Submitted by Morgan Smith as part of our contributors program.
As retail shops and consumers shun cash and embrace virtual payments, online payment processors are set to win. One up-and-comer poised to capture a piece of the market is Citadel EFT (CDFT), a Tustin, California-based company that provides merchant services and equipment across North America. The company has added 1,700 clients since its founding in 1989.
Citadel EFT differentiates itself by leasing merchants a choice of no-cost terminals. Other than interchange-style fees, there is no cost for the client merchant. Merchants are also welcome to have their websites adapted by Citadel EFT to accept credit card payments for only $5.95 per month.
The company is raising capital to fund its next growth spurt. Citadel EFT’s initial public offering took place in February of this year, with the original price of $0.14 per share. Since then the stock price has gyrated wildly in percentage terms, though it has remained at $0.05 or less since May.
Citadel EFT’s low-cost model has quietly added big supporters. Networking site WoobEB has named Citadel EFT the exclusive payment processor for its 200,000 members. Citadel EFT is on a solid path to attract new customers, as it is currently one of the cheapest merchant service providers. The company charges $5.95 per month for its internet credit card system. Meanwhile, Intuit (INTU) charges $19.95 per month for the same service. And Citadel EFT currently charges merchandisers an average $0.22 per transaction, compared with eBay (EBAY) unit PayPal’s $0.30 per transaction average. Given that the U.S. economy included e-commerce sales of $161.5 billion last year, even a small sliver of that commerce can be a substantial amount.
In the second quarter of 2012, Citadel EFT stabilized its income statement by declaring profits of $76,000. It did this on revenue of $119,000, which was 7% off the second quarter of 2011. But just a few key victories, and WoobEB is a great example, will turn the revenue picture around in a hurry. WoobEB’s merchants will create about $6 million in billings, so a modest 1% fee would accrue $60,000 in additional revenue to Citadel EFT. A few more victories like that, and Citadel EFT’s low cost model should be self-sustaining.
Finally, as with all low-priced stocks, there is a great deal of leverage built into the price. It is not hard to imagine Citadel EFT’s stock selling in the $0.06 to $0.09 range in the next six months, which would double or triple an investment made at its current price. There is also very little downside at a stock selling at $0.03 per share. Aggressive investors, take note.
I recently sat down with Citadel EFT’s Chief Executive Officer Gary DeRoos. He made it clear that there is no shortage of competition in the payment-processing arena. Citadel EFT’s biggest competitors at the moment are “Square Up, Chase Paymentech, Merchant Warehouse, Bank of America, Wells Fargo, Costco, Sam’s Club, and a growing list of local banks.” But he also made it very clear that Citadel EFT is on a fast growth path. He noted that “the company saw 2012 revenues grow 23% year-on-year.” He said that “consumers use credit cards even more during recessions, and that the payment processing market is highly recession resistant.” Mr. DeRoos also stated the company’s goal of achieving an annual growth rate of 20 to 25%. The company recorded a profit of $40,000 to $50,000 per month over the last six months.
According to Mr. DeRoos, the most profitable merchants for Citadel EFT are “restaurants, dentists, optometrists, veterinarians, general healthcare practitioners, home improvement contractors, plumbers, electricians, termite control companies, and others that typically charge $10,000 plus per month, especially those operating in major cities like Los Angeles, Chicago, Houston and New York City.”
Mr. DeRoos also explained how Citadel EFT’s pricing model allows the company to offer a far better deal to clients. He said “the company offers a merchant account and credit card terminals cheaper than competitors by negotiating good rates and pricing with its processor. This enables Citadel EFT to offer clients a merchant services package with no annual fees, no monthly minimums, no address verification, no batch fees, and next-day funding. Citadel EFT also offers Visa and Mastercard security measures, a debit percentage of 1.1%, and a credit percentage of 1.6%. Transaction fees ranged from $0.16 to as little as $0.05″.
But the competition has not been slacking either. In the second quarter of 2012, Paypal was the fastest growing part of internet behemoth eBay. PayPal’s volume rose 20% from the 2011 second quarter to $34.5 billion, and revenue increased 26% to $1.38 billion. That volume growth may accelerate going forward as PayPal is partnering with Discover (DFS) to bring PayPal to some 7 million domestic offline locations. eBay reported solid revenue and income numbers, and that momentum is likely to continue over the next several years.
eBay’s momentum is a good sign for Citadel EFT, which is only recently made inroads with marketing and efforts to get exposure for its low-priced model.
Also a barometer, Intuit offers a wide array of business and financial services. It is best known for its TurboTax tax preparation software and QuickBooks accounting software. But Intuit also owns the nation’s seventh largest merchant services unit, and the company saw $417 million in revenue from the unit in its recently concluded fiscal 2012, a 20% increase from the 2011 level. Intuit reported revenue of $4.15 billion in 2012, up 10% from 2011. Adjusted profits came to $1.4 billion, or $2.97 per share, up 10% and 16%, respectively, from 2011.
I thought a year ago that Intuit’s stock price had gotten ahead of where it should be. But now, selling at a price to earnings ratio of about 18 and a five-year PEG of 1.25, I believe Intuit is fairly valued and a decent stock for investors interested in a diversified tech company.
Overall, the payment processing sector is undervalued to fairly valued.
Discover is best known for its credit cards. Discover’s halcyon days of growth are largely behind it. Over the past five years, the company experienced average profit growth of 24% annually, but analysts see growth averaging no better than 11% going forward. On the other hand, among companies specializing in credit cards and payment systems, Discover is selling at a far better five-year PEG (0.85) than either Visa (V) (1.11) or Mastercard (MA) (1.09). There is also the possibility that Discover, with its modest market capitalization compared to Visa and Mastercard, would be an acquisition target. Vague rumors suggesting a takeover by Apple (AAPL) have made news.
In the second quarter, Discover reported earnings of $537 million, or $1 per share. This was off from the $1.09 reported in the same quarter of 2011, a difference management attributed to reserve releases in the 2011 quarter.
I do not recommend Discover to most investors. The stock is already up over 50% in the past 12 months, and earnings in 2013 will likely not come close to 2012 numbers. I also believe that Discover’s low price to earnings ratio relative to its peers will be a chronic condition.
In a high-growth sector, the smallest players have the most to gain in the grab for market share. Citadel EFT presents a unique opportunity for aggressive investors looking for exposure to the fast growing payment processing industry. The next time you are out at a restaurant waiting for the waiter or waitress to take your debit or credit card like the other thirty customers around you, think about the vast opportunity it creates for payment processing companies like Citadel EFT. It might surprise you.