Subtraction by Addition

A pretty common thing that happens with companies is that investors think shares are undervalued.

They'll accuse the company of being overly complicated. Investors dislike complexity. They'll pay more for simple things. Simplifying the company will lead to a higher share price, their theory goes. The easiest way for companies to simplify is to jettison parts of the business.

After some cajoling, investors and management might agree. Management carves off part of the business. Share price goes up. Shareholders are happy. If management owns enough shares, they're also happy-ish.

A less common thing that happens is that investors think the shares of a company are undervalued and some parts of the company are so bad that they and management agree to pay someone else to take them. Like calling up a junk hauler to take all the crap accumulating in your garage.

What's even less common is that shares pop 30% when a company pulls this trick.

Simply Terrible

But here's EML, an Australian payments company, handing over the keys to its Irish-based business and a fist full of dollars to a liquidator and shares shooting 30% higher on the news in January. And its price likely still has more to run.

The company manages gift card programs for retailers and reloadable payment cards popular with some corporate and government customers. A lot of the company's business historically came from mall-based activities. It was a solid model — stable and hard to displace — but malls aren't exactly a growth area. It wanted to diversify. It expanded into reloadable cards. Some companies like to use these to manage meal and travel expenses and some government agencies use them to manage benefits programs.

EML grew on its own and by acquisition. It gobbled up other tiny companies that did this same sort of thing. Maybe it got a little too confident in its ability to expand this way.

In 2019, EML agreed to acquire a company called Prepaid Financial Services (“PFS”) in Ireland that did prepaid things like EML already ran but also included a digital banking arm.

Just months after the acquisition, PFS got a new regulator when the UK left the EU. The new regulator got busy. It quickly went to work uncovering all sorts of shenanigans that unmasked PFS as a money pit from the jump.

A few months later it made another acquisition that leaned more towards banking and less towards prepaid things. This one wasn't the regulatory mess of PFS, but it did complicate the overall business. And investors hate complexity. Shares are down 80% since those salad days before these deals.

Floating Up

Besides the mall thing and the dubious acquisitions thing, a nice feature of EML is its customers give it cash up front. You can put that money, called "float," in the bank and earn interest until the customer uses it. For a few years, this didn't matter much. Banks weren't paying interest. Now, though, they are. Interest rates sit around 5% today.

So, what does going from zero to 5% interest mean for EML?

Ignore the funds associated with the Irish mistake and allow the remaining funds to catch up to current market interest rates and EML could earn an additional $40 million or so per year, even if it doesn’t get all of that 5% interest on their float.

Just that stream of cash alone—the part that materialized from higher interest rates—the part that didn't exist a year ago—could carry more than half of the value of the entire company today.

Before PFS, before it began earning interest, the business was profitable and Mr. Market valued it several times higher than it does today. Those other activities are still profitable and still have value.

Given its mistakes, it would be a surprise if the stock reached its prior heights. But subtracting its money-losing Irish business will boost its bottom line. It’ll also simplify the overall equation for investors. Adding cash from higher interest will round off an improved situation. In the end, the company’s larger cash flow should solve the problem of reaching a much higher stock price.

Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.