Description

The below write-up focuses on what has changed at NCR since previous posts.  For those not familiar with the business, a general description of NCR can be found in the write-up posted on June 15, 2017 and we'd also point you to the Company's Investor Day presentation from Nov 7, 2018 (https://investor.ncr.com/static-files/7f1f62e4-53f4-469c-8683-993cb70f997c)

In the write-up we discuss eight main points that we believe will drive more than 50% upside in the stock through 2020.  Despite these materially positive changes, the stock is flat over the past twelve months and since new management joined last April (shortly after which, the new CEO bought in the open market at $29 a share, not much lower than today's price).  Additionally, the stock has also massively underperformed since Blackstone bought at $30 per share in 2015.     

1. New management
2. Entry into payments
3. New ATM upgrade cycle
4. Significant gas station POS opportunity
5. Improvement in digital banking 
6. Main competitor Diebold Nixdorf Inc (NYSE: DBD) in financial distress
7. Upside to numbers and conservative management team    
8. Rumors of PE interest limiting downside

We discuss each of these eight points in greater detail below:

1. New Management - On April 30, 2018, NCR appointed a new CEO (Michael Hayford) and Chairman (Frank Martire), who were previously CFO (2009-2013) and CEO (2009-2015) of Fidelity National Information Services (“FIS”), respectively.  While at FIS, they created a tremendous amount of shareholder value through both capital allocation and execution increasing FIS' share price over 3x from 2009 to 2015.  One of the main levers to realize value they pulled at FIS was purchasing early stage companies that were targeting the banks but did not have the brand or the sales force to fully realize their technology's potential.  This is a strategy they will employ at NCR, which we believe is a better platform to execute it on given NCR's 136 year-old brand, which is well-known among banks given its ATM footprint and service engineers on the ground.  Additionally, new management has relationships with many of the financial services customers that NCR is targeting.  After joining, Hayford and Martire also overhauled the executive team, replacing the COO, CFO, appointing a new CTO, and creating several new business units. 

2. Entry into Payments - NCR acquired Jetpay in Dec 2018, providing the Company with payment processing to vertically integrate with their POS offering.  NCR has 20-25% share of the market for POS systems in restaurants in the United States through their restaurant POS offering called Aloha.  This represents $150-$200bn of GPV, of which the Company is targeting 15% payments penetration.  We believe this number to be conservative given Lightspeed POS (CA: LPSD) is targeting over a 50% payments penetration of their customer base and PAR Technology (NYSE: PAR) identified a 55% penetration TAM on theirs.  But for now, assuming the Company's conservative penetration target of 15% and a 50bp take rate (vs LPSD targeting 65bps), the Company could generate over $100mm of high-margin revenue.  This opportunity is not baked into street numbers and is heavily discounted in the Company's valuation.  Further, NCR has additional opportunity to penetrate their other verticals such as hospitality with payments. 

3. New ATM Upgrade Cycle - The majority of ATMs run on Windows 7, whose Jan 14th, 2020 end of life is approaching after which Microsoft will no longer support it.  Consequently, demand has been robust as customers need to upgrade or replace their ATMs ahead of this date.  Reflecting this, NCR's ATM sales increased 21% y/y for the past two quarters and we expect significant growth into and residual demand after.  Outside of the refresh cycle there are secular tailwinds to ATMs offsetting less use of cash, such as: a) rising minimum wage rates are forcing banks to consider buying more high-end ATMs to save on labor costs, and b) tax reform made it more economical for customers to buy new hardware as 100% of capital expenditure can be expensed for tax purposes through 2022. 

4. Significant Gas Station POS Opportunity - Card networks have given gas stations until October 2020 to upgrade their POS systems to be EMV compliant after which they will have to bear the cost of card fraud.  NCR has historically had low market share with POS hardware at the gas pump but good share with the convenience stores at the gas station.  The company is now leveraging its position at the convenience store to try to take share at the gas pump.  To do this, NCR is offering retrofit gas pump EMV compliant POS hardware with screens that will drive traffic to the store (e.g. a customer may be able to order coffee at the gas pump and then go into the store to pick it up). Since most gas station owners realize higher profit margins in the convenience store, this solution can be very appealing.  Our checks with early adopters like Speedway have been positive.  The US has over 1mm gas pumps with the POS costing ~$8k per pump, assuming a conservative 10-15% market share this represents over a $1bn revenue opportunity that is not in sell-side numbers yet nor has it been written about in research reports..

5. Improvement in Digital Banking Software - In 2013, NCR acquired Digital Insight, a Digital Banking company.  Under previous NCR management, this business was mismanaged due to a wrong sales strategy where they replaced the Digital Insight's specialized sales force with the general sales team at NCR.  Given the specialized nature of the product, a focused sales team is needed to effectively sell the product.  New management has reinvested in the business and on Jan 29th hired a new head, Douglas Brown, for the unit.  Brown was most recently at FIS, where he was Head of Digital and Mobile - our checks on him have been very positive.  Our checks also imply an opportunity for NCR in the space if they invest in the product and team, both of which they have done.  The turnaround effort has begun to bear fruit, going from largely no wins to 7 announced this past quarter alone.  For context, we estimate Q2 Holdings (NYSE: QTWO), a Digital Banking competitor with a ~$3bn market cap, added 38 in all of 2018 while growing revenue 24% y/y.  We expect to see continued improvement on this front given the secular growth for Digital Banking, NCR's brand, a new team, renewed investment and a competitive with Q2's.

6. Main Competitor Diebold Nixdorf Inc (NYSE: DBD) in Financial Distress - as has been well documented, DBD has been struggling and burdened with an overly-levered balance sheet.  This has forced them to retreat in certain areas, cut costs that have resulted in customer frustration, along with solvency concerns from their customer base.  Of note, when Diebold acquired Wincor Nixdorf, a German based ATM company, in 2015 they cut a significant portion of their ATM service engineers as part of the synergies.  This resulted in customer frustration with the quality of their Service business, which had been an area of strength.  Further, currently customers are concerned that more engineers will have to be cut as part of DBD's turnaround strategy.  This is in contrast to NCR who is investing in the space and has the ability to service DBD ATM machines.  Consequently, NCR has been able to gain share in Services, and with contracts of 3-5 years in length we expect NCR to continue to take share as contracts come up for renewal in the coming years.  NCR's commentary around Europe has also been more positive, implying they are gaining share there too.  DBD has also decided to back away from the US retail space.  Last, DBD's balance sheet has prevented them from being as aggressive as NCR on transitioning the business to more software and services, with DBD forced to allocate limited FCF to paydown debt while NCR has targeted $350mm for M&A this year.

7. Upside to Numbers and Conservative Management Team - we believe there is a high likelihood of upside to the Company's guidance as they didn’t take up their full year guide despite a much stronger business than when they initially provided it.  For example, below is an excerpt from the Q4 '18 call when they initially provided guidance compared with the commentary on the Q1 '19 call:

Q4 '18: "We think we'll get a little growth out of ATM business this year into '19."

Q1 '19: "And you can see in the first quarter, the results are strong. As Andre talked about, the backlog heading into the second quarter is also very strong. So I feel very good about the second quarter. I think we talked about this heading into the year, we felt that '19 would be a solid year for us in the ATM business, and it's starting to bear out that way. On the digital banking that you referenced, I think we feel pretty good about -- I think -- actually probably better than pretty good."

As seen in the above excerpt, management was also bullish on Q2.  Additionally, while at FIS  management earned a "conservative beat and raise" reputation.  With 2019 as their first full year under the helm, we believe management is setting themselves up to repeat this formula going forward.  Street numbers are currently in line with Company's guidance.

8. Rumors of PE Interest Limits Downside - Over the past month, Bloomberg and Dealreporter have reported that several Private Equity firms, including Warburg Pincus and Apollo, were exploring a purchase of the Company, and that NCR had enlisted Bank of America to help it explore options.  While we would be disappointed were NCR to agree to a sale to a financial sponsor given the upside opportunity in the stock, we believe Private Equity interest helps limit downside in the stock.  Further, the Board granted management extra share-based compensation if the stock was above $40 for 15 straight days before February 15, 2019.  While the deadline has passed, we believe this is evidence of the Board's willingness to evaluate potential offers, the significant dislocation between the stock price and where the Company believes it should be, and the shareholder alignment between the board, management and shareholders.

Valuation

In our base case, we see over 50% upside for NCR by year-end 2020 using a 12x FCF multiple.  In our more bullish cases, we see over 75-100% upside potential from multiple expansion due to their transition towards a higher-margin and more recurring software business model (during their Nov 2018 Investor Day new management targeted software and services revenue to represent 80% of the total by 2023, up from 2/3 today) and upside to opportunities such as payments where we believe we may be overly-conservative.

Catalysts

• Company provides more clarity around the gas station POS opportunity
• Beat and raise to guidance
• Continued evidence of share gains
• Improving software mix
• Further data points around the turnaround of Digital Banking
• Takeout

Risks

• Supply Chain Issues - NCR struggled with supply chain issues in 2018, but successfully closed 3 plants in 2018 and began to outsource manufacturing, production and logistics.  The results of this transition started to bear fruit in the back-half of 2018 and NCR expects to continue improving the profitability of the segment throughout the year.
• Missteps on growing Software and Services
• Competition from Korea based Hyosung - Hyosung is more focused on low-end ATMs and NCR more on the higher-end.  Additionally, as banks close branches they are more focused on higher-end machines to replace what used to happen at the branch.  Consequently, we don't see this threat as significant especially when compared to the share gains NCR is taking from DBD.  

The information provided in this presentation is provided for informational purposes and is not investment advice or a recommendation to purchase or sell any specific security.

Catalyst