Tyro Payments TYR has confirmed a nonbinding offer to acquire 100% of competitor Smartpay at NZD 1.00 per share, mostly in Tyro shares with a cash component. The market's reaction is slightly positive with shares up by approximately 2% on March 17.

Why it matters: At this early stage, a deal is far from certain. However, Tyro’s takeover proposal could present an opportunity to expand scale and product offerings given Smartpay is a smaller competitor, which offers similar products and services for small- to midsize enterprises. 

• Smartpay offers mobile payment solutions, such as using your mobile to tap and pay, and business cash advances, which could complement Tyro’s existing payments and banking services. Smartpay may benefit from Tyro’s stronger market presence, particularly in healthcare and hospitality.
• The integration of both companies’ technologies and customer bases could lead to improved efficiencies, expanded market reach, and enhanced value propositions for SMEs.

The bottom line: It’s too early to incorporate this potential deal into our fair value estimate for no-moat Tyro Payments, which remains AUD 1.40. Shares are about 25% undervalued, likely due to concerns over the Reserve Bank of Australia's proposal to ban debit card payment surcharges.

• But with its ongoing focus on product innovation, strong market position, and growth potential, we believe Tyro shares are cheap.

Business strategy and outlook

Tyro Payments provides merchants with the required infrastructure to accept electronic payments, as well as business banking products. It is the fifth-largest merchant acquirer in Australia by terminals, behind the major four banks. The firm mainly caters to small to medium-size enterprises in the hospitality, retail and health sectors. It is also expanding into adjacent verticals like trade, accommodation and services.

Tyro has historically gained share in the Australian card payments market--especially from generic nonbank merchant acquirers. Its value proposition is to address merchant friction points, rather than being a generic merchant acquirer. Tyro’s solutions are easily integrated, accept a broad range of payment types, and come with a multitude of ancillary features. These features can be industry-specific (for example remote payments and bill-splitting for restaurants) or available to all (for example online gateways for e-commerce payments or least-cost routing). The intention is to embed its solutions into a merchant’s ecosystem to limit switching; and allow Tyro to cross-sell other products like business loans.

Tyro acquires merchants mainly via digital marketing and referrals from its point-of-sale system partners. Prospective merchant acquiring partnerships with other institutions--such as its alliances with Bendigo Bank, Telstra, and Australia Post--is another avenue for growth.

We see strong growth prospects from increasing penetration into a broadening addressable market. This is likely to be backed by further bolt-on acquisitions to enhance its offerings and the structural shift toward electronic payments. But improvements in gross profit margins may be limited due to competitive pressures, despite benefits from lower interchange and scheme fees due to growing debit card usage. The major banks have a reinvigorated their focus on banking and global merchant acquirers are contending for a slice of the overall payments market. We believe Tyro will keep reinvesting for growth, limiting the degree of operating leverage it can achieve.

Tyro bulls say

• Tyro’s growth outlook is strong and there is potential for ongoing market share gains from smaller/generic merchant acquirers.
• Merchants benefit from using Tyro, as evidenced by signs of client stickiness to date. For example, there has been growing takeup of Tyro’s ancillary features, increased cross-selling success and limited merchant churn, even after the January 2021 service outage.
• Tyro will be increasingly profitable and cash-generative over time. This is due to its limited capital requirements and ability to leverage revenue growth over its fixed costs.

Tyro bears say

• Tyro’s offerings are replicable by larger, better-resourced institutions with existing and bigger payment networks. As such, Tyro may need to match its larger peers in pricing over the long run.
• As an early stage financial technology firm, Tyro is vulnerable to competing innovation and regulation risks that could diminish the relevance of its business.
• Increased competition could necessitate higher spending on software, terminals, salary and marketing. This may result in lower-than-expected profitability and return on capital.

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