Nets IPO Shows Investors Value Cash Flow Prospects

(Bloomberg Gadfly) -- Call it Nets appeal. Europe's IPO market looks set to get a fresh boost from the Nordic payments provider, whose market debut has been brought forward to Friday at a price likely to be at the upper end of its 130 to 160 Danish krone range. The warm reception shows what's needed to generate excitement for a continental deal these days.

Of the top 20 new issues in the region this year, all but three have priced at the middle or lower end of their price range, according to Bloomberg data. Why has this been different?

The "fintech" theme doesn't fully explain it. Nets isn't that sexy -- it's a payment processing business. Shops across the Nordic region use its network and technology for point-of-sale transactions, while banks use Nets to manage their customers' credit and debit cards. The company also handles direct debits and standing orders.

The shift towards cashless payments offers a credible secular growth story, but not at the double-digit rates normally associated with tech firms. Nets lifted revenue last year by 6 percent, and aspires to deliver the same in the short term. On that basis, revenue should be about 7.3 billion Danish krone ($1.1 billion) in 2017. If the company can achieve its targeted high-30s margins, Ebitda would be around 2.8 billion Danish krone in the same year. A deal at the middle of the price range would value Nets at 29 billion Danish krone, or 38 billion Danish krone including debt -- 13.6 times 2017 Ebitda, in line with rival Worldpay.

Like Nets, Worldpay was also brought to market by private equity firms Advent and Bain. The difference is that it really is growing revenue at more than 10 percent -- plus it has been publicly traded for a year. So to assign both companies the same value is a bit too flattering for Nets.

However, Nets may yet appeal as a cash generator for shareholders. The company has been talking up its dividend-paying capacity and claims to be good at turning accounting profit into hard cash.

The claim isn't easily supported by the recent financial history, a smorgasbord of one-offs caused by restructuring and acquisitions. Assume 2017 is a less cluttered year. If capex and restructuring charges develop in line with company guidance, while tax charges are modestly higher than 2015, that might lob off 1.3 billion of Danish krone from Ebitda, leaving 1.5 billion Danish krone of free cash flow. That would put Nets on a free cash flow yield of 5 percent. Worldpay is on less than 4 percent on most analysts' estimates.

Doubtless Nets would like to be seen as a racy growth story supported by a dividend stream on the side. It's more likely that investors, frustrated with a negative rate world, have seen it as a yield play with a bit of growth on the side.

It marks a curious turn of fortune for private equity IPOs. Investors often shun them, thinking the rapacious owners have already sucked out all their value. But private-equity backed businesses tend to have good cash flow characteristics, as this supports leverage. In this environment, these may also now support a successful IPO.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Chris Hughes in London at chughes89@bloomberg.net.

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net.