July 02, 2012 - 5:11pm EST by
2012 2013
Price: 22.82 EPS $2.46 $2.72
Shares Out. (in M): 161 P/E 9.3x 7.8x
Market Cap (in $M): 3,666 P/FCF 10.9x 8.7x
Net Debt (in $M): 447 EBIT 578 672
TEV ($): 4,113 TEV/EBIT 7.1x 6.1x

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  • Payment services
  • Duopoly
  • Industry Tailwinds



Founded in 1884 as the National Cash Register Company, NCR today manufactures and services ATMs, retail point of sale systems, and other self-service kiosks for a wide range of industries.  As the #1 player in the global ATM industry, NCR is well positioned in an attractive, stable oligopoly.  Moreover, NCR has multiple growth opportunities ahead, including: a large ongoing ATM upgrade cycle at North American regional banks; emerging market ATM growth; increasing bank branch automation over time; increasing its mix of higher margin software and services over time; and growth from other industries such as retail self-checkout machines and hospitality industry growth from the high margin, fast-growing Radiant business, which NCR acquired last year.  The Company estimates these growth avenues will allow it to achieve 7 – 9% top line and 15 – 20% bottom line CAGRs from 2012 – 2015.

NCR has two additional characteristics that we believe make it particularly interesting here: 1) its 2012 guidance is exceedingly conservative, as NCR grew top line 8% organically in Q1 yet its guidance implies no organic growth for the remainder of the year; and 2) it has an opportunity to debt finance its large underfunded pension obligation, which we believe would be extremely accretive for the Company and remove an important overhang on the stock.  NCR trades at a very attractive valuation of ~7x pension-adjusted TEV / EBITDA and ~10x pension-adjusted P / E.  We believe if NCR were to debt fund its pension, it would trade closer to its main competitor Diebold on 15x forward P / E, resulting in a valuation of $30 - $33 per share, representing 21% - 45% upside from the recent stock price of $22.82.

Investment Thesis

Core Business is Well-Positioned in Attractive, Stable Oligopoly

NCR has the leading market share in the worldwide ATM industry.  This industry is attractive as it is very consolidated with high barriers to entry, leading to stable profits in mature markets and opportunities for growth in emerging markets.  While many smaller regional players exist, the worldwide ATM market can generally be characterized as a series of local duopolies, with NCR playing in effectively every geography.  NCR’s major competitors are Diebold in North America, Wincor Nixdorf in Europe, GRG in China, and Hyosung in the rest of Asia.   NCR is quite geographically diversified, with 40% of revenue from the Americas, 25% from Europe, and 35% from the ROW.

The North American ATM market is a true duopoly, with NCR and Diebold each having just under 50% market share.  High barriers to entry preserve this dynamic, specifically technology/expertise, long-term relationships with the customers (banks), and most importantly the service networks required to service the large installed base of ATMs (which rely on proprietary hardware and software technology).  NCR and Diebold each have ~3,500 service technicians spread across the U.S.  In steady state, mature ATM markets like the U.S. are replacement markets, offering stable profit pools for NCR.  ATMs are generally replaced every 7 years, at an average price of ~$30k / ATM, and accompanied by annual service contracts for roughly 15% of the upfront cost (ie, ~$4.5k / ATM / yr).  This gives NCR a stable, recurring revenue pool from mature markets that ends up being roughly 50% product / 50% service revenue (ie, in any given year they are selling X ATMs for $30k each, and servicing 7x X ATMs at $4.5k each).  In recent years, the 7-year replacement life has been shortening as customer ATM use has increased wear-and-tear and technological advancement in ATMs has quickened, a trend which benefits NCR (more on this below).

ATMs, and automation in general, are currently a large focus area for the banks.  JP Morgan spent a substantial amount of time at its February 2012 investor day talking about a strategy to transform its branches to include more automation and self-service, in order to reduce costs and improve convenience for customers.  NCR is on the cutting edge of this transition and is trialing new innovations like self-service tellers and ExpertLink tele-tellers.  In general banks value the idea that these automated platforms can allow customers to perform 90%+ of current teller transactions via self-service, support extended hours access for customers, and lead to more efficient staffing for the banks, lowering average costs per transaction.  The upgrades enable bank employees to focus on higher impact interactions, such as selling loans, mortgages, and other products.  Any increase in sales can be significant for banks as they search for new ways to boost profits during a period of low interest rates, weak loan demand, and rising costs from new regulations.

Multiple Growth Opportunities Ahead

While developed ATM markets are mature, NCR is far from being a boring hardware business.  At its recent analyst day it laid out targets for 7 – 9% revenue growth and 15 – 20% EPS growth from 2012 – 2015.  It has multiple runways for growth in coming years, including:

-          Emerging Markets Growth


Industry consultants RBR project 6% global ATM industry revenue growth, driven largely by developing markets.  While the US has 1,500 ATMs per million people, China is at 100 and India is at 50.  The continued urbanization of developing countries, along with growing middle classes, desire for self service, and aggressive deployment of new technologies will drive demand for additional ATMs for years to come. 


-          Deposit Automation Upgrade Cycle

After delaying CapEx during the financial crisis, North American regional and community banks are currently in the early innings of a large upgrade cycle to the newer technology ATMs, which include automated deposit capabilities.  These ATMs save banks an estimated $1 per transaction, and thus have a payback period of roughly only 2 years (assuming $30k average price and 15k transactions / yr, on average).  The regional banks are now playing catch up to the national money center banks, which migrated to these ATMs over the past few years.  Of the 450k ATMS in the US, 50% are bank-owned and 50% are limited functionality (gas station/convenience store, hotel lobby, etc).  Of the 225k bank-owned ATMs, 175k belong to regional and community banks, of which only an estimated 20k have been upgraded to deposit automation to date.  It’s estimated that in the next ~3 years, another 100k ATMs will be upgraded, representing a roughly $3bn revenue opportunity for NCR and Diebold.  NCR noted on its Q1 conference call that revenue had more than doubled from regional banks in the quarter.  Importantly, gross margins are much higher for sales to regional banks (~40%) than national banks (~20%), which receive large bulk discounts.  It’s also important to note that by the time the regional banks finish with this upgrade cycle, there’s a good chance the big banks will be ready for another round of replacements and upgrades to the very latest technology, scalable deposit (which lets customers deposit multiple checks and bills in any orientation into a single module).  Several other potential upgrades also provide growth opportunities, such as the replacement of magnetic stripe cards with more secure EMV (chip cards), cash recycling technologies, more ADA compliant ATMs, and other technologies to increase bank branch automation mentioned above.

-          Grow Services and Software Mix and Improve Margins

From 2007 – 2011, NCR improved its mix of services revenue from 46% to 51% of total revenue, and is now 51% services / 49% products.  In addition to being more stable and recurring, service revenues are also higher margin.  From 2008 – 2011, NCR improved its service gross margins from 19% to 27%.  This compares to its gross margin on products of 23%.  NCR believes it can continue to increase its services revenue, by offering more value added services to its customers (not just break/fix service calls, but software upgrades, reports and data analysis, monitoring services, etc), and continue to increase its service margins (more and better monitoring and diagnostics leads to improved reliability and up-time, fewer on-site visits to fix the ATM, etc.).    An important part of NCR’s strategy to grow its services and software mix is its recent acquisition of Radiant (see below).

-          Growth from Other Industries (Retail, Hospitality, Travel, Gaming, etc)


Financial Services (ie, ATMs) is just over 50% of NCR’s revenue.  Another 30% comes from retail POS devices, where NCR is the #2 global player behind IBM.  This segment is currently benefitting from growth in self-checkout devices, which represent a large cost cutting opportunity for retailers, who can generally replace 4 checkers with one self-checkout device (an estimated 6-month payback at an annual cost of $30k / checker and a $60k price for the device).


The rest of NCR’s revenue comes from other industries such as travel, gaming, and most notably hospitality, where it last year acquired the very fast growing, high margin Radiant business.  Radiant sells POS devices and software products, mainly to restaurants and specialty retailers in the US.  Radiant had grown at a 15% revenue CAGR and 22% EBITDA CAGR in the five years prior to its acquisition by NCR.  Its gross margins of 46% are significantly higher than NCR’s (low – mid 20%s) due to its higher mix of recurring high margin software and services revenue.  Management has guided to $40 – 50m of cost synergies, but more interesting are potential revenue synergies as NCR leverages its global direct sales force to sell Radiant’s products and services internationally (Radiant had primarily been a US business).

The combination of all of these opportunities gives us confidence that management should be able to achieve its 2015 growth targets.

Guidance is Conservative

At its Q1 conference call on April 19, NCR gave 2012 guidance for operating income (ex pension expense) of $570 – 585m.  This compares to $434m in 2011, representing a $144m year-over-year increase at the midpoint of guidance.  Yet, between 2011 and 2012, a few things happened:

1)      The Company sold its money-losing DVD kiosk business, which it had been building out the past few years in an unsuccessful effort to compete with Coinstar’s RedBox, to Coinstar.  The elimination of this business alone should add $47m to operating income between 2011 and 2012

2)      The Company purchased Radiant, a transaction which closed at the end of August 2011.  Radiant’s 4-month contribution to NCR’s operating income in 2011 was $22m.  The inclusion of an extra 8 months of Radiant should add $44m to operating profit at 2011 levels, but the business is growing >20% / yr (and has not slowed down at all, according to management commentary), which should add another $13m based on Radiant’s organic growth ($66m 2011 Radiant run-rate * 20%).  So the Radiant acquisition should add $57m to operating income between 2011 and 2012 ($57m = $44m from 8 extra months of inclusion + $13m from organic growth)

3)      The Company said its Year 1 cost synergy targets for Radiant were $20 - $30m, ie $25m at the midpoint.  So these cost synergies should add $25m to operating income between 2011 and 2012

Adding these 3 components together amounts to a $129m year-over-year increase in operating income.  This implies that the Company only expects a $15m organic operating income increase from the rest of its business for the full year.  Yet, in Q1, the rest of the business grew $11m year-over-year on an operating income basis in the quarter (the whole Company grew $30m, of which Radiant was $19m).  Thus, guidance implies essentially no organic growth for the final 3 quarters of the year.  This is in spite of the Financial Services business growing top-line 17% in Q1 and management commenting that the ATM environment is currently as strong as they can ever remember thanks to the regional bank upgrade cycle discussed above.  It would seem to us that the Company’s 2012 guidance is exceedingly conservative.

It’s worth noting that conservative guidance is nothing new for NCR.  Since current CEO Bill Nuti took over as CEO in 2005, the Company has beaten its initial guidance every year except 2009, by an average of 12%.

Pension is an Opportunity

Since the 2008 financial crisis, NCR has had a large underfunded pension liability.  The liability is very large relative to the size of the Company ($1.3bn net underfunded obligation vs. current market cap of $3.4bn and TEV of $3.9bn).  We believe this liability creates a significant overhang on the stock, as a large GAAP pension expense ($165m in 2012) confuses the accounting and distracts investors from the performance of the underlying business, which has been and continues to be very strong.  Moreover, the Company is being forced to contribute large amounts of cash ($215m in 2012) into the pension, which it is funding out of its free cash flow (ie, equity funding).


The Company has increasingly communicated that it is considering debt financing its pension obligation, and in fact has committed to make an announcement on some type of strategy to address the pension by the date of its 3Q earnings call (likely late October).  We think debt funding the pension would be extremely accretive, and likely allow the stock to trade more in line with, or even at a premium to, the earnings multiple of its closest competitor, Diebold. 


This year, according to its own guidance, which is conservative, NCR should generate “EBITDAP” (EBITDA before GAAP pension expense) of ~$750m.  Its current net debt is only ~$400m, which it was able to borrow at only L+200.  Given the attractive growth prospects and strong cash flow characteristics of the Company (annual CapEx requirements are roughly ~$165m, and the Company’s tax rate is ~27% given its international business mix), NCR could easily borrow the $1.3bn amount of its underfunded pension at a rate below 7%.  This would result in $66m of additional after-tax interest expense ($1.3bn * 7% * (1 – 27%)), significantly lower than the $165m GAAP pension expense that is running through the Company’s income statement, and well below the $215m in cash the Company is putting into the pension this year.


Another way to think about this is purely as a capital structure question.  The Company is generating strong cash flow, has healthy growth, is relatively unlevered, and is trading at ~10x earnings adjusted for pension.  If the Company does indeed have to put >$200m of cash into its pension for the next 6 years or so, should it be doing that with its free cash flow (ie, equity dollars), or should it borrow at 7% pre-tax / 5% after-tax to do that and use the cash flow it’s generating to buy back its own stock trading at a ~10% earnings yield?


Attractive Valuation


At the recent stock price of $22.82, NCR has a market cap of $3.7bn, TEV of $4.1bn, and pension-adjusted TEV of $5.4bn.  We conservatively estimate the Company will generate EBITDAP of $750m this year and $840m in 2013, representing Pension-Adjusted TEV / EBITDAP multiples of 7.3x and 6.4x.  Given CapEx of $165m, Pension-Adjusted TEV / EBITDAP – CapEx multiples for 2012 and 2013 are 9.3x and 8.0x, respectively.


The Company is generating roughly $400m of free cash flow this year before pension contributions (based on $750 of EBITDAP, $165 of CapEx, $40 of interest, $100 of taxes, and $40 of environmental obligations).  If the Company were to debt fund the entire pension as discussed above and incur additional after-tax interest expense of $66m, PF FCF would be $334m, representing a 9.3% FCF yield to the current market cap, which we believe is entirely too cheap for a dominant market-leading business growing earnings 15% per year.


Diebold, the Company’s closest competitor, which is smaller and less geographically diversified, trades at 8x and 7.5x 2012 and 2013 EBITDA, and 12x and 10x 2012 and 2013 EBITDA – CapEx.  Diebold trades at 15x and 14x 2012 and 2013 EPS, respectively, or roughly a 7% FCF yield to the equity.


If NCR were to trade at a 7% FCF yield based on our 2012 PF FCF of $334m, it would imply a stock price of $30, and if it were to trade on that yield on our 2013 estimate the stock would be >$34.  On an EPS basis, if NCR were to trade at 15x consensus 2013 EPS ex pension of $2.72, that would represent a $41 stock price.  Even if you backed off the full pension liability of ~$8 / share (ie, $1.3bn pension obligation / 160m shares outstanding), the implied stock price is $33.


The midpoint of NCR’s 2015 EPS guidance (ex pension) is $3.95 / share, which we do believe is achievable.  If NCR were to trade at Diebold’s current forward multiple of 14x that number one year in advance (ie, mid-2014 or 2 years from now), it would imply a mid-2014 NCR valuation of $55 / share.  Again, subtracting off the full pension liability of $8 / share, that implies a mid-2014 stock price of $47, or 106% upside from the current price.


By any of these metrics, NCR appears cheap to us given the quality and growth prospects of the business.




NCR has a strong core business with exciting growth prospects over the next few years.  Guidance is conservative and the pension is creating an overhang, obscuring the attractiveness of the underlying business.  The valuation is compelling, and the Company has committed to make an announcement on the pension by late October.  Using a variety of valuation methodologies, we believe NCR should be worth $30 – 33 today, and potentially much more in a few years as the Company makes progress on its growth initiatives.





Reporting earnings in excess of guidance


Pension strategy announcement on or before Q3 earnings call


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