Description

Verifone, a global leader in the point-of-sale (POS) card transaction equipment and service industry, is certainly struggling to overcome a series of investor disappointments. Frankly, its string of struggles has lasted for a number of years now, with a few moments of relief. In true contrarian fashion, I believe today’s entry point of around $16 per share with a valuation of about 10x their lowered earnings expectations, tilts firmly in favor of bottom-feeders.

At today’s stock price - after a recent plunge due to yet another quarterly report that included still-lower guidance for Q4 and 2017 (down 3% revenue next year) - and now returning to a share price last seen back in 2013 that represents a dramatic round-trip from $38 a year ago - I believe a turnaround, both operational and share price, is far more likely than a continued decline for Verifone.

My belief is based on four points.

First, Verifone is an incumbent first-tier provider of POS systems in an increasingly complex and security sensitive card transaction processing world. While price competition in certain markets, such as Latin America, is real - with longer-term industry dynamics described well by of21 in his 2013 short-biased writeup on Verifone’s main competitor, Ingenico - I continue to believe that larger scale retailers require the level of sophistication offered by Verifone. This will increasingly be the case for mid-sized merchants, representing an market expansion for Verifone (and, of course, its more sophisticated competitors.)

Between Verifone and Ingenico, they represent a very significant proportion of market share, both in the US and globally, in POS systems sales. In the US alone, among major, first-tier, retailers, Verifone has massive market share and years of experience as a trusted vendor.

It’s my belief that these types of customers depend on strong and solid service providers for such an important element of their business operations - essentially, the money-based touchpoint of a customer’s interaction with the merchant. I believe that they will choose to take the safer vendor route, again and again - as long as innovation keep pace with the consumers’ and merchants’ demand for new services, design, speed and security.

Second, with regard to innovation, services and security, Verifone has a slate of new product offerings soon coming to market - mPOS (their lower cost suite of terminals to compete with low cost providers), Engage (a media-enabled, services-integrated multi-line system) and Carbon (a more sleekly-designed answer to those attracted to the newer, touch-screen POS experience.)

The operational benefits of these new systems is a simpler, unified chassis that enables for faster technical certifications and overall flexibility for future product roll-outs and changes. This systems rationalization process has been a multi-year push by Verifone under their new CEO, Paul Galant.

Third, Verifone stands to benefit from the loosening of the current chip-enabled card transaction (known as EMV) transition bottleneck seen with small and midsize US businesses (SMB) who’ve been delaying their systems switchover. Despite Visa’s June decision to ease the chargeback pain (with the under-$25 transactions no longer subject to chargebacks), it is inevitable in the US that most SMB merchants will make the switch over the next two years.

The EMV transition has certainly been slower this year than once expected by  investors after the quicker EMV rollout directly following the early 2015 fraud/chargeback risk shifting mandate onto merchants backs and off of Visa and Mastercard. This “early-adopter and then foot-dragging” by the SMB market created a snapback effect for Verifone and others in the US POS equipment space. However, this  doesn’t mean that additional EMV transitions are not going to happen. They will, because they must.

According to reports, the bottleneck has produced a situation where about 1/3rd of retailers have now made the switch to chip-and-pin systems, roughly 1/3rd are in the process and are facing systems certification slowdowns (which Visa is working to alleviate) and 1/3rd have not yet begun the process (which Visa has enabled with their looser chargeback rules.)

I contend that the majority of the 2/3rds of remaining merchants in the US who have not yet enabled chip-based transactions will eventually make the switch and Verifone’s product offerings - both up and down the spectrum of price points and their various service levels - will allow investors to break out of the current doldrums of disappointment and lowered guidance.

Fourth, Verifone has been steadily working toward a more-lucrative services model versus a device seller. The benefits of moving to an annuity-based, systems-as-a-service push is an obvious objective of Verifone. The lifetime value of the customer is multiples that of a device-only customer. With the added complexity of needs with regard to modern-day POS systems, it seems inevitable that Verifone will benefit greatly as they pioneer this business model transition in the US, as they’ve done in their European markets. For example, in their EMEA geographic segment, services are about 45%, which is where I believe the US segment will be headed in the years ahead.

At this point in time, approximately 30% to 35% of Verifone’s US revenues are categorized as services, as opposed to simply device sales. This business model shift has been a big push by management over the past few years and I clearly think it’s smart, of course.

Together, these four beliefs should help turn the sentiment around for investors in Verifone.

Valuation Considerations:

With expectations so low now - roughly valuing Verifone’s equity at about 10x to 11x earnings estimates for 2017 of about $1.40 to $1.50 per share and at an EV/EBITDA ratio of about 6x - I think it is priced low enough today to warrant a turnaround-based investment today.

Overall, for 2017 management has guided to a revenue decline of 3% off of a base of $2 billion for 2016. With non-GAAP earnings for 2016 estimated to be about $1.65 per share, this projected revenue decline with commensurate cost cuts likely translates into an EPS decrement of about $0.15 to $0.25 per share.  

To help meet these lowered earnings expectations, Verifone has been cutting expenses and I believe will likely be entering a bit lighter R&D phase in the coming quarters as their new product push is coming to fruition due to what was once an underinvestment in innovation by prior management.

Earnings Guidance for Q4 2016 and 2016:

Basic Business Description:

“VeriFone is a global leader in secure electronic payment solutions at the point of sale (“POS”). For over 30 years, we have designed, manufactured, marketed and supplied a broad range of innovative payment solutions and complementary services that enable secure electronic payment transactions and value-added services at the POS. Our solutions and services enable merchants to address their payment acceptance complexities, enrich the interaction between merchant and consumers, and increase merchant revenues. Key industries in which we operate include financial services, retail, petroleum, restaurant, hospitality, taxi, transportation, and healthcare.” (Source: Form 10-K)

Catalyst

Valuation, new product launches and overcoming the disappointments of the slow EMV transtiion.