Updates #8

SHVA's results take a disappointing turn. Notes on pricing and legal positioning .

Held.

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Automatic Bank Services (SHVA) reported Q1 2025 earnings early last week, and released a follow up press release about 48 hours later. In short, the results were mediocre and present a some questions for the longer term trajectory of the business.

My ongoing thesis revolves around continued transaction growth in digital payments in Israel domestically, but also that SHVA would be able to increase their per-transaction, and per terminal, economics overtime. The potential for SHVA to take price is a major differentiator between itself and the vast majority of other payments opportunities globally.

The recent set of results have posed some questions about SHVA’s current pricing regime at the same time that its expenses and capital commitments are rising. These unexpected increases are seemingly well in excess of where the company’s guidance would have otherwise suggested. Investors have not been pleased with this state of affairs. I can’t say I’m thrilled either.

SHVA operates a number of businesses, however, the main going concerns are: debit/charge card switching (connecting merchant acquirers and consumer charge cards), the renting of payment terminals and connected pin pads, and ATM switching (allowing a customer to access their bank balance via the connected charge card). You’ll note the use of ‘charge card’ instead of the more familiar ‘credit card’ as Israel has an idiosyncratic system of card payments. It’s largely a debit-based system, mixed with a 30 day settlement mechanism, as opposed to the American system of revolving credit balances. Domestic switching in its current form exists because Visa and Mastercard participated in the Middle East’s embargo of Israel in the late 1960’s and early 1970’s. Fate loves irony.

SHVA is an unusual corporate entity in that it is, to the best of my knowledge, the only national payments switch that exists in a publicly traded security. Visa and Mastercard own some of this infrastructure elsewhere but it represents an infinitesimally small part of their business. More often they are mutually owned infrastructure. This was true of SHVA until 2019. Israel was falling woefully behind in terms of domestic payments services, and its forced birth as a publicly traded company was meant to remediate part of that shortcoming. It is undoubtedly true that since 2019 a whole range of new payment services have been rolled out by SHVA but there have been a number of twists and turns along the way.

There is a constant, multi-pronged tension that exists within the company which has frustrated analysts like myself. SHVA’s history as mutually owned infrastructure has repressed the prices it charges for its core switching services and left it with a shareholder register likely quite antagonistic to price hikes. The four large domestic banks - Israel Discount Bank, Bank Hapoalim, Bank Leumi, The First International Bank of Israel - control 40% of the outstanding stock. These are, of course, some of SHVA’s largest customers. In turn, SHVA’s position as a critical piece of national infrastructure means it’s regulated. That regulation is most prominently felt in directives for new capital projects, and an apprehension on behalf of SHVA management to aggressively take pricing as they almost certainly should. This ever turning dynamic of at-odds interests leaves the minority shareholder in something of an odd situation.

The regulatory regime is opaque but crucially important. In May 2023, SHVA no longer sat under the regulatory supervision of the Bank of Israel (BOI). Supervision in this sense meant that material business decisions could not be taken without the BOI’s formal consent. In the run up to this ‘guardianship’ lapsing an external CEO, with no institutional history at SHVA, was recruited to conjure of a new vision for SHVA’s future as publicly traded company. Israel’s Supervisor of Banks also held a limited regulatory authority of SHVA prior to its status as a Joint Services Company (a kind of banking licence) was revoked. Hotam - Israel’s interbank payment and clearing regulator - also exercises some authority over SHVA due to its status as a ‘controlled payments system’ pursuant to the prevailing Payment Systems Law. The dark horse in the regulatory regime is the Israel Competition Authority (ICA).

Since the government of Israel made the directive for SHVA to become a standalone company, they experienced a number of regulatory dictates that has guided their conduct. This began with the EMV transitionary directive (the mandate to make contactless payments the standard for merchants across Israel), and subsequently then extended to the provision of digital wallet transactions which took effect in 2021. Not long after this SHVA was directed to separate its back-end operations from the interbank payments operator MASAV (sometimes referred to as MASAB). SHVA’s status as a controlled payments operator limits its business operations to 6 primary areas of operation. It has petitioned on several instances for this last restriction to be dropped, but it appears that the Israeli authorities would not allow this to happen unless the interested parties (the four large domestic banks plus Visa and Mastercard) stake’s are reduced to 5% each.

It’s important to note that Israel’s formal legal foundations are nascent by comparison to elsewhere in the developed world. While their forms of government seem to mimic what we are familiar with in the West, the landscape isn’t built on hundreds of years of established common or civil law. Israeli law essentially ‘started’ at the point that Israel became its own nation. The dispassionate onlooker might describe Israel as a representative democracy, but I’ve seen many more Israeli’s describe it as a judicial oligarchy. This tension has expressed itself in recent years with the willy Benjamin Netanyahu attempting to curb the influence of, and gain control over, Israel’s highest courts. Irrespective of where any person finds themselves on the various political divides here, there are seldom few legal certainties to be relied on, especially in corporate law. The government and their regulators are influential, as are the courts. Long established commercial interests shouldn’t be underestimated either.

To the best of my knowledge, the relevant competition and regulatory law revolves around a few foci that seek to combat consumer harm and industry concentration. There’s a two-pronged legal foundation for this. First, the Restrictive Trade Practices Law (RTPL), and, second, the Economic Competition Law. Importantly, it is not illegal for a monopoly to exist. A monopoly business, however, is unable to take steps to actively limit competition in a certain domain or charge prices which cause consumer harm:

The RTPL outlines a two-stage test for proving excessive pricing, with the plaintiff needing to first demonstrate that the price is exorbitantly high and then the monopoly proving its fairness.

On several occasions, industry experts have indicated that SHVA’s obscurity and complete lack of external promotion has been a specific strategy aimed at avoiding the ire of the ICA. I don’t think it takes any great legal scholar to deduce that SHVA is neither expensive nor unfair. By any conservative estimate, they charge a fraction (my guess is an average of 1/3rd) of what is charged for their services in Western Europe and North America.

As a slight aside, the Tel Aviv Stock Exchange, with the acquiesce of the financial regulator and with the idea of satisfying these legal tests, updates its own rate card on the advice of consultants who research equivalent pricing on the relevant service lines globally.

Putting aside the question of pricing for one moment, the competition question is important to keep in mind when considering pricing:

2016 Israel Payments White Paper

Above is SHVA’s positioning in the traditional Israeli card transaction scheme. You’ll see the mention of ‘Domestic switch 2’. This is an allusion to a proposal made by the regulator almost a decade ago that curiously turned out to be even more expensive than having a single piece of switching infrastructure.

The key issue with SHVA’s network is that its core constituency is small. On each side of any transaction sits about five major players (the four large banks plus a regional bank who act as issuer and merchant acquirer the majority of cases). Certainly the different types of integrations along the supply chain has been expanding (and rightfully so) but this core locust of network constituents is modest. As I have already said, four of these five players de facto controls SHVA. In a world where these banking interests are further diluted (TASE is a good example of what can happen here) the question becomes: what would the banking sector do in the face of high switching costs generally?

My inclination would be to say: not much. Israel Discount Bank, for example, generated a pre-tax income in the last twelve months of nearly 7B Shekels. Write that across the four other banks. Compare this to SHVA’s entire pre-tax profit pool for the last twelves months of 65M Shekels. The cost, the energy, and the regulatory approval needed to create a new switch seems prohibitive, of not completely fanciful. Much more likely seems the introduction of QR code technology for example (which completely obviates the need for a card transaction) or the advent of the long awaited Digital Shekel. The latter seems like another of these fanciful proposals by the BOI, but the former is a different question. Here again SHVA is saved by another accident of history: the 30 day settlement terms for Israeli charge cards.

From my now extensive experience with payments via QR codes in SEA, the draw of using this sits with both the consumer and merchant. The consumer finds the mechanism quick and painless, and the merchant completely sidesteps fees for the processing of card payments - especially credit cards. Israel’s odd domestic charge card setup pushes even more convenience onto the consumer largely at the expense of their banking institution: a peron’s spending balances aren’t settled until weeks after their transactions have taken place giving them something of a working capital benefit. It’s quite a consumer surplus that would be nixed by instantly settled payments.

For context, a comprehensive list of the latest (2023) tariff updates can be found below, as well as the implications for digital wallet transactions and EMV upgrades in the years around this: