| 2007 | 2008 | ||||||
| Price: | 8.50 | EPS | |||||
| Shares Out. (in M): | 0 | P/E | |||||
| Market Cap (in $M): | 173 | P/FCF | |||||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | |||||
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TIER is a payment processor growing organically north of 20% and trades at less than 8X EV/Free Cash Flow and has numerous catalysts. The company is currently undergoing a strategic reorganization that will transform the company from a poorly integrated government IT services company into a high growth payment processor with a leading market share. Tier’s return on tangible net assets after the company restructures will skyrocket because the company operates using negative working capital and very low capital expenditures.
| Market Cap | 173 |
| Cash and Marketable Securities | 86 |
| Enterprise Value | 87 |
| Proceeds from 2008 Divestitures | 25 |
| 2008 Restructuring Cost and Wind Down | -5 |
| Adjusted Enterprise Value | 67 |
| Net Operating Losses | 78 |
| TTM Sales | 100 |
| Sales Growth | 25% |
| Potential EBITDA Margin | 10% |
| Maintenance Capex | <$1mm |
So you add this up, and you could be buying a company with an EV of $67mm after divestitures and restructuring costs, with $12+mm in future recurring Free Cash Flow (18% Yield) growing north of 20% year.
Company History
Tier
Technologies is a story of a government IT services company that tried to grow
through acquisitions but failed to successfully integrate them which led to serious
accounting issues. Now the company is
trying to shed its IT services business and focus on its Electronic Payment Processing
(EPP) business.
The EPP segment, called Official Payments, was acquired by Tier in July of 2002 for 87mm. Official Payments provides electronic payment processing solutions, including payment of taxes, fees and other obligations owed to government entities, educational institutions, utilities and other public sector clients. It did about $100 million in revenues for the twelve months ending 9/30/2007 up 26% from $78 million the prior year, and management has guided for mid 20% growth for fiscal year 2008. In Q4 revenues grew 30.5%.
Essentially Official Payments allows their government and other public sector clients (which total 3000) to receive payment for tax, tuition and utility payments with a credit or debit card. This enables individuals or businesses to pay federal, state, property, and employments taxes online or over the phone. For this convenience users are charged a convenience fee for around 2.5% of the size of transaction. Official Payment’s revenue is derived from the convenience fee, and its direct costs are the bank interchange fees that Official Payment pays in order to complete the transaction. They work with merchant processors like Heartland and Global Payments to obtain card authorization, validate card numbers and expiration dates. Official Payments also issues confirmations to the cardholder and the government customer.
1) Convenience—Paying taxes or DMV fees/fines, tuition etc. online through official payments is easy to do and quick. For people who to mail a check or are traveling, they are able to pay taxes quickly and easily online or over the phone to avoid late fee penalties and interest.
2) Avoiding Late Fees/Penalties—Many users of Official Payments do so because they are making last minute payments to the IRS or other tax authority. They would rather pay a convenience fee than a late fee, finance charges, have their car impounded or electricity turned off.
3) No Cash in the Bank Account—Cardholders who use Official Payments often don’t have cash in their bank account to pay taxes or other charges that come due. Many Americans live month to month on paychecks and/or carry credit card balances. These cardholders have no other means to pay tax bills or other expenses that come due particularly if they are large in size. Students can find
4) Rewards—There are numerous reward programs where card users get miles, points and/or cash back. An example would be the following: A free flight on many mileage programs is 25,000 miles. Credit card companies have offered double miles during tax season, so a person who pays $12,500 in taxes can get 25,000 points or a free flight in many cases. He/she paid an additional $311.25 which is still cheap for a full fare coast to coast, however there are always special offers going on which are cheap too.
5) Small Size of Transaction—Transactions average between $600 and $1200 depending on what part of the year it is. Convenience fees therefore between $15 and $30 which is small amount and often overlooked. Cardholders are accustomed to paying bank charges for ATM, Credit Card annual fees, late payment fees which run at similar levels.
6) Convenience Fee is Tax Deductible for Small Businesses--So for a small business owner charging taxes on the credit card is a lot easier decision.
The key growth drivers to the business are number of transactions, size of transaction and cost of interchange. The business will continue to grow revenues for the following reasons:
1) Federal Taxes—Currently only 1.2% of filers pay taxes with a debit or credit card. The number of payments has been growing north of 20% for the past few years and the IRS expects double digit growth.
2) State Taxes—Currently about 20 states still do not offer card-based payment while the company has already 26 states as customers to date.
3)
Local Governments—Currently the company
contracts with about 2000 local governments (cities/towns etc.) to enable
residents to pay property taxes etc. The
company estimates that there are over 80,000 prospective local governments that
do not offer card based payments some of which are huge prospects such as Los
Angeles and Chicago.
Expansion of New Vertical Markets—While the company as a whole is only growth 25%, Tier is expanding into higher growth markets such as universities and utilities which are growing at 64% and 37% respectively.
1) Brand Value--Official Payments has Brand Value and can defend its market position because it has first mover advantage. Official Payments is the only company that has been providing the IRS with credit card services since the IRS began allowing credit card payments in 1999. When Official Payments goes into a new government or institutional customer like a university, it has the advantage of a reputable track record.
2) Customer Base is Captive—Official Payments is integrated with its government entity customer. Time and effort is spent setting up the transaction processing relationship that customers do not want to go through again unless something is going wrong.
3) Marketing to Existing Cardholders—Once a cardholder uses Official Payments for a transaction, that cardholder can be marketed to for future transactions.
The CEO and CFO are relatively new to the company and have come in to restructure the company. The CEO has stated that he believes the stock is undervalued and would return money to shareholders once the divestitures take place in the form of aggressive buybacks.
The primary competition for Official Payments is LINK2GOV which is a division of Metavante (MV). I estimate that LINK2GOV currently does about $50mm in revenues and has been growing rapidly. Metavante acquired LINK2GOV in November of 2005 for $63.5mm. Touchnet is private company that does about $10mm in sales and focuses on the education vertical.
Comparable
Company Valuations
Metavante—19X
2008, and 17.5X 2009 on 12% earnings growth
Heartland
Payment—22.5X 2008 and 17.8X 2009 on 22% growth
Global
Payments—20X 2009 Fiscal Year Ended May
NIC Inc
(Provides Internet Portal Services for Governments)—40X 2008
Income Statement
For my
analysis I will only focus on the EPP business as a stand-alone based on past
financials and my interpretation of management’s future strategy. Management has broken out the EPP’s
profitability as a business unit, but not a stand-alone public business. I have added in costs of executive
compensation and public company costs for the purpose of valuing the business
post restructuring. These costs are listed as Unallocated Corp. Costs below.
| Actual 2007 | 2008 | 2009 | |
| Revenues | 99.4 | 124 | 155 |
| Gross Profit | 24.1 | 30.5 | 38.5 |
| G&A | 7.8 | 9.8 | 11.1 |
| Sales and Marketing | 7.1 | 9.4 | 11.1 |
| Depr and Amort | 3.2 | 3.3 | 3.3 |
| Unallocated Corp. Costs | 2.5 | 2.5 | 2.5 |
| EBITDA | 6.6 | 8.8 | 13.6 |
| Maintenance Capex | 1 | 1 | 1 |
| Free Cash Flow | 5.6 | 7.8 | 12.6 |
Balance Sheet and Capital Expenditures
Official Payments’ operations require zero capital and very little capital expenditures to grow. Working capital excluding cash and assets/liabilities held for sale are flat to negative due to the fact they get paid in 5-6 days. The business is not capital intensive as the company has the ability to grow business without having to spend on infrastructure for computer hardware or new office locations. Once the company sheds it’s businesses you will see a pure processing company with extremely high returns on net tangible assets.
Net
Operating Losses
Tier has a total of $78mm in NOLs for its EPP business. Of these amounts, $48.6 million of federal net operating loss carryforwards and $29.6 million of state net operating loss carryforwards were acquired in the acquisition of OPC.
Valuation
1) Discontinued Operations—The company has said that these businesses are worth $25mm and have letter of intents in hand. They hope to close the transactions within the next few months.
2) Wind down Businesses—These are two businesses that they will operate until the customer contracts expire. They should generate a few million in cash flow over the next few years.
3) Corporate Overhead—These are costs associated with the board, executive management and certain shared services that the businesses use. It is the remnants of a bloated poorly managed company. They will be cutting these expenses rapidly and the overwhelming majority of these expenses support the businesses that will be sold. Last year there were $16mm of costs. We estimate that these costs will hugely drop after the discontinued businesses are sold and that they will only spend about $6mm in FY 2008.
4)
Electronic Payment Processing (EPP)—This is the
crown jewel of the company and represents the future of the company. That being said, EPP (Official Payments) has
also been operated inefficiently and its margins are not at its full
potential. As mentioned above, the
company has been operating under different processing platforms at various
locations which is hugely inefficient.
Given the mid-twenties top-line growth the EPP should be valued at 15X
FCF or 190mm on 12.6mm in FCF.
Sum of the Parts
| Cash | 86 |
| Discontinued Operations | 25 |
| Wind down Business | 1 |
| 2008 Corporate Overhead Cost | -6 |
| EPP Business | 190 |
| Total | 296 |
| 20.4mm shares Outstanding | Target Price $14.5 |
Risks
Rising
Interchange Fees
More
competition
Inability to
sell non-core businesses
Higher than
expected and longer than expected restructuring costs
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