The “Switzerland” of Payments

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

Investors looking for a play on the movement towards electronic payments would be well served to consider the, "Switzerland" of payment systems. VeriFone (NYSE: PAY) is positioning itself to benefit no matter who leads the way in the next payment revolution. With the company recently reporting earnings, investors get a chance to examine the huge growth this company is seeing. Considering the company's growth prospects and current price, I have no trouble calling this company one of the best values in the payments industry. 

The payments industry is undergoing a transformation much like when the first debit and credit cards were introduced. Entrants into the field such as eBay's (NASDAQ: EBAY) PayPal unit, new products like Google Wallet, and even Apple's recently released Passbook, are changing the way customers think about what they carry in their wallet. The great news for VeriFone investors is their company is central to many of these solutions. The company made two extremely impressive statements in this quarter's earnings report. First, the company supports 9 of the top 11 payment processors. Second, VeriFone supports Google, PayPal, Groupon, Visa, MasterCard, and American Express. As you can see, almost no matter who wins the battle to transform the payment industry, it's very likely VeriFone will be there to benefit. Let's look at the company's earnings report and you'll see just how impressive this company really is.

To understand VeriFone's earnings, I should mention that the company has acquired two major businesses in the last year or so. Hypercom and Point have both added significantly to both revenue and earnings at the company. Revenues increased 56%, but even without acquisitions, revenue grew 16%. The company also saw non-GAAP earnings-per-share increase an impressive 53%. On a geographic basis, the U.S., Canada, and Asia were the strongest regions. As investors might expect, struggles in Europe were a drag on the remainder of the company's business. VeriFone saw strong growth in both their Systems Solutions division with revenue up 38%, and the Services division reported revenue growth of 119%. Clearly the company has benefited from its recent acquisitions, but the longer-term growth driver is the adoption of more electronic payments. The company's financial statements showed a few positives, but also a couple concerns that investors need to know.

VeriFone increased its gross margin from 41.52% last year to 42.43% this year. This increased margin helped drive higher operating cash flow, which was up 40% before asset changes. There are two challenges that VeriFone will face in growing earnings in the future, and both are related to the company's recent acquisitions. First, the company now carries about $1 billion more debt and 17 million new shares. Second, this additional debt increased the company’s interest expense from under 20% of operating income last year to almost 30% of operating income this year. These are not necessarily major problems, as much as line items to watch going forward. With such impressive growth, one assumption that many people might make is that the stock would be expensive as well, but nothing could be further from the truth.

Looking at the payments industry, one of the more popular names mentioned is eBay because of their PayPal unit. I've made the argument in the past that at some point PayPal will become more important to eBay than their traditional marketplaces business. However, eBay's stock is not as attractive as VeriFone, because the company sells at a decent premium to its roughly 13% expected earnings growth. A direct competitor of VeriFone's is NCR (NYSE: NCR), which is more diversified than VeriFone and its offerings. The company offers point-of-sale terminals, software and support services, ATM machines, and much more. NCR looks like a good value in its own right. The stock sells at less than 10 times forward estimates, and earnings growth expected at more than 15%. However, VeriFone offers an even better option. For a company seeing huge earnings growth, and operating as the veritable Switzerland of the payment industry, the stock appears tremendously undervalued. Keep in mind; this is a company analysts expect to grow earnings by more than 25% over the next few years. In addition, the company has beaten earnings expectations consistently over the last four quarters. When you hear these two facts, you don't expect the stock to sell for less than 12 times forward earnings projections. It's possible that investors are worried about the additional debt and shares the company issued to make their recent acquisitions. However, those concerns appear unfounded considering the company's recent earnings. I would suggest investors put VeriFone at the top of their Watchlist. If the company continues on its current path, the stock won't stay undervalued for long.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of VeriFone Holdings. Motley Fool newsletter services recommend eBay. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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