NetSpend IPO: Buzz Fueled by Greendot Success

| About: NetSpend Holdings (NTSP)

With roughly two million active cards as of June 30, 2010, NetSpend is the second largest US provider of general-purpose reloadable prepaid debit cards (GPR cards), which are primarily designed for the 60 million "underbanked" customers in the US who lack full access to traditional checking and savings account. The company's customers are attracted to the card's convenience, lack of overdraft fees and minimum balances, and as many banks are turning away low-income customers, NetSpend cards represent an alternative to cash for many customers. With $7.6 billion of transactions made using its cards in 2009, representing a 40% share of this nascent market, NetSpend is one of the two clear leaders in this fast-growing space. Its $200 million IPO will follow in the footsteps of closest competitor Green Dot (NYSE:GDOT), which had a very well received IPO in July. Goldman Sachs (NYSE:GS), BofA Merrill Lynch (NYSE:BAC) and William Blair are the lead underwriters on the NetSpend deal, which is one of five scheduled on the IPO calendar for the week of October 11.

Card Characteristics

NetSpend cards are sold at 39,000 retail store locations, which range from check cashers like ACE Cash Express to grocery stores like Winn-Dixie. They are also issued by 800 corporate employers that use direct deposit NetSpend cards to pay employees without bank accounts. The FDIC-insured cards are Visa- or MasterCard-branded and can be used anywhere those cards are accepted, including for online purchases.

Attractive Market

With more than 25% of US households estimated to be underbanked and searching for a convenient alternative to traditional bank accounts on the one hand and living on a cash basis on the other, the GPR card market is forecasted to grow at a 92% CAGR from 2008 to 2012 to reach almost $120 billion in loaded funds by 2012. NetSpend, which generates revenue from transaction fees paid by cardholders (79% of 1H10 sales) as well as interchange fees paid by merchants (21%), has benefited from these positive industry trends and has grown its top line at a 49% CAGR from 2005 to 2009, reaching $252 million in the last twelve months. Like other payment processors, the company has a scalable business model and EBITDA margins were near 25% in the 1H10.

Key Risks

Competition is a major risk to this story, and NetSpend recently surrendered the #1 spot in the market to its competitor Green Dot. The average lifetime of NetSpend's cards is only 11 months, and while an increasing number of customers using direct deposit may help to raise this number, churn is still a key issue across the industry. Other risks include high regulations, possible legislation targeting payday lenders that also sell NetSpend cards and retailer concentration (ACE Cash Express accounts for 37% of revenue).

IPO Buzz

Interest in NetSpend should be fueled in part by the successful upsized IPO of competitor Green Dot, which has gained 35% since its July debut. However, with NetSpend's growth lagging Green Dot, it may not garner as strong as a reception, especially as the proposed valuation does not appear to offer a significant discount to Green Dot. Nevertheless, buzz around the prepaid industry is high and the expected industry growth should allow both companies to grow quickly in the coming years.