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Take Electronic Payments to a New Level

Steven Bulwa

I focus on the areas of new media, alternative energy, medical technology and next generation design and manufacture technology. The focus of my columns will be to try to identify situations that have gone unrecognized by the market, or mispricings created by market inefficiencies. Because of the way the market operates, there is great opportunity to uncover these situations.

For starters the coverage universe has shrunk, and that has divided the market into two areas:

1. Stocks that languish waiting for a catalyst;
2. Stocks that are overanalyzed momentum vehicles.

I tend to focus on the first group, and that's because individual investors need to know where they stand in the investor hierarchy: at the bottom. The only real advantage available to individuals is information, and the only place to get an edge is with less-followed, small- to mid-cap stocks. Distorting matters further, stock prices are dictated by the collective actions of individuals applying unrelated, differently motivated and mostly erroneous logic to their decisions.

But I say that's great. The nuttier the logic and the more superficial the analysis, the better. It can only create more opportunity for a well thought out, rational approach to stock-picking.

I seek to provide ideas that improve returns while they mitigate risk. I achieve this by applying strict valuation criteria, diversifying among 25-30 positions and adding some shorts to the portfolio to hedge against a market fall. If I had my way, I would rather be exclusively long, but when the market gets in a selling mood, everything gets sold. I would rather mitigate some gains while protecting against an unexpected market fall.

Before I get to my first idea, let's briefly discuss Efficient Market Theory. For those of you unfamiliar, it is a theory they teach you in business school suggesting that information is disseminated so quickly and efficiently that stock prices generally reflect all relevant information and are priced correctly.

What a bunch of nonsense.

This assumes that we all interpret information the same way and act on it similarly. There are so many reasons this is wrong, but mainly it is wrong because most people react to stocks and money emotionally rather than intelligently. (Let's not even get into emotional intelligence.) Beyond that, there is no agreement on valuation and many technicians don't even consider valuation in the decision-making process.

Other contributors to the mechanism of valuation distortion are growth investors, momentum investors, hedge strategies, technicians, investment bankers, TV personalities, etc. Two common elements for all these market strategies/participants is a short-term focus with valuation being the least relevant criteria for success.

Over the longer term, I believe the market does serve its ultimate purpose of valuing businesses and creating liquidity, but in the short term, there are great inefficiencies created by the aforementioned. We can take advantage of this in two ways.

On the long side, we can seek out the situations that will be the focus of the broader market in the near future, but have not been exploited yet. On the short side, we can target stocks whose price has risen way beyond the future potential of the business due to the herd mentality of the market.

Remember, we don't need to make a lot of noise, flying under the radar is fine. A double is a double. With many momentum favorites, valuation is so extreme and hope is so high that a misstep by one of these companies equals a large loss. I prefer situations where expectations are low and one positive event is the catalyst for large gains and downside is minimized. Put yourself in enough good risk/reward situations and identify a catalyst and you will make money.

Now let's dispense with the theorizing and look at a concrete example: Tier Technologies(TIERE Quote - Cramer on TIERE - Stock Picks), which is a low-risk play on a high-growth theme.

A New Tier in Electronic Payments

The only checks I write anymore are to my kid's daycare. I'm not alone, and this has been a real boon for companies like Checkfree(CKFR Quote - Cramer on CKFR - Stock Picks) and Global Payments(GPN Quote - Cramer on GPN - Stock Picks). These companies have experienced tremendous growth, both more than doubling revenue over the past five years and the stock prices doing even better. This is a high-growth area and will continue to be because it saves money. While generally a slow technology adopter, the government is quickly realizing the benefits of online transactions.

That's where $160 million market-cap Tier comes in. It operates in this space and is doing well, but the company is suffering due to a short-term reason, which is what piqued my interest.

The company provides electronic payment products and transaction processing through its Official Payments subsidiary to federal, state and local governments for everything from income taxes to child support. However, its stock has suffered for a variety of reasons.

A restructuring effort in 2003 led to a decline and a recent restatement has further depressed the stock. This restatement has delayed the company filing its annual report, adding the E to the ticker symbol. (We're waiting on a 10-K.) I don't believe the restatement to be an issue -- everyone and their mother is restating in the SarbOx era -- and on March 30 the company issued a statement indicating the impact will be insignificant.

However, a look under the surface shows this to be an extremely cheap company with strong growth prospects and a solid balance sheet.

Tier vs. Competition
	TIERE	CKFR	GPN
Price/Sales	1x	5x	4.6x
Market Value	$166 million	$4.6 billion	$4.2 billion
Price/Earnings	40x	30x	35x
Price/Book	1.1x	3.2x	6x
Source: Steve Bulwa

The only area in which Tier doesn't compare favorably is the P/E. I believe that earnings are currently depressed and as the company grows, there is room for significant margin expansion as benefits of scale are realized.

The company does boast some solid partnerships, including one with Intuit, which integrated Official Payments' electronic payment option within TurboTax OnlineSM and TurboTax desktop products, as well as the ProSeries product for tax professionals, allowing customers to pay their federal tax balance due with all four major cards: American Express, Discover, MasterCard and VISA. Official Payments provides electronic payment services for the Internal Revenue Service, 26 states, the District of Columbia and 2,000 local government clients nationwide.

At current levels, and with $2.80/share in cash, the company trades at 25 times earnings, ex-cash.

Tier is rapidly signing up new government programs for electronic payment products and processing and recently announced revenue of $38.8 million for the quarter ended Dec. 31, 2005, which was a 22.2% increase over the prior year's quarter. I believe this is a great long-term growth story trading at a significant discount because of short-term events.

If we apply an industry-favorable price-to-sales multiple of 3 times, that would equal a stock price of $23, a significant improvement over today's quote of $8.10. With continued growth and margin expansion, the company could easily earn 75 cents a share in two years, making a $20 price target more than reasonable given industry comparisons, which might possibly be conservative.

I hope this is useful, and I look forward to receiving any and all feedback. This is just the beginning and I look forward to sharing more ideas with readers and contributors. (Maybe we can even have a few good disagreements.)

Please note that due to factors including low market capitalization and/or insufficient public float, we consider TIERE to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.