Stamps.com: Now Very Interesting

Summary

• After the challenging year Stamps.com has had, Q2 2019 offered investors some respite.
• Substantial acquisitions and heavy stock-based compensation take away from Stamps.com's bottom line profitability.
• On balance, its valuation is starting to look attractive.
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Investment Thesis

Stamps.com (NASDAQ:STMP) is a stock which has rapidly fallen from grace. Naturally, this appeals to my contrarian, deep value stance. Stamps.com is trying very hard to steady its footing.

For now, its valuation, despite being more attractive, is still slightly expensive for this value investor.

Changing My Mind

Back in March 2019, when the share price was approximately $83, I wrote an article titled, My Lessons In Sunken Cost Bias, and here is an excerpt:

[I was] spending time trying to figure out why investing in this company could work out satisfactorily. As investors, the more time we spend on a company, it is only natural that we become increasingly optimistic about its positive prospects, while at the same time turning down the volume on the negative reasons why it won't work out.

The point of that article was to describe how I had spent a considerable amount of time attempting to ascertain all the moving parts of an investment in Stamps.com and whether it carried enough margin of safety. At the time, I concluded by saying that investors would be better off not getting involved with the company.

Today's share price is a more appealing $55 and $1.2 billion market cap - essentially the same price Stamps.com was in 2015.

Looking ahead, Stamps.com still carries a lot of uncertainty, predominantly around whether it will continue to be as acquisitive as it has been in the past.

Below is a table from my previous article to get a feel for Stamps.com's cash flow movements.

For example, for 2018, Stamps.com's cash flow from operations reached $276 million. But that year, Stamps.com spent $209 million in the acquisition of MetaPack. Consequently, Stamps.com's 2018 actual free cash flow is not $273 million, but closer to $60 million once MetaPack is incorporated.

Passionate shareholders might contend that acquisitions are not typically factored into free cash flow calculations. And they would be correct were it not for the recurring nature of acquisitions which Stamps.com embarks on.

Future Profit Margins?

Another problem for shareholders is that it's difficult to know what Stamps.com's profit margins are likely to look like in 2020.

The fact that the USPS commission revenue has been eliminated is one problem. Lower margins as Stamps.com broadens its international offering is another problem.

On the other hand, Stamps.com is determined to broaden its portfolio of solutions so customers can use alternatives to the USPS.

Having said that, when it comes to Stamps.com's margin profile, investors should remember that the real cost to its operations is in the form of stock-based compensation which amounts to $45 million for 2019.

Given that Stamps.com's full-year 2019 GAAP midpoint net income is only expected to reach $35 million, this does not leave investors with enough to make for a highly compelling investment.

Share Repurchases: Mistimed?

Stamps.com's balance sheet carries $110 million of cash and equivalents and approximately $56 million of total debt, thus a solid $54 million net cash position.

Given that it continues to be a solid cash flow generating company, and its share price collapsed, it is nice to see Stamps.com have a share repurchase program.

Since announcing its share repurchase program in March 2019, through to the end of June 2019, Stamps.com had repurchased approximately $20 million worth of stock at approximately $68 per share.

Given how aggressively the company was repurchasing the stock in the first quarter, and only a further $10 million after the first quarter, it highlights a management team which is either a poor capital allocator, or a management team which was caught flat-footed with the loss of the USPS commission revenue, or both. Either way, investors should be wary of just how much trust one puts into this management team.

Valuation - Satisfactory Margin Of Safety

Superficially, Stamps.com has the trademark of a very attractive investment.

It appears to be an asset-light operation. However, as highlighted above, it is a consistent acquirer of companies, which takes substantial cash flows away from shareholders.

Secondly, it has a disproportionately high stock-based compensation structure.

Finally, for the full year 2019, Stamps.com's bottom-line GAAP EPS number is expected to reach approximately $2.00 at the mid-point. Given that the share price is still above $55, this puts the stock at a forward multiple of 22x, which becomes interesting if the company can continue to grow in 2020.

The Bottom Line

Stamps.com is undergoing a very dynamic period in its operations. Realistically, for now, there is very little light at the end of the tunnel.

Having said that, investors should be realistic that despite diminished profit margins going forward, there is still a very much worthwhile and cash flow generating business, which already has much of the downside priced in already.

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Disclosure: I/we 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.