| 2014 | 2015 | ||||||
| Price: | 22.86 | EPS | $0.00 | $0.00 | |||
| Shares Out. (in M): | 52 | P/E | 0.0x | 0.0x | |||
| Market Cap (in $M): | 1,157 | P/FCF | 0.0x | 0.0x | |||
| Net Debt (in $M): | 2 | EBIT | 0 | 0 | |||
| TEV (in $M): | 1,159 | TEV/EBIT | 0.0x | 0.0x | |||
| Borrow Cost: | NA | ||||||
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- Prepaid Debit Card
- Secular decline
- Payment services
- Competitive Threats
- GREEN DOT CORP GDOT 12/22/2021
- GREEN DOT CORP GDOT 12/06/2019
- GREEN DOT CORP GDOT S 09/21/2010
- BETA
- NATIONAL VISION HLDGS INC EYE 10/14/2019
- PERRIGO CO PLC PRGO 03/08/2016
- NATIONAL VISION HLDGS INC EYE S 10/02/2019
- WALMART INC WMT 01/07/2022
- American Express Company AXP 10/14/2020
- American Express AXP 05/11/2015
- AMERICAN EXPRESS CO AXP 02/16/2020
- WAL-MART STORES INC WMT 11/11/2009
Description
Thesis—Short: I believe as much as 50-60% of the company’s revenue is in structural decline.
hawkeye901 has already posted a good write-up on GDOT with plenty of background, so I’ll refer you to that for a more detailed introduction. That said, not much has changed and the short is probably more attractive today that it was at $60.
As a quick refresher, GDOT is a provider of prepaid debit card products, primarily at WMT, which according to their 10-K represents 82% of their units (less on revenues since the WMT cards are priced lower than the GDOT branded cards). At the time of the IPO, this was an all trees grow to the sky story as prepaid was addressing a TAM of 10s of millions of unbanked and underbanked consumers in the US. This is a perfect lead in the first structural problem with the company: while the TAM is likely real (although way overstated), GDOT operates in the worst possible customer acquisition channel—a j-hook at WMT. This compares to First Data, Citi and a number of other global financial institutions who provide the same service via payroll. Ironically, First Data does the prepaid payroll cards for WMT’s own employees, despite GDOT’s “strong relationship” with the company. As a result the customer churn on GDOTs cards is incredibly high. The company has stopped disclosing the metrics (the last disclosures showed it to be 40-50% per quarter range), but the 10-K tells us that the average customer life is still 7 months. So in essence, GDOT has to completely replace its entire customer base twice a year.
THE KEY DEBATE:
YTD the stock is down ~12% as investors fret over how to handicap the outcome of a contract renewal with WMT (contract expires May 2015). Specifically GDOT is the program manager for a Wal-Mart branded prepaid card. The range of outcomes to this event are tremendous and its importance cannot be overstated considering that WMT has historically represented >60% of the company’s revenues. As a side point it’s worth noting that despite proclaiming itself as the leader in the industry, GDOT doesn’t have any real brand equity since the vast majority of its volumes are leveraged from WMT’s brand.
BUSINESS TRENDS:
At first blush, GDOT looks very cheap, but its balance sheet is deceptive. While Bloomberg will tell you that the company has $850m of cash, all of it but $149m is tied up as regulatory capital in the bank holding company (pro forma for the recent TPG acquisition). If I model the business as if there were no contract reset with WMT, the company is trading at 6.8x my 2015 EBITDA (again PF for the acquisition).
What’s even more amazing than an EBITDA that’s declining at a 9% annualized rate, is how low quality the EBITDA that they did produce actually was. My observation is based on the company taking an axe to its marketing budget in 2013 to make numbers. For a bit of perspective the stock imploded in mid-2012 bottoming around $10. Subsequently it spent most of 2013 as a beat and raise story, but we can see in the below chart that the beats were very low quality:
GDOT’s marketing spend (as disclosed in the 10-K) shrank from almost $22m in 2012 to $10m in 2013. This alone added 2 pts to its EBITDA margin in 2013.
I should point out that the above LTM EBITDA is adjusted to exclude $5.6m that management tried to sneak into Q1 results. The adjustment relates to a 1x benefit from accounts that previously had courtesy fee blocks that were lifted in the period. More difficult to adjust for/quantify however, was the accounting change made in Q1 as the company increased its capitalization rate for internally developed software. The point here mostly meant to demonstrate that while the above trends are bad, they’re actually even worse if you take into account management’s shady behavior.
Competition has always been a key focal point for the investment community when it comes to this name. To that point management has spent the last several years almost goading their competitors talking about how much Amex or Chase spent on marketing etc. and giving meaningless statistics without context to demonstrate that they’re outselling everyone and that competition hasn’t impacted them.
Well that seems to have stopped. Anyone who has been paying attention knows that American Express takes prepaid very seriously and has no intention of going away quietly. Investors first became concerned when Amex introduced its WMT exclusive Bluebird product in late 2012. GDOT was dismissive of the offering despite the fact that Amex ramped to >1m customers in its first year. Recall that it’s taken 15 years for GDOT to get to 4.5m customers and that’s while using the WMT brand. Things took another turn for the worse in April of this year when WMT opened its shelves up to even more prepaid venders including Serve, also from Amex. It’s important to note that Serve is not a WMT exclusive product (like Bluebird), but is the cheapest card on the market by a long shot. Based on this study the WMT MoneyCard (the lowest cost of GDOT’s products) ranks 13th: http://www.nerdwallet.com/prepaid/
So when we think more deeply about GDOT’s WMT business comping down 12% in the same quarter that Serve was put on the shelf next to it, do investors really believe that’s a coincidence? If they do, I can confirm that it’s not. I spoke to the Global SVP in charge of prepaid at Amex on 9/23/14 and asked him directly. He commented that his WMT business has “accelerated significantly”. Even more damning is that a year ago at this time management was getting the sell-side all lathered up about 6 new MoneyCard products they were rolling out in Q4. We can see pretty clearly how that went. So now we’ve come full circle to this week’s GoBank announcement… I’m taking the under.
What about the non-WMT business? Notice its growing nicely as indicated by the red bars in the chart above. Well it should be the question is will it continue. Starting in Q4 of last year, GDOT dramatically expanded its distribution footprint by signing new partnerships with check cashers and the dollar stores. As noted by JP Morgan in their 12/11/13 note, “New distribution agreements grow footprint by >70%”. So in essence the company grew its distribution footprint by over 70% and is achieving 20ish % growth as a result. These are clearly less productive assets. It will be interesting to see what happens when those distribution gains have to be lapped? What’s most ironic about this is that at the time of the IPO in 2010 GDOT looked down its nose at check cashing as a channel (that’s how NetSpend is distributed), but now that they’re starving for growth it’s ok. As a point of reference, Amex has vowed never to get into the check cashing channel given “reputational issues” and “brand degradation” risks.
This lengthy explanation is instructive in establishing a baseline for management’s credibility (in case the long-term stock chart wasn’t enough). On their Q3’13 call they were successful at squeezing shorts by announcing they would growth revenues by at least “double digits” in 2014. Undoubtedly, this confidence was informed by the abovementioned new product launches and increased distribution. Their downwardly revised guidance now calls for 5.6% revenue growth. GoBank is just the next iteration of the same playbook.
So at 6.8x 2015 EBITDA, I’m comfortable being short. I’m simply not convinced that is a low enough price considering how quickly the internal metrics are deteriorating with the backdrop of mounting competition. This is all before even considering what might happen in the WMT renegotiation.
WMT CONTRACT NEGOTIATION:
While nobody really has any clue what’s going to happen with the contract renegotiation with WMT, the sell-side is widely unimaginative when considering the range of outcomes. They successfully set-up a straw man and beat it this week, by saying that the GoBank announcement proves GDOT will not lose the WMT contract. First off, no it doesn’t, not even close. If WMT was negotiating with Kellogg and they expanded shelf space for one brand of cereal that doesn’t mean they’re not going to take shelf space away from the other Kellogg brand that’s comping down 12%. Second, I haven’t spoken to a single short who thinks GDOT is going to lose the WMT contract. Please see above for why I’m short—the WMT renegotiation is my free call option.
The contract that’s being negotiated was signed in 2010 and had a duration of 5 years. Embedded in that contract were 2 step-ups in commission payments to WMT to 22% in 2011 and 26% in 2013. My best guess is the baseline assumption for the bulls is that GDOT will get renewed with another 4% step-up to 30% on the commission rate. I don’t think people have put much though into the term. WMT isn’t in the habit of signing 5 year deals. GDOT knew they would need one to appease investors during the IPO so they gave away 5% of the company in their negotiation to get it. Irrespective of that fact, it’s been a pretty steady overhang on the stock for the entire time the company has been public. So unless GDOT dilutes investors by giving another slug of stock to WMT, I would expect the duration to be less than 5 years (probably 2 or 3 years). If that’s true, then the company will be in the clear for <12 months before it once again starts dominating every discussion management has. It would be instructive to know how the contracts with WMT were structured before 2010, but management won’t tell us. I’m guessing that’s not because the terms were so amazingly good.
So based on the above pricing comparison how would the bulls react if WMT told GDOT they wanted to start doing free reloads like Amex? The 10-K tells us that 87% of GDOT’s reload volume comes via WMT (it’s admittedly unclear how much of that is for the MoneyCard vs. third party). For context, reloads amount to 27% of GDOT’s revenues. Moreover, if both WMT and Amex are offering free reloads, how well do you think GDOT will be able to hold the line on pricing for their third party reloads? What about the monthly fee? What if that gets axed on the WMT branded cards? In both of these scenarios the company would experience a positive margin mix as the commissions to WMT are higher than other partners, but that would occur in the face of revenues falling off a cliff. Beyond that the after effect would leave GDOT with a portfolio of branded cards that aren’t even close to price competitive and in turn they would be forced to choose between market share and pricing. The company claims that price doesn’t matter and that the GDOT brand means something to customers looking for a trusted financial partner. Garbage. If you Google “prepaid card” GDOT doesn’t even show up on the first page in the organic search results. NetSpend shows up 4th, while the WMT MoneyCard shows up 5th. 100% of GDOT’s brand equity is tied up in WMT.
Clearly these are hypothetical scenarios, but you can guarantee the process is going to be super competitive. As a data point when this contract was bid in 2010, First Data reportedly offered to do it for free. The only reason WMT didn’t let them is because WMT was worried they weren’t a customer facing organization. Either way, free sets the bar pretty low.
At the end of the day GDOT finds itself in a pretty classic conundrum: it’s a single product company competing against global institutions that have different incentives for being in the space and are therefore willing to pursue the opportunity as a loss leader to feed another part of their business.
TPG ACQUISITION:
I have a lot of thoughts here, but will try to summarize. Good companies with 50% EBITDA margins don’t sell themselves for 5x EBITDA. I view the tax channel as a very low quality way to acquire customers and it exposes them to an outsized amount of fraud, which will likely increase their regulatory costs. See the 60 Minutes piece from last weekend (GDOT cards are prominently featured, but never mentioned outright): http://www.cbs.com/shows/60_minutes/video/RzmZGQTr7RPHG2pfxMj4ufrsdTRnQXPd/biggest-irs-scam-around-identity-tax-refund-fraud/
In addition, H&R Block has been aggressively lobbying congress to pass legislation that would require an annual certification process for tax preparers. They claim this will reduce fraud. It also has the side benefit for Block of adding a hefty regulatory burden to independent preparers, likely forcing a lot of them out of the industry. This probably isn’t a good thing for the 25,000 independents that feed TPG’s business.
ONE MORE THING:
Sequoia announced earlier this year that it intends to distribute its holdings including its Series A Preferred stock to its LPs. In total this amounts to 10.1m shares. In August management indicated that about 25% of this had been completed. Therefore in addition to the 6.1m shares coming to market as part of the TPG acquisition, Sequoia still has another 7.5m that they’re going to quietly dribble out to unnatural holders. Together these 13m shares represent ~43 days trading volume:
http://www.sec.gov/Archives/edgar/data/1386278/000138627814000011/a2014-02x06seqdistribution.htm
BUSINESS TRENDS:
At first blush, GDOT looks very cheap, but its balance sheet is deceptive. While Bloomberg will tell you that the company has $850m of cash, all of it but $149m is tied up as regulatory capital in the bank holding company (pro forma for the recent TPG acquisition). If I model the business as if there were no contract reset with WMT, the company is trading at 6.8x my 2015 EBITDA (again PF for the acquisition).
So the implied question is, does this valuation fairly reflect the underlying fundamentals in addition to the unknown range of outcomes related to the WMT renewal? To approach this question let us first just consider the business performance. As can be seen in the chart below, GDOT’s EBITDA seems to be in perpetual free fall:
What’s even more amazing than an EBITDA that’s declining at a 9% annualized rate, is how low quality the EBITDA that they did produce actually was. My observation is based on the company taking an axe to its marketing budget in 2013 to make numbers. For a bit of perspective the stock imploded in mid-2012 bottoming around $10. Subsequently it spent most of 2013 as a beat and raise story, but we can see in the below chart that the beats were very low quality:
GDOT’s marketing spend (as disclosed in the 10-K) shrank from almost $22m in 2012 to $10m in 2013. This alone added 2 pts to its EBITDA margin in 2013.
I should point out that the above LTM EBITDA is adjusted to exclude $5.6m that management tried to sneak into Q1 results. The adjustment relates to a 1x benefit from accounts that previously had courtesy fee blocks that were lifted in the period. More difficult to adjust for/quantify however, was the accounting change made in Q1 as the company increased its capitalization rate for internally developed software. The point here mostly meant to demonstrate that while the above trends are bad, they’re actually even worse if you take into account management’s shady behavior.
It’s hard to image the company cutting its marketing budget to levels not seen since 2009 would be good for sales—well it’s not. Management spent all of last year talking about how sales growth decelerated because they’re such stand up guys and they turned away so many fraudulent customers etc. Maybe so. They also coincidentally stopped supporting the business. The effects of this are evident in the below chart as we can clearly see that the growth rate in their WMT revenues has been on a steady decline since Q4’12:
Decelerating revenues at WMT is one thing, but GDOT’s revenues have actually been negative at WMT for 3 straight quarters, comping down 12% in Q2’14. So as a recap, WMT has historically represented ~65% of GDOT’s business, but that mix is now down to ~55% because they’re comping down double digits at the customer that controls 2/3 of their business and +80% of their units. The sell-side is somehow applauding this as “diversification”. I wonder how happy those buy rated analyst will be when GDOT “diversifies” their way out of WMT? Moreover, what can GDOT possibly be saying in their contract negotiations with WMT right now? “I know we’re not supporting the business with marketing dollars and as a result we’re comping down 12%, but how about another 5 year contract?”
Competition has always been a key focal point for the investment community when it comes to this name. To that point management has spent the last several years almost goading their competitors talking about how much Amex or Chase spent on marketing etc. and giving meaningless statistics without context to demonstrate that they’re outselling everyone and that competition hasn’t impacted them.
Well that seems to have stopped. Anyone who has been paying attention knows that American Express takes prepaid very seriously and has no intention of going away quietly. Investors first became concerned when Amex introduced its WMT exclusive Bluebird product in late 2012. GDOT was dismissive of the offering despite the fact that Amex ramped to >1m customers in its first year. Recall that it’s taken 15 years for GDOT to get to 4.5m customers and that’s while using the WMT brand. Things took another turn for the worse in April of this year when WMT opened its shelves up to even more prepaid venders including Serve, also from Amex. It’s important to note that Serve is not a WMT exclusive product (like Bluebird), but is the cheapest card on the market by a long shot. Based on this study the WMT MoneyCard (the lowest cost of GDOT’s products) ranks 13th: http://www.nerdwallet.com/prepaid/
So when we think more deeply about GDOT’s WMT business comping down 12% in the same quarter that Serve was put on the shelf next to it, do investors really believe that’s a coincidence? If they do, I can confirm that it’s not. I spoke to the Global SVP in charge of prepaid at Amex on 9/23/14 and asked him directly. He commented that his WMT business has “accelerated significantly”. Even more damning is that a year ago at this time management was getting the sell-side all lathered up about 6 new MoneyCard products they were rolling out in Q4. We can see pretty clearly how that went. So now we’ve come full circle to this week’s GoBank announcement… I’m taking the under.
What about the non-WMT business? Notice its growing nicely as indicated by the red bars in the chart above. Well it should be the question is will it continue. Starting in Q4 of last year, GDOT dramatically expanded its distribution footprint by signing new partnerships with check cashers and the dollar stores. As noted by JP Morgan in their 12/11/13 note, “New distribution agreements grow footprint by >70%”. So in essence the company grew its distribution footprint by over 70% and is achieving 20ish % growth as a result. These are clearly less productive assets. It will be interesting to see what happens when those distribution gains have to be lapped? What’s most ironic about this is that at the time of the IPO in 2010 GDOT looked down its nose at check cashing as a channel (that’s how NetSpend is distributed), but now that they’re starving for growth it’s ok. As a point of reference, Amex has vowed never to get into the check cashing channel given “reputational issues” and “brand degradation” risks.
This lengthy explanation is instructive in establishing a baseline for management’s credibility (in case the long-term stock chart wasn’t enough). On their Q3’13 call they were successful at squeezing shorts by announcing they would growth revenues by at least “double digits” in 2014. Undoubtedly, this confidence was informed by the abovementioned new product launches and increased distribution. Their downwardly revised guidance now calls for 5.6% revenue growth. GoBank is just the next iteration of the same playbook.
So at 6.8x 2015 EBITDA, I’m comfortable being short. I’m simply not convinced that is a low enough price considering how quickly the internal metrics are deteriorating with the backdrop of mounting competition. This is all before even considering what might happen in the WMT renegotiation.
WMT CONTRACT NEGOTIATION:
While nobody really has any clue what’s going to happen with the contract renegotiation with WMT, the sell-side is widely unimaginative when considering the range of outcomes. They successfully set-up a straw man and beat it this week, by saying that the GoBank announcement proves GDOT will not lose the WMT contract. First off, no it doesn’t, not even close. If WMT was negotiating with Kellogg and they expanded shelf space for one brand of cereal that doesn’t mean they’re not going to take shelf space away from the other Kellogg brand that’s comping down 12%. Second, I haven’t spoken to a single short who thinks GDOT is going to lose the WMT contract. Please see above for why I’m short—the WMT renegotiation is my free call option.
The contract that’s being negotiated was signed in 2010 and had a duration of 5 years. Embedded in that contract were 2 step-ups in commission payments to WMT to 22% in 2011 and 26% in 2013. My best guess is the baseline assumption for the bulls is that GDOT will get renewed with another 4% step-up to 30% on the commission rate. I don’t think people have put much though into the term. WMT isn’t in the habit of signing 5 year deals. GDOT knew they would need one to appease investors during the IPO so they gave away 5% of the company in their negotiation to get it. Irrespective of that fact, it’s been a pretty steady overhang on the stock for the entire time the company has been public. So unless GDOT dilutes investors by giving another slug of stock to WMT, I would expect the duration to be less than 5 years (probably 2 or 3 years). If that’s true, then the company will be in the clear for <12 months before it once again starts dominating every discussion management has. It would be instructive to know how the contracts with WMT were structured before 2010, but management won’t tell us. I’m guessing that’s not because the terms were so amazingly good.
In terms of coming up with a thoughtful range of outcomes there are many. It’s entirely possible that WMT brings in Amex as a second program manager for the MoneyCard, thus offering the program on 2 networks (Visa and Amex). This would be an absolute disaster for GDOT. Moreover, it’s possible that WMT cuts its commission rate with GDOT, but in the process forces them to slash pricing on its products. As of right now 62% of GDOT’s revenues come from customer pay fees (again that’s pro-forma for the recent acquisition). These are fees charged to the customer associated with monthly usage, reloads etc. Does anyone who has ever heard of WMT actually think that they’re simultaneously serious about being a player in prepaid, but content to let the card with their branding be underpriced by the competition? That’s what’s happening right now:
So based on the above pricing comparison how would the bulls react if WMT told GDOT they wanted to start doing free reloads like Amex? The 10-K tells us that 87% of GDOT’s reload volume comes via WMT (it’s admittedly unclear how much of that is for the MoneyCard vs. third party). For context, reloads amount to 27% of GDOT’s revenues. Moreover, if both WMT and Amex are offering free reloads, how well do you think GDOT will be able to hold the line on pricing for their third party reloads? What about the monthly fee? What if that gets axed on the WMT branded cards? In both of these scenarios the company would experience a positive margin mix as the commissions to WMT are higher than other partners, but that would occur in the face of revenues falling off a cliff. Beyond that the after effect would leave GDOT with a portfolio of branded cards that aren’t even close to price competitive and in turn they would be forced to choose between market share and pricing. The company claims that price doesn’t matter and that the GDOT brand means something to customers looking for a trusted financial partner. Garbage. If you Google “prepaid card” GDOT doesn’t even show up on the first page in the organic search results. NetSpend shows up 4th, while the WMT MoneyCard shows up 5th. 100% of GDOT’s brand equity is tied up in WMT.
Clearly these are hypothetical scenarios, but you can guarantee the process is going to be super competitive. As a data point when this contract was bid in 2010, First Data reportedly offered to do it for free. The only reason WMT didn’t let them is because WMT was worried they weren’t a customer facing organization. Either way, free sets the bar pretty low.
At the end of the day GDOT finds itself in a pretty classic conundrum: it’s a single product company competing against global institutions that have different incentives for being in the space and are therefore willing to pursue the opportunity as a loss leader to feed another part of their business.
TPG ACQUISITION:
I have a lot of thoughts here, but will try to summarize. Good companies with 50% EBITDA margins don’t sell themselves for 5x EBITDA. I view the tax channel as a very low quality way to acquire customers and it exposes them to an outsized amount of fraud, which will likely increase their regulatory costs. See the 60 Minutes piece from last weekend (GDOT cards are prominently featured, but never mentioned outright): http://www.cbs.com/shows/60_minutes/video/RzmZGQTr7RPHG2pfxMj4ufrsdTRnQXPd/biggest-irs-scam-around-identity-tax-refund-fraud/
In addition, H&R Block has been aggressively lobbying congress to pass legislation that would require an annual certification process for tax preparers. They claim this will reduce fraud. It also has the side benefit for Block of adding a hefty regulatory burden to independent preparers, likely forcing a lot of them out of the industry. This probably isn’t a good thing for the 25,000 independents that feed TPG’s business.
ONE MORE THING:
Sequoia announced earlier this year that it intends to distribute its holdings including its Series A Preferred stock to its LPs. In total this amounts to 10.1m shares. In August management indicated that about 25% of this had been completed. Therefore in addition to the 6.1m shares coming to market as part of the TPG acquisition, Sequoia still has another 7.5m that they’re going to quietly dribble out to unnatural holders. Together these 13m shares represent ~43 days trading volume:
http://www.sec.gov/Archives/edgar/data/1386278/000138627814000011/a2014-02x06seqdistribution.htm
I and/or others I advise hold a material investment in the issuer's securities.
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