Description

Business

Founded in 1991 as an IT services provider, Tier Technologies (TIER: NASDAQ) or TIER has suffered through the mismanagement cycle of innumerable small-cap companies; growing pains via serial acquisitions, (formerly) entrenched management, lack of oversight by the Board of Directors and ultimately shareholder fatigue. It is important that investors understand where TIER has been, the path along which newly installed management is taking TIER and hopefully, a conclusion to this story.

TIER is a leading provider of electronic payment solutions in the growing “biller-direct” category. Led by its wholly owned subsidiary Official Payments Corp. (OPS), TIER enables consumers and small businesses/government agencies to use a credit card, debit card or electronic checks to make payments online, over the phone, or in person at point-of-sale. By partnering and connecting with a host of payment processors and payment service providers, TIER is able to offer clients a “single source solution” that simplifies electronic payment management. These solutions include multiple payment options; bill presentment, convenience payments, installment payments and flexible payment scheduling. 

TIER has partnered with over 4,000 direct billers nationwide to process over 9,000 different payment types. 

TIER has three reporting segments: EPS, Wind-down and discontinued operations.

Electronic Payment Solutions (EPS) are provided through TIER’s wholly owned subsidiary Official Payments Corporation (OPC) and operate in the following biller direct markets:

• Federal—includes federal income tax and business tax payments
• State and local—includes state and local income tax payments and business tax payments
• Property tax—which covers state and local real property tax
• Utility—which includes private and public utilities
• Education—which consists of services to post-secondary educational institutions
• Other—which includes local government fines and fees, motor vehicle registration and payments, rent, insurance, K-12 educational meal payments and fee payments and personal property tax

For the meantime, TIER operates Voice Systems Automation (VSA) which provides call center interactive voice response systems and support systems. VSA is in the process of being wound down over the next two years because the services are not compatible with the long-term strategic direction of the company

Timeline

• 1991: TIER is founded in California to provide IT consulting services
• 1991-1997: TIER experiences organic growth and growth via acquisitions, culminating in a successful IPO in December of 1997
• 1998: TIER completes secondary public stock offering
• 1998-1999: TIER grows internally and through eight acquisitions
• 2001: TIER completes another secondary public stock offering
• 2000-2002: TIER completes four acquisitions; including the pivotal “Official Payments Corp” which positions TIER as the leading provider of electronic payment processing services in the government market
• 2004: TIER relocates to Reston, VA to be closer to government agencies; completes the EPOS Corp acquisition which establishes TIER as a leader in Interactive Voice Response (IVR)
• 2005: TIER reincorporates as a Delaware corporation and moves to a single class of common stock
• 2009: TIER completes acquisition of ChoicePay Inc. 
• August 2010: Alex. P Hart joins TIER as President/CEO and the Board of Directors
• April 2011: Discovery Group (14.7% owner of the shares outstanding) sends a letter “The TIER board must immediately engage an investment bank and proactively pursue all strategic alternatives, including a sale of the company.”
• June 13 2011: TIER names Jeff Hodges, CFO; Jeff was most recently CFO of Firethorn Holdings, a mobile banking and payments subsidiary of Qualcomm Inc.

Investment Thesis

• Appointment of new CEO: Alex Hart was President and CEO of Corillian Corporation (CORI: NASDAQ), a leading provider of online banking and bill payment software and services, from 2002 until its acquisition by CheckFree in 2007 for $245MM in cash. During Alex’s tenure at CORI, revenues grew from $39MM to $65MM and the EV was ~$18MM upon his arrival. 
• TIER’s management contends that there are a number of value creation opportunities: “a lot of low hanging fruit that frankly we’d like our shareholders to enjoy as opposed to an acquirer” was stated on the Q3 2011 conference call; “differentiate TIER as a value-added payment provider from the commodity providers of payment processing services.”
• Completing the consolidation onto a single technology platform: the conclusion of this process will give TIER a viable platform to grow transactions, lower costs and become more attractive to potential acquirers; the substantial cash outlays for the required hardware investments have been made ~$10MM
• TIER currently has $33.8MM available in cash, plus an additional recently released (August 2011) restricted cash of $6MM; TIER generated operating income of $300K in the Q2 and $500K in Q3; there is little to no risk of a sudden operating cash burn
• Activist investors monitoring progress: Discovery Group, small-cap activist investors remain the largest shareholders at 2.45MM shares and have been vocal regarding their thoughts on the path TIER should take in the near term (see April 2011 13D)

Investment Risks

• Increased competition: The electronic payment transaction solutions and e-commerce services are highly competitive markets; from time to time a new entrant will enter as a low cost provider and cause momentary market pricing disruptions. Not to mention the FIS’s and FISV’s in the space. 
• IRS contract renewal: During Q3, federal income tax transactions were -8% YOY and dollars processed were -19.3%. Much of the decline is attributable to the economic cycle via the state/local tax verticals.
• In 2009, TIER made the decision to consolidate their operations onto a single technology platform “over time” and in 2010 determined that the consolidation of this platform and migration of ~4,600 biller direct clients will take longer than anticipated. This project is now expected to be done by the end of calendar year 2011 or mid calendar year 2012. This is an arduous process and possible future capex of $8.3MM.
  • The goals of the consolidation were to facilitate TIER’s ability to develop, sell and implement new and enhanced product offerings, improve margins by spreading fixed platform costs over a number of transactions and to simplify operations. 

Valuation & Strategy

• At $3.50 per share, TIER currently has an EV ~$18MM and will have sales in the $120MM to $130MM range. A majority of the acquisitions reviewed in the electronic payment space have changed hands for approximately 1x revenue, which equates to $7.20 a share for TIER. TIER’s Board of Directors has historically viewed TIER as “cheap” below $7.00 through past buybacks and the most recent tender of 1.6MM shares at $6.10 per share in January 2011.
• TIER’s management is taking a hard look at their single largest direct costs, which are interchange fees and payment processing fees that are paid to the payment networks. Management is focused on seeking better rates from the payment networks and their payment processors, adding lower cost processors and incentivizing billers to utilize TIER payment options that provide TIER higher margins. The successes in the aforementioned endeavors are pivotal in TIER’s near term and ongoing profitability. 
• Larger potential acquirers: 
  • FIS $8.1B Market Cap
  • FISV $7.5B Market Cap
  • GPN $3.5B Market Cap
  • EGOV $739MM Market Cap
  • EEFT $832MM Market Cap
• Net-net TIER provides decent downside protection through a strong balance sheet, new and capable management and significant upside appreciation should the stars start to align, especially due to TIER participating in the consolidation of the electronic transaction space as a target.

Q3 Quarter Management Comments

• Alex Hart: “I have been at TIER for almost a year now and I look back at where we started, I am relatively pleased with our progress despite the fact that I’m not pleased with our financial performance at the moment. I joined the company with the belief that TIER was well positioned to take advantage of the growth in the Electronic Payment space and the increasing importance to the biller direct model. I’m more excited about our prospects today than I was 12 months ago. The challenges have been bigger and more numerous than I anticipated at that time, but I believe that we now have a team that is capable of accomplishing great things.”
• Alex Hart: “Jeff Hodges, our new CFO, is the most recent addition to our team. Jeff has an extensive background in payments and a very clear sense of what TIER needs to do to improve. Jeff has focused on creating a type of planning, forecasting and management system that we need to both improve results and provide more clarity and transparency to the investment community. In fact, one of his primary goals was to develop a set of metrics and models that will enable us to provide guidance for fiscal year 2012 during our next call.”
• Alex Hart: “Another recent addition to the team is our Head of Sales, Mark Lavin. Our inability to both sign new customers and expand existing relationships has been a major disappointment this year and is the primary reason for our lackluster revenue numbers. But I am confident Mark is making the right moves to position us for stronger performance in 2012.”
• Alex Hart: “Our decoupled product development approach is resulting in new capabilities that will not only enable us to sign new clients and expand existing relationships, but will also enable us to consolidate our three platforms sooner and more inexpensively than we would have with our historical approach.” 
• Conference call question: “You have been fairly open with shareholders that your engagement with TIER was one in which were hoping to identify somewhat of a more expedient fix to the business to try and deliver shareholder value or perhaps if you conclude that TIER belongs—is better off as part of a larger organization. So it seems like we are not going down either path at this point. So can you help me understand what has changed?”
• Alex Hart conference call answer: “We are going down the first path and frankly, the second path could occur at any time. I do think there is still a lot of opportunity, a lot of low hanging fruit that frankly we’d like our shareholders to enjoy as opposed to an acquirer.”

Catalyst

Acquisition Candidate

New Management implementing strategic plan

Downside protection due to large cash balance