Tickers in this Article: SWY, KR, BBBY, GDOT, NTSP
Gift cards are big business. According to The Nilson Report, consumers are expected to spend $274.7 billion on gift cards by 2016, a 48% increase in just five years. It's for this reason that Safeway (NYSE:SWY) is selling a minority stake in Blackhawk Network Holdings Inc., its gift-card subsidiary. Should investors buy the IPO? Or does it make more sense to own Safeway's stock? I'll have a look.

SEE: IPO Basics

Who Is Blackhawk?
Back in 2001, Safeway CEO, Steve Burd, was searching for ways to generate more from its existing grocery assets. Former Atari executive, Don Kingsborough, was brought in to sell more nontraditional goods to its customers. What he came up with was "... a leading prepaid payment network utilizing proprietary technology to offer a broad range of gift cards, other prepaid products and payment services in the United States and 18 other countries." In other words, Blackhawk provides more than 500 leading consumer brands access to over 100,000 active retail distribution locations and 160 million consumer visits per week. It is one of the largest third-party gift-card distributors in the world. Whether you're at the cash register of your local Safeway, Kroger (NYSE:KR), Bed Bath & Beyond (Nasdaq:BBBY) or many other retailers, the gift-card racks you see in front of you are put there by Blackhawk Network.

What's It Worth?
That's a good question. In a December 2007 article in The Wall Street Journal, Burd estimated that Blackhawk's pretax income that year would be approximately $100 million, double its 2006 profit. An analyst for FTN Midwest Securities estimated its 2007 revenue at $170 million. The revenue figure seems plausible; according to Blackhawk's registration statement, its 2008 revenue was $361.8 million. Since 2008, it's grown revenue by 28% annually. At just under $1 billion, it's very possible that revenues grew from $170 million over five years.

However, I'm having a hard time with the $100 million pretax income figure Burd mentioned in the WSJ article. Blackhawk's operating income in 2012 was $76.8 million, significantly less than its supposed pretax profit in 2007. Clearly, Safeway has changed the way Blackhawk accounts for its profitability. I think we'll have to stick with the figures in the S-1.

SEE: Understanding The Income Statement

An independent third-party valuation of its common stock on Dec. 29, 2012, came up with a figure of $10 per share. The estimated number of shares outstanding after the IPO, including those shares to vest in the future, is approximately 114.1 million, which puts the value of Blackhawk Network Holdings at $1.14 billion. Adjusting Blackhawk's 2012 revenues to subtract commissions paid to its distribution partners, its valuation is two-and-a-half times sales. Its two main competitors: Green Dot (NYSE:GDOT) and Netspend Holdings (Nasdaq:NTSP) trade at multiples of 1.01 times and 3.14 times revenues, respectively. This suggests $10 per share will be in the ballpark when they are ultimately priced.

What Does It Mean for Safeway?
Prior to 2013, Safeway's stock was moribund, averaging a 4% annual decline in each of the previous four years; it underperformed the S&P 500 in all of them. Then it announced its plans for Blackhawk Network in September and its stock started to come alive. In February, it delivered strong Q4 results, including a 40% increase in earnings year-over-year to 94 cents per share along with a third consecutive quarter of market share gains. Finally, rumor has it that several Canadian grocery chains are considering making an offer for Safeway's 225 Canadian locations.

All three of these developments have lit a fire under its stock, but can this continue? I highly doubt it. Safeway's stock is up 68% since its 2012 low of $14.73 last July; it hasn't been this high since 2010. With CEO Steve Burd stepping down in May, it's possible that its stock might get a small boost from his departure, but more than likely it's dead money until it decides what to do with its remaining Blackhawk Network shares and its Canadian stores. If it distributes its remaining Blackhawk Network shares to shareholders and sells the Canadian operations for several billion, then and only then, will we see it move up to $30.

SEE: Earning Forcasts: A Primer

The Bottom Line
If you're a Safeway shareholder, Blackhawk Network is a small part of its overall picture. However, it's extremely profitable and growing. If its shares go out at $10 to $12, I'd be very tempted to pick some up. I'd also be crossing my fingers that, after the IPO, the remaining shares held by Safeway are distributed to shareholders on a tax-free basis. As for Safeway's stock, I don't hold out as much hope. Without some kind of catalyst in the future (I've mentioned several possibilities) I wouldn't be buying any more. I would, however, wait to see what it does with Blackhawk Network before contemplating selling. You don't want to punch a gift horse in the mouth.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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