Even with 10,000 banks in the United States, there are tens of millions of people who are still regarded as "unbanked" or "underbanked." That's created an opening that two young public companies - Green Dot Corp. and NetSpend Holdings Inc. - aim to fill.
Both sell "general-purpose reloadable" debit cards. Think of these products as reloadable gift cards, branded with Visa or MasterCard logos, that can be used at multiple merchants. Or think of them as debit cards not linked to a particular bank account. Their "unique characteristics," says D.A. Davidson & Co. analyst John Kraft, make them the fastest growing products in the prepaid-card sector.
As a result, Green Dot and NetSpend are two of the few compelling high-growth stories in the financial sector, with year-over-year revenue gains in the 35-per-cent to 40-per-cent range for Green Dot and 20-per-cent plus for NetSpend. Their shares have been priced accordingly, with each trading at a forward price-to-earnings multiple of roughly 35, lofty territory for any stock.
A revenue miss by Green Dot last week, coupled with an analyst downgrade of the company, has caused both stocks to continue their pullback from their 52-week highs. That creates an opportunity for investors who want to bet that consumers will find the reloadable cards a compelling choice versus big banks on one side and cheque-cashing outfits on the other.
"It is our opinion that the [general-purpose reloadable]market is in its infancy and that overall consumer awareness remains low," SunTrust Robinson Humphrey analyst Andrew W. Jeffrey says.
"Rising consumer education and greater use of the cards as chequing account substitutes should improve" the economics of the business, he says, and "meaningfully above-average organic revenue growth will continue for longer than the Street currently contemplates as the industry gains ubiquity."
Consumers who take advantage of free or reduced-cost chequing accounts at a traditional bank will find that the fees for a reloadable card seem pricey. Green Dot's cards cost up to $4.95 (U.S.) to purchase and have monthly maintenance fees of up to $5.95. There's also a "reload" fee of up to $4.95 when the card user adds money at a retail location. NetSpend's fee schedule is slightly different, with more "back-end" costs like overdraft charges.
Herein Lies the Growth
What makes the economics of reloadable debit cards more appealing is that U.S. banks are offering free and reduced-fee chequing accounts to fewer consumers in the aftermath of legislation that scaled back the ability of financial institutions to charge overdraft fees. Various studies estimate the number of underbanked and unbanked Americans at 40 million to 60 million. Green Dot, which went public last July, aggressively argues that its target market also includes bank customers who make less than $75,000, which adds another 100 million people to the target.
Herein lies the growth: There are only about nine million to 10 million general-purpose reloadable debit cards kicking around, half belonging to Green Dot and NetSpend.
The companies partner with retail merchants and other businesses. NetSpend has a deal with Ace Cash Express and a handful of other retailers. Green Dot has 50,000 retail locations at 7-Eleven, CVS Caremark, Rite Aid and - the biggest prize of them all - Wal-Mart, where Green Dot is the exclusive supplier of the reloadable Wal-Mart MoneyCard.
The Wal-Mart Connection
Some of the excitement about the Wal-Mart partnership includes a bet that Green Dot could ultimately become part of a "Bank of Wal-Mart" strategy, something bankers deeply fear. Green Dot is awaiting regulatory approval to buy a small Utah bank, something that it says will help it cut out the costs and risk involved with partnering with a commercial bank to issue cards.
An article last fall in the trade publication U.S. Banker pointed to Wal-Mart Stores Inc.'s international expansion into financial services, coupled with new U.S. offerings and the Green Dot relationship. "To some observers, the birth of the Bank of Wal-Mart, with retail branches scattered around the country, is less a matter of 'if' than 'when,' " the article said. (Wal-Mart maintains that it has no interest in owning a bank.)
Wal-Mart provides two-thirds of Green Dot's revenue, making some analysts skittish about the card provider's dependence on the giant retailer. Green Dot recently signed a five-year contract extension with Wal-Mart, but it came at a hefty price. Green Dot agreed to triple Wal-Mart's commissions from a mid-single digit percentage of fee revenue to 22 per cent. It also issued enough stock to Wal-Mart to give the retailer 5-per-cent ownership of the company.
Rivals
While Green Dot is perceived as the industry leader, with NetSpend following, both have competition. A division of grocer Safeway Inc. owns the Blackhawk Network, with its own reloadable card. Money-transfer king Western Union Co. - with its 46,000 agent locations - offers two reloadable cards.
There's little to keep traditional banks from entering the space, although the fact they haven't managed to find a way to lock in roughly 50 million underbanked potential customers suggests they will be either unwilling or unable to, analysts note.
And then there's that valuation. Green Dot's recent earnings disappointed because the company beat expectations by less than investors hoped. In addition, the company's current-year guidance was merely in-line with consensus expectations. But "while such a premium valuation brings high expectations, we think it remains justified," Morgan Stanley analysts say.