Payment Data Systems: A Company Worth A Look In The Exciting Mobile Payments Space

| About: Payment Data (PYDS)

Summary

The mobile payments industry is set for significant growth.

Payment Data Systems is an emerging player in the mobile payments space.

Based on its growth potential, Payments Data Systems’ current valuation is not justified.

This is a very important period for retailers. The holiday season was launched with the start of "Black Friday". In 2014, an estimated 87 million shoppers hit retail stores on Black Friday. The National Retail Federation (NRF) expected an even higher number to hit stores in 2015. But an even higher number of individuals were expected to shop online on "Cyber Monday". An estimated 127 million people shopped online last year. Throughout the holiday season, online shopping will account for a significant portion of total holiday season shopping.

MarketWatch, citing data from the Adobe Digital Index, noted that e-commerce sales totaled $1.73 billion on Thanksgiving Day. Around 57% of traffic came from mobile devices such as smartphones and tablets. According to e-commerce software company ChannelAdvisor, online same-store sales rose 43.4% on a year-over-year basis. Increasing e-commerce sales are being driven by the increasing use of smartphones and tablets. Importantly, this trend is not just restricted to the U.S. Shoppers, who are increasingly moving online globally.

One of the beneficiaries of this trend has been the payments processing industry. In fact, PwC's Strategy& notes that the payments sector was once seen as a "quiet corner of the financial world" but the industry now is "on a roller-coaster" ride. Strategy&, in its report, cites the example of Starbucks (NASDAQ:SBUX), which in October 2014 said that around 15% of its purchases in its U.S. stores were paid through its mobile app. The company even has plans to launch a Mobile Order program across the U.S. by the end of this year.

The growth in the mobile payments sector has attracted even the likes of Visa (NYSE:V) and MasterCard (NYSE:MA). According to Forbes, both companies could see significant revenue boost on the mobile payment sector front. Forbes, citing data from Gartner (NYSE:IT), notes that globally mobile payments transaction volume was around $235.4 billion in 2013. Gartner further notes that in 2014 mobile payments transaction volume was estimated at around $325 billion and is expected to grow to $717 billion by 2017. That would represent a CAGR of more than 30%.

The outlook for the mobile payments industry is very robust and this got me interested in the sector. While looking for pure-play mobile payment processing companies, I came across a small San Antonio-based company called Payment Data Systems (NASDAQ:PYDS). PYDS has been covered by Seeking Alpha author Nicholas Bodnar in an article in October. Bodnar in his article focused on three potential catalysts for PYDS. One of the catalysts highlighted by Bodnar is an increase in federal funds rate. I have discussed the Fed fund rate in some articles here. There has been a great deal of uncertainty over when the Fed will hike its benchmark interest rates, which have stayed near zero since the financial crisis. But following a strong jobs report for October and November and based on the minutes of the Fed's most recent monetary policy meeting, it is likely that the central bank will hike its benchmark interest rates at its upcoming meeting later this month. The other catalysts highlighted by Bodnar were the Akimbo platform and a potential acquisition. I want to focus specifically on PYDS's growth prospects and the challenges the company faces right now.

Let me first start with PYDS's growth prospects. At an investment conference in October, Payment Data highlighted that it has seen a 28% CAGR in transaction processed between 2011 and 2015 (estimated). The company expects to process 14,500,000 transactions in 2015. If the growth rate is maintained by PYDS, the company would process nearly 50 million transactions by the end of this decade. In terms of dollars processed per year, between 2011 and 2015, PYDS has seen a CAGR of 75%. In 2015, the company expects to process $3.4 billion worth of transactions. If the CAGR is maintained for the next five years, by the end of this decade, the dollar volume processed by PYDS would total more than $55 billion. More importantly, the company's CAGR would be more than double that of the anticipated growth for the industry. As I noted above, market research firm Gartner expects transaction volume (in dollar terms) to grow at more than 30% annually between 2014 and 2017. Given that PYDS has grown at double that pace, and could potentially continue to do so, makes the company an attractive takeover target based on growth prospects. Also to put what the growing transaction volume means into prospective, in 2014 PayPal (NASDAQ:PYPL) processed $228 billion worth of transactions. So by 2020, PYDS could potentially become a fourth of the size of what PayPal currently is. PYDS's current market cap though doesn't reflect this potential in my opinion.

Despite the growth prospects, PYDS shares have struggled this year. One reason was the disappointing second-quarter results. For the quarter ended June 30, 2015, PYDS reported revenue of $3.42 million, up from $3.30 million reported for the same period in the previous year. While the revenue did increase on a year-over-year basis, the growth does not reflect the mobile payment industry's true potential. Having said that, the second quarter is a seasonally slow quarter. Revenue in the third quarter saw a 1% decline on a year-over-year basis. According to CEO Michael Long, the decline was primarily due to a 9% drop in return-check transactions processed. Long noted that in October the company launched a new product that meets the market needs and allows merchants to remain within regulatory compliance without the need to build out large and complex systems and see higher expenses. Long added that the response to the newly launched product has already been encouraging and, as a result, revenues are expected to rebound in the fourth quarter. I believe a rebound in revenue could provide a boost to the stock price.

The other concern has been operating expenses. The company's operating income was just $91.8k, down from $466.4k reported in the June quarter last year. The big drop in operating income was due to significantly higher operating expenses. Operating expenses rose from $2.84 million to $3.33 million. The increase though was mainly due to stock-based compensation. This trend continued in the third quarter of 2015. Stock-based compensation rose from approximately $73k in the third quarter of 2014 to around $338.5k in the third quarter of 2015. Operating income, meanwhile, dropped to $23.3k in the third quarter of 2015 from $676k. Third-quarter operating income though was also negatively impacted by costs associated up-listing to the NASDAQ. In my opinion, higher stock-based compensation is keeping market participants on the sidelines. But higher stock-based compensation is not necessarily a bad thing as it aligns the goals of shareholders and management. Importantly, it does not affect PYDS's cash position, which is important for a small company with limited resources. Also the stock-based compensation is not dilutive as SA author Adam Stockmeister noted in his September article on the company. Stockmeister noted that excluding unvested restricted shares and options, current shares outstanding are 7.37 million, which is actually lower than what it was in 2014. Operating income will also see an improvement once revenue picks up. The company is confident of a recovery in revenue in the fourth quarter. Remember that the fourth quarter is also a seasonally strong quarter because of the holiday season.

Another reason why investors are not warming up to PYDS is possibly lack of interest from institutions. However, the company has completed its up-listing recently. Up-listing to the NASDAQ will certainly increase the stock's visibility and more importantly create awareness among institutional investors. Once the smart money moves in, there will be increased confidence.

Disclosure: I am/we are long PYDS.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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