Should Investors Pay Any Price For VeriFone?

By Stephen D. Simpson, CFA | December 06, 2010 AAA

There is no question that electronic payment specialist VeriFone (NYSE:PAY) was hit hard both by the recession and an accounting problem, but there is equally no question that the stock has rebounded sharply since its lows in early 2009. With electronic payments and credit card usage growing throughout the world, is there still enough runway for this company to validate what looks like a very high valuation?

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A Solid End To The Fiscal Year
VeriFone has done relatively well in terms of beating estimates over the past year or so, and the company ended this fiscal year on the same note. Revenue rose 27%, with 40% growth in the U.S. and 18% internationally.

Profitability also improved this quarter. Gross margin (on a non-GAAP basis) rose about two points to 40%, and earnings were better on an operating and net basis, whether investors chose to use GAAP or non-GAAP accounting.

The Road Ahead
Assuming that VeriFone's acquisition of Hypercom (NYSE:HYC) goes through, the company will not only patch a hole in its business model (Western Europe), but have one less competitor to worry about in the market. Competition is actually an interesting subject with VeriFone, as Ingenico will be the only straight-up competitor after this deal, though the likely need to divest the U.S. business of Hypercom may create a second competitor.

In fact, to some extent VeriFone embraces and works with would-be competitors. The company is partnering with eBay's (Nasdaq:EBAY) PayPal to combine PayPal's P2P capabilities with VeriFone's mobile solutions. Likewise, the company is working with First Data, bought by KKR & Co. (NYSE:KKR) in 2007, in some markets, including petroleum merchants (point of sale electronic payments in gas retailing is a big ongoing opportunity for VeriFone).

The Bottom Line
VeriFone certainly has some major points in its favor. It operates in what may soon be a duopoly, and the core underlying growth trends (electronic payments and greater usage of credit/debit cards) are strong around the world. And yet, the company can not translate this into especially high margins or persistently high returns on invested capital. That makes the rich valuation on these shares somewhat puzzling - investors are seemingly racing each other to pay up for a company that does not seem to merit quite so much love. (For more, see The Bottom Line On Margins.)

VeriFone certainly has a valuable franchise, and perhaps there is more inherent value to the business than statistics and cash flow indicate. By those numbers, though, it is hard for a value-oriented investor to conclude that there is any free ride available in these shares today. (For more, see The Value Investor's Handbook.)

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