BLACKHAWK NETWORK HLDGS INC HAWK
May 12, 2015 - 7:04am EST by
ima
2015 2016
Price: 36.19 EPS 0 0
Shares Out. (in M): 55 P/E 0 0
Market Cap (in $M): 2,000 P/FCF 0 0
Net Debt (in $M): 280 EBIT 0 0
TEV ($): 2,280 TEV/EBIT 0 0

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  • Retail
  • Spin-Off
  • Duopoly
  • Competitive Advantage
  • High Barriers to Entry, Moat
  • Rollup

Description

COMPANY DESCRIPTION:

HAWK operates a global prepaid payment network, specializing in gift cards. HAWK distributes cards at almost 200k locations, primarily through the grocery retail channel. Approximately 80% of revenue is generated in the US and 20% is generated internationally. 80% of revenue is from gift cards, with the remainder mostly from telecom sales and the corporate and incentives market.

 

INVESTMENT THESIS:

HAWK is a high quality business

HAWK operates a high quality business, where scale in distribution and content create a significant competitive advantage and barrier to entry. The North American market is a duopoly, where HAWK competes predominantly against Incomm and competition is rational. HAWK dominates the retail grocery channel; Incomm has the majority share of the mass, drug, and convenience channel. Globally, the market is more fragmented, but Incomm and Euronet are the primary competitors. The vast majority of revenue is sold at retail through 3-5 year exclusive distribution agreements. Gift card square footage is the most profitable square footage for a retailer by a large margin, and switching costs are very high. Distribution partner retention is close to 100%. Content providers view gift cards as an inexpensive customer acquisition tool where the user is more likely to purchase full price merchandise and is likely to spend 50-100% more than the face value of the gift card. HAWK also has decent of visibility into its future costs and revenues, and its margins are very stable. Adj. net margins have been 4.9% to 5.2% over the last five years because of these dynamics. HAWK also has negative working capital and very limited net tangible capital employed in the business. Consequently, growth is not capital constrained and ROTIC is ~40%.

 

HAWK has attractive organic growth prospects

Our survey work indicates that gift card purchases are becoming increasingly recurring and gift card popularity is growing rapidly. In the US, Gift cards are the most requested gift item today. HAWK represents $11B of load value in the $56B US third party gift card market, which has grown 10-15% annually for the last few years. The US market is expected to continue growing HSD/LDD for at least the next three years through a combination of increasing consumer acceptance of gift cards, same-store productivity improvements (more sq. ft. allocation, increased marketing and loyalty programs), content expansion, and the growth of open loop (visa, mastercard) products.  Google trends for gift card terms have grown 14% annually on average over the last seven years, and VAR confirms that HAWK should continue to experience HSD/LDD organic growth domestically over the next few years. The international market for third party gift card distribution is growing 30-50% per year, with APAC growing triple digits. Penetration in international markets is  a fraction of that in the US. Prepaid cards in total represent 1% of non-US retail sales vs. 6% in the US, and HAWK’s average international distribution location generates $20k of load value per year vs. $160k in the US. Our research indicates that HAWK should be able to maintain a 30-50% growth internationally for the next few years given the low penetration levels.

 

HAWK has an attractive opportunity to roll-up adjacent markets

In the last two years, HAWK has invested $450mm in acquisitions that were strategic, synergistic, and financially attractive. HAWK has used M&A to expand geographically and into new prepaid card verticals. Acquisitions offer meaningful synergies because segments of the acquired businesses can be layered onto HAWK’s existing operating platform. HAWK is currently 2.3x levered, and management has indicated that they are comfortable at 3-4x leverage. They will be aggressive about M&A, and the deal pipeline is robust. VAR indicates that the management has internally laid out a plan to invest $1-2B of capital in either buying or building in new geographies and verticals. VAR has also indicated that there are 20-30 good acquisition candidates that management has identified as targets.

 

Management and the Board are solid

Management is well respected in the industry and well-liked by investors. They know their business well, and they are regarded as smart, strategic thinkers highly focused on creating shareholder value. They are also regarded as decisive leaders that demand results from their teams. People who know them well would invest their own money behind them. Over the previous two years, management has allocated capital wisely to several smart acquisitions: 1) a geographic expansion into Germany where HAWK was able to meaningfully accelerate load value growth through HAWK’s existing distribution and content relationships, and 2) three companies in the corporate market that create a powerful offering in a new vertical for HAWK and offer siginificant cost and revenue synergies. There are also several blue chip investors and executives (KKR, Accel, KPCB, Safeway, EA, Vodafone, WMT) on the Board.

 

VARIANT PERCEPTIONS:

Meaningful capital investment opportunity

Consensus is giving HAWK no credit for management’s plan to invest capital through accretive M&A in new verticals and geographies. VAR indicates that management has done a good job so far of acquiring strategic platforms at reasonable prices. Synergies are meaningful, HAWK has considerable remaining debt capacity, and the pipeline for new deals is robust. We believe that M&A can create significant shareholder value and enhance shareholder interest in the company.

 

Operating leverage

Consensus doesn’t expect HAWK to exhibit operating leverage in the next couple years. In the past, HAWK hasn’t shown operating leverage historically on an annual basis because management has invested excess earnings into digital and international opportunities. However, it’s clear that the business has operating leverage since net margin in the fourth quarter is 4x that of the first three quarters, while average weekly revenue is only 2x. We expect HAWK to continue investing in digital, but digital revenue contribution should grow from 2% today, absorbing some of the investments. Digital is also higher margin because the content and distribution economics are the same but digital eliminates printing and distribution costs. Also, operating margin in HAWK’s international region has recently turned positive, and this should provide greater contribution going forward. M&A synergies should provide some additional support to operating leverage.

 

KEY RISKS:

Customer and supplier concentration

HAWK’s top 3 and top 25 distributors account for 35% and 77% of revenue, respectively. On the content side, Apple is the largest supplier, at 15% of sales. Disruption with any of these relationships could be a major setback for the company. However, HAWK has its top 5 distributors contracted through at least 2017, and the costs of switching providers is very high. Apple is contracted through 2016, and we have heard that HAWK’s relationship with Apple is exceptionally strong.

 

Digital disintermediation

The most significant risk to the long thesis is digital disintermediation. If digital distribution of gift cards becomes meaningful, HAWK’s physical distribution network becomes less valuable to its partners, and it could see slower growth or margin compression. However, digital distribution is only 3-4% of the market today and is expected to reach 7% by 2016. A large portion of this will be through Amazon, whom HAWK has partnered with in a traditional distribution relationship. HAWK has also invested $100mm on digital capabilities and has formed a digital distribution partnership with or is working on one with Google, Apple, and Paypal. Given its scale, partnerships, and capabilities, HAWK has the opportunity to become a leader in digital, but there is a risk that they will fail to capitalize on the opportunity. HAWK’s websites have anemic traffic growth and worse SEO rankings than competitors. Nonetheless, we heard consistently that even if HAWK fails in digital, it wouldn’t create a meaningful problem for at least 3-5 years.  

 

VALUATION:

In our base case, we apply a 20x PE multiple to 2017E EPS of $2.41 and add $4.50 for the NPV of the tax shield. This implies a $53 stock price, representing 47% upside and a 21% IRR over the two year investment horizon.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Share price collapse – HAWK currently trades $12mm per day, and HAWKB trades $14mm per day. At the next annual meeting in May, investors will vote on a share collapse. I expect this to increase liquidity and investor interest in the name.
  • Declining comparisons to GDOT – some investors still comp HAWK to GDOT, which operates in a much more competitive industry with significant regulatory headwinds. HAWK doesn’t face these issues, so this issue should continue to fade with time.
  • Earnings beats

 

 

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    Description

    COMPANY DESCRIPTION:

    HAWK operates a global prepaid payment network, specializing in gift cards. HAWK distributes cards at almost 200k locations, primarily through the grocery retail channel. Approximately 80% of revenue is generated in the US and 20% is generated internationally. 80% of revenue is from gift cards, with the remainder mostly from telecom sales and the corporate and incentives market.

     

    INVESTMENT THESIS:

    HAWK is a high quality business

    HAWK operates a high quality business, where scale in distribution and content create a significant competitive advantage and barrier to entry. The North American market is a duopoly, where HAWK competes predominantly against Incomm and competition is rational. HAWK dominates the retail grocery channel; Incomm has the majority share of the mass, drug, and convenience channel. Globally, the market is more fragmented, but Incomm and Euronet are the primary competitors. The vast majority of revenue is sold at retail through 3-5 year exclusive distribution agreements. Gift card square footage is the most profitable square footage for a retailer by a large margin, and switching costs are very high. Distribution partner retention is close to 100%. Content providers view gift cards as an inexpensive customer acquisition tool where the user is more likely to purchase full price merchandise and is likely to spend 50-100% more than the face value of the gift card. HAWK also has decent of visibility into its future costs and revenues, and its margins are very stable. Adj. net margins have been 4.9% to 5.2% over the last five years because of these dynamics. HAWK also has negative working capital and very limited net tangible capital employed in the business. Consequently, growth is not capital constrained and ROTIC is ~40%.

     

    HAWK has attractive organic growth prospects

    Our survey work indicates that gift card purchases are becoming increasingly recurring and gift card popularity is growing rapidly. In the US, Gift cards are the most requested gift item today. HAWK represents $11B of load value in the $56B US third party gift card market, which has grown 10-15% annually for the last few years. The US market is expected to continue growing HSD/LDD for at least the next three years through a combination of increasing consumer acceptance of gift cards, same-store productivity improvements (more sq. ft. allocation, increased marketing and loyalty programs), content expansion, and the growth of open loop (visa, mastercard) products.  Google trends for gift card terms have grown 14% annually on average over the last seven years, and VAR confirms that HAWK should continue to experience HSD/LDD organic growth domestically over the next few years. The international market for third party gift card distribution is growing 30-50% per year, with APAC growing triple digits. Penetration in international markets is  a fraction of that in the US. Prepaid cards in total represent 1% of non-US retail sales vs. 6% in the US, and HAWK’s average international distribution location generates $20k of load value per year vs. $160k in the US. Our research indicates that HAWK should be able to maintain a 30-50% growth internationally for the next few years given the low penetration levels.

     

    HAWK has an attractive opportunity to roll-up adjacent markets

    In the last two years, HAWK has invested $450mm in acquisitions that were strategic, synergistic, and financially attractive. HAWK has used M&A to expand geographically and into new prepaid card verticals. Acquisitions offer meaningful synergies because segments of the acquired businesses can be layered onto HAWK’s existing operating platform. HAWK is currently 2.3x levered, and management has indicated that they are comfortable at 3-4x leverage. They will be aggressive about M&A, and the deal pipeline is robust. VAR indicates that the management has internally laid out a plan to invest $1-2B of capital in either buying or building in new geographies and verticals. VAR has also indicated that there are 20-30 good acquisition candidates that management has identified as targets.

     

    Management and the Board are solid

    Management is well respected in the industry and well-liked by investors. They know their business well, and they are regarded as smart, strategic thinkers highly focused on creating shareholder value. They are also regarded as decisive leaders that demand results from their teams. People who know them well would invest their own money behind them. Over the previous two years, management has allocated capital wisely to several smart acquisitions: 1) a geographic expansion into Germany where HAWK was able to meaningfully accelerate load value growth through HAWK’s existing distribution and content relationships, and 2) three companies in the corporate market that create a powerful offering in a new vertical for HAWK and offer siginificant cost and revenue synergies. There are also several blue chip investors and executives (KKR, Accel, KPCB, Safeway, EA, Vodafone, WMT) on the Board.

     

    VARIANT PERCEPTIONS:

    Meaningful capital investment opportunity

    Consensus is giving HAWK no credit for management’s plan to invest capital through accretive M&A in new verticals and geographies. VAR indicates that management has done a good job so far of acquiring strategic platforms at reasonable prices. Synergies are meaningful, HAWK has considerable remaining debt capacity, and the pipeline for new deals is robust. We believe that M&A can create significant shareholder value and enhance shareholder interest in the company.

     

    Operating leverage

    Consensus doesn’t expect HAWK to exhibit operating leverage in the next couple years. In the past, HAWK hasn’t shown operating leverage historically on an annual basis because management has invested excess earnings into digital and international opportunities. However, it’s clear that the business has operating leverage since net margin in the fourth quarter is 4x that of the first three quarters, while average weekly revenue is only 2x. We expect HAWK to continue investing in digital, but digital revenue contribution should grow from 2% today, absorbing some of the investments. Digital is also higher margin because the content and distribution economics are the same but digital eliminates printing and distribution costs. Also, operating margin in HAWK’s international region has recently turned positive, and this should provide greater contribution going forward. M&A synergies should provide some additional support to operating leverage.

     

    KEY RISKS:

    Customer and supplier concentration

    HAWK’s top 3 and top 25 distributors account for 35% and 77% of revenue, respectively. On the content side, Apple is the largest supplier, at 15% of sales. Disruption with any of these relationships could be a major setback for the company. However, HAWK has its top 5 distributors contracted through at least 2017, and the costs of switching providers is very high. Apple is contracted through 2016, and we have heard that HAWK’s relationship with Apple is exceptionally strong.

     

    Digital disintermediation

    The most significant risk to the long thesis is digital disintermediation. If digital distribution of gift cards becomes meaningful, HAWK’s physical distribution network becomes less valuable to its partners, and it could see slower growth or margin compression. However, digital distribution is only 3-4% of the market today and is expected to reach 7% by 2016. A large portion of this will be through Amazon, whom HAWK has partnered with in a traditional distribution relationship. HAWK has also invested $100mm on digital capabilities and has formed a digital distribution partnership with or is working on one with Google, Apple, and Paypal. Given its scale, partnerships, and capabilities, HAWK has the opportunity to become a leader in digital, but there is a risk that they will fail to capitalize on the opportunity. HAWK’s websites have anemic traffic growth and worse SEO rankings than competitors. Nonetheless, we heard consistently that even if HAWK fails in digital, it wouldn’t create a meaningful problem for at least 3-5 years.  

     

    VALUATION:

    In our base case, we apply a 20x PE multiple to 2017E EPS of $2.41 and add $4.50 for the NPV of the tax shield. This implies a $53 stock price, representing 47% upside and a 21% IRR over the two year investment horizon.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     

     

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