Description

It’s very rare that we flip from being short a name to being long within a 12 month period but that has happened with Green Dot (GDOT) and we think it has multi-bagger potential from here.  The key to our pivot after the stock puked in August was our diligence on their BaaS (Banking as a Service) business which we think is worth at least double to market cap by itself. In addition, it’s consumer business which has been challenged by silicon valley funded Neobanks such as Chime, N29, etc, has launched it’s own digital product to compete (Unlimited Card), and is a good “contra WeWork/Softbank” trade as their portfolio companies pivot to focus more on profitability vs the scorched earth market share strategy.

GDOT was last written up on VIC in 2014 as a short, coincidentally this was the last period of heightened competitive activity in the industry as Amex and Chase tried to enter the market sparking a price war (unless you were very cute with your cover the short would have been quite tough).  The situation back then was very similar to today, irrational pricing, fears of the business going away, and a WMT contract that needed to be renewed, which except for the WMT part is exactly where we find ourselves today. The stock price hasn’t changed much since then but the business is completely different in a much improved way:

• WMT represents about 33% of their business vs closer to 70% and they just resigned them to an expanded deal that doesn’t expire until 2027 (7 years vs the prior two renewals of 5 years)

• Their consumer business is 60% of the business now vs 100% back then, of this 60% only 10% is “churn n’ burn” one time use cards vs close to 100% in 2014, the rest is stickier higher margin direct deposit accounts

• They have created a BaaS platform from scratch that counts AAPL, UBER, INTU, as customers (all with fresh multiyear contracts)

So what happened in 2019 to get the stock collapsing from $90 to $25?  It has really boiled down to competitive pressures from the Neobanks mentioned above, this caused active card growth go negative as consumers experimented will low cost digital alternatives, this caused earnings estimates to decline basically every time they reported earnings.  The final straw was a surprise reset of 2020 expectations on the Q3 call which, while disappointing, feels like a kitchen sink setup.

From here our bullish thesis rests on:

• They are competitively advantaged vs their start up entrants because they can provide their corporate customers and consumers with a fully integrated process, most importantly this includes their bank charter, nobody else has this and it’s a big deal, more on this later

• The BaaS/Platform services business is worth somewhere between $1B and $3B alone depending on your valuation aggressiveness vs the current $1.3B cap.  The closest comp would be QTWO which trades at 9x forward sales, but due to the banking integration mentioned above we think it is actually more valuable (a little tidbit, despite GDOT’s gross looking chart and depressed valuation QTWO won’t deny that they have a great product if you talk to them).  Again, they just signed a multiyear and expanded deal with UBER, and have existing contracts with INTU/AAPL

• The decline in active cards in their consumer business should stem as their new Unlimited Card product, which competes directly with the Neobanks, gains traction.  Early app downloads and account metrics are positive. This is really what has driven the stock down this year

• This is a contra Softbank/WeWork trade.  Chime is similar to other “disruptors” like Compass or OpenDoor in the sense that they aren’t providing any incremental value or offering better products, they’re just subsidizing a lower cost to consumers supported by a pile of cash that is being lit on fire.  It seems the tides may have turned here after the WeWork debacle.  

• Resigning WMT to a 7 year deal cleared a big overhang and with their other large customers also resigning multiyear deals there is very little in the way of contract risk for a number of years (it had been rumored almost since they signed the UBER contract that PYPL would take it from them…) 

• GDOT is dirt cheap, it trades for 12x our 2021 cash EPS and 6x EBITDA, we think earnings power a couple of years out is easily $3.00+ supporting a $60+ stock price

• The balance sheet is clean with $80m in corporate cash, no debt, and we estimate an overcapitalization of $100m at the bank level 

• The 2020 guide which implies EPS of $1.75 or so feels like a kitchen sink to us.  It includes further weakening of the consumer business until 2H when comps get easier, it includes the assumption of further rate cuts from today’s levels, it includes a marketing cushion in case competition reaccelerates, and it includes spending to ramp up all the new business they’ve won in their BaaS segment (a good thing in our books…)

Why owning their own bank matters

Simply put, it’s control.  Let’s look at the consumer end of things first.  Chime’s platform relies on their platform software integrating into Galileo’s processing platform which integrates into their banking partner’s (Bancorp) plumbing for the real nuts and bolts. GDOT does all of that themselves.  It kind of shows that Chime is really a marketing company with a user interface for banking attached. Anyways, as a result Chime has had numerous outages including the most recent (https://fortune.com/2019/12/04/chime-bank-debit-card-problems-growth/) which left customers without access to their funds and causing some to be arrested because they couldn’t settle restaurant tabs!  We’ve heard that this has caused the regulators to start knocking on their doors.

When it comes to BaaS, our first question when we were short the stock was why would tech titans like UBER/AAPL ever need GDOT to do anything for them?  The key really is end to end integration from a banking back end to a customer support program all provided by GDOT. But really what it allows someone like UBER to do is tweak their program instantly without having to go back to the bank and ask for help every time something needs to get done (ie--their switch to instant payments after every ride).

It should also be mentioned that GDOT is not monetizing their $1B float at the bank and mgmt has talked about getting more aggressive about doing so.

How it plays out from here

We think 2020 #s have been derisked so downside from here feels limited given the valuation and balance sheet strength.  The stock will work materially higher when the consumer business stabilizes and/or if they sign another large BaaS customer.  Our guess is that the consumer business returns to growth in Q3 but leading indicators such as app downloads will give a more real time picture and the stock should trade off that.  Someone from the fintech world coming in and acquiring this is a real possibility and given the valuation levels the group carries it would be accretive for almost anyone. We’ve been short SQ for a while but I would cover if they bought GDOT, which they should given how much financial sense it would make and the fact that they’ve been trying to get a bank charter for a few years.

Summary

GDOT’s business has always been about providing the underbanked with financial services, this is a secular growth story.  Every few years they go through a competitive cycle and remake themselves, you want to buy the stock in the middle of the battle.  On the other end of this their consumer business will likely be almost all digital and their BaaS business will be much larger. The WeWork disaster feels like a turning point for undifferentiated cash burning “me too’s” from silicon valley and this has been GDOT’s biggest pain point.  

Catalyst

-performance of the Unlimited Card

-news on Chime’s success or regulatory issues 

-performance of the consumer active card metrics in 1H 2020