How To Trade VeriFone Ahead Of Earnings Release

Feb. 9.12 | About: VeriFone Systems, (PAY)

Let your cell phone pay! Place Orders On-line! The entreaties to use mobile e-commerce are everywhere. The dreams of software engineers just a few years ago, near-field-communication NFC technology is turning mobile devices into wallets…and more. Conventional wisdom - and I cannot disagree - is that the metamorphosis of the cellular handset from a mobile phone to a multi-tasking concierge presents a huge opportunity for providers of the software and equipment needed by retailers to serve the passing customer.

U.K.-based Juniper Research estimates that the total value of mobile payments for digital and physical goods, money transfers and near field communication transactions could reach $670 billion by 2015. This represents more than a doubling from the $240 billion market size in 2011.

Nowhere is enthusiasm higher in the sector than for VeriFone Systems, Inc. (NYSE:PAY). Analysts have estimated a 24% compound annual growth rate for VeriFone - one of the highest projected growth rates in the point-of-sale solutions sector. The stock is trading at 16.0 times projected earnings, well below analysts projected growth rate. Since VeriFone is scheduled to disclose first fiscal quarter 2012 results at the beginning of March 2012 and the company produced upside surprises in each of the last four quarters, it seems timely to consider a trade in PAY.

With a market size in the billions it should not be surprising that VeriFone has plenty of competition in the market for its bread and butter point-of-sale terminals. Heartland Payments Systems, Inc. (NYSE:HPY) is a strong player and other suppliers include First Data Corp., Pax Technology Ltd. and CyberNet, Inc., just to name a few with a presence in the U.S. market. Nor is there is any shortage of competition for reservation, payment and back office solutions for retailers, hotels and restaurants. International Business Machines (NYSE:IBM), Danaher's Gilbarco (NYSE:DHR), NCR Corp. (NYSE:NCR) and MICROS Systems, Inc. (MRCS) are all significant challengers. However it is notable that published growth estimates for most of these are well below 20%, giving VeriFone the fast growth crown in the retail payments sector.

The comparison begs the question "What does VeriFone have going for it that the others are missing?" One strong point is the acquisition of Global Bay Mobile Technologies in November 2011. Global Bay has perfected a mobile inventory tracking and payments app that allows sales personnel to engage customers away from the checkout desk. What is even more exciting is Global Bay's customer list of very well known retailers - Guess (NYSE:GES), Timberland (NYSE:TBL), True Religion (NASDAQ:TRLG), Crocs (NASDAQ:CROX). The Global Bay app complements VeriFone's PayWare card swipe sleeve and app, which competes with Square, one of a handful of new players aspiring to get a cut of the mobile payments pie.

The Global Bay deal came on the heels of VeriFone's takeover of competitor Hypercom Corporation. To get approval from the U.S. Justice Department, VeriFone had to let go of Hypercom's point-of-sale equipment business in the U.S., but ended up with a Hypercom's strong presence in Europe. With Hypercom in its corner VeriFone is expected to be in a better competitive position outside the U.S. with an installed base of terminals to upgrade for acceptance of mobile phone payments.

Just in case its own products are not enough to secure a berth in the mobile commerce sector, in early 2011, VeriFone forged a partnership with MICROS Systems, a top provider of point-of-sale solutions for the restaurant industry. VeriFone is counting on MICROS to help bring payment by smart phone to the restaurant table. Wait staff could also use mobile devices such as a tablet to take orders while customers stand in line.

VeriFone has also teamed up with Google, Inc. (NASDAQ:GOOG), which is apparently maneuvering to build advertising sales and to secure stake in the mobile payment space along side PayPal and ISIS, the cellular joint venture among Verizon (NYSE:VZ), AT&T (NYSE:T) and T-Mobile. One of the most recent software introductions for Google's Android platform, Gingerbread, includes support for NFC technology like that embedded in VeriFone's point-of-sale terminals. Google has a reputation for linking arms with just about any company with digital technology. Thus, in my view, announcing a partnership with Google is less than impressive unless there is something real behind it. However, the fact that the number one search engine, Google, picked VeriFone, the number two point-of-sale terminal provider in the U.S., suggests there is something "real" about Google's intentions.

Are two deals and two partnerships enough to convince you of VeriFone's prospects? It appears there little disagreement over the implications of these developments among the dozen or so analysts following VeriFone - at least in the near-term. Published estimates point to a 24% growth rate for VeriFone.

The narrow range of estimates is also informative. For the fiscal year ending April 2012 earnings estimates range from $2.55 to $2.65 on sales estimates fall between $1.90 billion to $1.92 billion. There is quite a bit of agreement on the coming fiscal year 2013. The 2013 earnings estimates range from $3.00 per share to $3.35 per share on sales in a range of $2.08 billion to $2.25 billion.

As finely tuned as these publishing analysts might be to each other, few have been able to keep up with VeriFone's sales or earnings success. VeriFone beat the consensus estimate in each of the last four quarters. Notably the margin of error has declined each quarter, suggesting that analysts are getting a better grasp of VeriFone's competitive position or perhaps they are wiser to management sandbagging guidance. In my view, another surprise for the first fiscal quarter 2012 is more likely than not.

Even after the recent surge in the PAY price after MasterCard (NYSE:MA) announced its roadmap for electronics payments in late January 2012, VeriFone shares appear undervalued. The well regarded Price-Earnings to Growth measure suggests VeriFone shares are undervalued by 33% - forward earnings multiple of 16.0 times divided by projected growth rate 24.0%.

If you are on board with this bullish valuation, when should you take a long position in PAY - before or after the fiscal first quarter is announced on March 5th? Despite clear upside surprise in each of the last four quarters, PAY shares have traded up on VeriFone's earnings announcements only twice. (See the table below.) Negative sentiment in the broader market can only be blamed for the jaundiced investor response on one occasion - following the release of the April quarter results on June 2, 2011. On all three other dates, the broader market was relatively tranquil or moving upward with little of the usual news in the air of some pending economic disaster. Broader economic factors and sector news appear to have greater influence over PAY price movement than does VeriFone's fundamental performance.

Thus it seems investors have the latitude of buying PAY now and buying PAY later.

PAY Price Performance Near Earnings Announcement Dates

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.