Goldman Sachs will run an initial public offering for shares of NetSpend this week. With the exception of two million shares already held by investors that will be put into the IPO, it will bring lots of new equity to the company.
This has been a coming-out summer for alternative financial services companies. NetSpend filed an S-1, the form used by potential IPO registrants to demonstrate their value to shareholders, on July 15th. Green Dot had an IPO earlier in the year. Buy Here-Pay-Here used care retailer Drive-Time had said that they would offer shares. Although DT did subsequently withdraw their IPO, the underlying fact remains: in a stagnant IPO marketplace, investors are making an exception with companies in the "shadow banking" system. NetSpend differs from other prepaid card companies (Green Dot, Blackhawk, Rush Card) in that it comes closes to providing a vertical set of services. NetSpend has to partner with a bank, but short of that, it does just about everything else.
I like to evaluate a prepaid card company by how it makes its money. There are plenty of ways to pick
up revenue in this space. Firms charge fees to open an account, to use an ATM, to make a PIN transaction at a checkout counter, to get a new card, and even to put money on the card. They can also pick up a substantial amount of revenue through interchange fees. Stores pay interchange for transactions, and those dollars can be distributed to the prepaid company if they have such an agreement with their bank partner.
NetSpend is in a sweet spot where revenues are going up even as margins grow. NetSpend's revenues grew by more than 65 percent in 2006 and in 2007. Revenues are still gaining, albeit at a slightly lower pace. In recent years, the company has found a way to shift from a low margin operation to one that eeks out about 15 cents of operating income on every dollar in sales.
NetSpend customers pay a variety of fees to use their cards. They are charged a fee for both a signature or a PIN transaction, for an ATM transaction, and for the purchase and reload of cards. Some customers can avoid those fees with a special account product. In that case, the fees are charged at intervals. They made about $13 million on overdrafts in 2009.
That means that one important question about the competitiveness of NetSpend is the extent to which their consumers are sensitive to that revenue mix. Every dollar that NetSpend or Green Dot extracts through interchange, as opposed to harvesting from fees, is one more dollar of saving for that consumer. Fees create a zero sum relationship between a card company and their customers. By contrast, interchange fee revenue speaks to a relationship of mutual interest.
It has been an expectation that consumers in the alternative financial services marketplace demonstrate a relative indifference to pricing. Part of that is mixed in with a fear of uncertainty. Pricing in debit cards is fixed, whereas pricing at a bank branch is driven by overdrafts.
Interchange accounts for about one in every five dollars of revenue at NetSpend. That share is increasing over time. In 2007, interchange fee revenue was just 17 percent of all operating revenue, whereas it was most recently 21.9 percent. Green Dot, by contrast, has jumped from 19 percent to 27 percent in just the last year.
The interchange equation suggests that Green Dot will give consumers more sense of value. Again, it is hard to know if that matters. Maybe cost is trumped by convenience. Green Dot markets through Wal-Mart and retail drug stores, whereas NetSpend partners with check cashers, payday stores, and the like. Green Dot claims that 93 percent of Americans shop at a store that carries a Green Dot card. NetSpend, by contrast, has been able to stake an advantage in the payroll card market. That is a good place to be, because payroll accounts tend to load more onto cards than other types of accounts. It is possible that they are actually serving different markets. Nevertheless, a straight-up interchange comparison does point to Green Dot's favor.
Consumer advocates are apoplectic about another feature of NetSpend cards. NetSpend offers a high cost credit product onto some of their cards. It is referred to as the "i-advance." Generally, it works like this: card users can borrow money in $20 increments for up to 35 days. For each increment, they are charged a fee of $2.50. By some standards, it is technically not a "loan." The term of the loan varies. It ends with the next direct deposit payment to the consumer's card. Customers can't get the credit without linking a payment source of their card via direct deposit. That is the sticking point for consumer advocates, because that system echoes of payday lending. Certainly, the pricing is similar. The only difference is that it is more convenient. People don't have to drive over to the strip mall to get some high-cost short-term credit. With NetSpend and the i-advance, it is ready and waiting inside their billfold.
The Million Dollar Question
What price will the NetSpend IPO find this week?
The Mercator Advisory Groups estimates that $200 billion will be loaded onto prepaid cards in 2013. That would represent a fivefold surge in loads from 2009. In 2008, Mercator reports that just $8.9 billion went onto GPR cards. It is a market that is poised to boom. There is a substantial moat in this space. It takes some doing to establish contracts with important retailers and it certainly isn't simple to develop the intellectual assets for the products. NetSpend and Green Dot are the two publicly-traded vehicles for investors that want to get into this sector.
The easiest detail is that Green Dot went to market with 52 cents per share in earnings, while NetSpend is coming to investors with shares that bring 21 cents to shareholders. Green Dot's IPO priced near $35 per share, but now it more near to $48 per share. At the time of the IPO, Green Dot had reported 91 cents in diluted EPS for 2009. At that earnings level, a share price of $35 represented a p/e of about 38. Earnings for the next 12 months are estimated at 85 cents per share, and the existing price is upwards of $48. That is a forward-looking EPS of 56.
From those comps, shares of NetSpend might sell at between $8 and $12. If you assume that the new cash will go to retire NetSpend's $59 million in outstanding debt (bearing interest of just 6 percent), then earnings increase another $3.54 million per year. At the same eps levers, the new price range should then fall between $9.50 and $14.50 per share.
Warning: you really shouldn't make any investment decision based upon these numbers. Seriously.