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Green Dot (GDOT) shares sold-off sharply (down 61%) on July 27, 2012 in response to the company's 2Q12 results and materially lowered guidance for 2H12. Competitive threats and newly implemented risk controls caused management to significantly cut 2H12 guidance, which now implies 10-12% revenue growth, adjusted EBITDA margin contraction and a significant slowdown in active card growth. The reduced 2H12 guidance was driven by recent management discussions with several of its customers. Management learned several of its currently exclusive customers have plans to offer prepaid cards in addition to Green Dot's. Additionally, Green Dot announced it has implemented new controls to reduce the risk of fraud. Green Dot believes these new risk controls will erase 5-10 points of active portfolio growth. In response to increased competition and the newly implemented risk controls, management offered what it feels is "worst case" 2H12 guidance (reflected in the table above). 2012 revenue growth guidance was lowered to 10-12% from 20-24% and 2012 EPS to $1.29-1.32 from $1.65-1.70. The guidance reflects approximately 5% active portfolio growth (from +20%) and 15% growth in cash transfers (from +20%). Furthermore, management commented that its growth profile in 2013 may be similar to its 2H12 outlook.
There Were A Few Positives from the 2Q12 Earnings Call
- Green Dot entered into a long-term, exclusive partnership with a leading provider of financial services for the higher education channel. The education partnership calls for Green Dot Bank to serve as issuer and Green Dot Corporation to serve as program manager to provide accounts to students for refund disbursements and for their general banking needs.
- Green Dot entered into a multi-year agreement with UniRush LLC for Green Dot Bank to be the exclusive issuer of the retail version of the Visa Prepaid RushCard and for Green Dot Corporation to co-manage the portfolio with UniRush. The RushCard will be a key component of Green Dot's new, segmented retail merchandising solution that the company is calling "Category of the Stars," which also features leading brands synonymous with mass market purchasers, older Americans, and sports enthusiasts.
- Green Dot initiated the first phase of beta testing for its new mobile-centric checking account product. Expectations are for a broader beta rollout to occur before the end of 2012, followed by increasingly broad rollouts in subsequent months. Green Dot believes this new checking account product has the potential to be a meaningful contributor to its business over time because the market for disgruntled checking account users looking for an alternative would seem to be robust and because the company believes that the usage and retention behavior on these accounts would be more akin to a checking account model than a prepaid card model.
Green Dot is the largest provider of general purpose reloadable (GPR) prepaid cards in the U.S. based on active cards and gross dollar volume loaded, offering money management solutions primarily to the un/underbanked demographic (approximately 60 million U.S. adults) in the United States. The company sells its cards and offers reload services primarily through its network of 55,000+ retail locations in the U.S. through its major partners, which include mass merchants (Wal-Mart, Kmart, Meijer) drug stores (Walgreens, CVS, Rite Aid, Duane Reade), convenience stores (7-Eleven, The Pantry, Circle K) and others (Radio Shack, Kroger).
Industry Growth and Dynamics
Prepaid cards work like a normal debit card, typically under the logo of Visa Inc. (V) or MasterCard Inc. (MA), making them usable at stores and online. However, they aren't attached to a checking account and aren't subject to the same consumer-protection requirements as traditional debit and credit cards. According to Mercator Advisory Group, U.S. consumers are expected to load $353.8 billion onto "network-branded" prepaid cards, or those that carry the logo of a card brand such as Visa or MasterCard, in 2014, up from $148.4 billion in 2010. I believe the 2014 estimate will likely prove too high in a weak consumer macro environment, so let's be conservative and downwardly adjust the 2014 estimate to $300 billion. Assuming that U.S. consumers load $300 billion (instead of $353.8 billion) onto cards in 2014, the prepaid card market is growing at over 19% annually.
Most prepaid cards are not subject to the Durbin amendment, a provision of 2010's Dodd-Frank financial-overhaul legislation that cut in half the fees merchants pay each time a consumer swipes a debit card. As a result of the exclusion of prepaid cards from the impact of the Durbin amendment, the prepaid market has recently attracted a slew of mainstream lenders, including J.P. Morgan Chase & Co. (JPM), U.S. Bancorp (USB) and American Express Co. (AXP), as they look for additional revenue sources amid fee limits on other products. See the 'M&A' subsection below for further thoughts on this.
Green Dot has a fabulous balance sheet with net cash + ST investment + LT investments per share = $5.94/share. Adding the restricted cash increases net cash/share to $6.24. While competition will certainly increase over the next few quarters and 2013 EBITDA margins will likely contract to high teens (reflecting higher commissions paid to Wal-Mart beginning May 2013), the current stock price of $9.06 is ridiculously inexpensive. At $9.06 per share, GDOT is trading at 1.3x 2012E EV/EBITDA and 1.1x 2013E EV/EBITDA. Further, the FCF yield to enterprise value is over 50% in 2012E and over 57% on 2013E FCF. The current valuation is unsustainably low and most likely reflects the flood of price-insensitive sellers exiting the shares on July 27 (18.4 million shares traded vs. 750,000 shares traded/day average).
Let's look at valuation from 2 perspectives: M&A value and Comps. First, a quick comment regarding the number of fully-diluted shares. A review of the sell-side notes reveals that some analysts have failed to include the conversion of the preferred shares into common shares to arrive at the number of fully diluted shares that is applicable to an enterprise value calculation or in an M&A scenario. The correct number of fully diluted shares is 44.0 million (not 36 million - 37 million).
M&A: Green Dot is an extremely attractive acquisition candidate for financial services companies or big-box retailers interested in the prepaid card business. Green Dot would be immediately accretive to almost any public acquirer. The list of potential acquirers is quite long, but certainly includes American Express or Western Union (WU), Walmart (WMT) or banks in payments, such as U.S. Bancorp, Wells Fargo (WFC), Bank of America (BAC), Comerica (CMA), MetaBank (MFG) and JPMorgan. Walmart already owns approximately 6% of Green Dot. Green Dot would be an outright steal at 5x 2013 EBITDA + the net cash, ST + LT investments on the balance sheet. The most likely final takeout multiple would be 5x-7x 2013 EBITDA.
- 5x 2013 EBITDA + net balance sheet cash + ST + LT investments = $17.76 per share
- 6x 2013 EBITDA + net balance sheet cash + ST + LT investments = $20.12 per share
- 7x 2013 EBITDA + net balance sheet cash + ST + LT investments = $22.49 per share
Comps: Green Dot's new guidance reflects a worst-case scenario where the company has growth at mid/high single digits. The transaction processing sector trades at an average of 15x 2013 EPS. Using a slightly discounted multiple of 13x 2013 EPS for GDOT = $18.20/share.
I expect GDOT shares to bounce back from the current hyper-depressed level ($9.06) to the mid-teens ($14 - $17) over the next 1 -3 months. It seems there were multiple sellers on July 27, that wanted to exit their GDOT positions regardless of price. This rush for the exit led to the outsized price decline.
M&A chatter will quickly pick-up once investors and potential acquirers refocus on Green Dot's dirt cheap valuation, the strength of Green Dot's balance sheet, the value of its 55,000+ installed base of retail locations, the robustness of GDOT's Green PlaNET technology platform and the numerous companies that want to quickly enter the rapidly growing (19%+) prepaid segment. If Green Dot goes into play, I expect multiple bidders and the final takeout price to be $20+/share.