Description

Metabank (CASH) is an Iowa-based bank with a fast growing prepaid debit card operation (Meta Payment Systems—MPS) that will benefit from a rising interest rate environment. With a little luck, I believe the stock is capable of tripling over the next two years if the Fed raises rates to 3%+. (I will note that liquidity is limited, so this is more appropriate for PAs or smaller funds willing to be patient.) And my apologies to Ringo, but I was already writing CASH up when he posted TBBK and mentioned CASH as a potential follow-up.

Conway originally wrote the idea up in early 2007 when the stock was at $29. I recommend reading it to get a quick review of the company and the prepaid debit card business if you are not familiar with it in addition to the TBBK write-up, which I coincidentally wrote up a few years ago. Since then, CASH has performed well, although the traditional banking division did manage to make a few bad loans (nothing too serious however, and the company avoided any bailout money), and the profitability of the payments division has been hurt because of the low rate environment despite rapid top-line growth.

Recent Results and Developments

Results for the December quarter were excellent. CASH reported $1.2M of net income, or $0.45 per share, with $0.9M coming from the payments division, $0.5M coming from the traditional bank (and -$0.2M for corporate overhead). MPS saw its fee-based revenue grow 29% from $15.1M from a year ago to $19.5M. Net interest revenue also grew 34% from $2.5M to $3.3M, although this is from a small base. Non-interest bearing deposits also grew 37% over the year.

The quarter actually would have been much more profitable, except that Meta effectively has to pre-fund loan loss provision expense associated with MPS’s tax refund business (prepaid cards and refund anticipation loans to Jackson Hewitt and H&R Block customers), which generates the majority of its revenue in the current March quarter. This was $3.6M of the $4.7M in total loan loss provisions, or roughly $0.89 per share in after-tax EPS. This was offset, however, by $1.9M in securities gains, so the net drag to CASH was roughly $1.7M, or about $0.42 of EPS.

Credit quality remained good. Nonperforming assets (NPAs) rose marginally from $14.7M in September to $15.2M (they fell from 1.76% of total assets to 1.65%) and remain quite manageable, with only $0.1M in gross charge-offs and $0.5M in recoveries. NPAs stand at 124% of reserves, but the loss severity of the bad loans looks limited given the low charge-offs in the quarter.

In January, the company decided to reorganize MPS in effort to reign in costs and focus its many initiatives to those with the best revenue opportunities. This resulted in a reduction of 47 staff positions (about 10% of the entire company), reducing operating costs by $5M annually ($1.00+ in EPS), and will be neutral to March EPS and accretive thereafter.

In February, CASH also completed two common stock private placements, raising $8.9 million on the sale of 415,000 shares representing 13.5% of current outstanding shares. The offering was accretive to book value and intended to finance the continued rapid growth in deposits and assets, not plug any holes in the balance sheet from bad loans. CASH’s TCE ratio (tangible common equity divided by total assets) was a somewhat thin 5.1% at the end of the year, so the added capital is timely and puts the TCE ratio closer to 6%.

CASH’s Enviable Balance Sheet

Below is a snapshot of MPS’s balance sheet:

The reason why we should be excited about CASH’s prospects in a rising rate environment is that $541M of its deposits are non-interest bearing, or a substantial 62% of the total funding. As interest rates rise, CASH will enjoy operating leverage as yields on its assets rise while its funding cost remain near zero. With a 5% net interest spread vs. 3.32% currently, CASH’s annual net interest revenue would be about $15M higher, translating to around $2.50 of EPS.

Normalized Earnings

For calendar year 2010, I am forecasting MPS to generate $90M in revenue, and $8.8M in net income. I expect the traditional banking operations to generate $20M revenue and lose $1.0M. Combined, I expect the company to earn $2.32 in core EPS for the calendar year. For 2011, I am forecasting $129M in revenue for the entire company, $13M in earnings (10% profit margin) and $4.00 of EPS. In 2012, I am forecasting $159M in revenue, 22M in earnings (14% profit margin—lagging benefit of rising rates), and $6.70 in EPS. I will warn that modeling this company is difficult and management is very reluctant to give any guidance on the operating lines, so take the umbers with a grain of salt, but with top-line growing near 25%, the benefit of rising interest rates, and their restructuring, these numbers are fairly easy to get to.

Risks

MPS does have $19.9M invested in four trust preferred securities that the OTS (Office of Thrift Supervision) has forced CASH to classify as “substandard” because one of the national ratings agencies has rated them sub-investment grade. The securities are Huntington Capital Trust II SE, Bank Boston Capital Trust IV, BankAmerica Capital III, and Key Corp Capital I. Although interest payments continue to be made on a timely basis and no requests for payment deferrals have been made, CASH is at risk of a potential write-down. I estimate it could be as much as $6M in a worst-case scenario.

CASH, through its tax refund prepaid card operation, is getting more heavily involved with tax refund anticipation loans (RALs), which have been a lightning rod for regulatory risk in the past.

CASH is a bank. They have over $400M in loans, and in this struggling economy, it is possible and even likely that there will be some more credit quality hiccups on the way to recovery.

Valuation

CASH’s estimated tangible book value for March is $17.50 per share. With the stock at $23, that puts P/TB at 1.3 times. While the stock did dip below $10 during the financial crisis, I believe book value represents a realistic floor value, translating to downside of 25%

Even though CASH is technically a bank, its metrics make it more of a processing company—notably net interest income made up only 25% of revenue while fee-based income made up the remaining 75%. Most banks get 70%+ of the revenue from net interest, which generally gets a lower valuation multiple.

Total core revenue in the December quarter was $27.4M, or about $110M annualized. CASH’s market cap is $72M, putting the company at a trailing price-to-sales ratio of 65%--this is cheap for a processing company that will likely post healthy profit margins in the foreseeable future.

Charles Schwab trades at 30 times 2010 earnings, largely on expectations of improved profitability from rate increases. If you are looking for an interest rate play, CASH has far more upside.

CASH trades at a non-heroic 1.3 times book value and 10 times my 2010 EPS of $2.32. This is depressed by $1-2 because of the low interest rates. They are growing their top-line at nearly 30% and operating in a prepaid debit card industry that is growing rapidly as a whole. A company with normalized EPS of $4.00 growing near 30% per year can trade at 15 times earnings or $60 per share.

As Ringo recently pointed out in his write-up of TBBK, TBBK bought Stored Value Solutions (formerly run by Brad Hanson) for $60.6M when it had $115M in deposits, for a 50%+ deposit premium—pricey perhaps, but justified given the $800M in deposits it has today. In addition to a large stream of non-interest revenue, CASH’s MPS operation (currently run by Brad Hanson) has $592M in deposits, of which $541M were non-interest bearing—the most valuable kind of deposits. CASH’s entire market cap is only $72M, 13% of the non-interest deposits. The company is worth substantially more than the current value in a take-out.

Why is the stock cheap? In addition to the temporarily depressed earnings from the low rate environment, I believe there are two non-fundamental reasons why the stock is cheap:

No one on the sell side covers the company, and the last VIC posting was July 2008 until Ringo’s mention of them last week in his TBBK write-up. The company has been lost to investors since the financial crisis.

The high degree of seasonality, the September year-end, the rapid growth, the haphazard quarter-to-quarter profitability, and lumpy/one-time items of the last few quarters makes them difficult to model. This has disguised the value of the growth they have been reporting, but it is also what creates the current opportunity.

I believe the company is on the verge of consistently reporting profits, which will make the progress and the value much more apparent.

Catalysts:

Upside from rising interest rates

Catalyst

Upside from rising interest rates

March quarter is seasonally strongest quarter

Reporting consistent profitability along with rapid growth