Credit and debit card transactions only continue to grow, but investors have clearly tired of VeriFone's (PAY) uninspiring performance and management missteps. That leaves investors looking to payment processors like Heartland Payment Systems (HPY) or Global Payments (GPN) to play the trend, or European payment and security companies like Gemalto (GTOMY.PK) and VeriFone's co-duopolist Ingenico (INGIY.PK). Unfortunately, not unlike VeriFone a little while ago, it looks like the market already expects a very full growth outlook for Ingenico.
Recent Results Suggest Very Solid Growth
Whereas VeriFone recently warned the Street that there would be barely any revenue growth for its January quarter, Ingenico came through with a solid December quarter.
Revenue rose about 10% on a comparable basis, with terminal revenue of about 10% and underlying transaction/service revenue growth of about 9%. Ingenico delivered the same sort of weak performance that VeriFone warned about (down about 2%), but it looks like the company gained share in the quarter. Elsewhere, growth in Latin America (up 31%) and Asia-Pacific (up 27%) was quite strong, while North America growth was fairly sedate (up 3%).
Unfortunately, the nature of Ingenico's reporting (as with many European companies) makes quarterly margin comparisons quite challenging if not impossible. On a half-versus-half basis, Ingenico saw worse gross margin (down about 70bp, and below analyst estimates), and a three-point sequential decline in operating margin that was more in line with expectation.
Gaining From VeriFone's Missteps?
As a duopoly that controls about 85% of the world's payment terminal business, growth for one player frequently comes at the expense of another. A few years ago, Ingenico lost share to VeriFone in North America largely due to incomplete product offerings and a slow roll out of the Telium OS. Now, though, that may be going the other way.
It appears that VeriFone has been spending too much time on software and service offerings, and has seriously fumbled some hardware upgrades. That has given Ingenico an opportunity to regain terminal share in North America. At the same time, though, it increasingly looks like Ingenico is just basically out-executing VeriFone in markets like Europe, Brazil, and China and taking an increasing amount of market share in these fast-growing markets.
Can Ingenico Press The Advantage?
The real question for Ingenico is whether they can sustain the momentum they are building at VeriFone's expense. That could be particularly important in the two largest card-using economies - China and the United States.
North America is actually a pretty small market for Ingenico - representing less than 10% of revenue - despite the U.S. being the second-largest user of debit and credit cards. VeriFone holds a share advantage of about 52% to 25% in the U.S. for three primary reasons. First, there is the aforementioned product rollout issues in Ingenico's past that allowed VeriFone to capture (and keep) many retailers. Second, VeriFone offers what have effectively become the de facto encryption standards for the U.S. Lastly, VeriFone has been more aggressive in rolling out point of sale (PoS) terminals in locations like taxis and gas pumps - perhaps a legacy of VeriFone's greater historical focus on retail (whereas Ingenico has been much stronger in banking).
Can Ingenico turn this around?
While both VeriFone and Ingenico have technology for chip-and-PIN card technology (a standard being advanced by Gemalto and supported by both Visa (V) and MasterCard (MA), Ingenico has a bigger share in this area. Not only would a greater/faster switchover in the U.S. toward chip-and-PIN accelerate the terminal refresh timeline, but it would also give Ingenico a chance to press home this advantage. Likewise, this migration should weaken VeriFone's advantages in encryption, as the chip-and-PIN approach significantly reduces the need for end-to-end encryption.
Ingenico is also looking to leverage its stronger position in payment services. In addition to offering the terminals that take cards, Ingenico offers services at multiple levels of the payment processing process. From pre-processing services like centralizing transactions from a location/company (so that all of a retailer's charges go through as a batch) to transmitting data to banks, to value-added services like card recharging/reloading, Ingenico is effectively building out an end-to-end suite of products and services. That can make Ingenico more attractive to merchants as its simplifies and streamlines the process (dealing with one provider instead of three), plus it gives the company more avenues to compete on price and service quality.
While Ingenico recently paid quite a lot for Ogone (paying almost nine times trailing sales), the potential synergies and the advantages of rounding out the online payment service offerings makes it a worthwhile deal for the long term - said differently, it was going to cost Ingenico more in time and money to build on its own what Ogone offers today.
Mobile Is A Free-For-All
Like VeriFone, Ingenico has a lot to lose in the migration to mobile payments. Unlike VeriFone, though, it seems that Ingenico has spent more energy working on mobile payment solutions rather than trying to convince investors that competitors like Square aren't so much of a threat.
Square has clearly made a big splash in the market, with an estimated $8 billion in processed sales volume and the latest funding round valuing the company in excess of $3 billion (against $2 billion for VeriFone and roughly $3 billion for Ingenico). Interestingly, though, many of the other mobile payment rivals have moved aggressively to match or beat the 2.75% per-swipe fee. Intuit's (INTU) GoPayment, eBay's (EBAY) PayPal Here, and VeriFone's Sail all offer their services for about 2.7% per swipe. While there are differences in terms of customer service, payment/chargeback terms, and so on, I think you could argue that the market really is more about marketing than capabilities or costs right now.
That still doesn't mean that Ingenico is going to maintain its status. Ingenico's initial offering in mobile was a rather unwieldy "sled" device, but the company does now offer a card reader that plugs into a phone/tablet jack like the other systems. Perhaps more importantly, though, Ingenico has been developing these systems with the expectation of eventual migration to a chip-and-PIN system. What's more, Ingenico also has an NFC card reader product that should help it fend off potential competition from integrated offerings from companies like NCR (NCR) and MICROS (MCRS) in the future, and simply plug into existing Ingenico PoS terminals.
Share Growth, Market Growth, And Competition
I do believe that Ingenico has a good chance to capitalize on VeriFone's missteps and gain share in the U.S., Brazil, and China. I find it quite unlikely that Ingenico will become the market leader in the U.S., but there is significant potential here - particularly if the company can improve its offerings for the retailing sector and match VeriFone's efforts to get into markets like taxis.
At the same time, I think there are changes in the underlying markets that will mitigate some of the growth to be had from share growth. In China, for instance, I believe low-cost/low-feature rivals like Shenzhen Zhentong (SZZT) will gobble up a lot of the low end of the market - not so bad for Ingenico's margins, perhaps, but more of a risk to the revenue growth outlook. In the U.S. and Europe, though, I see mobile payment solutions threatening the VeriFone-Ingenico duopoly and taking away some of the business. While I think Ingenico can stay relevant with products like NFC readers and back-office software/services, there's going to be a shaking-out process.
All in all, I see Ingenico growing its top line at close to 7% - about a point higher than what I project for VeriFone. I see stronger growth for software/services (low teens), and this could be the biggest area of potential outperformance, though less price competition/erosion in terminals would also be a definite bonus.
On the margin/cash flow side, I see VeriFone slightly outgrowing Ingenico but largely because VeriFone has more room to improve - I do believe Ingenico will improve its margins as it builds out its service/software offerings, but I think the company will be hard-pressed to go past the mid-teens. In all, I see Ingenico growing its free cash flow at a long-term rate of about 9%.
Harder To Own Than Average
While Ingenico has legitimate free cash flow and pays a token dividend (yielding about 1%), this could be a challenging stock for some American investors. There is an ADR program here, but the liquidity is so low that investors must use limit orders or risk being victimized by opportunistic market makers. It's also important to note that European accounting and reporting standards are different, and investors who need complete quarter-by-quarter financial statements are not going to be satisfied with this company.
Those risks aside, this is still an ownable stock. Ingenico provides ample shareholder information in English and the liquidity for the European shares (INGC.PA) is fine. With most quality brokerages now offering trading in Europe at reasonable commissions, buying the shares in Europe is an option that investors should seriously consider.
The Bottom Line
I like Ingenico's business and I believe management here is more dependable and reliable than at VeriFone. That said, the market seems to really love these companies when they're hot, and Ingenico's run of superior performance has pushed up the valuation. A long-run estimate of 9% free cash flow growth suggests a fair value of about 40 euros. That makes this a watchlist stock at best for me now, though I don't deny that Ingenico has the momentum today and the potential for real share gains.
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.
