Green Dot Making Investors A Little Green

By Stephen D. Simpson, CFA | March 15, 2012 AAA

It's not uncommon for new stocks to give back a lot of their market cap as the initial public offering (IPO) buzz fades and initial buyers look to cash out. In the case of Green Dot (NYSE:GDOT), that readjustment period has been pretty difficult as the stock is off nearly 60% from its all-time high. Making matters worse, competition is heating up and management's decisions have left more than a few investors scratching their heads.

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Not Quite Living up to all the Growth Hopes
Green Dot has logged three straight quarters of below-consensus revenue, and that frankly weighs heavier with institutional investors than the fact that that revenue is growing at a better than 20% clip. Where Green Dot is earning some credit is with the margins, as the company did pretty well in the last quarter with a two point improvement in adjusted operating margin.

Certainly a 20%-plus growth is nothing to ignore, and the 41% rise in gross dollar volume last quarter suggests strong adoption and usage of the Green Dot prepaid cards. Still, the first few post-IPO quarters often set the tone for a company and missing expectations hasn't helped sentiment. For related reading, see How An IPO Is Valued.

How Much of a Threat Is Competition?
With approximately 60 million under-banked potential customers in the United States, it would seem that Green Dot can afford to share the market. Yet, emerging competition seems to be one of the biggest worries on this stock.

NetSpend (Nasdaq:NTSP) is certainly one to consider, as it is a pure play reloadable card company. Likewise, Western Union (NYSE:WU) is putting a lot of support behind its own reloadable cards.

The bigger recent threat is American Express (NYSE:AXP). Not only does it have a well-known and well-established brand name, but the company has started a pilot launch of its new Bluebird card through Wal-Mart (NYSE:WMT) - Green Dot's long-term partner in retail. Although the Bluebird has some drawbacks (including a $200 weekly ATM limit, no FDIC insurance, no direct deposit), it has a fee structure that could be appealing to some customers.

Multiple Risks to Consider
Green Dot could face emerging challenges on multiple fronts. First, the company's retail distribution strategy is unlikely to maintain exclusivity. The company's agreement with Wal-Mart lasts several more years, but that may not preclude renegotiations or amendments. Likewise, exclusivity is a word that often attracts the attention of regulators and the company may find that it has to share shelf space with Western Union, American Express and the likes at Walgreen's (NYSE:WAG), Wal-Mart and so on.

Further government regulation is also a risk. By the standards of reloadable cards, Green Dot's fee structure is relatively straight-forward. Nevertheless, it stretches belief to think that millions of people will start using these cards without the government looking to tighten its grip.

Last and not least is a risk of management losing focus. Acquiring Bonneville Bancorp was a logical move and will allow the company to transition away from General Electric (NYSE:GE) and Synovus (NYSE:SNV), as well as ultimately saving money on back office expenses.

The recent deal for Loopt is another matter, though. Green Dot is paying $43 million for this "geosocial networking services" company, and the synergies with its prepaid card businesses are not obvious to me. Perhaps it will strengthen the company's hand in mobile payments, but the argument that it will aid in customer acquisition and retention seems like a stretch right now.

The Bottom Line
The major shake-ups in the banking sector have created a lot of opportunity for bank alternatives, particularly as banks ratchet up the fees for account holders and debit card users. To that end, Green Dot clearly has a good opportunity in front of it. What's more, the margins here are solid and the long-term free cash flow growth potential is compelling.

The two biggest questions are whether management can execute on the opportunity and whether these threats to the business model can be fenced in. If Green Dot can achieve low-teens free cash flow growth for the next decade, the shares have a fair value in the $40's, but Wall Street has clearly taken a "show me" attitude with this stock today. For related reading, see Analyzing The Price-To-Cash-Flow Ratio.

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

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