Description
VALUATION AND TRADING STATISTICS AS OF 6/23/2004:
(in millions, except per share)
Price: $14.02 / share
Enterprise value: $161 (adj. for 6/04 equity offering)
Market Cap: $187 (adj. for 6/04 equity offering)
Net CASH: $34 - includes $19 million of
convertible preferred (conversion
is triggered when stock is above $20 for 90 days)
- Also Adj. for 6/04 equity offering
LTM Revenue: $99
LTM EBITDA: $22 (22%)
LTM 3/31 2004E (my estimate)
EV / EBITDA: 7.4x 6.5x
EV / EBITDA (less m. capx) : 7.8x 6.8x
Price / Earnings: 32.5x 25.6x (distorted by large cash balance from secondary offering)
ROIC: 10% 13.2%
BUSINESS SUMMARY
Portland based TRM Corporation (“TRM”, or the “Company”) has two primary business segments:
ATM Business. TRM installs, manages, services, and sells automated teller machines (“ATMs”) in the United States (35%) and in the UK (65%) in non-bank or off-premises locations – mostly in retail and convenience stores. As of March 2004, TRM had an installed base of 4,000 ATMs and generated over $40 million in revenue from this business segment. The ATM Business was launched in 1999 and has grown rapidly (2000-2003 CAGR of 58%).
TRM’s management of the ATMs in their network includes maintenance, service, transaction processing, and in some cases providing the cash and labor required to fill the machines. Store merchants share in the fees generated by surcharges charged to cardholders and interchange fees paid by financial institutions. TRM’s primary source of gross margin is from the surcharge ($1.50 - $2.00 / per transaction) and interchange fees ($0.50 / transaction). Typically when a merchant purchases a machine, the merchant receives most of the surcharge revenue and the service provider receives the interchange fee. If TRM owns the machine, the merchant will only receive a small share of the surcharge fee. ATM service contracts are generally 5-7 years in length and therefore, a large portion of the Company’s revenues are recurring in nature.
Copy Business. TRM owns and operates self-service photocopy machines in retail establishments such as groceries, pharmacies, stationery stores, hardware stores, and gift shops in the US (75%), UK, and Canada. As of March 2004, TRM had an installed based of 25,877 copying machines. Retail merchants are paid a percentage of revenue generated. The Copy Business generates strong, predictable cash flow and had Revenue and EBITDA of $53 million and $13 million, respectfully. However, it is a mature business with limited opportunity for growth. Copy volume decreases have been off-set my higher prices per copy, keeping revenue flat.
TRM is focusing on growing the ATM business in the US and UK while sustaining and optimizing the Copy Business. TRM is using the Copy Business’ steady cash flow and strength of their service infrastructure to facilitate the growth of the ATM Business (both organically as well as by acquiring networks of ATMs from smaller, higher costs competitors). TRM is also growing the service side of their business. Recently, Triton, one of the leading ATM manufactures endorsed TRM as their national service provider. Additionally, TRM is well positioned to be a vendor of choice as banks continue to outsource the management and service of their ever increasingly large ATM networks.
FINANCIALS (MILLIONS)
2001A 2002A 2003A 2004Q1A
Copy Business
Sales $59.0 $54.8 $53.3 $13.9
Growth (9%) (7%) (3%)
EBITDA 9.8 9.9 12.8 3.9
Margin 17% 18% 4% 28%
ATM Business
Sales $18.8 $27.8 $41.6 $11.6
Growth 82% 48% 49%
EBITDA (1.7) (0.5) 7.6 2.3
Margin nm nm 18% 19.8%
Combined (also includes very small software business)
Sales $79.0 $85.2 $95.9 $25.9
EBITDA 7.6 10.0 19.5 6.4
Net Income (4.8) (5.2) 4.0 2.1
INVESTMENT HYPOTHESIS
The ATM service providers / transaction processors are going through massive consolidation. Cardtronics (filed S-1 3/04) and Global Axcess (OTCBB: GLXS), two independent owners of ATM machines, are also growing rapidly - both organically and through acquisition. Larger low-cost providers, such as TRM, are acquiring regional high-cost players and immediately seeing earnings growth. In a call with Michael Dodak, COO of Global Axcess, he mentioned that Global Axcess will likely double their business this year – “20% organically and the rest through acquisition”. Cardtronics has grown from 3,300 to 12,000 ATMs in 3 years.
TRM will continue to grow their ATM business, while the Copy Business will be flat to slightly-declining. The Company has relatively low debt and generates substantial cash flow that can more than meet the company’s cash needs and growth initiatives going forward. Under my projections, the Company will generate $40 million in Free Cash Flow ($4.41 / share) in aggregate over the next 3 years.
The Company currently trades at 6.8x 2004E EBITDA and 7.1x EBITDA less maintenance capex. While there are no perfect comparable companies, a few of the ATM manufacturers and service providers such as Diebold, NCR, and eFunds, and Global Axcess publicly trade and have an median trailing EBITDA multiple of 9.0x. The Company has better margins and growth rates than these comparables. Over the last 3 years the ATM Business has grown EBITDA by over 30% per year and has the resources and opportunity to continue at this pace.
My financial projections assume:
(i) 35% growth in the ATM business for 2004 and then 20% thereafter, with modest margin improvements. (Q1 2004 numbers show continued margin improvement beyond what I have predicted)
(ii) flat copy business. Volume is decreasing, but more than offset by decreases in discounts.
I believe these assumptions are fair given (i) size and growth of the market, (ii) historical growth of the Company and the acquisitive posture the company has taken), and (iii) consolidating nature of the industry. Given my projections and DCF analysis, I believe the target price of the stock is $30. TRM’s Q1 fully diluted EPS of $0.24 ($0.30 Basic EPS) puts them well on a good pace to reach my 2004E of $0.76. It should also be noted that the conversion of the preferred stock (triggered when the stock price is above $20 for 90 days), is accretive to earnings.
INDUSTRY / MARKET ANALYSIS
The global ATM industry is estimated to be $14-15 billion according to ATMmarketplace. Off-premises (non-bank) ATMs grew from 156,000 in March 2000 to 238,000 in December 2003. TRM has one of the largest US non-bank networks in the United States and is the largest in the UK. Costs of ownership are declining as a result of economies of scale, better monitoring and cash management systems, and migration to PC-based ATMs with open-architectures. PC-based machines give owners more options with regards to who services and maintains the equipment and therefore benefits low-cost providers with national networks. A substantial amount of the cost associated with maintaining an ATM is related to cash-management. To the extent that machines have better/remote monitoring capabilities and systems for auto-reconciliation and auto-cash ordering, owners will reduce their costs and working capital requirements.
I also spoke with, Dan Tierney, EVP of TRM, who said that management believes that there are plenty of expansion opportunities within the US and UK, however, they are examining new markets. According to Mr. Tierney, TRM has been able to increase its average surcharge fee and that the demand remains relatively inelastic. Average surcharge was $1.00 in 1996 and now is over $1.50.
Banks are increasingly interested in outsourcing the care of their ATM networks to cut costs while keeping up with technological advances. Earlier this year, the National Bank of Canada announced C$368 million outsourcing deal over 10 years with INTRIA Items to supply check, lockbox and currency processing which includes ATM envelope processing, deposit processing, and cash supply. TRM’s large and established distribution and service network positions it to benefit from similar types of relationships in the US and UK. TRM’s recently announced a relationship with Triton (60,000 ATM installed based), where TRM will offer installation and maintenance service to Triton’s customers. In many cases TRM is providing service for its competitor’s ATM machines. Further, E*Trade recently announced that they are considering selling their 15,000 ATMs, as it a non-core asset.
As for the copy business, the market is nearly saturated and demand is declining as a result of the increased popularity and affordability of home copiers. TRM expects this business to continue to generate strong cash flows, but the number of machines in the field will likely decrease.
CUSTOMERS
TRM’s direct customers are the merchants that own/run grocery, drug, hardware, convenience stores, etc. The Company has also entered into relationships with regional chains such as Albertson’s and Eckerd Drugs. No customer accounts for more than 10% of the Company’s revenue. Many of the Company’s customers choose to have ATM or copying machines for draw, but do not wish to own their own ATMs and simply participate in a placement program to generate store traffic.
The ultimate end-user, the cardholder, is a smaller subset of all ATM users. Theses card holders are willing to pay surcharges for convenience and have relatively inelastic demand. “Once a customer is willing to pay $1.50, the incremental $0.50 to $2.00 is not going to change their purchase decision,” said Dan Tierney.
COMPETITION
TRM competes with other non-bank owners of ATM’s for finding quality locations. TRM is the largest non-bank ATM deployers in the UK. In the United States, there are several larger ATM services in the market. The largest, Cardtronics has 12,000 and recently filed an S-1. On the maintenance side of the business, TRM has a large network for service and distribution created around its 30,000 installed based of copying and teller machines, which gives it significant economies of scale vis-à-vis its competitors. All of TRM’s technicians are trained to install and service ATM machines. Having said that, Tierney pointed out that, “[their] real competition is the economy. If a merchant goes out of business, there’s a real cost to TRM.”
The Copy Business competes with home copy machines and other companies that use the retail concept like TRM. These players tend to be regional in nature. TRM does not generally compete with full service copy centers like Kinko’s. These companies tend to cater to higher volume and/or quality customers.
MANAGEMENT
When TRM initially launched their aggressive ATM roll-out strategy, the Company was over extended and financially strained. Ken Tepper was named CEO and tasked with the responsibility of cleaning-up the balance sheet and get the company back on track. Under Tepper’s control the Company has prospered. Tepper and the rest of the management team are significant owners in the Company. The rest of the management team is well experienced in this business.
INVESTMENT STRENGTHS AND RISKS
Strengths
• Rapid Growth and High-Margins. TRM was able to leverage its Copy Business’ infrastructure to rapidly create a large non-bank ATM portfolio in the US (and the largest in UK). TRM continues to grow its network and has demonstrated an ability to buy ATM portfolios at prices that are accretive to earnings. TRM’s conservative balance sheet and public currency, will give TRM plenty of options in acquiring ATM networks from other higher cost owners.
• Cash Flow. Aggregate FCF over the next 3 years is $39 million or $3.83 / share. The Copy Business alone has historically been a stable generator of cash-flow with high margins. To the extent that revenues from the Copy business decline, it will be mitigated by margin improvements as merchants revenue share is on a sliding scale.
• Fragmented Industry / Favorable Market Trends. Projected growth in the number of ATMs, industry consolidation, and trend towards outsourcing all suggest that TRM will continue to grow both in the US and UK.
• Positive Comp Revenue. TRM’s ability to raise surcharge fees without affecting demand – drives comp sales growth.
• Triton Relationship. Triton endorsed TRM as their nationwide service provider. Triton does not have a service arm of their own. TRM also sells and places Triton machines with their own customers and was named one of only 6 distributors of Triton’s ATMs in the UK.
Note: The COO of Global Axcess told me that servicing of ATMs may be better provided by local providers. His company considered using a national provider and decided to subcontract the work on a market by market basis. He thought it was better to have a more personal relationship with a local provider.
• Economies of scale in sales and service. TRM benefits from the existence of a well established service and distribution system.
• Conversion of preferred stock is accretive to earnings. The company’s preferred stock is forced to convert if the stock price is above $20 for 90 consecutive days. The current dividend $1.5 million. 2004E EPS pre-conversion is $0.68 vs. $0.70 pro forma for the conversion.
Risks
• Fiercely Competitive Business. The competitiveness in this industry could negatively impact transaction fees. There are many independent owners of ATMs and national and regional banks, which are less sensitive to the economics of the individual machines, that are expanding networks.
• Legislation. Various regulations have been proposed to reduce or eliminate the fees charged for ATM transaction.
• Integration of acquired ATMs. Synergies created from buying networks of ATMs and integrating them into TRM’s cost structure could take longer and be more difficult that expected. The Company has only recently begun to grow through acquisition.
Catalyst
CATALYST
Industry consolidation and successful execution of their growth strategy. The larger players in the industry who have national networks, like TRM, enjoy significant economies of scale. TRM has been successfully buying smaller portfolios (100-500 atms) of atm’s and layering them into their cost structure. The top 10 independent owners of ATMs (non-bank owners) only own 23% of the non-bank domestic atm machines.
On June 23, 2004, TRM sold 5.1 million primary shares in a secondary offering which raised over $60 million. The equity offering will provide TRM a war-chest that will allow them to to continue this strategy. The offering could also bring research coverage to this previously oncovered stock.