From time to time, the banking sector will see a transformative innovation, such as the ATM or online banking. But it often takes time to get consumers to change their habits. Yet when it happens, the results can be a big money maker.
This appears to be the case with the prepaid card market. The roots of this space go back to the late 1990s and the pioneers include a variety of risk-taking entrepreneurs.
After much investment and trial and error, it looks like the prepaid card market is hitting an inflection point. Consider that a study from Mercator Advisory Group shows that the volume of transactions is expected to grow at a stunning +48.3% compound annual rate from 2008 to 2012, exceeding $291 billion.
Why the growth? First of all, a prepaid card is fairly easy to use and convenient. In most cases, a consumer will go to a retailer and get a prepaid card. He or she will then go to the check-out person and the hand over, say, $100 in cash. The cashier will then load this onto the card. So, the limit on the card would be $100 and the consumer can use it to make store purchases like a credit card, or even online purchases at e-tailers like Amazon.com (Nasdaq: AMZN). The card itself usually has a MasterCard (NYSE: MA) or Visa (NYSE: V) logo.
All in all, prepaid cards have become quite popular for the large segment of the population that is considered "under-banked." These are low income persons or those who have difficulties getting credit. A recent study from the FDIC estimates the under-banked population at roughly 60 million.
So with strong growth -- which is likely to continue for the long haul -- it is no surprise that some of the leaders in the prepaid card market have hit the public markets this year, providing investors a way to participate.
Here's a look at three:
1. Higher One (NYSE: ONE) -- The company provides college students the option to receive cards when their student loans are directed to an FDIC-insured checking account. To this end, the focus is on a major pain point: financial aid. Higher One has built a platform that makes it easier for higher education institutions to process student loans and then disperse the money through these cards. The upshot is lower costs and paperwork. At the same time, Higher One helps educational institutions meet stringent federal regulations.
To expand its footprint, the company has also been aggressive in adding new services, like online banking and billing. Ultimately, this could result in lower turnover as students graduate.
In its latest quarterly report, Higher One certainly demonstrated the power of its business. Revenue spiked +116%, to $26.9 million. True, a boost came from its acquisition of Informed Decisions, a developer of e-commerce solutions, but the fact remains that the company still has a significant amount of organic growth.
However, there are still some concerns. Perhaps the most important is the impending federal threat of changes to school loans regulations. This may ultimately have some dampening effect on Higher One's growth rate.
2. NetSpend Holdings (Nasdaq: NTSP) -- The company has roughly two million active prepaid cards and has generated about $8.8 billion in gross dollar volume in the past 12 months. With this powerful momentum, revenue has shot up from $45.7 million in 2009 to $225 million in 2009. During this time, net income has gone from $0.7 million to $18.2 million.
NetSpend's distribution is broad, with about 39,000 locations in the United States. The company has also been savvy in building a corporate business -- that is, companies allowing employees to get their payroll deposited into a prepaid card.
But NetSpend certainly has some risks. In fact, on the eve of its IPO, the company's main banking partner, Meta Financial Group (Nasdaq: CASH), was the subject of regulatory action from the Office of Thrift Supervision. The agency claimed that there were "deceptive practices" and that various prepaid cards had to be suspended.
To deal with the situation, NetSpend is arranging deals with other third-party providers. This should solve the problem, but there will still be disruption within the company, which could slow down growth.
3. Green Dot (Nasdaq: GDOT) -- Like NetSpend, Green Dot focuses on the retail market. Its partners include companies like Walgreens, CVS, Rite Aid, 7-Eleven, Kroger, Kmart, Meijer and Radio Shack. But the most important one is Walmart (NYSE: WMT), which accounts for a majority of revenue and is even an equity holder in the company.
Another differentiator for Green Dot is its technology platform, which is called Green PlaNET. It is a sophisticated system that allows point-of-sale connectivity to payment processors like Visa and MasterCard. With this, Green Dot has been able to privately label cards for other companies. What's more, the Green PlaNET network makes it easier to add new functionality. For example, there is now connectivity with PayPal.
As should be no surprise, the financials have been mouthwatering for Green Dot. In the last quarter, revenue increased +44% to $90.3 million, and GAAP net income was $12.5 million. The number of active cards is about 3.2 million, up +60% over the year.
> No doubt, all of these prepaid card operators are top-notch. But the fact remains that NetSpend has regulatory issues, which will be a distraction. More importantly, there has been revenue deceleration in the past couple years. At the same time, Higher One has issues with potential new compliance rules.
In light of all this, Green Dot looks like the best bet for investors. It is the leader in the prepaid card space and will benefit from the Wal-Mart relationship. After all, the mega retailer considers financial services to be strategically important, and Green Dot has the right solution to deal with the tricky compliance rules and technology challenges.
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