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With the advent of emerging technologies such as contactless mobile payments, it’s clear that the payment landscape is on the verge of a major secular shift. Given the increasingly evident movement to the usage of smartphones as a gateway to do virtually anything from checking in to a flight at the airport to redeeming coupons to buying coffee at Starbucks, without a doubt there will be winning and losing companies.
Although the movement of the payments industry has intrigued investors for several years now, given the fact that private competitors such as Square have entered the space and threatened the dominance of global leaders such as VeriFone (NYSE: PAY), Ingenico (NASDAQOTH: INGIY.PK), and NCR (NYSE: NCR), it remains difficult to pinpoint when the payments industry as a whole is best poised to profit. However, one should keep in mind that the payments industry is a sleeping giant; indeed, this sub-sector of technology is slow-moving, but one particular dominant player’s stock price has recently been hit, presenting a unique buying opportunity for those who are willing to ignore the short term and dig into the company’s fundamentals and long-term opportunities.
Verifone Overview & Competition
VeriFone is a California-based global provider of point-of-sale hardware and related services, such as encryption software and certified payment software. With a $2.53 billion market cap and over 50% of revenues coming from outside the United States (approximately 43% from emerging markets), VeriFone allows retailers, financial institutions, taxi cabs, payment processors, gas pumps, and other merchandisers to accept a platitude of payment methods, such as signature and PIN debit cards, credit cards, RFID (contactless radio frequency identification), smart cards, pre-paid cards, electronic bill payments, check authorization and conversion, signature capture and EBT (electronic benefits transfer) cards. Given the fact that we are in the midst of a major payment landscape transition to contactless, and because the payments sector in general is underappreciated and undervalued, in addition to recent events surrounding the company, VeriFone is in a unique position to capture market share over the next few years.
VeriFone currently has approximately 20 million point-of-sale terminals installed in over 120 countries. Further, they boast nearly 70% of market share in the United States, with a presence in 163 of the 200 biggest retailers. With regard to VeriFone’s competition, the only one with similar scale and presence is Ingenico SA, a point-of-sale player headquartered in Neuilly-sur-Seine, France – VeriFone and Ingenico are the only two pure plays in the POS space. VeriFone also competes to a lesser degree with Global Payments, Fiserv, and MICROS, and other payment innovators such as eBay’s PayPal and Google Wallet, a virtual wallet that allows consumers to pay from their mobile devices.
One of the key reasons that VeriFone is poised to profit from the shift in the payment landscape is the fact that the majority of their payment terminals are equipped to handle new payment mechanisms such as NFC (near-field communications). In addition, with their deep saturation into brick-and-mortar retailers both domestically and abroad, it is likely that VeriFone will remain entrenched as a dominant point-of-sale (and by relation, payments) company for the next decade. Due to the costly nature of replacing payment systems, and the customer relationships VeriFone has cultivated over the past several decades, replacing incumbent hardware is cumbersome for most. VeriFone has also intelligently diversified its product offering, with no single product or service as a dominating revenue source.
In addition, while in technologically progressive countries the payments landscape is evolving, one must not forget that POS systems in general still represent a vastly underpenetrated market in emerging economies. According to recent management commentary, in China, India, and Russia for every 1,000 people there are only 5 POS terminals, whereby it's 35 in the United States.
Which brings us to the present: VeriFone’s stock has plunged in the last year by nearly 34%, over 21% of which occurred in 2013. At the end of May, it closed at $23.33, close to its 52-week low of $17.93. Investors became alarmed when in February, the company pre-announced that they would miss their net income targets. This was coupled with the departure of CEO Doug Bergeron. However, in looking at the company’s recently reported first quarter earnings, VeriFone’s Non-GAAP net revenues were $430 million, and gross margin as a percentage of net revenues was 43.6%, 7 basis points higher than the same quarter a year go. In addition, over the last 5 years VeriFone has grown its top line by 16.5%. It’s true that the market has punished VeriFone for a disappointing first quarter, but perhaps too much so.
So how does VeriFone compare with its primary pure play rivals, Ingenico and NCR? To begin with, Ingenico recently reported strong Q1 2013 results, boasting revenue growth of 21% year over year to 291 million Euros (possibly the result of macroeconomics rebounding in Europe). In addition, an EMV (Europay/Mastercard/Visa) upgrade cycle is slated to begin in 2014, from which both companies should benefit – this global standard defines the way in which financial transactions are processed, all the consumer to the issuing bank. Both Ingenico and VeriFone should benefit from this upgrade cycle, as merchants will be forced to upgrade their outdated point-of-sale terminals to comply with this standard, which may add incremental revenue opportunities in 2014. However, for 2014, VeriFone will be focused on improving it’s operational performance internally for the next few quarters to years, during which time InGenico and NCR could steal market share. Currently, the market is assigning NCR with the highest P/E multiple of 38.3x, and it also boasts the highest return on equity at 14%, more than double VeriFone’s 5.2%.
Historically, VeriFone has always bounced back impressively from rockier periods, and 2013-2014 should be no exception. In addition, a private equity takeover is not out of the question, and even speculation of such an event could potentially drive the stock north. In terms of cash flow, VeriFone has stated in their most recent first quarter earnings report that they expect free cash flow will be in in the range of $170-$190 million, up from fiscal year 2012’s $155 million.
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Colin Tweel 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!