There are very few days when a stock takes a 40% dive and I wish it crashed even more. Verifone [PAY] is beginning to feel like one of them. If you haven’t noticed, Verifone’s stock dropped 42.8% yesterday (Feb 21, 2013) after it announced in a press release that it now expects net income for the first quarter ending January 30th to be significantly less than what it originally guided. The company now believes that its first quarter net income will come in at 45 cents to 50 cents a share as compared to Wall Street’s consensus of 80 cents a share.
The result? Verifone was punished viciously by the market and a billion dollars was wiped off its market value in less than 24 hours, leaving the company at a market cap of 1.97 billion. In a research note to its clients, SunTrust expressed its shock and simply commented, “We are simply at a loss to explain such a huge miss.” The rest of the Street also threw in the towel — Deutsche Bank now rates Verifone as a sell, dropping its price target to $15 a share; Wedbush reduced its price target from $33 to $22 while UBS similarly cut its rating from $39 to $26. Reading into some of the market commentary on this company, it seems as if Verifone should be immediately euthanized and put to bed as soon as possible. But is it really such troubled times at the largest credit card swipe machine maker in the world?
Verifone engages in the design and marketing of point-of-sale electronic payment devices, security and encryption software and other value-added services. If you have used a debit or credit card to pay for your meal at a McDonalds or a White Castle chain, chances are that you would be swiping your card on a Verifone machine. If you live in New York City, look out for the Verifone card reader the next time you are paying with a credit card on a yellow cab. In fact, the next time you go to a petrol kiosk that allows you to pay at the pump with a swipe of your credit card, look out again for Verifone’s logo imprinted on the card machine. Simply put, Verifone is the market leader in payment terminals. According to Value Line Research, the company works with 70% of the top 1,000 retailers in America and 83% of the top 200. In fact, it really only has one other strong competitor in the payment devices business and that is French-based Ingenico SA (used in 7-Eleven convenience stores in New York City). With an impressive line-up of customers and such an entrenched business, does it really sound like a dying business to us?
A lot of the market chatter before the announcement yesterday has been the perceived rising threat of new entrants such as Square. What Square does is to allow businesses to use a small device that can be plugged into a mobile platform such as an iPhone or an iPad in order to collect payments on the go. With gross revenue of about $40 million and zero profits to show for its venture so far, Square is now valued at the private market at $3.25 billion. Verifone, with $1.8 billion in annual revenue to boot, is valued today by the market at a billion dollars less than a scrawny technology upstart. Again, Square made $40 million with an ‘M’ and Verifone made $1.8 billion with a ‘B’. Yet somehow, Square is valued much more than Verifone.
The father of value investing, Benjamin Graham, once taught us about a quirky little fellow called Mr. Market. Mr. Market is somebody who turns up every day at the stock holder’s door offering to buy or sell his shares at a different price. Usually the price quoted can be plausible and close to what the stock is actually worth. Occasionally, it is ridiculous. Verifone’s stock price in relation to Square’s private valuation definitely looks a little out of whack.
Now, let’s do a few simple back-of-the-envelope calculations. In FY 2012, Verifone generated $218 million in operating cash flow. That’s real money that went into their pockets. At the current market cap of $1.97 billion, the company is selling on the market at about 10 times its operating cash flow. Its main competitor, Ingenico SA, trades on the Paris Stock Exchange at a market cap of around €2.38 billion with a much lower operating cash flow of €100 million. That means its main competitor is selling on the troubled European markets at a much higher premium of 24 times operating cash flow. eBay Inc, whose valuation is now driven much more by its PayPal payment business, also trades at a much more costly ratio of 18 times operating cash flow. Staying within the credit card payment universe, Mastercard also trades higher at 21 times operating cash flow. Why should an entrenched business like Verifone trade so much less?
Benjamin Graham once opined that in the short-term the market is driven largely by sentiment like a voting machine. However, in the long-term, it acts more like a weighing machine (i.e. the stock price will eventually reflect the true value of the company). Verifone looks very much like a business that has fallen out of favor with the market’s voting machine and its stock price will probably continue to plunge even further than the 40% drop it recently suffered. However, only time will tell if the business actually deserves the punishment that the market has doled out to their stock price yesterday. Judging by the strength of its underlying business and the relative valuation of Verifone as compared to its peers, I am inclined to believe that the market has gotten it wrong on Verifone this time.
Written by Kapitall's SiHien Goh