Sunday, December 5, 2010

Verifone (PAY) a Cyclical Stock Capable of Generating Super GDP Growth

Verifone (PAY) is an equity that gave results recently and the stock market  was very impressed. Verifone is an exciting growth stock and is good to research because it offers a cyclical growth story that should deliver earnings and revenue growth in excess of GDP growth. This article is intended to provide some brief equity research. Any comments, positive or not, are welcome. I believe Verifone to be a stock that is worth if consideration to an equity investors portfolio.

Verifone is the global leader in secure electronic payment solutions. The idea behind this play is that there is an inexorable shift towards using electronic payments instead of cash and cheques to pay for Point of Sale (PoS) purchases. Verifone make the Electronic Point of Sales (PoS) terminals that you might be asked to pay with in the retail environment.

As such, their fortunes are tied to the cyclicality of the economy, but they should be able to achieve super GDP growth as these terminals are expanding market share. Similarly, as more of them are used (due to increasing growth in the economy) they are subject to wear and tear and, the upgrade cycle should be reduced. Finally, International expansion (particularly in emerging markets) offers strong growth prospects. Many countries in the world are significantly behind US adoption of electronic PoS and furthermore, many are not even used to using electronic payments. Therefore, long term growth prospects are good.

Verifone has recently announced the acquisition of Hypercom (number three in market) which should complete in H2 of 2011. This would make Verifone the market leader, ahead of Ingenico of France. Indeed, the sector is undergoing consolidation and I would expect the market leaders to be able to increase margins according. In this analysis, I will focus on Verifone and then make concluding remarks about the intended Hypercom acquisition. The Hypercom deal makes execution sense-it will consolidate the industry-but also strategic, as Hypercom are well placed in emerging markets.

A quick look at the Geographic breakdown of revenues reveals where the growth is coming from


Three Months Ended October 31, Twelve Months Ended October 31,
2010 2009 Change 2010 2009 Change
 
United States and Canada $ 122,109 $ 86,998 40 % $ 440,873 $ 343,042 29 %
Europe 70,166 68,485 2 % 268,197 265,548 1 %
Latin America 53,887 35,563 52 % 197,804 150,071 32 %
Asia   29,809   26,783 11 %   94,663   86,053 10 %
$ 275,971 $ 217,829 27 % $ 1,001,537 $ 844,714 19 %

source: Verifone

These earnings are  complemented by Ingenico's recent numbers, who have been reporting weak North American performance but strong Asian Growth. Ingenico are currently better placed in Europe and in particular in Spain and Portugal. I suspect these markets will face difficulties over the next few years as EPoS is very well established in Spain. According to Verifone's presentation, Spain is only bettered by the US in terms of PoS devices per population. I favour Verifone.

Looking at the trading history...


To October
2007200820092010
Revenue902,890921,930844,7141,001,537
Gross Profit299,232293,031282,129370,312
Margin33.14%31.78%33.40%36.97%
Operating Profit28,480-315,823-128,966102,424
Margin3.15%-34.26%-15.27%10.23%
Pre-Tax-9,298-351,438-148,20978,245
Margin-1.03%-38.12%-17.55%7.81%
Current Assets603,582562,850622,193761,091
Current Liabilities306,767266,534245,653259,806
Assets/Liabilities1.972.112.532.93


source: Verifone, Earnings View

...we see that they suffered with the cyclical slowdown in 2008-2009. However, gross margins are improving and -as the last section indicates- the business is generating cash flows. Verifone has always generated good cash flows. I've attached some previous cash flow data with my estimates as to what they could do in the next few years...








 
2007
2008
2009
2010

2011Est
2012Est
Revenue
902,890
921,930
844,714
1,001,537

1,140,000
1,254,000
Net Profit
-34,016
-425,322
-157,455
98,827

144,845
175,570
Margin
-3.77%
-46.13%
-18.64%
9.87%

12.71%
14.00%
Op CF
76,738
21,683
100,987
158,868

199,845
230,570
Working Capital
12,532
-30,311
101,622
-2,842

-11,400
-12,540
WC % Turnover
1.39%
-3.29%
12.03%
-0.28%

-1.00%
-1.00%
Net Op CF
89,270
-8,628
202,609
156,026

188,445
218,030
Margin
9.89%
-0.94%
23.99%
15.58%

16.53%
17.39%
Capex
-37,965
-22,051
-12,054
-11,578

-17,100
-18,810
Capex % Rev
-4.20%
-2.39%
-1.43%
-1.16%

-1.50%
-1.50%
FCF
51,305
-30,679
190,555
144,448

171,345
199,220
FCF% Rev
5.68%
-3.33%
22.56%
14.42%

15.03%
15.89%
FCFYield
1.47%
-0.88%
5.44%
4.13%

4.90%
5.69%





source: Verifone, Thomson/First Call,Earnings View

These numbers are based on a share price of $39.87 and a market cap of $3.5bn. They assume EPS of $1.65 (midpoint of their recent guidance) for 2011 and $2 for 2012. I've assumed 10% revenue growth for 2012. I haven't included Hypercom in these numbers.

Frankly, a 5% forward free cash flow yield is close to what I would pay for this type of business, particularly as they have the added risk of the Hypercom integration. However, this risk needs to be balanced by the growth prospects and synergies to be achieved. Furthermore, Verifone will see upside, given an improvement in the global economy. It is the uncertainty over the knock on effect of European growth prospects that causes concern here. If they prove to be dissipated then current trends for the US and Emerging Markets look to be very strong and Verifone's prospects look very bright. If European bond yields remain high than the effect on retail could be significant.

Whereas I think around $40 provides a fair approximation of the risk/reward calculation, this target should be raised to, say, $45 given a stabilisation in Europe and/or continuation if US growth prospects. Otherwise, I will monitor Verifone with a view to picking some up on weakness. This is a very attractive industry and, if you are looking for some cyclical exposure than I think Verifone is a good stock to look at.



Source: Verifone Presentation
             Verifone Results







































































































































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