[FLT – FleetCor; WEX – WEX Inc.] Beyond Fuel: Part 1

With Visa and Mastercard, the feedback mechanism between issuers, merchants, and consumers is well understood. As I wrote in a previous post:

If you wanted to build your own payments network to compete with Visa, you’d need to win over the issuing banks.  Of course, you won’t get the issuers if you don’t have merchants to accept your card and you won’t get the merchants unless you have the issuers’ card customers, who want to know that the card is accepted nearly everywhere

A similar dynamic holds true for the 2 leading fuel card issuers, FleetCor and WEX, only instead the demand side is confined to fleet operators and the supply side is restricted to gas stations, truck stops, and convenience stores.  And whereas Visa and Mastercard are payment operating systems who earn their keep by enabling spend – as @LibertyRPF once put it, just as Microsoft maximized the value of Windows by attracting third-party developers who built a growing abundance of applications that compelled enterprises adoption, Visa and Mastercard host third party solutions (“apps”) from PayPal, Stripe, and others to draw more volume to its rails (for more on this, see my post Expanding the Rails: Part 1) – WEX and FleetCor are compliance applications that provide value, in part, by restricting it.  Fleet operators adopt fuel cards to curtail spending abuses, secure fuel discounts and, particularly in the case of large clients, where WEX is over-indexed vs. FleetCor, to gather data and run analytics on spending patterns. 

For instance, with WEX, fleet operators can spot trends in fuel prices at gas stations in its network, identify exceptional spending patterns, and shape that data as easy visuals on a dashboard.  By fusing telematics – tank levels, truck location – with card data from WEX, a fleet operator can see that this truck is at that gas station when a WEX card is charged and that the amount of fuel going into the trunk’s tank matches the amount of fuel leaving the pump (i.e., the driver isn’t filling another tank that he isn’t supposed to).  Once adopted, fleet card systems are pretty sticky, especially when paired with reporting and analytics, with voluntary attrition rates of around 5%-6% (involuntary churn from customer bankruptcies brings the attrition rate up to 8%-10%). 

WEX and FleetCor are like banks in that they earn interchange fees, levy late fees, and charge interest as compensation for bearing credit risk, though in WEX and FleetCor’s case that risk is very short-term. In a typical card transaction, WEX pays the merchant in 10 days and is paid by the fleet operator in 25. But as spending controls are integral to fleet operations, the underwriting risk borne by FleetCor and WEX is far less than that carried by a credit card company.  Provisions peaked at 12% and 10% of revenue in 2008 for WEX¹ and FleetCor, respectively, compared to 37% for Capital One and 32% for American Express².  In 2020, provisions amounted to 7% of revenue for FleetCor and 5% for WEX, easily absorbed by 50%-55% EBITDA margins generated by both companies heading into the Year of COVID. 

FleetCor’s origins date back to the 1980s, when it launched the Fuelman network by licensing its payments technology under 20-year contracts to franchisees who each paid a $50k site fee up front for the right to sign up fleet operators and gas stations in their markets.  The franchisees limited the number of participating merchants in each market and in return for being granted semi-exclusivity, those merchants agreed to pay 5% of whatever was spent on Fuelman cards in their stores, far more than the typical ~2% paid on transactions intermediated on Visa and Mastercard’s rails.  The franchisees then paid 10% of their revenue to FleetCor.  As part of the Fuelman network, fleet operators could control what their drivers purchased, receive discounts on purchases at participating merchants, and retrieve data on how much was being spent on what and when.  Merchants realized higher fuel and food sales.  FleetCor collected high-margin recurring royalites. 

Seemed simple enough.  But by 2000, with the Fuelman card network running in 31 markets, many franchisees were losing money or just breaking even and FleetCor was flirting with bankruptcy.  To turn things around, the Board hired Ron Clarke who, with the backing of Summit Partners³, took advantage of an an option baked into franchise licensing agreements that allowed FleetCor to buy out franchisees according to a formula that resulted in take-out multiples averaging just 3x-4x EBITDA in 2001 and 2002⁴.  Ron’s idea was to better manage the acquired branches and centralize corporate functions like accounting and HR across them.  It worked. In 2000, FleetCor was doing 10% EBITDA margins on $23mn of net revenue.  9 years and 40 acquisitions later, it was generating 50% margins on $354mn of revenue.

Fuelman is a closed network, meaning it authorizes, clears, and settles all transactions on its rails according to its own proprietary standards, giving it fine-grained control over when the cards get used and which items can be purchased, as well as a granular SKU-level point-of-sale data⁵.  WEX is closed too.  A driver that uses his fuel card at a point of sale device with WEX’s software installed will be prompted for a Driver ID number and an odometer reading, which – along with time, location, quantity and price of fuel, and other data – fleet operators can analyze to extract efficiencies or detect anomalous spending patterns at certain locations or from certain drivers.  And by aggregating the purchasing power of its fleet customers, WEX can secure discounts – on fuel, hotels, tires, and other travel related products and services through the Fleet One EDGE Program – that operators of small heavy-duty fleets could not obtain on their own.

But whereas Fuelman built its nodes piecemeal from the ground up, WEX entered into private label programs with large oil companies – serving as the outsourced fleet credit and sales division of Exxon Mobil, for instance – who brought their franchised gas stations to WEX’s network, and struck long-term white labeling agreements with large leasing companies like GE and PHH.  WEX’s ~150bps take was well below Fuelman’s ~5%, but its network was far larger.

To catch up with WEX, FleetCor deviated from its closed, bottom-up strategy and partnered with Mastercard, which today intermediates most of FleetCor’s North American fleet volumes.  This maneuver dramatically expanded FleetCor’s reach, but came with 2 trade-offs. First, the interchange rates were far lower and second, the controls were more limited.  On an open-loop network like Mastercard, FleetCor can restrict purchases to merchants falling under the Merchant Category Codes (MCCs) defined by Mastercard but can’t deny specific product purchases at those merchants.  So whereas on a closed loop, a truck driver might only be able to use his card for fuel, on an open loop card he might stack his cart with soda, cigarettes, chips, and other items that the fleet operator might want to forbid.  But for the most part, small/mid-sized fleet operators that FleetCor cater to don’t really need all the fine-grained controls and are apparently fine with FleetCor riding on a third-party network.  So today FleetCor operates a hybrid network, combining the closed-loop, higher margin Fuelman network with the more expansive, lower margin Mastercard network.