Gravity Pay Puts Spotlight On Booming Transaction Sector

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Includes: FISV, GPN, MA, V, VNTV
by: Dana Blankenhorn

Summary

Transaction processors can be very profitable.

Processors are not being replaced as new payment methods come along.

Transaction processing stocks are on fire.

A lot of people have weighed in on the decision by Gravity Payments to put a $70,000 floor under salaries, but there's a factor in this that investors are missing.

That is, Gravity can do this because of the industry it is in, and that sector is booming. The CEO in this case also gave himself that $70,000 salary, but don't cry for him. He and his brother own all the equity.

Gravity is a transaction processing platform. Someone pulls out a credit or debit card, they run it through a terminal at a store or behind a computer, and the processor handles the computing details, passing the transaction among the buyer's bank and seller's bank, then handling settlements.

My wife has made her career in this sector, so I have sought ignorance of it in order not to violate her confidence. When she got her job, over 30 years ago, she told me she "wanted to work on a computer that makes money." Thus, I know two things about processing. It's complicated and it's profitable.

This year the sector has been on fire. Over the last year, gains among the publicly-traded players have averaged 30%-40%. The best known are Visa (NYSE:V), up 33% and the subject of a recent stock split, and MasterCard (NYSE:MA), up 30%. But there are also independent processors like Vantiv (NYSE:VNTV), up 34%, and Heartland (HPY), up 37%.

These companies run with relatively few employees. Most are highly-skilled computer programmers who must not only run highly-secure systems but jump on new regulations from Visa or the government in order to maintain their status. A breach in security, like one that hit Heartland in 2009, can be very costly - losses were estimated at $140 million a year later and were not yet capped.

The point is, there aren't many people working at these companies who are worth less than $70,000 each. For a relatively new processor like Gravity, privately held and founded in 2004, there are literally none.

Despite all the publicity over mobile payments and new methods of payment, the processors also sit in a secure position. Devices like Apple (NASDAQ:AAPL) Pay and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) Wallet don't really bypass existing payment systems. They augment them. Transactions must still be processed, and these systems simply add transactions to existing networks.

Let's look at one such processor to see what investors are getting. Fiserv (NYSE:FI), based in Brookfield, WI, had earnings of $754 million, or $2.98 per share fully diluted, on revenues of $5.06 billion in 2014. Its operating margin was about 25%, and that had been stable over five years. Top line growth over the previous four years averaged better than 5%. The balance sheet showed $3.77 billion in debt covering $9.34 billion in assets. Operating cash flow was moving slowly past the $1 billion/year mark.

It's a nice stable business worth $18.76 billion at the start of trading today. Given the industry's growth, it sports a relatively bargain Price/Earnings ratio of 26, and there are less than 239 million shares outstanding. Within the industry, it's a relative bargain - Visa currently sports a P/E of nearly 30, Vantiv a P/E of 54, and Heartland a P/E of over 56.

Investors need to look closely at the processors to see if they're doing things other than credit cards. A lot of industries are moving toward a back-end processing model, and these companies find related industries attractive. Fiserv, for instance, does payroll processing. Intercontinental Exchange (NYSE:ICE), which is basically a payment processor for trading securities, owns a little operation called the New York Stock Exchange. (Maybe you have heard of it.)

Anyway, it's a nice business. The computers do indeed make money. It's an area where the employees are valuable, where a $70,000 salary is not out of line, and investors are now discovering it. The Gravity story may lead a few more that way.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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