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 One of their favorites: Verifone Systems Inc, a $3.2 billion market
cap company that is one of two major global manufacturers of
point-of-sale terminals and mobile payments systems and could profit
from any major upgrades of payment technology. Analysts at JPMorgan
Chase and Jefferies & Co upgraded their outlook for the company in
the last 10 days, helping send its shares price up about 25 percent
since the Target breach was first reported on December 18.
Yet for its shares to continue to rally, Verifone must prove to
analysts and portfolio managers it has taken steps to right its own
ship after several years of choppy performance.
That question mark is a product of several years of poor
acquisitions and a history of missing earnings estimates that left
the company's shares down more than 20 percent for the year just
before the Target breach become public — in a bullish year for
stocks. It hangs over the company as a new wave of credit card
technology looks poised to finally make inroads in the U.S. after
being the standard in Europe for years.
"Verifone has a tremendous and recently unappreciated position in
the industry, yet it's kind of a messy place. The new management
team looks great, but this is like waiting for Godot," said Jeffrey
Bronchick, whose $56.3 million Cove Street Small Cap Value fund has
one of the best performances in its category over the last three
years, according to Morningstar data. In the Samuel Beckett play,
two characters wait endlessly for Godot, who never shows up.
Verifone declined to make executives available for this article.
Bronchick said that he sold his position in the company during its
recent rally in large part because, at approximately $29 a share,
its stock price looks expensive. The stock trades at a forward
price-to-earnings ratio of 19.5, which is well above the
approximately 16 times multiple of the broad market.
"The stock is reflecting a seamless next two years and I think
there's little likelihood of it," he said.
TECHNOLOGY UPGRADE
The bullish case for Verifone rests largely on expectations that the
slow-to-change credit card industry is set to adopt new technology
that could cut fraud in the United States. The country accounts for
nearly half of global credit card fraud despite handling only 27
percent of all card volume, said Darrin Peller, an analyst at
Barclays who covers the industry.
Merchants, retailers and credit card issuers have long resisted
upgrading to a card system, now ubiquitous in Europe, that stores
information on chips embedded in the cards themselves. Rather than
relying on the easily copied magnetic stripe on the back of cards,
these cards, called EMV for Europay, Mastercard, Visa, create a new
code for every transaction, making it difficult for hackers to
duplicate.
As an incentive to push card issuers to upgrade, Visa has warned
that merchants' banks may start bearing the costs of fraud starting
in October 2015 if the merchants don't upgrade.
Some Verifone terminals were in use at Target locations, according
to Peller, the Barclays analyst. That investigation continues and
Peller said it was unclear whether they were involved in the data
breach, but he did not expect Verifone to face liabilities in
connection with the loss.
Target said on January 10 it could not yet estimate the costs it
would face in relation to the breach. The company did not respond to
a request for comment or say what terminals it used. Verifone
declined to comment for this article.
The data breach at Target has created "a growing sense of urgency"
among merchants to upgrade their point-of-sale terminals in order to
read EMV cards, noted Andrew Jeffrey, an analyst at SunTrust
Robinson Humphrey. "For the first time, we get the feeling that the
cost of conversion is being outweighed by the open-ended liability
associated with making consumers whole when their accounts are
compromised, and the potential damage to retailer's brands," Jeffrey
noted.
An implementation of the EMV system in the U.S. would push merchants
into buying 15 million to 20 million credit card terminals, said
Peller, the Barclays analyst.
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Those purchases — which Peller says large companies would split
between Verifone and French company Ingenico, its main competitor — would likely help turn around Verifone's solutions services
division. Revenues in that part of the business fell 20 percent, to
slightly below $1.07 billion, in its fiscal year that ended in
October.
"Verifone could see around $100 million or more in incremental
annual revenue for a few years from its existing U.S. installed
base, with longer-term upside from market-share gains and services
revenue over time," Peller noted in a report published in 2012. He
said the estimate is still reasonable.
NEW MANAGEMENT
That upgrade process would likely help Verifone investors more than
Ingenico shareholders largely because several years of poor
management have depressed Verifone's stock price, said David Rudow,
an analyst who works on the $968 million Thrivent Mid Cap fund.
He sees new CEO Paul Galant, who came on board September 23 after
heading up Citigroup's enterprise payments business, as more capable
of steering the business than its previous management team, which
Rudow said ignored product cycles and focused too much on
next-generation mobile payment systems at the expense of the more
profitable terminal business.
"If you look at stock charts, Ingenico is a beautiful chart — straight up — and Verifone is the opposite," he said. Ingenico's
shares rose 44 percent in 12 months to new all-time highs and are up
450 percent over the last five years. Despite their relative stock
performance, Verifone and Ingenico have remarkably similar product
lines and are the two largest providers in nearly all markets they
compete in, he said.
The idea that "execution issues experienced by Verifone are
eminently 'fixable'" prompted Bradley Safalow, founder of
Atlanta-based research firm PAA Advisors, to recommend a short
position on Ingenico in November. He expects the company's share
price, currently trading at nearly 66 euros, to fall to 35 euros as
Verifone continues its turnaround.
Jason Kupferberg, an analyst at Jefferies, said Galant will likely
take steps to standardize products across Verifone's global regions,
allowing the company to cut by half the number of distinct products
it offers and cut costs as well. Verifone said in December that it
expects to earn up to $1.40 in net income per share in its 2014
fiscal year, a figure 10 percent below Thomson Reuters I/B/E/S
estimates of $1.56 per share.
"This management team looks like it's trying to under-promise and
over-deliver and is being very conservative in their guidance," said
Joshua Schachter, whose $90.1 million Snow Capital Small Cap Value
fund has been adding to its position in Verifone.
VALUATION CONCERNS
The Verifone rally following the Target breach has led some analysts
to question if the company is becoming overvalued.
"Before recommending the stock after the run it's already had, I
would argue that you probably want to see a couple of more quarters
of evidence that it can regain market share back and grow from
here," said Peller, the Barclays analyst.
The stock is currently trading at $28.98, slightly above the median
target price of $28.50 among the 15 analysts tracked by Thomson
Reuters. That high price is leading some investors to wait for a
pullback before buying back in.
Among them: Bronchick, the Cove Street portfolio manager who
recently sold his shares.
"If this company was trading at $21 a share, I'd be pounding the
table for it," he said.
(Reporting by David Randall; editing by
Linda Stern and Gunna Dickson)
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