Should You Watch This Stock Like a Hawk?

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Benjamin Graham advised against investing in new initial public offerings (IPOs), as he believed that IPOs typically represent a means for exit for prior owners and are rarely priced at a discount. I like to keep an open mind and examine all investments, including IPOs, on a case-by-case basis. Blackhawk Network (NASDAQ: HAWK), one of the largest third-party gift card distributors globally and a wholly owned subsidiary of Safeway prior to its April IPO, recently caught my eye. However, issues such as distributor concentration, seasonality and strong parent influence prevent me from taking a position in the stock. Moreover, it has limited upside at current valuations, trading at 17 times forward P/E and 1.2 times PEG.

Your biggest strength could also be your weakest link

Blackhawk Network’s key competitive advantage lies in providing content providers with exposure to more than 160 million consumer visits per week via over 100,000 retail locations. This makes it highly dependent on its distributors. Products sold at Blackhawk Network’s top five distributors, which are all grocery retailers like Safeway, accounted for close to half of its fiscal 2012 revenues. This represents significant distributor concentration risk, which is partly mitigated by multi-year distribution partnership agreements, which typically have to be renewed every three to five years.

It is worth highlighting, however, that Blackhawk Network had previously issued common stock and warrants to four of its distribution partners, according to its prospectus. This is in line with competitive strategic analysis that states distributor concentration leads to a weaker bargaining power for Blackhawk Network, resulting in it possibly offering “sweeteners” to secure future contract renewals.

Quarterly reporting loses significance

While I have never been a fan of quarterly reporting, which results in undue management attention on short-term financial results, quarterly financial results do provide early warning signs of deteriorating business quality. It is intuitive that the last two months of every calendar is the season of gift-giving and as a result, about half of Black Hawk Network’s revenues are generated in the fourth quarter. This means that investors are unable to draw relevant insights from quarterly financial metrics like revenue growth and margins for the first three quarters of the year. 

Is a strong parent a boon or a bane?

While some perceive Blackhawk Network’s parent grocery background gives it an edge in winning over new grocery distribution partners, others are concerned over the significant control of Safeway has over Blackhawk Network. I belong to the latter group. Safeway has a 73% equity interest and controls 91% of the votes through its 93.6% ownership of Class B common stock, according to its most recent 10-Q. While I am not suggesting any issues with corporate governance here, I would prefer that minority shareholders have a bigger say. Moreover, this concentrated share ownership makes it more likely that Safeway will pare down its stake in the future, potentially depressing Blackhawk's share price.

Peer comparison

Blackhawk Network’s peers include Euronet Worldwide (NASDAQ: EEFT) and Green Dot (NYSE: GDOT). It is valued at a premium to its peers with a forward P/E of 17, while Euronet Worldwide and Green Dot are both valued at 14 times forward P/E.

Euronet Worldwide participates in many of Blackhawk Network’s product segments, excluding prepaid digital wallet services and electronic gift cards. In its prepaid services segment, it witnessed some Australian retailers cutting Euronet Worldwide as the middleman and going straight to mobile operators last year. In response to this new competitive landscape, it acquired ezi-pay, New Zealand's largest provider of gift card services in November 2012, as part of its efforts to diversify and expand its non-mobile content business.

Green Dot is the largest domestic provider of general purpose reloadable (GPR) prepaid cards. It competes with Blackhawk Network’s PayPower GPR card, but also has its cards distributed by Blackhawk Network. Green Dot also shares some investor concerns similar to those surrounding Blackhawk Network, and it faces significant concentration risk, with products sold at its top distributor Wal-Mart representing 64% of its fiscal 2012 revenues. In addition, it has a dual-class ownership structure favoring legacy investors.

Conclusion

The typical concerns over buying into newly listed stocks include the lack of a publicly traded financial track record and the share price drop following the expiry of the lock-up period for controlling shareholder sales. On top of that, Blackhawk Network has less bargaining power with distributors and has its revenue concentrated in the final quarter of the year. Current valuations for Blackhawk Network are reasonable but unattractive, representing a slight premium over peers.


Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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