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Tuesday, December 16, 1997

Phone: 214-849-2000
Website: http://www.paymentech.com
Price (12/15/97): $13


Restating earnings is never a good sign for any company. When Chief Financial Officer (CFO) David Truezel resigned from Paymentech on Sept. 24 in disgrace after the firm restated its fourth quarter earnings to show a loss, investors took the news badly. The firm's inability in late October to meet substantially lowered earnings estimates was taken even less in stride. Opening the year in the low $30s, Paymentech will close the year in the low teens.


Paymentech, formerly known as FirstUSA Paymentech, is the third-largest processor of credit card and debit card payments in the world after First Data Corp. (NYSE: FDC) and National Data Corp. (NYSE: NDC). The company processes transactions on the behalf of merchants, financial institutions, and sales agents for a variety of transactions. Paymentech generates revenue by collecting a negotiated percentage of each transaction it processes. For instance, in an example given in the company's 10-K filing with the SEC, Paymentech kept 67 cents on a $100 transaction.

Paymentech competes with a variety of companies including First Data, National Data, Electronic Data Systems (NYSE: EDS), Nova (NYSE: NIS), Envoy (NYSE: ENVY), Total Systems Services (NYSE: TSS), SPS Transaction Services (NYSE: PAY), and BA Merchant Services (NYSE: BPI). The industry has become highly competitive in the past few months with growth slowing for many of the major players. Additionally, the acquisition of smaller companies in the business to assist with profit growth has also dried up as quite a bit of consolidation has already happened and the remaining properties are not priced very attractively.


Income Statement

12-month sales: $212.5 million
12-month income: $11.2 million*
12-month EPS: $0.33*
Profit Margin: 5.3%*
Market Cap: $460.9 million
(*Includes one-time charges in the restatement, an extremely complicated set of charges that were not all pre-tax)

Balance Sheet

Cash: $108.9 million
Current Assets: $179.5 billion
Current Liabilities: $166.6 million
Long-term Debt: None

Trailing Price-to-Earnings: 39.4
Trailing Price-to-sales: 2.2


Paymentech's real problems began early this year when the Banc One (NYSE: ONE) and First USA (NYSE: FUS) merger was set to be consummated. You see, FirstUSA Paymentech was a spin-off from First USA and did all of First USA's merchant processing. However, Banc One's merchant processing unit had already been promised to First Data prior to the Banc One-First USA merger, meaning that Banc One could not integrate it with First USA Paymentech or give any of its existing business to First USA Paymentech.

While the merger was a win for First USA shareholders, for First USA Paymentech shareholders it was a total disaster. With Banc One owning 57% of Paymentech, no bank in its right mind would want to turn over its merchant processing activities to the majority holding of a rival bank. Overcapacity in the industry after years of quick growth and easy capital doesn't help either. With Paymentech reporting that it reduced costs for large customers in the fourth quarter and amid evidence that its growth was clearly slowing as a result of the company's Gansar unit being unable to sign up any new banks, it was hard to see very much upside.

Although the restatement would have caught any investor by surprise, the troubling potential of 57% of Paymentech's shares eventually being sold and the problems arising from Banc One's majority stake with no compensating gestures were there all along.

When Goldman Sachs analyst Greg Gould presciently removed the stock from Goldman's "recommended list" over concerns about slowing revenue growth and trouble signing up new customers, investors might have taken that as an exit cue. After the company restated earnings and the CFO left, that was definitely time to go.


Significant issues still hang over Paymentech's basic business and the implosion of its equity has dried up what once was an easy source of acquisition financing -- issuing new shares. Earnings estimates are not completely depressing, and the recent series of downgrades after the miserable quarterly earnings showing of $0.12 a share could be taken as a signal that the bottom has arrived. The company could easily do $0.50 per share this fiscal year and might even stand a chance of hitting current estimates of $0.59 per share.

Margins came in at 8% in the first quarter and although unlikely to return to peak levels of 11% to 12%, it is conceivable that the company could cut out 0.5% to 1.0% in costs and see some continued margin improvement. Additionally, the company's cash flow is much higher than earnings because of amortization costs related to past mergers.

Buying now is definitely betting that Paymentech can regain its footing and that the 57% overhang in the hands of Banc One won't continue to plague the company. The risk-reward would improve substantially if Banc One sold its stake or Paymentech were to merge with a smaller payment processor like BankAmerica-owned BA Merchant Services. Even at 2.3 times sales the company is near the bottom of the valuation range for merchant processors and is in no danger of going bankrupt anytime soon.

With the check continuing to die a slow death and credit cards used more and more for small purchases, the company is in a business where transactions will grow at a percentage rate in the mid- to high-teens for the foreseeable future. If the capacity issues can be addressed, Paymentech could earn decent money.

--Randy Befumo

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