Green Dot: Pessimism Creating Buying Opportunity

| About: Green Dot (GDOT)
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If your annual wages do not elevate you to the so-called 1% level, then your experience with a bank might fall under one of these categories - never-banked, previously-banked or underbanked. And if you happen to belong in one of those first two groups, it's likely you have used, or will soon use, a General Purpose Reloadable card, also known as a prepaid debit card. The benefits of providing a Visa or MasterCard branded card to users without the need for credit checks or a bank account have turned GPR cards into a dynamic growth industry. One of the most popular uses includes the ability to transact commerce online without a credit card or bank account.

Also GPR cards offer a great budgeting tool for family members, especially college students. There are anywhere from 40 to 60 million un-banked or underbanked Americans who until this innovation was created in the 1990s had not been able to participate in this country's rapidly evolving card-based economy. Since the mid-2000s, prepaid debit cards have been the faster growing segment of non cash payments, greatly exceeding the growth of traditional bank debit cards and credit cards (the latter which has actually declined).

The industry is often criticized for high fees yet a recent study by Bretton Woods, Inc., a financial services consulting firm, showed that an average consumer could spend less with a GPR card than at a bank account with similar services and balances. By loading higher balances (usually over $1,000) and by making frequent purchases, it's possible to actually be charged no fees at all. Also, general purpose prepaid cards are usually cheaper on average than using traditional check cashing services or money orders.

The largest of the GPR players and the pioneer in the industry is Pasadena, Ca.-based Green Dot Corporation (NYSE:GDOT) with approximately 4.4 million cards and $17 billion in Gross Dollar Volume. Branded cards include Green Dot and Wal-Mart's MoneyCard as well as targeted branded cards such as for AARP and NASCAR. The company went public in July 2010 at $36.00 per share and did a follow up offering in December of that year at $61.00 per share. Today the stock sits around $16.00 per share and is expected to earn about $1.14 in 2013 according to analyst estimates.

The stock's retreat from its all-time high in the low $60s was largely due to slowing growth and a sky-high valuation but more recently due to the inevitable competition that was bound to come. In October 2012, American Express rolled out a GPR card in conjunction with Wal-Mart called Bluebird. Green Dot is the exclusive provider of Wal-Mart's MoneyCard prepaid offering and represents nearly two-thirds of its revenues. Although Green Dot remains the exclusive provider of these services to the MoneyCard, Wal-Mart is not prohibited from offering competitive GPR cards within the store, thus providing an opening for American Express to enter this market. The doomsday scenario some investors envisioned, which brought the stock down over 20% in one day after the Bluebird announcement is not likely to occur. Partly because this is not a zero-sum game in terms of customer acquisition, meaning the entire industry is still growing and far from entering it mature stage. More importantly perhaps is the obvious fact that the Bluebird card can only be used at merchants or service providers that take American Express, whose numbers are still far below locations covered by the vast Visa/MasterCard network. And generally speaking, those locations that do take American Express aren't likely to be catering to the un-banked or underbanked segment of the population. In fact, during Green Dot's fourth-quarter earnings call, the company indicated that despite a decline in new card activations at Wal-Mart, the total active card base actually increased 3% and total revenues increased 14%.

Another important competitive advantage for Green Dot results from its acquisition of a small bank for $15.7 million in late 2011. As a bank holding company, it now has the flexibility to provide more products and services than it would otherwise as just a technology and distribution company. This move also reduces the risks of relying on unaffiliated bank issuing partners and now makes the company almost completely vertically integrated.

Green Dot's balance sheet remains strong with $190 million in available cash and no debt as of the end of 2012. The company's capital allocation focus remains on M&A and looks to acquire products or services in peripheral markets in order to diversify its revenue streams. I expect some tuck-in activity to occur during 2013, perhaps in the mobile banking space. The company's total capital needs are relatively modest and average between 4-5% of revenues so free cash flow generation is not an issue.

What's it worth? The simplest valuation tool is to look at the recent acquisition of its largest competitor, Netspend (NASDAQ:NTSP). In February of this year, Netspend was acquired by TSYS for about $1.4 billion, which put the takeout value at 11.5 X EBITDA. Green Dot has about 50% more revenues than Netspend and almost twice the active card base. Yet today Green Dot trades at only 5.5 X my estimate of 2013 EBITDA so the comparable M&A valuation would be in the low $30s for GDOT. However, the new competitive situation at Wal-Mart as well as the company's new self-imposed risk control measures will take a toll on growth in 2013 compared to prior years, yet the valuation discount still seems too great even taking that into account. Considering all those issues and the slower to flat growth in 2013 and then projecting mid-single digit growth over the long term values Green Dot in the $20-$22 range according to our calculations.

So whether you're never-banked, previously-banked, underbanked or, if you're reading this - probably fully-banked, there is probably a General Purpose Reloadable card somewhere in your future. And the lowest cost provider with the widest network of retail locations and the industry's leading reload network by far is Green Dot Corporation. Whether it remains a stand-alone company or becomes part of a larger organization, we believe the intrinsic value of the company is significantly higher than it is today.

Disclosure: I am long GDOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities or mutual funds. Before buying or selling any stock, bond or fund, you should do your own research and reach your own conclusion. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial advisor before making an investment decision. Mutual fund, stock and bond investing includes certain risks including loss of principal.