A Sweet Deal for NetSpend's Shareholders

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Recently, Total System Services (NYSE: TSS) announced that it would buy NetSpend Holdings (NASDAQ: NTSP) at about $16 per share, with a total transaction value of $1.4 billion. The offering price represented a 26% premium on NetSpend’s closing price last Monday.  Is $16 per share price tag fair for NetSpend’s shareholders? Is Total System a buy after this deal? Let’s find out.

NetSpend and Total System Business

NetSpend, founded in 1999, is a provider of general-purpose reloadable (GPR) prepaid debit and payroll cards to the under-banked and other consumers in the US. The company is selling its card via different distribution channels, including traditional retailers, directly-to-consumers, online marketing programs, etc. As of December 2012, NetSpend had more than 2.35 million active cards, as well as 500 distributors in more than 60,000 locations in the US. In the past 5 years, NetSpend has experienced a consistent growth in its revenue, from $183 million in 2008 to $351 million in 2012. However, the company generated a loss of $11.65 million in 2008. The loss in 2008 was due to a charge of $26.3 million for goodwill and intangible impairment. In 2012, NetSpend incurred nearly $37 million in settlement losses, which reduced the net income to $18.9 million. The operating cash flow in 2012 was $38 million.

Total System is a global payment solutions provider with three main operating segments: North America Services, International Services and Merchant Services. The majority of its revenue, $965.4 million, or 51.6% of the total revenue, was generated from North America Services. Merchant Services ranked second with nearly $512.6 million in revenue in 2012, while the International Services generated around $413.5 million in revenue.

Five Strategic Reasons to Acquire NetSpend

In order to finance the purchase of NetSpend, Total System will use its cash on hand and $1.3 billion in debt. The transaction is expected to be completed in the middle of 2013. In its presentation, Total System listed five main reasons to purchase NetSpend. First, Total System could enter a fast growing prepaid market that was expected to double in the next 4-5 years. Second, it could give Total System an opportunity to create new partnerships with its existing bank customers. Third, the company could expand its customer base by entering new segments, including Corporates and Government Agencies. Fourth, Total System could leverage NetSpend's wide distribution network and innovative products. Last but not least, the deal would give Total System a better diversification. After the buyout, the North America Services segment will represent only 41% of the total revenue, while NetSpend will account for 18% of the total revenue. 

<img src="/media/images/user_14219/screen-shot-2013-02-25-at-23102-pm_large.png" />

Source: Total System’s presentation

Is it Too Expensive?

In 2012, the combined EBITDA was around $613 million, 16% higher than Total System’s EBITDA of $528 million. With the current trading price of $22.90 per share, Total System’s market cap is $4.25 billion. The market is valuing Total System at 8x EV/EBITDA. After the deal, Total System would take on an additional debt of $1.3 billion and generate $613 million in EBITDA. Thus, the EBITDA multiple would be 9x. As NetSpend generated more than $87.1 million LTM EBITDA, the deal valued NetSpend at around 13.6x EV/EBITDA. The deal seems to be relatively quite expensive compared to Total System’s valuation and the market valuation of DFC Global (NASDAQ: DLLR), one of NetSpend’s peers. DFC Global is trading at $18.90 per share, with a total market cap of $792 million. The market is valuing DFC Global at only 5.32x EV/EBITDA. Among the three, DFC Global seemed to be the most profitable company. Its operating margin was the highest at 24%, while the operating margins of NetSpend and Total System were 20% and 19%, respectively. Among the three, only Total System is paying a 1.7% forward dividend yield to shareholders, whereas NetSpend and DFC Global are not paying any dividends.

My Foolish Take

I think Total System has overpaid to acquire NetSpend. Total System would be valued quite higher than the pre-acquisition's valuation due to its significant debt financing for the deal. Among the three, DFC Global is the better bet than the other two due to its highest operating margin and lowest valuation. 

hoangquocanh 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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