Going into this quarter, Wall Street wanted to buy into the idea of a VeriFone (NYSE:PAY) turnaround. Not only were the shares up more than 20% from their low, but the earnings estimate revisions had been pretty mild despite strong share gains at rival Ingenico (Nasdaq:INGIY). Last and not least, instead of being worried about further gains from next-gen payment rivals like eBay (Nasdaq:EBAY), Intuit (Nasdaq:INTU), and Square, many sell-side analysts were speculating as to who was going to buy VeriFone to accelerate their market growth.
Fiscal second quarter results are going to throw a bucket of ice water on a lot of that optimism. Not only are the share losses to Ingenico (and other providers) becoming more apparent, but customer dissatisfaction and industry pricing pressures are looming larger. I won't rule out the possibility that the right CEO hire and the development of a stronger value-added service portfolio could lead to an eventual turnaround at VeriFone, but it's very clearly going to take some time for that to happen.
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Another Weak Report Hits The Shares
VeriFone shares were indicated down as much as 15% in Thursday pre-market trading, as fiscal second quarter results disappointed the Street, and management issued very weak financial guidance.
Revenue fell 10% this quarter, as a decline in “solutions” (product) revenue of 19% buried an 11% improvement in service revenue. By region, North American sales declined 5% due to weak performance in gas stations, while Latin American and EMEA sales both declined 14%. Sales to Asia-Pacific were the lone positive, rising 3%.
With weak revenue, margins continue to erode. The company's adjusted gross margin fell more than two points from the year-ago period, while adjusted operating income fell by more than a third and operating margin contracted by nearly six points.
In terms of guidance, the management target of $400 million in revenue for the fiscal third quarter was more than 13% below the preexisting average estimate and about 8% below the Street-low estimate.
SEE: Understanding The Income Statement
Losing Share Here, There, And Everywhere?
VeriFone management can talk about “significant short-term challenges” if they like, but I think these challenges are starting to stack up as real long-term threats, particularly from a market share perspective.
VeriFone's chief rival, Ingenico, reported 24% revenue growth for the first quarter, with 30% growth in the U.S., 6% growth in EMEA, 23% (constant currency) growth in LatAm, and 81% growth in Asia. At that rate, VeriFone's market share is not going to hold up long. And it's not just Ingenico – Intuit's payments revenue was up 13% for its April quarter, eBay's PayPal revenue was up 18% (which admittedly is not entirely apples-to-apples), and Square continues to gain share in the small/medium-sized business market.
Simply put, I think there's a sizable shift occurring in the payment technology world, and VeriFone risks getting left behind. There's increasing disintermediation in the hardware, mobile is catching on fast, and value-added services are becoming increasingly vital in standing out amidst the crowd. To that end, whether it's Apple (Nasdaq:AAPL), Google (Nasdaq:GOOG), Intuit, Stand, PayPal, NCR (NYSE:NCR), Ingenico, or Gemalto (OTC:GTOMY), I think VeriFone has some serious competition to deal with – even with it's prior billion-dollar deal for Point.
SEE: A Primer On Investing In The Tech Industry
The Bottom Line
VeriFone isn't out of the running yet. The company still has a substantial installed base and disgruntled customers can, in time, be “re-gruntled”. Along those lines, if the board of directors can hire the right CEO, one who understands the growing importance of services and mobile/flexible hardware, VeriFone is far from a lost cause. Still, I do worry that the company has taken its market leadership for granted and doesn't really have a culture in place built around responding to what the customers actually want.
I suppose improved execution could take these shares back into the $20s before too long, and I won't completely discount the possibility that a new cycle of buyout rumors could reignite interest (particularly if the CEO search drags on). Even so, I think an investor has to have an exceptional amount of patience (and a high pain threshold) to mess with VeriFone right now.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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