Payment Data Systems Inc. (NASDAQ: PYDS) is a San Antonio, Texas processor of electronic payments for other companies. PYDS generates revenue across the payment processing value chain. The company has seen substantial increase in its transactions processed per year in the last five years. PYDS also has partnerships with some of the biggest names in Corporate America. PYDS is an emerging player in the fast growing mobile payments industry. The mobile payments industry and the payments industry in general have seen significant consolidation in the last three years. Despite being an attractive takeover target, PYDS currently has a market capitalization of just above $21 million. However, this significant undervaluation also represents an opportunity for value investors.

Consolidation In The Payments Industry

Mobile payments is the fastest growing area within the payments industry. According to Taiwan-based research firm TrendForce, consumers globally will use their mobile phones to spend a total of $620 billion on mobile transactions in 2016, which would represent a year-over-year increase of 37.8%. In 2015, mobile transactions totaled $450 billion. More important by 2019, this figure is expected to cross $1 trillion mark.

The growth in mobile transactions does not come as a surprise though. It is primary being driven by the increasing of smartphones and tablets. And remember that smartphone penetration in some of the biggest economies in the world such as India is still relatively low. So there is room for growth for the mobile payments industry.

It is not surprising then the industry is seeing consolidation. Indeed, even global payment processing companies Visa Inc. (NYSE: V) and MasterCard Inc. (NYSE: MA) have taken note of the phenomenal growth in the mobile payments industry.

2015 saw several acquisitions in the mobile payments industry and the broader payments industry. Samsung acquired LoopPay in February 2015. LoopPay is a provider of mobile wallet solutions. According to Re/code, Samsung paid $250 million to acquire LoopPay.

Paypal Holdings Inc. (NASDAQ: PYPL) acquired Paydiant, which serves as the back-end of the technology that provides sellers their own personal mobile payment options under their own brands. PayPal reportedly paid $280 million for Paydiant.

Global Payments Inc. (NYSE: GPN) announced the acquisition of Realex Payments, one of the largest and the fastest growing payment gateways in Europe. GPN paid $125 million for Realex Payments.

What Makes Payment Data Systems An Attractive Takeover Target?

Apart from the phenomenal growth being seen in the mobile payments industry, what makes Payment Data Systems an attractive takeover target is the company’s own impressive growth over the past five years and a clean balance sheet.

In 2011, Payment Data Systems processed just 4.3 million transactions. By 2015, the number of transactions processed by the company has growth more than three times. In 2015, the company processed a total of 14.3 million transactions. Between 2011 and 2015, PYDS has registered a CAGR of 35%.

In dollar terms, the growth has been even more impressive. In 2011, PYDS processed $204 million. In 2015, the company processed $3.3 billion. PYDS registered CAGR of 101%.

This growth has been primarily driven by PYDS’ successful partnerships. PYDS’ premier partnerships and clients include Fifth Third Bank, Wells Fargo, Eli Lilly, Merck & Co., Merrick Bank and Pfizer Inc. among others.

For the fiscal year 2015, PYDS reported revenue of $14.4 million, up 7.4% on a year-over-year basis. The company’s gross margins also improved in 2015 from 31.2% to 34.5%. PYDS’ adjusted EBITDA for 2015 was $2.9 million. The company’s net income for the quarter was $1 million, or $0.08 per share.

At the time of the release of the 2015 results, Michael Long, Chairman and CEO, Payment Data Systems, said that the company’s focus on innovation and delivery of world-class payments processing technology for its customers drove record revenues and results across all key operating metrics in 2015.

PYDS has certainly placed a great deal of emphasis on innovation and improving its offerings. Recently, the company announced the launch of Kind Hand, a giving and registration management solution for churches and charitable organizations built on Spark Development Network’s Rock RMS open source system. Churches and charitable organizations represent a key market for PYDS, according to Louis Hoch, President and COO at Payment Data Systems.

Earlier this year, PYDS had announced that it now supports Apple Inc.’s (NASDAQ: AAPL) Apple Pay(TM) on the Akimbo Prepaid MasterCard(R). The Akimbo Card is one of the first consumer prepaid cards to support Apple Pay.

To add to the robust growth, PYDS also has a very strong balance sheet, which is rare for emerging companies.

Valuation Anomaly

Despite making significant progress and registering robust growth in the last five years, PYDS is significantly undervalued. PYDS currently has a market capitalization of almost $21.80 million. Based on the 2015 revenue, PYDS currently trades at just 1.5x sales. For an emerging company in a fast growing industry, a multiple of 1.5x is not justified. According to data from Stern, the Green & Renewable Energy industry, which is another fast growing industry, has an average price to sales ratio of 4.06x sales. The Stern data shows that Internet stocks trade at almost 7x sales. If similar multiple was applied to PYDS, the company’s market capitalization would come to between $60 million and $100 million. Even then the stock would be significantly undervalued, considering that some of the acquisitions made in the mobile payment space have been well above $200 million. The valuation anomaly though makes PYDS is a very attractive proposition for value investors.

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