September 21, 2010 - 4:44pm EST by
2010 2011
Price: 52.00 EPS $0.80 $0.70
Shares Out. (in M): 48 P/E 65.0x 74.0x
Market Cap (in $M): 2,500 P/FCF 65.0x 74.0x
Net Debt (in $M): 115 EBIT 55 50
TEV (in $M): 2,385 TEV/EBIT 43.0x 48.0x
Borrow Cost: NA

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I think Green Dot ("GDOT") represents a fantastic short opportunity with perhaps more ways to win than any short I can remember.  I believe GDOT's current level of profitability is completely unsustainable and earnings will likely be much lower in future years.  At 46x run-rate EBIT and 26x tangible book value, I believe the potential downside here can be extraordinary.

GDOT went public in July 2010 with insider selling accounting for all the shares issued.  The company is in the hot space of prepaid debit cards and is already up around 50% from its IPO price.  GDOT is a fairly new company (formed only 11 years ago) and issues prepaid debit cards out of national retailers.  Walmart ("WMT") currently represents 64% of revenues and an even greater % of new cards sold. 

GDOT's revenue model is very straightforward.  It sells prepaid debit cards that customers can load cash on and use to make purchases or withdraw cash from ATMs.  The company sells the card for $3 through WMT and $5 elsewhere (Walgreens, CVS, Kroger, etc.).  In addition, the company charges $3-5 for monthly maintenance fee and earns additional revenues from interchange (when the card is used for a purchase) and ATM fees upon a withdrawal.  These cards are very popular with the under-banked community that may have limited banking options otherwise.

Reason #1 to short:  Low barriers + increasing competition

Despite the industry's nice growth in recent years, the space is extremely competitive and barriers to entry and competition are very low.  As the industry has grown, pricing has been coming down (WMT new card fee lowered to $3 from $9 and maintenance fee lowered to $3 from $5) and competition has been heating up.  Competitors like Netspend, Western Union and Account Now give away the card for free.  As regulatory changes put pressure on post-paid debit, we are likely to see a flood of competition in the pre-paid debit space in the coming quarters.

As I see it, there is nothing keeping this business model from seeing almost all of its profits evaporate.  Card issuers like GDOT are basically marketing companies that issue a piece of plastic (reminds me of a telephone calling card business model from years ago) and outsource all the valuable functions to companies like Mastercard, Visa, its banking partners and its retail distribution partners.  Brand loyalty is low and value-add is practically non-existent.  GDOT has invested virtually no capital in the business (despite the $2.4 billion enterprise value) and has been riding a wave of growth facilitated mostly by its roll-out in WMT stores over the past several years. 

Reason #2 to short:  50% churn rate...  per quarter!!

As you might imagine, paying $3-5 for a card and then $3-5 every month adds up for someone who is under-banked.  You can do the math on someone who puts $100 to $500 on the card and it is clear that the fees are exorbitant.  But, you don't have to trust me on this - the proof is in the numbers:  the company's churn rate has been 50% per quarter!  That means that the company is basically recreating its customer base every six months.  Not only does this draw into question the whole business model and value of the card, but it makes the revenue numbers generated by the company completely unsustainable.  This is not a nice annuity business living off of its growing base of cardholders.  Quite the contrary - if this business doesn't keep running on the card issuance treadmill, the entire business is likely to disappear in a few quarters.  This also confirms my point on the competitive issues as switching barriers are clearly low and brand loyalty is virtually non-existent.

Reason #3 to short:  Near and long-term implications of relationship with Walmart

In 2006, GDOT started a relationship with WMT and by 2007 the Green Dot card was issued in 2,500 WMT stores (70% of total stores).  By March 2010, GDOT was in 3,600 WMT stores (97% of total).  While this relationship has been critical to the success of GDOT thus far, I believe the company's reliance on WMT puts its future profits at significant risk. 

Months before the IPO, GDOT changed its relationship with WMT increasing WMT's sales commissions to 22% (over double the previous level) and granting WMT a 5% stake in the company in exchange for a 5-year relationship to sell the card in WMT's stores.  This stake was likely valued at around $100 million at the time of grant (it is worth more today).  GDOT conveniently excludes this clear cost of doing business from its pro forma operating income.  This cost of roughly $20 million per year must be included to capture the full economics of GDOT's business.  In five years, when the contract expires, WMT will once again extract its pound of flesh and they will likely see to it that GDOT makes only a modest profit.  It is unclear if WMT will demand more shares or simply a higher sales commission in the future, but clearly WMT holds all the cards in this relationship and will continue to be able to dictate financials terms.

Furthermore, as the relationship between GDOT and WMT becomes ever closer, I would expect to see GDOT's other large customers (Walgreens, CVS, Kroger, etc.) look to move business away from GDOT to competitors that are not seen to be as closely aligned with WMT.

Reason #4 to short:  Historical growth rates are misleading due to Walmart roll-out

Much of the excitement about GDOT stems from the extraordinary growth in card issuance over the past few years - from 722 thousand in 2006 to 3.1 million in 2009.  However, this growth was almost entirely fueled by the roll-out at WMT stores which is now complete.  Now that they are already in virtually every WMT store, I don't believe the historical growth rate is particularly meaningful.  In fact, growth has basically hit a plateau in the past few quarters and even declined in Q2 2010 over Q1.

Reason #5 to short:  Unsustainable revenues due to sensitivity of revenue model to pressure on price and card adds

Since the variable costs associated with issuing a new card is fairly low, I believe GDOT will potentially be facing significant pressure on profits from both price and lower volumes as the high churn makes adding new customers increasingly difficult with each passing quarter (in fact, given the high churn, GDOT has already churned through 9 million customers).

The company's quarterly EBIT is likely running around $13 million (after WMT stock costs and pro forma for the new sales commission).  If activations fall from the current quarterly level of 1.5 million to 1.0 and pricing declines by 10%, the business is barely profitable. 

Reason #6 to short:  Outrageous valuation

GDOT has 41 million basic shares outstanding plus another 7 million net shares from options and warrants resulting in a fully-diluted market capitalization of $2.5 billion and an enterprise value of $2.4 billion.  In Q2 2010, the company generated $17 million of reported EBIT but this number still failed to pick up a full quarter of the higher WMT commission.  As I mentioned above, I believe that number should be closer to $13 million when fully adjusted for the WMT commission and cost of the stock deal.  That places the valuation of GDOT at 46x run-rate EBIT which is extremely high even if the business were poised to grow dramatically.  But as I mentioned above, I believe there are many reasons to believe EBIT could be lower not higher in coming years due to competition and the increasing difficulty of replacing the high churn.

One other sanity check:  the enterprise value of GDOT is around 10% of Mastercard (MA).  MA generates about half of its profits overseas, so the implied value of MA's US business is probably around $12 to 13 billion (50% of its enterprise value).  GDOT is trading at a value equal to around 20% of MA's US business.   This strikes me as an almost impossible fact as MA currently generates close to $1.5bn of EBITDA domestically (10x more than GDOT can ever hope to generate) and has a business model that is far superior to GDOT in every respect.

Reason #7 to short:  Potential regulatory scrutiny

As many of you know, interchange fees and credit card fees are under increased regulatory scrutiny.  GDOT is effectively operating in a loophole in the Durbin Amendment carving out general purpose reusable prepaid cards and financial institutions under $10 billion.  It is impossible to know how this unfolds but given the high financial burden these cards pose to their users and the high levels of current profits being earned, this segment of the market is a likely target of increased scrutiny.

Reason #8 to short:  Large insider sales and shares coming off lock-up

All of the shares sold came from insiders and the lock-up expires in January 2011.  You can look at the prospectus for a list of shareholders and it will quickly become evident that there are dozens of shareholders sitting on enormous gains.  I suspect they will want to cash out as soon as they can.


Competitive pressures
Growth / churn issues
Walmart / distribution partner issues
Lock-up expires
Regulatory risks
Better investor understanding of the model / risks
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