Heartland Payment Systems Inc.
As I was researching Heartland, it was well on it's way to being named a Magic Formula Top Buy. Taken as a business, Heartland has it all. A focus on transparent fees, with no hidden charges so typical of the industry, has helped Heartland grab market share from the bigger players like First Data (DATA). Sales have grown at a compounded 20% per year over the last 5 years, and were continuing at a similar rate this year. Cards continue to grow as a form of payment, and this trend is set to continue. Payment processing firms benefit from high switching costs... most businesses are very leery about switching processors once they have one in place. And Heartland is in fine financial shape. Net debt is only about $30 million. Free cash flow is strengthening as the company completes it's in-house processing system rollout. And MFI return on capital has been steady and solid, if not spectacular, at around 40%. With strong growth, moat, and financial standing, Heartland seems to fit the bill as a top notch MFI stock
But Heartland's current low valuation (19% earnings yield) is due to a massive security breach at the end of January. Analysts estimated that up to 100 million credit card numbers were compromised, and several banks have had to re-issue Visas (V) and Mastercards (MC). Heartland tried to assure customers that personal information like Social Security numbers or addresses were compromised, but in situations like this perception is often reality. Even if Heartland does not lose the confidence of it's merchants, the company will be on the hook for reimburing the banks for the cost of card reissue. In the worst case scenario, one of the card brands may decide to stop doing business with Heartland, which would be fatal to the company. This is what happened to processor CardSystems after a breach in 2005 - a smaller one than Heartland's at "only" 40 million affected accounts.
Therefore, an investment in Heartland is fairly risky at this point in time. There are some reasons to be optimistic. CEO Bob Carr is a straight shooter, and immediately contacted merchants, released several press releases to investors, and quickly closed the leak. He sees this as an opportunity to improve security in the entire industry by implementing end-to-end encryption. In the week after the breech, Carr informed investors that Heartland had continued to add merchants at a faster rate than last year. Also, this situation has a lot of differences than CardSystems. That company's security problem was the lack of basic security measures like a firewall and virus software! I don't it think it's likely Visa or Mastercard will be dropping Heartland.
MFI investors willing to play the odds are likely to make a good profit on Heartland, but the downside risks are rather large.
Other MagicDiligence Content
Steve does not own HPY.
Joel Greenblatt and MagicFormulaInvesting.com are not associated in any way with this website. Neither Mr. Greenblatt or MagicFormulaInvesting.com endorse this website's investment opinions, strategy, or products. Investment recommendations on this website are not chosen by Mr. Greenblatt, nor are they based on Mr. Greenblatt's proprietary investment model, and are not chosen by MagicFormulaInvesting.com. Magic Formula® is a registered trademark of MagicFormulaInvesting.com, which has no connection to this website. The information on this website is for informational purposes only and solely represents the views and opinions of the author. No warranty is provided or implied as to the accuracy, completeness, or timeliness of this information. This information may not be construed as investment advice of any kind, nor can it be relied upon as the basis for stock trades. The proprietor of this website is not responsible in any way for losses or damages resulting from the use of this information. Alexander Online Properties is not a registered investment advisor. All logos are trademarked properties of their respective companies.
© 2008-2013 Alexander Online Properties.