Description

Lipman Electronic Engineering– LPMA $42.15

While this may not be a typical VIC stock - since the stock has a high growth rate and very little hair on it - we find it to be a compelling investment, largely “undiscovered” by US investors. LPMA just went public in the US on 1/29/04 (has been public in Israel since 1998) and is not followed by any US analyst yet. Merrill Lynch and Piper Jaffray underwrote the deal and will most probably cover the stock. LPMA issued shares in the US to raise money for acquisitions and to gain some of benefits of being listed in the US (prestige etc..). Pro-forma for the offering, LPMA has a rock solid balance sheet with $11 in net cash. We feel LPMA will appreciate to over $60 and potentially $90 within 12-18 months providing a 50% - 100%+ return. Currently the stock trades at less than 10x 2005 earnings net of cash. By our calculations this stock has a $30-50 of potential upside and only $10 of downside under our worst-case scenario providing a 3-to-1 risk/reward scenario.

Lipman is the world’s 4th largest provider of electronic payment systems – they sell credit card swipe machines and related equipment under the NURIT brand name. However, the company is gaining share in all the markets they operate due to their superior technology and strategy. The main competitors are Verifone, Hypercom (HYC $5.60) and Ingenico. Why is Lipman’s technology better? Verifone has been flipped from HP to Gores to GTCR over the last few years and had underinvested in technology for a few years. Hypercom until very recently was controlled by the founder, a brilliant engineer but not a businessman. While new management at Hypercom is fixing the business (HYC stock, which we also own, is cheap, and will probably be bought by someone else for its US market share – net of cash, it is less than 1x sales), it does not have as strong a technology platform. Ingenico, a French company (need I say more), did lots of acquisitions that have never been properly integrated, they still have 3 separate platforms they must service and upgrade.

Lipman approaches the business differently than its comps. LPMA sells solutions to financial institutions not just boxes/terminals. Lipman designs all of the products to be backward and forward compatible so that it can upgrade all of its products for enhanced services and transition customers quickly. Due to this focus they have not lost any major customer in 10 years of operations. LPMA wins new customers by offering systems that provide more capabilities and therefore more transaction on the system. These services include, prepaid cellular airtime, gift cards and even some lottery functions. We regard LPMA’s management as top notch as they have shown great discipline and managerial skill growing in a methodical way over the last few years with stellar results. Not only is the company poised to continue to grow organically, but the company is perfectly positioned to make bolt-on acquisitions to enter new markets.

Lipman has dominant market share in Israel, Turkey, and Spain and has moved aggressively into the US, UK, Brazil and China. Market share in Israel is 50% and 70% in Turkey. They have also started a pilot program in India. Lipman has also been first to market with wireless solutions. In the US market, the company has primarily focused on the ISO (Independent Sales Organizations) where the company has achieved 50% market share.

Is this a good business to be in? The industry growth rate is north of 10% worldwide. Is there any doubt that credit and debit card transaction will continue to grow and displace cash and checks as the primary payment method? 3 reasons for continued growth over the next few years: 1) Security protocols are increasing around the world to prevent fraud, usually requiring an new machine or upgrade 2) Emerging markets – biggest growth here will come from China which has planned a massive roll-out ahead of the 2008 olympics 3) FDC/CE is going to fight for increased market share and a massive PIN pad roll-out. LPMA is positioned extraordinarily well for the security upgrades, with strong product and has a strong and growing market share in china (always tough to get exact data out of China on market share). LPMA has grown at more than twice the industry growth rate the last few years.

LPMA’s approach has allowed the company to achieve outlandish margins. The company has achieved the critical mass to cover their R&D and SG&A and drops tons of cash to the bottom line. Operating margins were 25.7% through September of 2003 down 450bps from 2002 mostly due to some pricing issues in Brazil (these should be resolved through LPMA using local manufacturing to achieve lower cost and import duties) and currency. Additionally, tax laws in Israel allow for very low tax rates, although they will likely rise somewhat in future years. LPMA is confident it can achieve 22%+ net income margin for the foreseeable future. CapEx is only $2mm a year.

LPMA will most likely make one acquisition in the next 3 months of a business with $20-30mm in revenue and a second of similar size late this year or early next year. The acquisitions will be of “local” companies that operate primarily in one country and have key customers that are very hard for “outsiders” to penetrate. LPMA will cut out duplicate R&D and other expenses and use the relationships and salespeople in place to roll-out their industry leading products. These independent companies need to get bought because they do not have the technology to compete successfully going forward. We doubt acquisition will be transacted at higher than 1-1.25x sales and maybe much less. LPMA has already identified their 1st acquisition, spoken to management and customers and feels very confident it will be consummated.

Pro-forma for the offering LPMA has $11+ in net cash per share!!!

2003 sales for LPMA are estimated to be approximately $120mm. Conservatively, the company will grow 15% a year for the next 2 years organically. If the company can pull-off the two acquisitions I anticipate sales in 2005 should approach $200mm or better (this assumes no new business from the acquisitions). Assuming margins can be sustained – management fells they can be -that would yield $3.30 per share in earnings. We feel LPMA’s growth rate and ability to retain customers warrants a valuation of around 20 times and a minimum of 16x, implying a mid $60s price – plus net cash. Many lower quality, slower growth companies trade at higher multiples (not that most of us would buy them, but growth managers pay anything for growth). We think 15% organic growth is CONSERATIVE down from almost 40% in 2003. LPMA has $155mm in PF cash and should generate $25mm+ in 2004, we expect acquisitions will require $50-100mm, leaving $80-130mm of cash or $6-9.50 per share

For those of you who care about stock splits, the company will most likely do a stock split in the next few months.

Fully Diluted shares 13.5mm


Mid 2005 target price scenarios
With acquisitions:
2005 Revenue - $200mm
2005 EPS - $3.30
Mutliple - 16 – 20x
Net Cash - $5 - 7.40
Total Value - $57.80 - 73.40

With acquisitions and 5% new biz in those acquisitions:
2005 Revenue - $210mm
2005 EPS - $3.50
Mutliple - 16 – 20x
Net Cash - $5 - 7.40
Total Value - $61 - 77.40

Without acquisitions:
2005 Revenue - $159mm
2005 EPS - $2.65
Mutiple - 16 - 20x
Net Cash - $12 – 13.30
Total Value - $54.40 – 66.30

If we get a growth stock multiple - by late 2004 forward pricing target scenario:

With acquisitions and 5% new biz in those acquisitions:
2005 Revenue - $210mm
2005 EPS - $3.50
Mutliple - 20 – 25x
Net Cash - $5 - 7.40
Total Value - $75 – 94.9


Risks:
Israel company discount
Chinese block foreigners from their market
Future acquisitions are not well integrated
Nuclear winter requires us to use gold as the primary currency

Worst-case Scenario – no acquisitions and terrible execution
2005 Revenue - $140mm 8% growth (below market rate)
2005 EPS - $1.75 15% margin (750bps lower than last 2003)
Mutiple - 12 - 15x
Net Cash - $10 – 12
Total Value - $31 – 38.25

Catalyst

New NASDAQ presence; accretive acquisitions ahead; sell-side coverage coming; Verifone IPO later this year