Digital River Buys LML Payment In An Attempt To Restore Profitability And Strategic Strength

| About: Digital River, (DRIV)

Digital River (NASDAQ:DRIV) announced on Monday that it will acquire LML Payment Systems in a deal valuing the company at $3.45 per share, for a total deal value of $103 million. Shares of Digital River hardly moved on news of the deal. Shares of LML Payment jumped some 82% to $3.40 after news.

The Deal

Digital River said that it will acquire LML Payment Systems, a leading provider of electronic payment processing, risk management and authentication services. Digital River will pay $3.45 per share for LML Payment Systems, or $103 million. The deal positions Digital River to capitalize on its global success in online payment processing. LML processes online payments for 14,000 small to mid-sized merchants. Combined, the companies handle more than $20 billion in online transactions across a range of industries.

The company intends to leverage LML's ecosystem of banking, merchant, reseller, and developer relationships to expand Digital River's World Payment solution, and expand LML Payment Systems' white-label channel and mobile payment solutions.

CEO Joel Ronning commented on the deal:

This investment reflects our ongoing commitment to expanding our Digital River World Payment solution and continuing to diversify our global commerce business across multiple vertical markets. Each company has a strong reputation in the online payments market, robust platform and deep expertise in card-not-present processing. Our joint technologies and expert resources will create even more value for our combined client bases -- helping them to reduce time to market and providing access to new payment technologies and geographies.

LML Payment Solutions generated annual revenues of $34.9 million in 2011. The company net earned $6.7 million during that year. The $103 million deal values LML at 3.0 times annual revenues and 15 times annual earnings. The company expects the deal to be accretive to Digital River's earnings per share in its fiscal 2013.

The acquisition has already been approved by the board of directors of both companies. Digital River expects to close the deal during the fourth quarter of 2012. The deal is subject to a two-thirds vote cast of LML's shareholders, regulatory approval, and the usual closing conditions.


Digital River ended its second quarter of 2012 with $644 million in cash and equivalents. The company operates with $354 million in long term debt, for a net cash position of roughly $290 million. The strong cash balances, makes financing of the deal easy.

For the first six months of 2012, Digital River reported revenues of $193.2 million. Net income came in at $4.9 million, or $0.15 per diluted share. For the full year of 2012, revenues are expected to come in between $378 million and $390 million. GAAP earnings per share are expected to come in between $0.22 and $0.38.

Pro forma, the combination is expected to generate revenues of around $420 million for 2012. The combination is expected to earn around $17 million in 2012. No revenue or cost synergies are expected to be achieved in 2012 already.

Currently, the market values Digital River at $595 million. Subtracting Digital River's and LML's Payment Solutions cash balances of $320 million, while adding the acquisition price of $103 million, values the operating assets of Digital River at $380 million.

The market values the pro-forma combination at 0.9 times annual revenues and 22 times annual earnings.

Currently, Digital River does not pay a dividend.

Investment Thesis

Year to date, shares of Digital River have risen some 10%. Shares traded in a $14-$18 trading range for most of the year, changing hands at $16.66 on Friday.

Over the past five years, shares have lost roughly 60% of their value. Revenues have been stagnant around the $400 million mark in recent years. At the same time, profits fell from $63.6 million in 2008 to $17.2 million in 2011.

Digital River's management signaled that shares are cheap at the moment. During the second quarter, the company repurchased 1.4 million shares, roughly 4% of its shares outstanding. The board of directors has authorized another $100 million share repurchase program in response.

The acquisition of LML makes strategic sense, as the combination offers cross solutions to different customer bases and leverage online payment technologies. The deal value is quite significant, valuing LML at roughly one-sixth of Digital River's own market value, after offering a 80% premium to LML's shareholders.

While I appreciate the strategic rationale behind the deal, I am worried about the long-term prospects for smaller firms in the online payment industry, given that large technology companies and credit card companies have announced their ambitions in the field.

Future consolidation in the industry might result in a takeover of Digital River by a larger competitor, but I remain skeptical on the prospects for the company on a stand-alone basis.

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