Description

I am a short-seller. I love shorting. My personal account is net short, not based on some macro view, but I am drawn to over-hyped stocks. I wanted all my VIC ideas to be shorts.

STMP is my biggest position and my favorite idea. I am long.

When I first found STMP in early 2016 its successes made me an immediate skeptic. I wanted to short STMP. I wanted to hate STMP. But I couldn't get there. Then the short attacks started. First it was Friendly Bear on Seeking Alpha. Then Capital Forum. Next came Prescience Point. Then Avahaz did additional work for VIC - following another VIC short from earlier in the year. And just earlier today, Marc Cohodes threw his hat into the ring via Grant’s podcast and Twitter. These are all groups I respect. While each iteration of the STMP short thesis sounded exciting, the bear case has always faded as I realized that each negative point was either misguided or flat wrong.

Six years as a dedicated short-focused generalist has taught me a few things. One of which is when you think bears are wrong, you buy.

The Bull Pitch:
Stamps.com has transformed itself from a niche postage provider into a monopoly on the U.S. Postal Service’s non-retail shipping ecosystem. Stamps.com has a very attractive recurring revenue business model with mission critical solutions for dependent customers. The business model is capital-light with strong margins and high barriers to entry. Additionally, Stamps.com has a large and growing addressable market, strong structural tailwinds fueled by eCommerce, and a smart and opportunistic management team.  The balance sheet is clean and the valuation is undemanding and attractive due to relentless short reports. I believe STMP can compound earnings at over 25% for the next 5-10 years and will be a $500 stock in 5 years.

Background

STMP is a controversial and well-discussed idea in the hedge fund community. But let’s start with a background discussion. Stamps.com is the leading provider of internet-based mailing and shipping solutions. It became the first USPS-licensed vendor in 1999. The company has historically focused on small businesses and home office markets (SOHO), where customers pay STMP a subscription fee  of $15.99 per month for the convenience of being able to print USPS postage stickers from their computers. STMP is primarily displacing postage meters which have declined at a 5% annual rate for the last 5 years.

Stamps.com pivoted its business model in 2014 to focus on the high growth shipping market by making several smart acquisitions. They acquired ShipStation (6/30/14), ShipWorks (8/29/14) and Shipping Easy (7/1/16), and now own the three leading multi-carrier shipping solutions, which provide an essential service to the eCommerce and high volume shipping industry. Stamps.com also bought one of its few competitors, Endicia, on 10/20/15. Endicia was similar to Stamps.com because it received approval to sell PC Postage in 2000, a year after Stamps.com. Endicia focuses on high volume shippers such as large retailers, warehouses, and fulfillment houses. STMP now controls 2 of the 3 USPS PC Postage providers. Pitney Bowes is the 3rd.

I encourage you to review STMP’s investor presentation. This is a complex and confusing industry and each segment has its own nuanced structure.

Review of Short Reports:

The best bull case is often disproving the bear case. I’ll try and summarize the different bear stories and why I believe they are wrong.

Friendly Bear (report 1 and 2):

• Stamps.com is a credit card auto-renewal scheme that delivers zero value to customers. While STMP’s SOHO market is arguably a lower quality business due to high churn and continuous sales & marketing needs, it is a business that has grown organically and has been profitable for the last 10+ years. STMP’s value proposition has remained the same - save time and money by eliminating trips to the post office while also buying postage at lowerrates. This article is a great summary of STMP’s value-add. Has anyone been to the post office recently? It is a miserable experience.

In addition to new organic customers, Stamps.com has a massive opportunity to continue to displace high cost postage meters that are in structural decline (see PBI stock). For example, the Postal Advocate is a team of ex-Pitney employees that help their customers optimize postage spend. This frequently involves removing meters and switching to PC postage. Despite being ex-Pitney, they always recommend STMP solutions. Some Bears will also be surprised to learn that Stamps.com is displacing all of the government postage meters. They have GSA approval and are the postage printer of choice for most of the federal government (DOD, DOL, Homeland Security, etc).

• Customer complaints are evidence of an unsustainable business model. So is Netflix an unsustainable model as well? Most one month free trial business models have a lot of complaints. Netflix has terrible consumer affairs reviews and similar complaints to what The Friendly Bear quotes. Also, if STMP is a credit card renew trap I would expect churn and growth rates to have been impacted during widespread credit card hacks. Other consumer subscription models have used these fraud events over the last five years as an excuse for their increased churn or slower growth. STMP never has.  

• Friendly Bear also says there are better free solutions. USPS’s Click N Ship does not offer every type of USPS shipping option and it has much higher rates than Stamps.com.  The USPS increased Click N Ship to full retail pricing and the only way to print discounted postage online is through Stamps.com or Pitney Bowes. The USPS is incentivizing people to use Stamps.com instead of Click N Ship! Stamps.com is advertised in USPS Post Offices! Some bears might be surprised to learn Click N Ship, the supposed threat to STMP, is powered by Stamps.com. STMP is so integral to the USPS that it powers USPS’s free solution!  

• Pitney Bowes new product, SendPro, will destroy Stamps.com. While Pitney Bowes tried to make a splash with their new cloud based software solutions in the Spring of 2016, all they did was rebrand their existing solution. They have yet to be a meaningful player in this arena and every industry participant I’ve spoken with says Pitney isn’t even in the same technology ballpark as Stamps.com. The comparison is a sleepy, flat-footed Connecticut company to a fast moving silicon valley company. Even ex-Pitney employees direct potential customers to Stamps.com for PC postage.

Pitney Bowes lacks the incentive to aggressively market SendPro because it cannibalizes their high margin, meter business. I don’t see PBI as a material threat to STMP’s effective monopoly. It is also suspicious that the short attacks started around the same time Pitney announced their rebranded marketing. A key source for Capital Forum’s report is Jeff Crouse, a fired Stamps.com employee who was overseeing the SendPro project at Pitney.

• Shippo was approved by the USPS and is a direct threat to Stamps.com as well. Shippo splashed onto the shipping scene in early 2016 with a press release that made themselves look more important than they were in reality. Shippo does not have a PC postage license. Instead,  they were approved, like many others, for ePostage, which is a vastly different product than what STMP offers. The industry structure for this ecosystem is complex and many investors put STMP in the too tough pile. It was easy for the Bears to spin this confusion.

Shippo is just an API that competes with very little of STMP’s business. Shippo does not look anything like STMP’s core products. Shippo is one of many players that help companies tie directly to the USPS. The USPS has their own free API, and links to USPS integrators and providers. Shippo is one of many. While Stamps.com has the same solutions Shippo offers, STMP’s targets a much larger addressable market with a comprehensive product suite that offers turnkey solutions for any type of customer.

Shippo used to use Endicia’s API to connect to the USPS. I suspect that after STMP bought Endicia, they kicked out Shippo to strengthen their own competitive positioning. Shippo has since removed their original press release from their website and replaced it with a newer notice, one where comments are not allowed. Using the wayback machine you can see Shippo allowed comments in the past. By removing the original press release they removed comments complaining about Shippo’s downtime and complaints that Shippo no longer provided access to important parts of the USPS... and that customers were switching to ShipStation as a result.

This wouldn’t have been the first Rockerfeller-like move STMP has made. When Stamps acquired ShipStation in 2014 they kicked Endicia off the platform and appear to have stunted Endicia’s growth, only to acquire them soon after. They also kicked Express One off ShipStation, but this was in violation of signed contract terms. STMP paid a $10mm fine to settle and re-negotiate terms. Again, Bears have tried to spin this lawsuit as evidence of illegal kickback agreements, but this appears to be a gross misrepresentation.

• Undisclosed lawsuits, nefarious canceling behavior and removal of churn disclosure. The Friendly Bear spent over half of his report discussing a California lawsuit where Stamps.com had misleading advertising regarding their free trial period and improperly presenting its auto-renew contract policy. STMP got a slap on the wrist in the form of a $4mm fine and has since added disclosures to their website ( current vs past) in order make their credit card renewal more transparent. Friendly Bear made a big deal that Stamps.com wasn’t in compliance with their settlement terms and did not have a way for customers to cancel online. However, I signed up and was easily able to easily cancel online. This was old news as well as Stamps.com had previously been in trouble in 2009 for making cancellations difficult.

Putting all these pieces together the Friendly Bear concluded these changes would drive churn materially higher and this argument was supported by Stamps.com removing its churn metric. While I agree the removal of metrics is a huge red flag, STMP removed churn because it was actually improving as they were growing rapidly in lower churn categories such as multi-carrier solutions and high volume shippers. In response to the scrutiny, Stamps.com once again started reporting monthly churn, which has fallen from 3.5% in 2013 to 3% in 2016 for a 15% decline.

• Weak governance and insider selling. The Friendly Bear also criticized Stamp’s four member board as being too small. The company listened and recently expanded the board to 6 members by adding two reputable and independent board members, one from the SaaS industry and one from the investment community. Checks on these new board members suggest they are well aware of all of STMP’s key controversies and would be diligent before putting their reputations on the line.  

Friendly Bear also highlighted Lloyd Miller’s stock sales, but Mr. Miller has been a steady and consistent seller. Given STMP has appreciated so much since 2014, the dollar value of Lloyd’s sales make it look like an outlier vs.the quantity of shares sold. On an absolute basis, and despite all the sales, Lloyd’s position in STMP has still increased by over 150% over the last several years and STMP remains his largest holding at 15% of his $350M portfolio.

Since we are discussing insider sales, management has also recently sold a boatload of stock. Ken (CEO) sold 75k shares (~$10mm) and Kyle (CFO) has sold even more, around 145k shares (~$20mm). While Ken still still has over 250k options left (sold ~25%), Kyle has only 45k left (sold ~75%) - latest proxy.

The bull-biased explanation is Ken is going through a divorce (form 4) and Kyle has been CFO since 2004 and he has been a constant seller of STMP in order to diversify his holdings. Kyle has been restricted from selling for the past three years due to the M&A transactions. Additionally, management is granted their long-term equity incentive compensation every 3 years and the last award was 2014. In 2014 Ken received options for 250k shares and Kyle received 150k (what he sold), so their exposure to STMP upside should be increasing again soon (this is directly from the company). I could argue that this was the first time the management team could take some real chips off the table after nearly two decades of building a $2 billion dollar business. California isn’t a cheap place to live and why would management sell in front of bad news and open themselves up to a legal nightmare if the bear stories are correct? That wouldn’t seem like a smart move for a Stanford engineer/GSB graduate and a Dartmouth math major/Harvard Business School graduate, would it?

The insider selling is concerning, but there are many reasons management sells stock and not all involve the imminent collapse of the business.

• Friendly Bear says STMP is overvalued and deserves a 10x EBITDA multiple for a  $50/share target. At $110/share, STMP is currently trading at ~9.5x 2017 adj EBITDA, below Friendly Bear’s target valuation.

Prescience Point (report) and Capital Forum

The next iteration of the short thesis scrutinized Stamps.com’s growth and profits and suggested the growth is from fraudulent and improper behavior.  The report accuses STMP of exploiting USPS reseller agreements, despite the fact that the USPS has been a trusted and valuable partner for 17 years and is the foundation for Stamps entire business model. The thesis is, as soon as the USPS realizes STMP’s misdeeds, the relationship will blow apart.

I found the Prescience Point report misleading and full of unsubstantiated speculation. Instead of discussing every issue, Copperfield Research did a great job dissecting key inaccuracies and Ken McBride did a great job of addressing these issues on the 2Q16 earnings call. This is a must read to better understand the industry history and structure.

Prescience writes, “Wall Street analysts have no clue about how STMP is actually generating the majority of its financial results”. I disagree. While analysts might have been modeling STMP’s conservative guidance, those analysts that looked deeper were able to find an explanation; STMP’s multi-carrier solutions, primarily ShipStation, had exploded in popularity. This was a new market that Stamps.com was dominating. ShipStation was driving customer growth, at a higher ARPU, and postage printed growth, which also increased ARPU. Since ShipStation was primarily shipping packages, which are a ‘non monopoly’ USPS product and would qualify STMP for commissions from the USPS for each label printed, this would further boost ARPU.

Prescience further speculates that STMP is a dreaded roll-up where one-time acquisitions are masking a declining business and STMP is a churn and burn acquisition model. However, It appears to be the exact opposite. Stamps.com pays healthy incentive stock compensation to its acquisitions to keep managment hungry and engaged. Use the recent Shipping Easy acquisition as an example: “”May, 49, says she will stay on as CEO of ShippingEasy through at least the end of 2018. But she will likely remain in her post much longer. “I could see myself here through retirement,” she says.””

Last, let’s discuss the bear logic of the reseller agreements. Prescience Point had a fundamental misunderstanding of the reseller program but bears still argue, 1) the reseller program is cannibalistic to the USPS and, 2) STMP is getting lucrative kickbacks from resellers. These two arguments are mutually exclusive. Resellers generate revenue by selling postage to customers at prices below the “commercial base”, but above “commercial plus.” Their cost, which is negotiated with USPS, is a discount to “commercial plus.” The reseller collects the spread and STMP facilitates the process. The higher the spread, the more resellers have to ‘kick back’ to STMP for being a partner, which is also a privately negotiated contract and hence the opacity. In order to cannibalize USPS volumes, resellers like IntuiShip and others would need to price competitvely with the USPS, which would drive reseller gross profit spread lower and make STMP kickbacks more difficult.

This is not the case. Conversations with resellers suggest there is no gamesmanship from  Stamps.com as it is not possible for STMP to push additional volume through their contracts or squeeze additional margin from the USPS. Resellers are competing to win new business away from FedEx and UPS and are not targeting existing USPS customers.

That said, I have heard some resellers were confronted by the USPS in November for trying to sell postage below the “commercial plus” rate. This suggests one, or more resellers were trying to price below and cannibalize USPS volumes. Reseller contracts have 30 day cancellation clauses and the USPS has plenty of time to evaluate these allegations. Yet Stamps.com has mentioned how some reseller agreements have been extended and approved by the Postal Regulatory Commission (PRC).

So, are the Bears clinging to a misguided narrative regarding resellers? Even in a disaster scenario where the resellers are shut down, Stamps.com has said that less than 10% of total customers use resellers and no reseller is  greater than 10% of sales. I estimate resellers represent between 10-20% of total sales. But if the resellers were shut down, where would the volumes go? The end customers would still need to ship with the USPS, and they would need a Stamps.com account. The net result would be they would pay slightly higher postage rates. Stamps.com would lose the “kickback” from the reseller, which is likely small potatoes. The relentless focus on resellers is missing the forest for the trees.

VIC Short Thesis (link)

Avahaz’s key assertions are, 1) STMP increased its take rate by ~60%, likely by funnelling volumes through Intuiship, and 2) 75% of EBIT is at risk. While the author admits that it is just “opinion that Stamps.com has clearly used loopholes,” the entire foundation of his argument centers around one key assumption; a take rate estimate of 2.38% for Endicia.

Avahaz uses that estimate to back into a mix of paying customers vs. non-paying customers in 2013 and then layer on additional assumptions to show how STMP’s take rate has grown in 2015 and 2016, thus validating his opinion that STMP is cheating the USPS. All of this is an attempt to discredit Copperfield’s take rate analysis of service revenue / total postage printed that shows a flat to declining take rate for STMP.

I disagree with Avahaz’s assumptions, methodology and conclusion for several reasons:

• STMP’s business has a materially higher portion of monthly fee paying customers. This will make STMP’s headline take-rate look higher (something the author did highlight). In addition, STMP’s customer growth is driven by higher monthly subscription rate customers (ShipStation avg is $65) which is driving headline take rate higher.

• I have been told that the commission structure is 3% for priority mail, and the percentage falls as accounts increase and hit thresholds. Given Endicia has large high-volume shipping accounts, their blended commission take rate (after backing out monthly fees) should be much lower than STMP’s (after backing out monthly fees). As STMP adds eCommerce customers (ShipStation, etc) that are below the threshold, the take rate should increase as well.

• Most importantly, STMP only generates commissions on selling competitive products. The USPS has a monopoly on first class mail, so STMP does not collect commissions from printing basic stamps and other similar postage. This was likely a majority of the SOHO business before the 2014 transformation, yet Avahaz assumes that 40% of 2013 revenue came from commissions using his 2.3% assumed rate. This is unlikely. As non-monopoly products become a bigger mix of STMP’s reported printed postage, which continues as STMP grows package volumes, the take rate will increase as well.

• It is also important to note that Stamps.com said their commission structure has continued to move in their favor over the last 8 years. This is further evidence of STMP’s value-add relationship with the USPS.

• The fact that Stamps.com and ShipStation pricing are “Commercial Plus” is not proof that STMP is “using their Intuiship relationship to generate supernormal profits.” It is much more conceivable that Stamps.com is approved to offer those rates to customers.

To summarize, there are a number of puts and takes to appreciate when trying to calculate changes in STMP’s take rate. Avahaz’s analysis anchors on one key assumption and then layers on additional assumptions that expand his margin for error before arriving at the conclusion that STMP is ripping off the USPS.

Marc Cohodes - a short selling legend

Marc walked through the Prescience thesis with some additional twists. He said STMP is buying resellers and increasing rates and then redirecting volumes in order to arbitrage these spreads. He accuses Stamps.com of cannibalizing USPS business and ripping them off.

Additional quotes from the podcast:

• “It’s a very simple business”

• “It’s a market that isn’t growing at all.”

• “What kind of stupid name is Stamps.com?”

As discussed earlier, I believe there is a fundamental misunderstanding of how and why STMP has been successful, which is leading to unsubstantiated speculation of fraud and over-earning.

Is Stamps.com over-earning at the expense of the USPS?

I struggle to see how this could be true. Stamps.com generates EBIT margins in the mid to upper 40’s and provides the most efficient, cloud-based solutions for USPS customers. In contrast, Pitney Bowes’ North American Mailing segment generates EBIT margins in the mid to low 40’s for providing high-cost meters to USPS customers. PBI’s North American sales are also 3.7x higher than STMPs!

After making assumptions to back out monthly subscription revenue, I estimate STMP has a commission take rate in the 2-3% range. Is 3% of postage value too much to pay for a critical technology partner that is growing volumes at over 40% and helping the USPS diversify away from low margin bulk mailing? STMP is a partner that is aggressively marketing the USPS and driving innovation to stabilize the financial position of the USPS.

Laughably, Bears argue STMP’s exploitation of the USPS is part of the reason for the USPS’s financial distress. Are STMP’s commissions of ~$150mm on $5.5b of postage value printed (in the highest growth segments) the driver for USPS’s $5b annual losses? No. The USPS talks about how they are successful in all of their competitive offerings (where STMP is most helpful), but faces regulatory and legislative hurdles in order to improve their unprofitable monopoly segments.  

I encourage you to read the USPS quarterly press releases, listen to conference calls, and read the Postmaster General’s comments regarding postal reform to better understand the dynamics at play. Continued innovation, enhanced technology and package growth are critical for the USPS's survival. "Continued innovation in our package business is essential to our ability to meet our universal service obligation to the American people as First-Class Mail continues to decline. These products provide an essential, and growing, level of contribution to help us pay for our institutional costs, and thus help to sustain the network that benefits all mailers". So where is the problem? "The price cap that is currently imposed on market-dominant products and services is clearly not enabling the Postal Service to achieve financial stability despite our best efforts to reduce costs...The growth experienced in the past few years in package revenue is not enough to offset the decline in revenue from market-dominant products." Stamps.com is part of the long-term solution for the USPS.

So what is the real short thesis?

Short interest has remained remarkably high at ~25% of the float, which is confusing to me given the seemingly speculative nature of the short thesis and the fact that my channel work has been universally positive.

STMP appears to be a binary play on whether the USPS loves Stamps.com or hates Stamps.com. If the USPS hates Stamps.com, they will change commission contract terms, dismantle reseller agreements, and incentivize strong PC postage competition. Or, if my work is correct and the the contracts don’t change, management hasn’t been lying or engaging in fraud, STMP is a “gigantic long”.

What is the motive? Where is the evidence?

Stamps.com and the USPS have been partners for over 17 years and Stamps.com has invested over $1.5b in S&M, R&D and capex to help build tools to help the USPS grow their business. I struggle to see a motive for why STMP management would rip-off their critical partner and the foundation for their entire business, and risk management's livelihood and reputation for a quick buck. Stamps.com had a growing and profitable business prior to the repositioning the company, so why start cheating now?

I also struggle to see any evidence that the USPS is anti-Stamps.com. All USPS actions suggest they are actually pro-Stamps.com. Stamps.com is the technology enabler of Click-N-Ship, the USPS changed Click-N-Ship pricing to push customers to PC postage vendors (either Stamps.com or Pitney). Stamps.com replaced all government postage meters with PC postage. The USPS signed off on all of STMP’s acquisitions and the USPS keeps increasing STMP’s commission structure.

I haven’t found any industry contacts, from customers, ex STMP employees, USPS employees, ex USPS, competitors, or partners that say anything other than USPS loves Stamps.com. In fact, the main source for a majority of the short report was Jeff Crouse, who was forced to apologize to the Postmaster General for causing unnecessary controversy for the USPS and Stamps.com. If that is not evidence of a strong and positive relationship between the USPS and STMP, I don’t know what is! Jeff also was recently let go from Pitney Bowes.

Stamps.com meets with senior USPS representatives weekly. Everything Stamps.com does is well understood by the USPS. Stamps.com has continued to deliver results and there has been no evidence that anything in the short reports is true.

Other reasons to like STMP

While I’ve touched on the main points as to why STMP is an attractive business and compelling investment opportunity, here are a few more points to consider.

• As one of just two PC postage providers, Stamps.com is the gatekeeper for all new multi-carrier solutions, similar to how they are the gatekeeper for resellers. Because customers of a new multi-carrier solution must also sign up as Stamps.com customers, it enables the company to have an early view at the best start-ups and potential competitive threats. That’s how Stamps.com found, monitored, and acquired Shipping Easy, thus maintaining their monopoly-like industry position.

• In addition to monitoring M&A prospects, STMP’s multi-carrier solutions also provides a wealth of customer data that is used to prospect customers for the USPS. While resellers cold-call customers in hopes of picking off some UPS and FedEx business, STMP’s knows which eCommerce shippers are using FedEx and UPS and can then work with the USPS to provide competitive rates to win additional business.

• FedEx and UPS continue to drop their dimensional weight factor, which makes the USPS package rates even more attractive. This will continue to drive USPS package growth. Industry experts, along with FedEx and UPS behavior, suggest that FedEx and UPS are conceding the under 10 pound market to USPS and this segment is growing quickly. This is a huge positive for Stamps.com the bears never discuss.

• As Stamps.com becomes more essential and valuable to its customers, it has the potential to enhance features and functionality by adding new products such as inventory management, customer management and mobile solutions. While bulls are excited about this potential next leg of growth, I am comfortable if the company just continues to dominate its current market which is rapidly growing and ripe with potential.

Think I’m biased? Here’s an independent industry participants view on the future of PC postage. “What does the future hold? – We view this space [PC postage] as continuing to grow with very few headwinds.”

Cohodes says he looks for crappy companies with promotional management teams that have rip-off business models. Stamps.com management team can be described as boring, but certainly not promotional. And is the USPS so disorganized to be actively directing their customers to a rip-off business model?. He says he never wants to short open ended opportunities, but as eCommerce explodes and as USPS pivots to focus on small packages, STMP could be open ended.

$500 five year target

At $110/share, STMP is currently trading at ~23x GAAP EPS, ~17x Adj EPS, and 9.5x EBITDA, using the midpoint of company 2017 guidance which has historically proven very conservative. This falls to ~20x, ~14x, and ~8.6x using my estimates, which are 10-20% above guidance (and STMP likely beats). I’d argue this is cheap for a business with these characteristics.  

I believe Stamps.com can compound earnings per share at ~30% based on 5-year organic revenue guidance of 20%, margin expansion, and return of cash via accretive repurchases. This will drive earnings per share to $25 in 5 years. At a 20x multiple, STMP would be worth $500/share. If the company added an easily-manageable two turns of leverage to accelerated buybacks, this would be wildly accretive and my target would be even higher.

Risks:
Like Cohodes, I respect short interest and the persistently high short interest is concerning. Friendly Bear does great work. Prescience Point does great research and is persuasive. Capital Forum has a great diligence track record. I know smart bears, but even smart bears don’t get every idea right. I believe they are trapped by confirmation bias. I am also a believer that if things look to good to be true, they usually aren’t true. While I don’t believe this to be the case with STMP, time will tell.  

Additional risks to the business beyond what I have already discussed:

• Pitney Bowes figures it out.

• Amazon, UPS, or FedEx do something disruptive to impact USPS volumes

• Growth was one-time in nature due to contract step ups or other one-time events.

• PC Postage competition increases and stunts growth - Easypost is in the process and may have been approved already.

Catalyst

n/a