VeriFone Stock Drops: What to Do Next

by Hilary Kramer | June 6, 2012 7:00 am

VeriFone Stock Drops: What to Do Next

verifone pin pad 630 VeriFone Stock Drops: What to Do Next VeriFone (NYSE:PAY[1]) has had a rough few days after last week’s  earnings report sent shares tumbling, so it was nice to see some positive action recently in an otherwise down market. I know you have a lot of questions about the drop and what to do next, so let’s start with a look at the results.

PAY reported better-than-expected fiscal second-quarter earnings of 64 cents a share, up from 46 cents per share a year ago and 58 cents per share in the previous quarter. Revenues of $479 million were up 62% from a year ago, reflecting the two major acquisitions of Hypercom and Pointe.

One of the main causes for the sell-off was doubts about internal revenue growth, which management said increased 15%. We’ve talked about how VeriFone has come under criticism for the way it calculates its internal revenue[2], and the company used careful wording in the press release when referencing it. The exact quote was “net revenues excluding revenues from businesses acquired in the past 12 months increased 15% from the year-ago quarter.” Some analysts believe the proper way to measure internal growth is to measure what growth would have been if the acquired businesses had been owned in both periods.

As you may recall, Hypercom was forced to sell its payment systems unit as a regulatory condition to complete the deal. If VeriFone is merely using its systems to replace Hypercom’s, arguably that should not be considered internal growth. The only specific comment made about the acquired businesses was that Hypercom-brand non-GAAP net revenues increased $8 million from the first quarter to $81 million in the second. However, in response to a question on the conference call, PAY indicated that they still expect 10%–15% internal growth after the acquisitions have reached their one-year anniversary date.

Also contributing to the sell-off was slightly lower-than-expected guidance of $2.60–$2.66 a share. All of that range except the top is below current estimates of $2.66. Since the company beat estimates for the quarter by 3 cents per share the guidance does imply lower expectations for the third and fourth quarter, which management blamed on unfavorable currency fluctuations.

And the third issue weighing on the stock was weak free cash flow generation. Free cash flow for the first six months of the year was $38 million, compared to pro forma net income of $134.5 million. In the second quarter, free cash flow was $13 million versus adjusted net income of $71 million. On the conference call, management said that the gap between net income and free cash flow will get smaller over time, and that a major culprit was merger integration costs, which have been previously accrued as an expense but were not paid for immediately.

The triple play of concerns brought the stock down 20% in the last week. I know it’s no fun at all to watch one of your stocks fall like that, and when it happens, we have to examine whether the long-term story has changed. If it has, we would want to cut our losses and move on. If it hasn’t, we want to hang on for the expected snap back, even if it takes a while.

I believe there is an unusual amount of short-term noise surrounding the stock, namely the accounting question of whether some of the growth relating to the Hypercom acquisition should be considered internal or not. I don’t want to dismiss the question as unimportant, but in the long run, growth will be growth, no matter how it is classified. All of this growth will ultimately become internal anyway.

In addition, free cash flow generation should increase as merger integration costs subside, and the currency fluctuations that resulted in slightly lower guidance can be a headwind or tailwind, but they don’t permanently change the story.

The three catalysts that should drive future growth remain intact:

  1. international expansion of point-of-sale electronic payment devices,
  2. strong incentives for smaller U.S. merchants to switch to those devices in the next couple of years, and
  3.  new mobile payment systems.

For these reasons, I believe selling at these prices would be a mistake, and I recommend you hang on to your PAY shares if you own the stock. And if you don’t, I believe that we will look back at these lower prices as a buying opportunity.

Endnotes:
  1. PAY: http://studio-5.financialcontent.com/investplace/quote?Symbol=PAY
  2. criticism for the way it calculates its internal revenue: http://investorplace.com/2012/04/buying-verifone-is-a-strong-portfolio-solution-pay-v-ma-goog-aapl/

Source URL: http://investorplace.com/2012/06/verifone-stock-drops-what-to-do-next-pay/
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