Payment Processing (70% of ’08 revs)

The basic revenue model in the payment processing business is as follows:  As an illustrative example, assume the customer makes total fuel purchases of $100 on date X using the Wright Express card (the average single purchase is less than this). WXS keeps approximately $1.90 of this total. The remaining $98.10 is paid by WXS to the merchant in X+11 days. In X+30 days, the customer pays $100 to WXS.  For 19 days the company  finances the balance, using its wholly-owned banking subsidiary to raise the money at rates of 4-5%.  The cost of financing for 19 days is thus about 25 cents, and the company makes $1.60 in this transaction. From this it pays overhead, credit losses and is left with roughly 80-90 cents of EBITDA.

Transaction Processing

(5% of ’08 revs)

Transaction processing is similar but does not require funding of customers’ purchase. In this business, the company processes the information about the transaction and  receives approximately 32 cents per transaction.  WXS does not pay anything to the merchant. Although the fee per transaction is lower, there is no working capital required

MasterCard segment (6% of ’08 revs)

WXS issues a standard corporate charge card and single purchase credit cards to small and mid-size businesses.  The company charges approximately 1% for each transaction.

Account Servicing

(7% of ’08 revs)

Account servicing revenue is generated by monthly fees paid by fleets for vehicle data reports provided by WXS. This revenue stream is dependent on the vehicles in the customer fleets and has been increasing at a steady rate.

Finance Fees:

(7% of ’08 revs)

Finance fees are charged to clients with overdue balances on a monthly basis. It had been increasing with the increase in revenue and receivables but with the reduction in fuel prices, this revenue stream is likely to be stagnant or show a marginal decline.

Revenue stream recurring and protected

The core business of WXS is a recurring revenue model.  Every day hundreds of thousands of vehicles make payments using the WXS card.  The company cites a customer retention rate of over 98%. 

For the core segment, which will generate 70% of revenues in 2008, revenues are determined by the following calculation:  [# of transactions] x [gallons of fuel per transaction] x [fuel price] x [payment processing rate].   Each of these factors requires consideration:

(1) # of transactions should show only small decline

We believe that WXS transaction levels are unlikely to suffer a significant drop in the current economic downturn, for the following reasons:

·   Broad base: The number of transactions processed has increased from 36 million per quarter in 2004 to 55 million per quarter in 2008.  The company has an extremely broad range of customers - 303,000 overall representing 4.5 million vehicles, which are predominantly comprised of medium trucks, light trucks and automobiles. As this broad scope represents a snapshot of national activity, the company expects changes in its transaction level to fluctuate in relation to changes in GDP levels, and thus decline in the low single digits annually during the ongoing economic downturn.

·   Adding new customers:  However, the company has been consistently adding new customers, and it is logical to believe that it would continue to do so, as companies look to firms like WXS as a way to control costs.  In addition, some of this is already ‘in the bag’, as in late 2008 the company signed the GSA, a government agency with a massive fleet of 250,000 vehicles.  This represents a 5.5% increase to WXS’s total customer base, and management expects it to add 3-4% to the annual transaction volume.

·   Room to grow: WXS is the market leader in the fleet payment processing industry in terms of the total number of vehicles serviced, processing transactions for nearly 15% of the total fleet market in the United States. However, approximately two thirds of US fleet vehicles still do not use any kind of fleet card. This provides ample opportunity for WXS to increase its market share.

(2) Gallons per transaction steady

Gallons per transaction hasn’t changed much over years. The customers were buying 19.9 gallons of fuel per transaction for their vehicles in 2005, and 20.1 for the last quarter. It has been fairly steady in a very narrow range of 19.9 to 20.5 for the last three years.

(3) Hedged for gas prices

Since its spinoff from Cendant in 2005, WXS has consistently hedged 90% of its fuel price exposure.  The company locks in a range (usually 5-6 cents) by buying a put option and selling a call option. The costs of buying the put are largely offset by the proceeds from selling the call.  Thus it is nearly free of cost. The option contracts are based on the wholesale price of unleaded gasoline and the retail price of diesel fuel.  For this core business, the company has locked in gas prices of $2.86-$3.08 for 2009 and $3.25-$3.66 for 2010.  The company is 90% hedged at these levels for 2009 and 40% for 2010. This has locked in an attractive margin for the company.

(4) Hybrid pricing model should result in increased processing rates

The payment processing rate measures percentage of the overall transaction that is kept as revenue by WXS.  It has been dropping steadily, down from 2.3% of the bill in 2004 to 1.71% in the most recent quarter.  While gas prices were high in recent quarters, WXS shifted many customers over to a hybrid pricing model.  This generates a fixed fee per transaction in addition to a percentage of the gross transaction price, and thus when gas prices fall, the overall percentage of the transaction will now rise for WXS as a result.  The company has converted nearly 55% of its customers to this hybrid model. Most of the new agreements are being structured as hybrid payments, and the company says that the portion of customers on the hybrid model will be 60% by early 2009.  Our analysis of past data, interviews with current users and conversations with management has led us to build in a base pricing assumption of $0.30 fixed and 1.2% variable per transaction.  Thus for an average fill-up at $2.00 per gallon (approximately $40), WXS would generate $.78 in revenue (1.95%) under the hybrid model. 

Operating costs well controlled and understood

The variable cost involved in servicing an incremental fleet or processing additional payments is very low. Margins should increase with additional scale.  The sales and marketing function has been operating successfully for several years.

Interest payments will fall sharply due to working capital reduction and interest rate drop

The company has two categories of borrowings – the first is CDs issued by its industrial bank division, and the second is on a revolving credit facility.  In 2008, the company will likely spend approximately $32 million in interest on the CD’s, and $11 million on the revolver.  In 2009, we are projecting these costs to decline to $14 million and $6 million, respectively.  This is due to:

·   Reduced working capital:  As gas prices have plummeted, the company will see receivables drop dramatically  from $1,373 million in Q3 to an estimated $788 million in Q4.   This will lead to a significant drop in interest costs.

·   Lowered interest rates:  In Q1 2008 the company was paying 5.16% for new CD deposits.  LIBOR was at 4.6%.  Currently, CD rates are between 2.6% to 3.6% depending on maturities and 1-month LIBOR is 0.88%. 

Low leverage, No liquidity issues

The company maintains extremely low leverage, with a TTM Debt / EBITDA of only 1.3x.  It has a credit line of $450 million that comes due in 2012, which is currently drawn at $212 million. There are two key covenants, and both are well within the boundaries:

·   The debt covenants require Debt/EBITDA (LTM) to be less than 3.0.  It is currently at 1.3x

·    The Interest coverage ratio is defined as EBITDA/Interest and has a minimum of 3.0.  The funds raised by the banking subsidiary of WXS and the interest thereon are not to be considered part of debt or interest for the above computations. In the most recent quarter WXS is comfortably at 12.7. 

Minimal Cap Ex

Capital Expenditures are very modest for this business, averaging $13 million for the last 3 years.  This is mainly spent on technology upgrades.  Adjusted EBITDA has averaged $137 million over the same period.

Strong free cash flow

As a result, the company has the following free cash flow – defined as EBITDA – [taxes] – [interest] – [cap ex]

2007

TTM

2008P

2009P

2010P

EBITDA

151

159

148

141

146

Less: Taxes

-33

-31

-37

-40

-43

Less: Capex

-19

-19

-18

-18

-18

Less: Interest

-13

-12

-11

-12

-12

FCF

87

96

81

71

73

Significant barriers to entry exist

There are significant barriers to entry in the business for any new entrants:

·   WXS has a proprietary closed-loop system that is accepted at over 90% of fuel retail outlets in the US.  This is difficult to replicate.  The company also has a strong brand franchise that is widely respected and trusted.

·   The company has longstanding relationship with fleets and fuel retailers.

·   The company wholly owns and operates a bank subsidiary that it uses to fund its receivables.  Without such an entity, it would be extremely difficult for a player to replicate a similar business model.  A large commercial bank can possibly offer a similar offering but it will require a lot of time and effort in building such a network.

·   Credit card companies are a less effective threat because their networks are not set up to capture the necessary data.  By having its own closed-network, WXS can capture the driver and vehicle identification, odometer reading, fuel grade purchased, gallons of fuel purchased, etc.  The WXS system can also prevent out-of-bounds transactions from occurring.  It is this data and the company’s IT tools that allow clients to analyze their operations and control spending which provides significant competitive advantage.

Leveraged competitors

There are three main competitors for the company – FleetCor, Comdata, and Voyager Fleet Systems. Two of the three are owned by private equity concerns. Fleetcor was bought by Bain Capital, Advent International & Summit Partners.  Comdata was a wholly owned subsidiary of Ceridian which was acquired by Thomas H. Lee Partners and Fidelity National Financial for a total consideration of $5.3 billion in May 2007.  It is likely that each still maintains significantly more leverage than WXS, putting them at a disadvantage.  This is likely to soften pricing competition and potentially create an opportunity for growth via acquisition. 

Stable management

Michael Dubyak, the company’s CEO, has been with the company for 20 years, since well before its spinout from Cendant.  Melissa Smith, the Chief Financial Officer has more than 10 years of experience with the company.

Red herrings distort earnings and market perception

Two items create misplaced concerns for the casual examiner of WXS:

·   Unrealized hedges: Each quarter the company includes a GAAP adjustment to earnings for unrealized hedges on its fuel program.  In recent years, as fuel prices rose, this has been significant and negative, impacting EPS by 90 cents, 77 cents, and 91 cents over the last 3 years.  However, this is a non-cash item and thus earnings is not a good measure for the company.

·   Cendant obligation: The WXS balance sheet also contains a large obligation owed to former parent Cendant ($315 million at end of Q3 2008).  This actually represents a benefit to the company.  When the company was spun off, its asset values were marked to current market value.  This allowed the company to generate significant future depreciation, reducing its tax obligation.  Cendant will receive 85% of this tax benefit, while WXS will receive 15%.  In 2007, a tax law change in New Hampshire led to a non-cash, one-time adjustment of $78.9 million to WXS earnings.

Negative pricing trends could continue

The net transaction rate has been declining steadily over the past several quarters.  While this will improve with the hybrid model and falling gas prices, prices are likely to remain under pressure for the foreseeable future due to competition.  Many of WXS’ larger clients are signed to multi-year contracts.  Management has stated that 2008 was particularly active with renegotiations.

Credit risk could worsen and company has exposure to customer bankruptcy

The company has suffered in recent quarters as the default rate has increased on its receivables.  Historically, this has been at between 0.11% and 0.22% of receivables.  In the last 2 quarters it has been at 0.20%-0.23%.  Management has warned that it could rise as high as 0.4% for Q4 2008.  However, some of the increase would be because of the decrease in the denominator as fuel prices drop.

The company keeps the receivables in its own books for a period of 30 days. Consequently, it has a constant exposure to potential credit losses. It is much better placed compared to a credit card company where the customers can purchase anything on their cards. With WXS, card usage is strictly limited to business necessities. The fleet customer card balance is non-revolving, which helps lessen the credit risk exposure as distressed customers can be cut off before accumulating very large balances. Since, the expenses are of non-discretionary nature in order to continue running a business, the payment on WXS card will rank high in the order of payments for a fleet owner.

However, bankruptcies of these businesses do present a risk.  In our opinion, the single biggest threat to WXS would be the bankruptcy of a major customer, leaving all of its receivables due in question.  This is particularly concerning because each $1 in receivables held by WXS represents approximately $55 in revenues to WXS.  The company’s largest customers include: the GSA, AT&T, Exxon Mobil, GE Fleet Services, Hess, Gulf, PHH, GM and Allstate.

Fuel price exposure after 2010

The company is currently hedged fully through 2009 at levels that are favorable to the company.  In 2010 it is currently only 40% hedged at a price of $3.25-$3.66.  The company has said that, given the current low-price environment, it is considering a wait-and-see policy for hedges for 2010 and beyond. This leaves the company potentially exposed to significant revenue reduction in 2011 in the event that oil prices continuously stay at or around current low levels.

Base Case

Adjusted Case

Results

Q4 08

2009

2010

Q4 08

2009

2010

2010

Rev

2010

EBITDA

Share Price

(1) Base Case

292

146

22.43

(2) % chg # of transactions

-2.0%

-0.4%

1.8%

-3.0%

-3.0%

-3.0%

279

133

20.10

(3) Core proc rate decreases

1.86%

1.91%

1.91%

1.71%

1.71%

1.71%

275

125

18.54

(4) Fuel price increases

2.25

2.00

2.00

2.50

2.50

2.50

329

162

25.04

(5) Fuel price decreases

2.25

2.00

2.00

2.00

1.60

1.60

263

135

20.65

(6) Default rate increases

0.40%

0.35%

0.26%

0.50%

0.45%

0.35%

292

138

20.84

(7) CD Interest rate increases

4.0%

3.6%

3.7%

4.1%

4.5%

4.7%

292

141

21.62

Fuel Price decreases

# of Transactions drops

2010

Rev

2010

EBITDA

Share Price

2010

Rev

2010

EBITDA

Share Price

Core proc rate decreases

241

107

15.31

262

113

16.48

Fuel Price decreases

251

123

18.46

Base

Low Fuel Price

High Fuel Price

Drop in # of transactions

Drop in proc rate

Growth in Transactions

-0.4%

-0.4%

-0.4%

-3%

-0.4%

# of Transactions (million)

216

216

216

210

216

Gallons per transaction

20.0

20.0

20.0

20.0

20.0

Avg fuel price

2.00

1.60

2.50

2.00

2.00

Blended trans processing rate

1.91%

2.02%

1.82%

1.91%

1.71%

Base revenues (million)

165.4

140

197

161

147.4

Hedged fuel price

2.61

2.61

2.61

2.61

2.61

Hedge impact  (million)

39.2

62

14

38

34.9

Adjusted Revenue  (million)

204.6

202

211

199

182.3

2007

TTM

Q4 08

2009

2010

Transaction volume growth

16.2%

7.7%

-2%

-0.4%

1.8%

Core transaction % rate

1.94%

1.83%

1.86%

1.91%

1.91%

Default rate

0.16%

0.24%

0.40%

0.35%

0.26%

LIBOR

5.3%

3.4%

1.9%

2.1%

2.9%

Average fuel price

$2.84

$3.58

$2.25

$2.00

$2.00

Share Price

39.6

29.85

12.51

12.51

12.51

EV/Adj EBITDA multiple

10.4

8.5

4.3

4.0

3.3

Days - >

X

X + 11

X + 30

Customer makes transaction

100

Payment by WXS to the vendors

-100+1.8

Payment by customer to WXS

100

Receivable financed from bank subsidiary

98.20

Cost of financing

4%

Payment by bank subsidiary incl interest

-98.40

Cash flow for WXS

0

1.60