September 23, 2013 - 2:59pm EST by
2013 2014
Price: 7.02 EPS $0.65 $0.75
Shares Out. (in M): 47 P/E 10.7x 13.5x
Market Cap (in $M): 329 P/FCF 10.0x 13.0x
Net Debt (in $M): 105 EBIT 55 65
TEV (in $M): 434 TEV/EBIT 8.0x 6.7x

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  • Financial services
  • SaaS
  • Education


Higher One (ONE) is now down over 50% since the write-up by sfdoj posted over 18 months ago. I see real value in the shares today.

ONE is a hybrid between a financial firm and software-as-a-service company. In their hybrid setup, they serve higher education institutions (with their software-as-a-service model) and college students (as a debit card issuer).

About 65% of their revenue comes from the student side their business, primarily through its debit card revenue. The other 35% of revenues come from directly from colleges and universities, through software and service fees.

Today, they serve - in one capacity or another - colleges and universities that enroll about 13 million college students. This base of institutions represents over 60% of the total market of about 20 million enrolled college students in the US. I see this as a deep reach into which they can continue to grow over time.

As some repeated background, Higher One was started by a few Yale graduates back in 2000. As sfdoj mentioned in his/her write-up in March 2012, the company was originally funded by a few VC firms, some of which are still major shareholders. In 2010, ONE went public at $12 per share. Their shares traded for as high as $21 back in mid-2011 as growth surged. By last year at this time, their stock was trading for around $13 per share. Today, it's hitting new all-time lows of $7 per share. They are getting no credit for future growth prospects.

I do not believe this decline is indicative of a permanent re-rating of their business prospects or current operations.

ONE has basically gone from being a darling, fast-growing start-up to being seen as a slower-growing, maturing story in less than a year. This type of investor sentiment change is an ingredient for value as well as for value traps. At today’s valuation, I do not think it’s a trap.

Given that ONE already has some reach through its various product offerings into 60% of the enrolled college student population, some expectation of business maturation and growing pains should be expected. Yet, as long as the valuation compensates for those things, some maturation is okay with me.

Here is some background on their important services for institutions and students for those who didn’t read the prior writeup submitted by sfdof back in 2012:

Within their main software business, they provide a much-needed solution to the administrative costs and hassle of sending non-tuition financial aid disbursements to enrolled students. First off, for those who aren’t really aware of the mechanics of financial aid (I wasn’t), the Education Department funnels federal financial aid dollars to the school, they take their tuition and then the schools funnels much of the rest directly to the student.

In the past, and still, many colleges would issue paper checks to students to cover expenses outside of the tuition bill. Increasingly, the cost of manually processing these paper checks is viewed as wasteful and the Education Department agrees. This view of the Education Department is a longer-term positive for Higher One.

Currently, rule-making bodies charged by federal regulators have begun the process of formalizing the need for less cumbersome, less costly and less fraud-prone methods of disbursing financial aid money to students. The movement to outsource this financial aid disbursement process is still ongoing. The savings for schools is real and Higher One is one of the main players to solve this problem for schools.

ONE’s solution was to offer an outsourcing service called OneDisburse that handles this entire process for schools. The financial aid money flows to ONE first and the recipient student has three choices to receive their money - open a OneAccount with Higher One (more below), provide ACH deposit information to deposit it into their own bank account (many students are unbanked, of course) or just receive a paper check (this creates access delays for students, of course).

Clearly, having the student choose the OneAccount is preferred by Higher One.

Of the 4 million student population covered by the institutions that utilize their OneDisburse service, Higher One has captured over 2 million active OneAccount holders. Moving this adoption rate from about 50% is a long-term key to their continued growth and higher stock price.

To help round out their contact with decision-makers at colleges, ONE recently purchased a software analytics business that works to help schools retain their students by minimizing dropout rates. This is their Campus Labs business. Revenues from this segment are small at about 5% of total revenues. However, it increased the reach into schools they don't already have in their stable with the OneDisburse service.

Further, Higher One also sells a service called CashNet that allows for e-invoicing and payments, the setup of payment plans for students and parents, among other services for the colleges and universities.

In total, while their signature service, OneDisburse, creates a toe-hold relationship with schools that enroll about 4 million students, the other added services now involve Higher One in schools that have an additional 8 million enrolled students. This deeper penetration creates a large cross-selling opportunity.

Again, Higher One’s software-as-a-service end with their OneDisburse, CashNet and Campus Labs services generate about 35% of total revenues. This brings me to the other side of their hybrid business model - the financial institution side of the story - their OneAccount debit card business.

About 65% of their revenues come students who open and use "free" checking accounts, OneAccounts, that include the issuance of debit/ATM cards. These cards are made possible through ONE’s partnerships with a few medium-size bank partners that operate way in the background.

Primarily, Higher One’s OneAccounts are fed by the financial aid disbursements routed by the OneDisburse service.

They make money in two ways on their 2 million active OneAccounts.

First, they charge fees paid for by the accountholder, such as fees from the use of non-Higher One ATMs (largely, avoidable), overdraft protection fees (avoidable) and PIN-based transactions (avoidable). These user fees generates about two-thirds of this side's revenues.

These user fees also have drawn the most negative press precipitated by a negative Spring 2012 report produced by consumer advocate group, PIRG. The idea that students receiving government supplied financial aid are paying banking fees creates some natural empathy. The upshot of this bad press has forced ONE to significantly change its fee schedule for its OneAccounts.

As I’ve reviewed the fee changes, I believe the world should like the OneAccount lot more now. In the end, the attractiveness of the OneAccount drives most of the value of Higher One. It was important to address the controversy correctly and I think they’ve done it. Their changes - despite ONE’s seemingly extraordinary previous efforts to explain to students the ways they could avoid paying fees (as seen here https://www.higheroneaccount.com/studentaccount/feeschedules.do) certainly make the OneAccount a more user-friendly product. I think these changes are a good sign that management is capable of listening.

However, of course, the net result of their changes is lower user-fee revenue.

In addition to simply lowering their fees and in some case eliminating them completely (such as a controversial non-activity fee), they also introduced two new account types that fully replace usage fees with a flat monthly fee of around $5 per month.  You can view the details of the account types and fees here. https://www.higheroneaccount.com/studentaccount/feeschedules.do  

Under their old fee structure, Higher One generated about $50 per account, per year from user fees. The adoption of the flat monthly user fee has been developed to generate a more friendly, more predictable and, overall, similar revenue stream.

The adoption rates across these three account types had created some revenue pressure and  some uncertainty. So much so, they eliminated financial guidance upon last quarter’s call. This took the stock down, obviously.

First, they've clearly lowered some fees and that's created revenue pressure. That pressure, on a year-over-year basis, will be anniversary'd next spring. Second, the mix between the three account types isn't going quite as modeled. It must be that students aren't switching to the flat monthly fee plan as much as management originally anticipated. Ironically, they must be sticking with the regular account with the now-lower fees. Students aren’t the most proactive people, I imagine, and inertia is to be expected.

Regardless, I look at this better pricing structure as a revenue growth blip and ultimately a net positive to overall OneAccount growth in the years ahead. This is important because of the other way Higher One makes money on their 2 million OneAccounts.

The other 35% of financial revenue earned from the OneAccounts is simply from transaction fees paid by the merchant. Like a traditional bank debit card issuer, ONE get a slice of each purchase made by the students. Obviously, card usage is a key driver of revenue. Overall, these transaction related fees generate about $30 per account, per year out of the total revenue of $80 per account, per year.

In the final analysis, the more money that pours into these OneAccounts, the more the debit cards are likely to be used and the more revenue they generate on the transaction fee side of their business. And, the more attractive they make the account for students, the higher the OneAccount initial adoption rate at outset as incoming freshman. Finally, the more attractive they make the account, the more likely graduates will keep their accounts active for years afterward. They currently have about 10% of all US college students as account holders. Continuing their client relationship beyond their college years is another possible source of future growth.

The past year's revenue organic growth on the OneAccount business was 14%. However, the last quarter saw a decline overall and this is the crux of the story. This story was clouded by the lower fee structure as well as the account type mix. The bright spot was an increase in debit card usage, which shows the heart of the value seen by the students. 

Now, adding to this fee cloud, management has also cited another troubling issue. This, along with the account type adoption mix issue, resulted in the cessation of forward guidance until things become clearer. Overall, college enrollment fell last year and appears to have done so again this fall.

A trend like this feeds negatively into their business. When this occurs, financial aid disbursements drop and the student head count drops for their OneDisburse product. These are the metrics that drive how they price their OneDisburse service. As a result, ONE decided with the changes to fees and account offerings and this declining enrollment near-term trend, there was no way to issue guidance for now. It was very understandable, of course.

Of course, the market hated this and the stock is off 35% since late July.

My initial interest in Higher One came from my last write-up on VIC, Sallie Mae. Last winter, Sallie Mae made the decision to exit their own financial aid disbursement business run out of their non-core Campus Solutions subsidiary. I think this acquisition by Higher One was intelligent and helps to deepen their relationship with more higher education institutions.

ONE bought Sallie Mae's unit for about $50 million or 2x revenues. It adds about 100 schools and diversifies their revenues a bit. Apparently, Campus Solutions gets far less than the 50% student adoption rate ONE gets into their OneAccount type setup. Besides the sales opportunity synergies within the new school base, ONE sees benefits in terms of its OneAccount openings.

It is important to note, this increase in OneAccount adoption by students of former Campus Solutions schools will take time as new students are the best converts as freshmen. The other obvious benefit to taking out Campus Solutions is the removal of a competitor for the OneDisburse business. After all, OneDisburse is ONE's main entry point into the schools' financial aid departments.

ONE’s management expects the Campus Solutions business to be accretive in 2014. Sallie Mae apparently saddled it with a bloated cost structure and heavy corporate overhead allocations. ONE took on their employees to smooth the transition of Campus Solutions clients. But, there is no doubt they will slash costs and use their own IT and overhead. They'll likely keep the best sales people around. They described this as a once-in-a-lifetime opportunity that they couldn't pass up.

Between their Campus Labs and Campus Solutions acquisitions plus their huge share buyback last year and the new headquarter buildout in New Haven all within the past year, they've taken on about $100 million in debt. Thankfully, the debt is all floating at a 2.5% rate. Obviously, they didn't anticipate the Campus Solutions opportunity and likely wouldn't have done the big share buyback plan when they had $50 million of cash and no debt on the balance sheet. However, their EBITDA is substantially more than enough to handle it all.

Nonetheless, the timing of the enrollment slowdown, the cloud created by the fee controversy and the spending of their excess cash just before two acquisitions for about $60 million came down the pike clearly wasn't the best in terms of timing.

But, frankly, this is what put this stock into a very nice value range of $7 per share.

Here are their numbers:

Their revenues are likely to be somewhere close to $200 million or so for 2013. They should generate about $60 million in EBITDA from this. After factoring in maintenance capex of about $8 to $10 million, interest cost of about $3 million, plus non-cash stock-based compensation expenses of about $4 million and a 35% tax expense, I estimate their adjusted-EPS is about $0.65 to $0.70 per share. This is about 10x earnings at today's price.

I think this valuation is too low given that I think will return to growth in the years ahead.

At a high level, college enrollment is slated to increase about 1.5% per year over the next decade. Additionally, overall college costs are likely rise as well. Probably by another 5% per year. As a result, financial aid will likely continue to flow at a similar if not greater clip than that. This is the secular backdrop for both their OneDisburse and OneAccount business - growing at about 6-7% per year, but at a lumpy pace depending on the business cycle.

Added to this, they are riding a trend of necessary shedding of non-core administrative functions for colleges and universities. Sending out checks is not a core function and provides fertile ground for outsourcing. Higher One meets this need for its clients.

They currently provide the OneDisburse service for only about 20% of the higher education population. Half of the their customers are two-year community colleges and the other half are four-year schools. Only a small sliver of their customer base is the troubled for-profit schools, by the way. This need for administrative efficiency will not go away and picking up additional schools in their stable will help drive growth.

Even within their own client-base of schools today, about 30% have adopted the OneDisburse service that feeds the OneAccount business. Increasing this 30% adoption rate provides a lot of future internal growth opportunities. It is hard to guess about the ultimate adoption rate for their OneDisburse service, but the cross-selling opportunities are there. In fact, boosting the cross-selling opportunities appears to be the main driver of the CashNet, Campus Labs and Campus Solutions acquisitions.

The prior write-up on ONE last year did project some lofty assumptions related to the potential product adoption rates. It also created some lofty valuation levels. While it is always easy in hindsight to see the errors in now-evidently optimistic assumptions, I agree that the levers for future growth are clearly apparent to Higher One’s management team.  

What can go wrong? There could be major issues with the transition of Campus Solution's clients, real regulatory pressure from politicians who really don't like students paying any bank fees (as if that’s possible) and continued weak enrollment trends. There could also be a major change in how banks earn transaction fees on card purchases, but this is quite unlikely given the major changes already made over the few years by regulators.

With the recent weakness of Higher One’s stock and with it trading at about 10x today’s my current estimate of earnings and with Higher One in midst of a cloud regarding recent fee changes and short-term college enrollment trends, I argue that the current $7 per share price tag is a very good entry point.   

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


Other than valuation and the eventual re-initiation of foward guidance upon improvement in the visibility of their business, there is no clear identifiable catalyst.
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