Is This Overlooked Company a Worthy Long-Term Investment?

By William Bias - August 10, 2012 | Tickers: EBAY, NWL, PBI, STMP | 0 Comments

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When looking for investments I try to look for obscure overlooked companies with low debt and excellent cash flow generating capabilities. I did a stock screen search for companies with no long-term debt to equity ratios and one of the companies I came up with was Stamps.com (NASDAQ: STMP). This is a novel little company where for a monthly fee you can print electronic stamps and labels for envelopes and packages. This is an added convenience if you run a business that involves the shipment of a lot of packages. After researching the fundamentals of Stamps.com I decided that the worthiness of this company as a long-term investment is suspect.

Beyond Stamps

Stamps.com does a little more than just enabling a customer to print stamps for a monthly fee. They also sell hardware and supplies such as scales, envelopes and labels. Stamps.com also sells insurance for packaging and they have a photo stamp division where you can send pictures and turn them into postage stamps for a cost.

The company is investing less in the photo stamp division because margins are relatively low (see table below). My suspicion is that printing and shipping costs are the drivers behind the sub-par margins which is a shame because I think this gave the company an added novel touch.

It is worth noting that they did experience an uptick in photo stamp sales in 2011 due to a breakage in accounting in which they recognized a portion of unearned revenue because few customers redeemed photo stamp retail box cards. They said there would be no legal obligations, but I have to wonder if this could backfire on them.

Selling Stamps or Stock Options?

Looking at Stamps.com cash flow statement we see that in a number of years including 2011 the proceeds from stock options and the employee stock purchase plan exceed free cash flow (see graphs below). This tells me that in those years Stamps.com generated more cash from stock options than from selling products. So, can the company sustain itself by selling products or by floating stock options? Looking at the income statement for 2011, weighted diluted shares outstanding jumped 483,000 shares to 15.1 million shares. In the latest earnings release on July 26 the weighted diluted shares stood at 17 million shares for the first 6 months of 2012. The Stamps.com stock option program is very dilutive.

Temporary Net Income Inflation

The company has $345 million in net operating loss carry forwards that, pending meeting certain IRS guidelines, can be used to inflate net income as a tax benefit. My concern here is after the net operating losses become exhausted and net income and earnings per share go down as a result, that could impact Wall Street perceptions and the corresponding stock price. In the latest earnings announcement net income was increased by $11.7 million as a result of a tax benefit from Net Operating Loss carry forwards for 6 months ending June 30.

Competition

Stamps.com is not the only company that is in the business of producing electronic stamps:

DYMO Endicia - Newell Rubbermaid’s (NYSE: NWL) DYMO Endicia brands offers basically the same kind of service for a similar price structure as Stamps.com. They also offer the ability to put your photos or business logos on stamps. They offer a basic option for $9.95 per month. The lowest price option for Stamps.com is $15.99 per month.

pbSmartPostage - Pitney Bowes (NYSE: PBI) is the market leader in electronic stamps and labeling according to Stamps.com Form 10-K. One of Stamps.com features stated “avoid hidden fees.” Pitney Bowes’ pbSmartPostage website only advertises two rates of $14.99 and $16.99 per month which leads me to wonder what other costs could be associated with it. pbSmartPostage is also a great deal more difficult to remember than Stamps.com.

United States Postal Service - The Postal Service also offers electronic stamp and labeling service, and they have an agreement with ebay (NASDAQ: EBAY) to offer stamps and labels for free above and beyond the normal cost of stamps through the Click-N-Ship program. If I want to buy and sell something through ebay I can simply print a label or stamp that meets my needs without any additional charge beyond paying for the stamp or label.

Conclusion

I think with the fact that Stamps.com is investing less in the Photo Stamp division they are going to have a less diverse revenue stream in the future. The potential earnings volatility stemming from the net operating loss carry forwards is going to interfere with any positive perceptions from Mr. Market. Also the fact that in some years they make more money from stock options than from their product gives me pause. This produces dilutive friction against stock gains. Also the low barrier to entry resulting in multiple market participants having similar prices and services gives me reason to believe that the long-term potential of Stamps.com is limited.

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