Vantiv is a high quality, inexpensive, business with low capital intensity, limited downside, and a 5:1 risk/reward.
Vantiv is the forty year old merchant acquiring arm of the Fifth Third bank, and is the #3 merchant-acquirer and #1 pin debt acquirer in the US as measured by dollar volume of transactions. Fifth Third sold 51% of the company to private equity (Advent) in June of 2009. At that time, Vantiv purchased its own headquarters in Cincinnati and began the now completed process of separation. Although Vantiv has 128.7mm shares outstanding, only 50mm float. The company held an IPO in March of this year that left Advent and Fifth Third as majority owners. On December 6th, Fifth Third priced a 12mm share secondary offering at just below (-1.7%) the prior day close. That offering that will boost the float 25% (to 62mm S/O from 50mm S/O) and may serve as a catalyst to raise the profile of the company.
The payment processing space outside Visa and MasterCard is highly competitive and industry EBITDA margins, though high in absolute terms (30%+), grind down a little bit each year. However, from the segment analysis we can see that Vantiv’s margins are stable to improving while sales have grown.
In May 2011, Vantiv executed a definitive agreement with Discover to provide an end-to-end outsourced processing solution for their large merchant client base. The Discover conversion occurred in April 2012, and Discover supports PayPal for mobile payments. So, while there is plenty of opportunity to grow with the transition to pin debt from paper currency, the company also benefits from the transition to smartphone from plastic via this PayPal/Discover relationship. As an aside, Vantiv generates 100% of sales within the US, so if they can find a profitable way to offer their service abroad, this would represent a growth opportunity.
Merchant Services (73% sales):
They authorize, clear, settle and provide reporting for electronic payment transactions for 400,000 clients. Their top 25 customers account for 12% of sales, and include 8 of the 25 top retailers in the US. So, customer concentration is fairly low. In 2010 Vantiv acquired NPC and in so doing added 200,000 small to mid-sized merchants to the 200,000 merchant customer base developed under the Fifth Third umbrella. Small and mid-sized merchants are more difficult to reach on an individual basis, but generate higher per transaction fees. So the company improved the profitability of its mix with an acquisition – and the improved mix helped margins (see below). There are roughly 8mm merchants in the US that accept credit/debit and 20mm more who do not but could – this group of 20mm excludes federal, state and local governments as well as “non-merchant” entities that could begin to accept payments with smartphones. Roughly 100 service providers cater to the 8mm or so merchants that accept credit cards (and again VNTV is #3 of 100).
They provide 1,300 regional banks and credit unions (sub $15bn) with a turnkey solution to offer electronic payments to their customers (card issuer processing, payment network processing, card production, prepaid cards, ATM driving, fraud protection). Overall, there are 7,500 FDIC banks and 7,000 credit unions in the US. Fifth Third Bank represents 22% of segment revenue and the remaining top 24 customers account for 21%. So, there is some customer concentration here – but the majority comes from Vantiv’s deep relationship with Fifth Third.
At 7.2x $496mm LTM EBITDA and 6.4x $560mm of 2013E EBITDA the shares appear inexpensive in absolute terms and also in relative terms when compared to GPN (6.5x ‘13E) and HPY (7.5x ‘13E), respectively. 7.2x LTM EBITDA translates to 9.8x LTM free cash flow of $275mm, or a 10.2% free cash flow yield on a company with modest leverage (1.7x Net Debt/LTM EBITDA).
Low Capital Intensity:
In 2010 and 2011 net working capital was +/- 1-2% of sales and capital spending was 2-4% of sales. Both trends remained consistent in the LTM period ended 3Q 2012.
DOWN: Cut free cash to $200mm (down$75mm, or -27% vs LTM FCF of $275mm) and assume the company initiates a dividend because its outlook darkens. The dividend yield on $200mm of free cash at 8% would imply a share price of [(200mm/8% yield)/128.7 shrs]= $19.42, which is conveniently 5.0x LTM EBITDA or, in this case, about 6.0x LTM EBITDA if we reduced $496mm of EBITDA by the same $75mm we had reduced free cash flow. So, on 6.0x what I would call a worst case EBITDA, or 5x actual LTM EBITDA, there is 7.5% downside from here (19.42/21-1 = -7.5%).
There is always an unknown unknown – but based on what we reliably know today, the downside appears limited.
UP: The market realizes that the stock is too cheap for what it is (high quality, low capital intensity, Discover/PayPal relationship) and the shares then trade behind V and MA but ahead of GPN and HPY; it advances 2x of forward multiple 8.4x ‘13E instead of 6.4x ‘13E.
That would imply a $29.85 share price, or 42% upside.
From here we have $1.58 down and $8.85 up, or -7.5% down and 42% up. So, the upside is 5x better than the downside in a well-capitalized business with growing sales and stable to improving margins.
I do not hold a position of employment, directorship, or consultancy with the issuer. I and/or others I advise hold a material investment in the issuer's securities.
On December 6th, Fifth Third priced a 12mm share secondary offering at just below (-1.7%) the prior day close. That offering that will boost the float 25% (to 62mm S/O from 50mm S/O) and may serve as a catalyst to raise the profile of the company.