Given the controversy around Net1, I decided to look at Net1 from an investment analyst’s perspective and to try to understand exactly what Net1 does and how it generates its profits. The company is a bit like an onion, every time you peel away a layer, you uncover something else. I cry when I peel onions.
“We have observed that it is harder to build a long-term sustainable business by being purely a technology provider.”
“From our inception we have had to develop aggressive and disruptive business models for us to compete… (this) led us to view our technologies as an enabler, and to use these to provide financial and other services.” – Serge Belamant, CEO, Net1, Q2 2017 Results, Earnings Call Transcript
“… we believe now that the growth will be more focused on low income earners rather than purely beneficiaries…” – Serge Belamant, CEO, Net1, Q1 2017 Results, Earnings Call Transcript
How grant payments work
At enrolment a bank account is opened for the grant recipient with Grindrod Bank and she is issued with a white Sassa-branded MasterCard. Every month social grants are paid into those bank accounts once the recipient has verified her identity via a voice call or by fingerprint at any Sassa pay point or qualifying store. Once verified, the grant is transferred to the bank account and loaded onto the Sassa card.
Grant recipients can withdraw their money from CPS-run pay points free of charge (CPS operates 10,000 mobile pay points every month – think vans and spaza shops, community halls, sports centres, as well as well-known retailers), or from an ATM, in which case they are charged transaction fees.
According to field research conducted by International Labour Research and Information Group, while queuing at CPS pay points, grant recipients are marketed microloans. In order to take out a microloan, they need to open a new account with Grindrod Bank called an EasyPay Everywhere account and are issued with new green EasyPay Everywhere MasterCards. This account was introduced when legislation was passed prohibiting direct deductions from social grants. When a grant is paid into a Sassa bank account it is automatically transferred to the EasyPay Everywhere account where the deduction protections no longer apply.
There are 17-million grant recipients in South Africa. The 2017/18 budget allocated R151.6-billion to social grant payments. This means that on a monthly basis R12.6-billion is transferred into bank accounts held at Grindrod Bank. According to Grindrod Bank’s website they pay grants to 9.77-million distinct cardholders in close association with Cash Payment Services (CPS), who provide the card technology and manage the card programme.
(As an aside, this begs the question why the government cannot simply take over the Grindrod Bank accounts and the Sassa-branded MasterCards as from April 1, 2017 and use the Post Office for the actual distribution of grants? According to Grindrod Bank’s terms and conditions those cards are the property of the bank, not CPS!)
How Net1 makes money
Net1 owns a myriad subsidiary companies, of which CPS is just one. The names are irrelevant.
In terms of financial reporting, Net1 splits its sources of revenue into three, South African Transaction Processing (I will call this Grant Payment and Transaction Processing for ease of reference), Financial Inclusion and Applied Technologies (I will call these Financial Services) and International Transaction Processing (everything that falls outside of South Africa).
Grant Payment and Transaction Processing and Financial Services relate to their operations in South Africa. According to Serge Belamant their client base is currently “purely beneficiaries”.
“We generate our revenues by charging transaction fees to government agencies, merchants, financial service providers, utility providers, bill issuers, employers, healthcare providers and cardholders; by providing loans and insurance products and by selling hardware, licensing software and providing related technology services.”
Let’s break this down a bit:
|BUSINESS UNIT||NET1 REGULATORY FILINGS||PLAIN-SPEAK|
|Grant Payment and Transaction Processing||“The South African Transaction Processing segment consists mainly of a welfare benefit distribution service provided to the South African government and transaction processing for retailers, utilities, medical-related claim service customers and banks. Fee income is earned based on the number of cardholders paid. Utility providers and banks are charged a fee for transaction processing services performed on their behalf at retailers. For the year ended June 30, 2016, there was one such customer (read “Sassa”), providing 21% of total revenue.”||The revenue comes from payments from Sassa for the administration of the grants and from transaction fees related to the use of debit cards by grant recipients, whether they are the standard Sassa cards or the green EasyPay Everywhere cards. Transaction fees may be paid by grant recipients directly, or by shop merchants, by airtime and electricity providers and by banks. Effectively, every time a card is used and money flows between two parties’ bank account, transaction fees are charged.|
|Financial Services||“The Financial inclusion and applied technologies segment derives revenue from the provision of short-term loans and smart card accounts at a fixed monthly fee per card (read “EasyPay Everywhere”). This segment also includes fee income from merchants and card holders, the sale of prepaid products (electricity and airtime) as well as the sale of hardware and software. Finally, Net1 earns premium income from the sale of life insurance products and investment income through its insurance business.”||This unit makes money from micro-loans, life insurance products, fixed monthly fees from the EasyPay Everywhere accounts (although Net1 advertises the accounts as not charging a monthly fee, only pay-per-use fees), commission/transaction fees on the sale of electricity and airtime and some revenue from the sale and leasing of pay-point terminals to merchants.|
What does Net1 do?
I found it insightful to look at what Net1 says about its business model.
“We are able to provide our cardholders with competitive transacting accounts, microfinance, life insurance and money transfer products based on our understanding of their risk profiles, demographics and lifestyle requirements.”
Net1 profiles and targets grant recipients.
“Our largest financial services offering is the provision of short-term microloans to our South African cardholders, where we earn revenue from the service fees charged on these loans.”
Net1 makes most of its money in financial services by providing microloans.
“Our latest product, EasyPay Everywhere, provides our target market with an affordable all-inclusive transactional bank account with unfettered access to financial services such as microloans, life insurance, remittances, value added services such as prepaid utilities and bill payments through their mobile phones and our national network of ATMs and POS devices.”
Net1 markets a parallel bank account to the Sassa one. To take out a microloan you have to open an EasyPay Everywhere account.
“Transaction fees apply when cardholder transacts at point of sale or an ATM, including cash withdrawal, balance enquiry, insufficient funds and other miscellaneous ATM fees which are recorded when an ATM user performs a transaction at an ATM.”
Net1 charges transaction fees whenever a cardholder touches an ATM.
“Our Smart Life business… offers our customer base affordable insurance products applicable to this market segment, focusing on group life and funeral insurance policies.”
Net1 sells group life and funeral insurance.
And from Grindrod Bank’s Terms and Conditions:
“Clause 6.1. You consent to us:
6.1.2. using your personal information, as defined in the Protection of Personal Information Act 3 of 2014, to render the banking services set out in these Terms and Conditions, and to send marketing material from us and our affiliates to you, if you elected to receive same during enrolment;
6.1.3. providing your personal information to third party service providers, subsidiaries and affiliates for the express purpose of providing you with the banking services referred to in these Terms and Conditions, and in this regard you also consent to CPS as well as the aforementioned parties storing and processing your personal information.”
Grindrod Bank’s Terms and Conditions allow it, and its “affiliates”, to market services to grant recipients. And there goes Net1’s claim of not using grant recipients’ database.
To understand the intertwined nature of Net1’s operations it is also important to know that as at December 31, 2016, Net1 had 142 branches, 936 ATMs and 1,895 dedicated sales staff selling financial services.
And finally: Net1’s financials
CPS charges Sassa R16.44 per recipient for the administration component of grant distribution. In the 12 months to June 30, 2016 (their full financial year), this revenue amounted to 21% of Net1’s total revenue of R9.1-billion. Hence Net1 earned R1.9-billion in revenues from administering the Sassa contract for 12 months (21% x R9.1-billion).
On the assumption that the same 21% can be applied to pre-tax profits, the contract made an annual profit of R392-million.
(This might be of use to the Constitutional Court which ruled that CPS has no right to benefit from the unlawful tender award to it by Sassa).
But that’s not all…
Credit card-related transactions brought in a further R1.2-billion, or a pre-tax profit of almost R347-million. As we now know, almost all of these transactions originate from grant recipients.
So we are already at a pre-tax profit of R739-million. Net1 paid tax at an effective rate of 38.7% in 2016, but expect this to drop to somewhere between 33% and 35% in 2017.
But that’s still not all…
Let’s now look at Financial Services.
Net1 proudly reports that as at February 6, 2017 they had 1.8-million EasyPay Everywhere accounts, those of microlending infamy. They had also sold 280,000 life insurance policies, in addition to the basic life insurance policy provided with every EasyPay Everywhere account. So we now have over 2-million insurance policies. They provide 3-million people with pre-paid airtime and electricity.
Their microlending book stood at R825-million, although that is largely irrelevant. What is relevant is how they charge for it. Rather than charging interest, Net1 charges a “flat fee” for the duration of the loan. Short-term loans range from R410 to R1,050 to be paid-off over three or six months. A loan of R1,050 for six months has a “service fee” of R330, 31% of the original amount, or an effective annual interest rate of 164%. A loan of R410 for three months attracts a “service fee” of R100. That is interest of 24%, or an effective annual rate of 280%. Let’s not forget there is no risk of non-payment – they deduct the repayments directly off the guaranteed grant amounts!
Net1 earned R3.6-billion in revenues from financial services in the 12 months to June 30 2016 and a pre-tax profit of R791-million.
Let’s add it all up.
For the 12 months to June 30, 2016 Net1 reported the following:
|SOUTH AFRICAN OPERATIONS||REVENUE||PRE-TAX PROFIT|
Since Net1 made a total operating profit of R1.9-billion, the South African operations account for a massive 82% of that, most of it from South African grant recipients.
The same table for the 6 months to December 31, 2016 shows the following:
|SOUTH AFRICAN OPERATIONS||REVENUE||PRE-TAX PROFIT|
In Net1 speak:
On SA Transactions: “Our operating income margin for the first half of fiscal 2017 and 2016 was 25% and 24%, respectively.”
On Financial Services: “Operating income margin for the first half of fiscal 2017 and 2016 was 24% and 23%, respectively.”
Again, I think the Constitutional Court will be looking for these numbers.
As it stands the CPS contract is largely insignificant. In fact, if CPS supplied the service at no profit, it would still make R1.1-billion in profit from the grant recipients every year. And herein lies the crux of the matter.
Let me conclude by quoting from Net1’s very own Code of Ethics:
“Net1 UEPS Technologies and all its subsidiaries are committed to a policy of fair dealing and integrity in the conduct of their business. This commitment, which is actively endorsed by the Board of Directors of Net1, is based on a fundamental belief that business should be conducted honestly, fairly and legally. Net1 expects all employees, directors and other representatives to share its commitment to high moral, ethical and legal standards.” DM
Sygnia CEO Magda Wierzycka is no stranger to challenging the status quo. The actuary and consumer advocate believes in forcing transparency in the financial services industry, one educated investor at a time. Her outspokenness has earned her a legion of online trolls and is reported to have SA fund managers shaking in their boots. Shes the only female CEO of a fintech company in Africa and loves all things future tech. She tweets from @Magda_Wierzycka.
"Have no fear of perfection - you'll never reach it." ~ Salvador Dalí