Time To Act Locally On Global Payments?

By Stephen D. Simpson, CFA | October 10, 2010 AAA

Fishing for turnarounds is a little like fishing for sharks - get a bit careless and you could find yourself bitten. That is a good warning to keep in mind when perusing the recent earnings report and stock action from Global Payments (NYSE:GPN). While this leading transaction processing service company has a lot of value-type characteristics, its poor margin performance and questionable guidance are warning signs.

IN PICTURES: 5 Tips To Reading The Balance Sheet

The Quarter That Was
Global Payments certainly did blow away expectations this quarter. Total top line growth was about 7% for this fiscal first quarter, with strong results in the U.S. and Asia somewhat offsetting a pathetic performance in Canada and Europe. That is a feeble performance relative to the likes of Visa (NYSE:V) or Green Dot (Nasdaq:GDOT) (to be fair, these aren't entirely straight up comparisons).

Going a little deeper, U.S. revenue growth of 15% was fueled by strong transaction volume - a detail that would seem to suggest some market share gains, given the overall stagnation of consumer spending. GPN's transaction growth was more than double what Discover Financial Services (NYSE:DFS) reported recently. But perhaps consumers are more active than the economists think. (For more, see Discover Shows A Better Credit Environment)

Beyond that, the news is not so good. SG&A expenses grew more than twice as fast as sales, and the operating margin fell more than 200 basis points. Continuing a worrisome trend, North American margins fell almost 500 basis points, while international margins gained more than 300 basis points. Taking a step back, this is part of a broader trend that has seen North American margins fall almost 1,000 basis points in just three years - not a good sign for a would-be turnaround story.

The Road Ahead
GPN management guided towards a back-end loaded fiscal year, but that would defy recent trends where the fourth quarter has been the weakest. In any event, the company has some work to do. A major data breach at Heartland Payment (NYSE:HPY) may have given the company a leveragable competitive advantage in the U.S., but Canada needs some fixing.

With CIBC (NYSE:CM) saying that they will not renew a sponsorship deal for GPN in Canada, GPN has to find a new sponsor. Global Payments is looking to set up its own bank to accomplish this (or else they risk losing Visa), but that process could be more involved than the company realizes. True, it is not as though the company is looking to establish a retail bank and put branches next to every Tim Hortons in Canada, but this is a step outside the norm for a company that seems truly challenged in managing the business they already know.

The Bottom Line
Criticisms and concerns aside, there appears to be considerable potential value in these shares. Even modest assumptions (mid-single digits) on forward free cash flow growth suggest an upside for shares. Also, the company does have a real (even if too-often-discussed) growth opportunity in emerging markets, where credit and debit card usage is still uncommon. It becomes a toss-up for investors: Take the higher growth (and multiples) of a stock like Visa or Green Dot, or give GPN (or Discover) the benefit of the doubt and make a value call? (For more, see The Value Investor's Handbook)

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