Description

Higher One Holdings, Inc. (ONE) provides payment and refund disbursement services primarily to community colleges.  At $3.06, the company is trading for 10x trailing earnings, 5.6x fully taxed trailing free cash flow and 5.6x trailing EBITDA (all three metrics are adjusted for the sale of their data analytics business which is expected to close in early December, that is, i.e., the metrics assume the sale closed at 12/31/2014). The company has net cash of  $18 million (again, post sale of the analytics business) and produced a 14% ROE for the 9 ME 9/30/15 (assuming no earnings from the analytics business). This is a modest valuation, especially in view of current market conditions and the company’s very low capital requirements (annual capex is running less than $10 million while cash from operations is north of $30 million). 

Business summary

After the sale of the analytics business (~ 8% of revenue and 14% of EBITDA), ONE will be in two lines of business: a) Payments and b) Disbursements.  The Payments business (37% of revenue, 43% of EBITRDA) is a suite of five services offered as Software as service to community colleges.  These services include ePayment, eBill and Tuition Payment plans (enables schools to produce online bills and accept online payments), eMarket (provides shools with Internet storefronts) and Cashiering (accounting for cash transactions). The revenue for these businesses is subscription based with the exception of transaction fees for credit card payments made by students.  (Unlike private businesses, not-for-profit businesses in some states are allowed to charge extra for use of a credit card, hence the transaction fee revenue). The revenue and earnings for Payments business are growing, all be it slowly.

ONE’s Disbursement business (55% of revenue, 43% of EBITDA) processes payments to students in instances when their financial aid payments (paid directly to the school) exceeds their tuition.  This typically occurs when financial aid is designed to pay for books and living expenses not provided by the school. The need for this service arose because students tend to be transient, so schools have difficulty knowing where to send the checks, and students business offices are not capable of dealing with a high volume of students collecting checks in person. ONE takes over this function providing a software as service solution to the school under a subscription model.  Students register with ONE as part of the registration process at their school.  Students are given a marketing packet which summarizes the following three ways the student may receive any future refunds he may be entitled to from the school:

•        Direct deposit of funds in the student’s checking account.
•        Mail a check to the student.
•       Transfer the money into a OneAccount established by the student.  The OneAccount is a checking account with a debit card that is marketed by ONE and is managed by a partner bank.  (95% of ONE’s disbursement revenue is generated by ONE accounts).

The student then selects one of these three methods. Five percent of ONE’s Disbursement business revenue is generated from subscriptions paid by schools, 95% is from fees earned from OneAccounts.  Of the revenue from OneAccounts, about 45% is from interchange fees (fees that are transparent to the account holder) and the balance is from fees charged to the account owner.  Fees charged to the account owner fall into two categories: upgraded account fees (for broader access to ATMs, this costs customers $5 to $6 per month) and penalties. The Disbursement’s business is declining, 15% in the most recent quarter year-over-year. This trend is the result of a decrease in the number of recipients (down 6% year-on-year, probably due to better economy, fewer people are attending community colleges), lower refund sizes (down 3% year-on-year) and a lower percentage of refunds going into OneAccounts (down 10% year-on-year). At least part of the negative trend in OneAccounts has to do with rule changes as to how ONE markets OneAccounts in the packaging distributed to students during registration. ONE management says that they are addressing this by developing new and more compelling features that will be bundled with the OneAccounts.

Regulatory problem

In addition to the negative trend with OneAccounts, ONE is in the midst of regulatory actions by the FDIC and the Federal Reserve (Fed).  The genesis of the review was when ONE partnered with a new bank that was regulated by the Fed and the Fed took issue with how ONE marketed its OneAccounts. (ONE’s other partner bank is regulated by the FDIC. Until the Fed raised the issue, the FDIC had not expressed an objection to how ONE marketed its OneAccounts). The regulatory actions are focused on how ONE marketed its OneAccounts from May 2012 through December 2013. The regulators contend that ONE’s marketing practices during this period violated UDAAP (unfair, deceptive, abusive acts and practices) standards and are demanding ONE provide restitution.

As a result of the regulatory actions, ONE’s founders, Mark Volchek and Miles Lasater, left the company (1H 2014), replaced by Marc Sheinbaum.  Sheinbaum was the president and CEO of JPMorgan Chase’s auto and student loan business from 2007 – 2013; before that, Sheinbaum was the president of GE Money Services.  ONE took an $8.75 million charge in 2014 and an additional $21.9 million charge so far in 2015, i.e., $30.6 million of charges so far. ONE management thinks that the maximum exposure they have to remedy this problem is $70 million – we include $70 million in our calculation of ONE’s enterprise value (market cap of $168 million, pro forma cash of $85.5 million, operating leases of $2.7 million, potential restitution liability of $70 million and debt of $67 million yielding an enterprise value of $223 million).  Assuming management is about right regarding the company’s maximum exposure, ONE is still modestly valued, e.g., ONE generated $30 million of cash from operations during 2014 and $33 million of cash from operations during the 9 ME 9/30/2015. 

Catalyst

1.           On October 30, The Department of Education issued new rules (effective July 2016) governing how disbursements are to be made.  ONE management believes that some of its clients were holding-back contract renewals until after these rules were announced.
2.           ONE management is launching a number of improvement to the OneAccounts which it thinks will make the accounts more attractive to customers.