Monday, October 22, 2012

VeriFone Offers Growth but a Bumpy Ride

VeriFone $PAY disappointed investors recently with weak results and guidance, but is this a blip in an industry with strong prospects or is the company set to disappoint again with its strategy of seeking growth in a weak global economy?



Who is VeriFone?

VeriFone is the global leader in secure electronic payment solutions. The long term structural story here is that there is an ongoing shift towards using electronic payments instead of cash and checks to pay for Point of Sale (PoS) purchases. For example, VeriFone makes the Electronic Point of Sales (EPOS) terminals that you might be asked to pay with in the shops or restaurants.

As such, its fortunes are largely tied to the cyclicality of the economy but I think it is capable of generating growth in excess of GDP as its terminals expand market share. In addition, there is a replacement cycle with the terminals, which should generate secure cash flows as the business grows.



Long Term Growth Prospects

The business is cyclical but it also has some very strong secular growth prospects which will come from two main sources.

First is the adoption of EPOS solutions within the emerging markets. Most countries in the world are nowhere near the US in terms of adoption of EPOS, and as card issuance increases in these countries we can expect strong future growth.

The second is the emergence of mobile payment systems in which VeriFone is partnering with Google $GOOG and Paypal. Prospects for wide scale adoption look a lot better now that a Mobile Payments Committee has been formed. Its members read like a roll call of the key players that anyone might want involved. Google, VeriFone, Verizon $VZ, AT & T, Mastercard $MA and Visa $V all are signed up and this sort of thing can only encourage industry adoption.

For the telecom carriers like Verizon it represents a great opportunity to generate new sources of revenue as its traditional wire line market declines. It has teamed up with AT & T, Sprint and VeriFone to create the Isis platform, which should be launched in September. Isis is intended to compete with Google’s mobile payment offering but the good news is that VeriFone will benefit either way. It is a similar story with the transaction processors Visa and Mastercard, and, with these heavyweights on board, it is a good sign that things are about to take off.



Sounds Good but What Went Wrong?

Essentially two things went wrong in the quarter.

The first was that a fire in Brazil destroyed VeriFone’s staging and repair center. VeriFone is strong in Latin America and this event damaged earnings and cost them some market share. However, it does seem like the sort of one-off event that investors punish the stock price over, only to regret it as buyers come in later.

The second issue was some weakness in Europe. This should not be unexpected, but I think there is another angle here. VeriFone’s biggest competitor is Ingenico, and the French company is particularly strong in markets like Spain and Portugal. As the consumer is suffering in these economies, it would be no surprise if Ingenico stepped up competitive pressure in order to try to compensate in the stronger parts of Europe.

A combination of these factors caused Q4 guidance to be lighter than analyst estimates. VeriFone forecast revenues of $495-500 million versus analyst consensus of $519 million, and the stock took a summary beating

Some investors will no doubt rush to conclude that Square is potentially threatening VeriFone’s end markets, but I think the plug-in device could be about as popular as antenna used to be on mobile phones. In other words, it’s necessary when the technology isn’t around to do away with it.



Where Next for VeriFone?

I think the long term story is largely intact here and this could be a decent opportunity to gain an entry point. It’s easy for the critics to complain about the timing of the Hypercom acquisition but growth companies should, err, grow. The long term potential for VeriFone is still in place and these sorts of bumps in the road are part of the journey. The company has heavyweight partners who are committing to create new channels for VeriFone to generate profits, and mid-teens revenue growth is not something to be dismissed lightly in this marketplace.