Green Dot Flashing Yellow

By Stephen D. Simpson, CFA | April 26, 2012 AAA

I'm not exactly sure why, but specialty finance seems to have more than its share of flash-in-the-pan growth stocks that come out of nowhere, post a couple of years of great growth, and then all but disappear from the scene. The risk of a repeat performance seems to weigh on the shares of Green Dot (NYSE:GDOT), as many analysts project robust revenue and free cash flow growth, but seem to take a "no, you first" mentality to the stock.
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Q1 Numbers Okay, But Deceleration Is a Worry
On the whole, Green Dot's first quarter numbers looked reasonably good. Reported revenue grew 18%, as cash transfer revenue rose 27% and both card revenue and interchange revenue rose by about 15%.

Many of Green Dot's numbers have to be looked at through the lens of "ex-TurboTax" as the company no longer had Intuit (Nasdaq:INTU) as a partner. So then revenue actually grew about 27%, and active cards increased by about 20% and not the 10% reported, while new card activations were actually up 23% and not 1% and gross dollar volume (GDV) increased 33% and not 5%.

Profitability was OK, but leverage seemed to be lacking. Adjusted operating income rose about 19%, while the operating margin expanded just 10 basis points.

Growth deceleration is a hot topic with Green Dot, and for good reason. Although ex-TurboTax revenue growth was actually a bit higher than in the fourth quarter (27% versus 26%), metrics like active cards, GDV, new activations and cash transfers continue to show sequential deceleration in growth, while margins have stayed relatively flat.

SEE: Understanding The Income Statement

Walmart Still a Huge Factor
Walmart (NYSE:WMT) continues to have a disproportionate influence on Green Dot's business. Walmart is Green Dot's largest distribution partner and represented 64% of first quarter revenue - up from 58% in the fourth quarter.

This is an ongoing good news/bad news situation. Part of the bad news is that a commission reset is approaching (May 2013), and Walmart will almost surely want a bigger cut (when's the last time anybody said Walmart was generous?). Moreover, American Express (NYSE:AXP) is trialing its own prepaid card with Walmart (Bluebird) and that may give Walmart leverage to push a harder bargain, even if the Bluebird card is more limited than Green Dot's offerings.

SEE: Earning Forecasts: A Primer

Will Mobile Matter?
Green Dot acquired Loopt in large part to enhance its mobile payment efforts. Mobile payment is a big buzzy topic these days, with everyone from Visa (NYSE:V) to Verifone (NYSE:PAY) to eBay (Nasdaq:EBAY) going out of their way to highlight their involvement. Certainly it makes sense for Green Dot to be involved, as it may be a way of both attracting new customers and holding onto existing ones.

That said, there are ample question marks. Management won't say much of anything useful about their mobile plans, leaving investors with a good sense of real-time dilution (the costs), but only a vague notion of the long-term benefits. Along similar lines, management offered pretty robust guidance, but not a lot of specificity on how the company is going to get there.

The Bottom Line
It's readily apparent that the Street simply isn't buying the growth story at Green Dot. Whether that's because they don't trust the management, worry that the Walmart relationship will ultimately hurt margins, or believe that competitors like American Express and Western Union (NYSE:WU) will ultimately grab share, I do not know.

But what I do know is that sell-side projections call for a free cash flow growth trajectory in the mid teens, and that would imply a fair value in the high $40s. Reversing the equation, today's market cap suggests only 7% compound free cash flow growth over the next decade - a major divergence from current expected earnings growth rates. For investors who believe in the growth story at Green Dot, today's prices could be a great long-term opportunity, but more skeptical investors may well be thinking that this story is just a little too familiar for comfort.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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