Green Dot: Further Due Diligence

| About: Green Dot (GDOT)

Summary

Green Dot looks like a decent long opportunity.

However, valuation might not be as low as "advertised."

This article explains the valuation problem and also adds a couple of other issues.

Click to enlarge

Upon reading Yale Bock's Green Dot (NYSE:GDOT) article, titled "Get Some Green With Green Dot," I was all ready to deem GDOT a very good long opportunity. For sure, GDOT had its challenges over the last few years, with its consistent under-performance and under-delivery - but right now things seem to be improving, with active (debit) cards again increasing. Where active debit cards go, the rest of GDOT's fundamentals are likely to follow.

I was happy with the idea on two counts:

  • First, the company seems to be transitioning from an ugly shrinkage period to a period of renewed growth.
  • Second, the company seemed extremely cheap from a valuation standpoint.

I have no reason to question that the company is indeed improving (though later on I'll talk about two possible issues). However, when it comes to valuation, my dream of a super-cheap deal fell somewhat flat. Let me explain why.

On Valuation

On a superficial look, GDOT seems very cheap. Quoting from the article, which led me to dig into the stock:

The TEV/EBIT multiple is 6.11, and the TEV/(EBITDA - Maint CapEx) multiple registers 4.84, and TEV/Sales = .572. Other pertinent rations include Price/Sales = 1.57, Price/Book = 1.65, ROE = 5.95%, and ROA = 2.24.

These look like deep value valuation multiples for a company entering a period of fundamental improvement. But alas, these multiples aren't really as low as advertised.

You see, GDOT is a financial company. All those debit cards are loaded with customers' money. So you have your balance sheet brimming with cash and investments, but on the liability side, you also have customer deposits. In my view, these customer deposits aren't seen by automated data aggregators as straight financial debt of the kind which would otherwise be added to Enterprise Value (TEV, above), but they ought to be, since the company's cash is encumbered by them.

Obviously, these customer deposit liabilities are very large ($636.9 million, as of Q1 2016), and they nearly totally eliminate what would otherwise seem a very large cash position. It's not a coincidence that GDOT refers to its own unencumbered cash position as $151.2 million, and not $739-934 million (depending on including investment securities or not).

If we calculate TEV taking into account this reality, we then come up with a significantly higher value. We need to include:

  • $1.1 billion in market capitalization (including convertible preferred stock).
  • $180 million in net cash (consisting of $934 million in cash and investment securities, minus $116 million in debt and $637 million in customer deposits).

Thus, TEV is ~$929 million. Using 2015's $59.3 million EBIT, $153 million adjusted EBITDA and $50 million in maintenance capex, we come to the following multiples:

  • 15.7x TEV/EBIT
  • 6.1x TEV/EBITDA
  • 9.0x TEV/(EBITDA - capex)

Now, these aren't extraordinarily large multiples for an improving business. As such, GDOT could easily remain very attractive going forward, and the stock can perform well if the improvement continues. However, they're no longer massive bargain-basement multiples either, like they previously seemed.

It Should Be Noted

I should add that many will disagree with removing the customer deposits from net cash, even though the company itself sees it that way by listing "unencumbered cash" which is consistent with my measures.

After all, in many definitions of Enterprise Value, you will be greeted with "interest bearing debt" and not debt in general. And since the card deposits don't pay interest, they can be seen as being some kind of supplier account, which is a source of cash in EV analysis.

Still, it should also be noted that due to this problem, it's usual not to use EV/EBITDA at all when discussing financial businesses. This is so simply because the distortion of large cash deposits can change these valuation multiples tremendously.

Instead, things like insurance companies (where insurance premiums play the same part as customer deposits here) tend to follow different valuation techniques as well as give more weight to a simple (and often discounted) price/book multiple. GDOT's price/book multiple comes in at 1.6x. Notice, for instance, banks; they also all trade at discounted price/book values. And, arguably, a lot of the deposits they presently carry are no longer interest bearing either.

Anyway, this is still an important valuation issue, and depending on how one looks at it, GDOT can seem very cheap or just "rather cheap to fairly valued".

Two Possible Issues

This is mostly an aside, but I wanted to put it out there. There are two issues which might also affect GDOT going forward:

  • Manufactured spending. This is an issue where credit card "optimizers" get access to credit card perks like frequent flyer miles by manufacturing qualifying spending. It so happens that debit cards are often used for this purpose. The cycle goes like this: use a credit card to buy or reload a debit card (this sometimes counts as spending). Then use the debit card to pay off the credit card balance. There you have it, you just got some (or a lot) miles without spending anything. This generates demand for debit cards which might otherwise not exist.
  • Donald Trump. If Donald Trump wins, illegal immigration might face a significant setback. Such (immigrant) population is unbanked and likely to be a heavy user of debit cards. As such, a Trump presidency would likely be a negative development for GDOT.

Conclusion

In overall terms, I still find GDOT attractive due to the improving fundamentals and reasonable valuation.

However, I don't think the stock is as cheap as I originally thought. I think the article, which got me looking into GDOT, is using an optimistic valuation approach on account of the issue I identified.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GDOT over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.