and regulatory costs that will have to be incurred to accommodate the requirements the Irish regulator wants. And it will also cause delays in launching new programs.

“We’re looking for them to resolve its issue within the next couple of months and until then, it might still act as a bit of a negative catalyst for the stock.”

EML — reporting season

With all that in mind, investors are likely to be watching closely when EML releases its full-year results this week (scheduled for Wednesday).

And Shamgar provided some insights into what details the market will be looking for.

“In terms of the positives, I’m expecting them to flag strong volumes for July (post-financial year), with a recovery in the US and Europe,” he said

Shamgar said those two markets contribute the majority of EML’s earnings, with only around 10-15% of revenues generated in Australia.

“We could see them announce some more large customer wins and cash flow we know is going to be quite good as well.”

But on the negative side, the hold-ups stemming from its regulatory issues with the CBI could weigh on forward guidance – always an important component of full-year results.

“If guidance is too much lower than what consensus is, then I think the stock could potentially get sold off,” Shamgar said.

“But in my opinion that would be an opportunity to buy more, because longer-term this is an issue that can be resolved, and I think the company has strong industry tailwinds from the shift to digital payments.”

Payments sector tailwinds

Assessing its place amid those tailwinds, Shamgar said the company still has some attributes that separate it from other competitors.

“What stands out first is that the company makes money and is profitable,” he said.

“It’s been that way for the last 5/6 years and it’s grown profits consistently in that time. The core management team has also been around for about 10 years now, and everything they said they’ll do – they’ve done it.”

“So I think they deserve some benefit of the doubt that they’ll resolve this issue and continue to grow the business.

“They’ve also got a strong balance sheet, with ~$140m cash and no debt. So those are the things that stand out to me the most.”

Having listed in 2006, EML is something of an elder statesman among ASX-listed payments companies.

And as a comparator, Shamgar said US company Marqeta Inc, which recently listed on the Nasdaq, is a good gauge of how global investors are pricing the sector.

Both EML and Marqeta (Nasdaq:MQ) can be described as payments issuers – issuing cards via the global payment giants (such as Visa and Mastercard) and facilitating payments, whether through physical cards or mobile wallets.

That can be contrasted against payments acquirers – companies such as Tyro (ASX:TYR) – which are involved in taking payments.

“Marqeta IPO’d about a month ago, and it’s trading at something like 20x revenues compared to EML which is more like 7x,” Shamgar said.

“So in my view they are very similar businesses, but it shows US investors are willing to price those businesses on a significantly higher multiple than Aussie investors.”