The stock market is a funny place sometimes; one where you may just find yourself defending a stock you used to criticize pointedly. And yet, that's where I feel I am with VeriFone (NYSE:PAY). I didn't like this stock much back in the "what, me worry?" go-go momentum days and I'm glad I didn't actually short it, as the stock just kept climbing from 2009 to 2011. Now it's a different story. Investors have raised questions about how the company reports organic growth and everybody seems to be getting on board the mobile payments bandwagon. Although VeriFone still carries pretty robust fundamental valuation ratios every value investor looks at, this is a company that looks well-placed for ongoing growth. The question for investors now, though, is whether the company can please a momentum crowd that no longer seems willing to give the company much benefit of the doubt.
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Fiscal Third Quarter Good, but not Good Enough
For a company still priced for excellence, VeriFone failed to deliver a perfect quarter. Revenue grew 56% as reported, or 16% by the company's organic growth calculation. This result came in a little shy of expectations and while the miss was not that large, I think investors may resent that the company previously failed to disclose a facility fire in Brazil that took out about $10 million of revenue. VeriFone's organic growth looks more like 5 to 6% on a pro-forma basis, but North American organic growth did accelerate on a sequential comparison.
Margins continue to come in pretty strong. Adjusted gross margin improved three points from last year and nearly a point from the second quarter. Zooming in on net operating income and on the operating line, reported GAAP profits improved 38% while adjusted income rose 85%. Relative to expectations, VeriFone did OK on a margin basis, though much of the bottom line beat came from lower taxes.
VeriFone seems to be on the wrong side of market sentiment as it pertains to mobile payment developments. The stock was weak, for instance, on the announcement between Starbucks (Nasdaq:SBUX) and Square and bears have similarly talked up announcements like the tie-up between eBay's (Nasdaq:EBAY) PayPal and McDonald's (NYSE:MCD) in France.
I'd say a little perspective is in order. For starters, Starbucks wasn't a VeriFone customer anyway, as the company uses MICROS (Nasdaq:MCRS) point-of-sale (POS) terminals. Second, and I think this is a big one, this deal with Square isn't replacing or supplanting those terminals - it's augmenting them. Certainly there's a long-term threat here, particularly if smartphones and/or tablets supplant POS terminals at smaller retailers, but that's going to take a lot of time and it presupposes no competitive response from VeriFone.
Still Plenty of on-the-Ground Potential
I also think it's worth considering the mobile payment "revolution" in the context of what is still true today about customer payment behaviors. People may grumble in line when they see a customer ahead of them bringing out the checkbook, but the reality is that people still use currency and checks. Likewise, it wasn't all that long ago when using a credit card for a taxi or at a small retailer/service provider just wasn't an option.
What I'm getting at, then, is that even though some say that mobile payments could replace cash by 2016, mobile isn't going to erase existing consumer use of credit cards. So although there's going to be plenty of attention as to whether the new Apple (Nasdaq:AAPL) iPhone 5 has mobile wallet technology built in (and if so, what technology), I just don't see mobile payments substantially sapping the company's ability to post ongoing growth - particularly in emerging markets. Moreover, I would again suggest that VeriFone's installed base gives them at least a fighting chance to capture mobile business with their own approach (es).
The Bottom Line
VeriFone didn't help themselves by lowering revenue guidance with this earnings release, even if the revision was pretty modest. With the stock still pretty expensive on an EV/EBITDA basis, sentiment plays an abnormally large role, and it seems that the market thinks the company is getting left behind in mobile.
I still give VeriFone above-average odds of posting low-to-mid teens free cash flow growth over the next decade or so, though I admit that's an aggressive target. On that basis, VeriFone may actually be undervalued enough to consider adding to portfolios, but investors considering this name need to be aware of the abnormal volatility here and the risk that perception will drive the shares much more powerfully than reality.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.