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Online Banking Bust

Way back in April 2005, I used this space to introduce Fool readers to a relatively new niche industry (or at least, a niche industry to which the concept of making a profit was new). These were the online banking software makers:

  • Corillian (Nasdaq: CORI  )
  • Digital Insight (Nasdaq: DGIN  )
  • Online Resources (Nasdaq: ORCC  )
  • S1 (Nasdaq: SONE  )
  • Sybase (NYSE: SY  )

With earnings season in full swing, and four of the above five companies having just reported their quarterly results, now's good time to check back in on the major players and see how they're doing. Let's begin with a stroll down memory lane. Here's how the companies looked one year ago:

Ent. Value ($ in mil.)

Free Cash Flow ($ in mil.)

Proj. Growth Rate (%)


Ret. on Eq. (%)







Online Res.












Digital Insight












All data taken from Yahoo! Finance and based on trailing- 12-months' results.

And here's where they are today:

($ in

($ in










Online Res.
























Enterprise values and growth rates taken from Yahoo! Finance. FCF and ROE data are provided by Capital IQ, a division of Standard & Poor's, and based on trailing-12-months' results. Note that for Corillian, which did not provide a cash flow statement with its earnings release last week, and for S1, which has not yet released earnings, FCF data is only current as of April 2006.

Market view
So here's what Mr. Market seems to be telling us about the industry in general, and the companies in particular. First of all, "Blue Horseshoe loves online banking." Since I began writing about this mini-industry, the collective enterprise value of the five leading companies has increased 20%. Meanwhile, the S&P 500 is up just 8%. Clearly, the market thinks these companies will go far.

But it doesn't necessarily like each of them equally. Online Resources appears to be the investor favorite, with the market valuing its business 64% higher now than it did in April 2005. Corillian and Digital Insight are virtually tied, up 43% and 42%, respectively. Sybase's enterprise value has risen 27%, and only S1 has declined -- down 50%.

The Foolish view(s)
Now that you know what Mr. Market thinks, here are my own updated thoughts on the companies and their prospects, based on their most recent reports.

Revenue increased 19% year over year in the second quarter. But all of that growth came from adding the revenues of recently acquired companies. Organically speaking, revenues actually declined 3%, as a result of the firm selling far fewer "seat licenses" (bulk sales of licenses to banks to use Corillian's software) this year than last. Meanwhile, gross margins on the revenues continued to decline, down from 66% last year to 41% in the quarter just ended.

Analysts remain bullish on the stock, with all three who cover it rating Corillian a buy. The optimism stems in part from CFO Paul Wilde's promise to move margins back up past 51% by year-end, plus the improving predictability of profits resulting from a shift in revenues, from "lumpy" one-off seat license sales toward recurring revenues, which now make up 54% of Corillian's revenue base.

Also, while Corillian's competitors seemed to encounter problems with signing up bill-pay users this quarter (as you'll see below), Corillian had no such issues. Corillian CEO Alex Hart suggested that rival firms face two hurdles that Corillian need not leap. First, the rivals' smaller customer banks are often bought by the megabanks (think Wachovia (NYSE: WB  ) or Citigroup (NYSE: C  ) ) that Corillian services -- adding to Corillian's bill-pay totals while eating away at the rivals' numbers. Also, smaller banks may be maxing out the penetration of end-users interested in signing up for bill-pay.

Good as all that sounds, this Fool has his reservations. Corillian is more richly valued today than it was last year, but its free cash flow has dried up. I like the fact that management is conservative in predicting future successes. Sadly, though, that conservatism has proven well-founded.

Online Resources
6%. 8%. 9%. 3%. What do those numbers mean to you? To Online Resources investors, they meant a 5% drop in the value of their stock last Tuesday. Wall Street fretted over the break in the string of accelerating quarter-on-quarter sequential growth in bill-pay end-users serviced by Online Resources, worrying that the pool of potential online bill-payers was going dry.

Those worries seemed to ease over the course of the week, however, leaving Online Resources' stock sitting 5% higher on Friday than it was just before the earnings report. The fact that the CEOs of Corillian, Online Resources, and Digital Insight spoke with one voice last week -- saying they saw no trend of declining interest in bill-pay -- likely helped revive the stock. Also helpful was Online Resources' pledge to grow its revenues by as much as 25% in 2007 and beyond.

Online Resources may not be out of the woodshed yet, however. The company recently bought out Princeton eCom for what Online Resources CEO Matt Lawlor called a "full price" -- in more ways than one. Between paying interest on the heavy debt load it took on to make the purchase, and the need to amortize a lot of goodwill, Online Resources' GAAP numbers are going to look mighty ugly this year, with earnings per share unlikely to exceed $0.05. On the plus side, free cash flow that is already improved over last year's should improve even further later this year, as Online Resources' capital expenditures moderate somewhat. Fools might want to take a closer look at this one if future quarters' GAAP earnings news knocks the price down again.

I don't have a whole lot to say about this one. S1's done pretty badly, earnings-wise, for some time now (earnings were negative in three of the last four fiscal years) -- and the stock has been roundly punished for it. That said, the company has lots of cash on the balance sheet, and it sports price-to-sales and price-to-book ratios much lower than its competitors. S1 doesn't impress me much as a business, but as a potential buyout target, the stock could be attractive.

Digital Insight
"If price were no object, DI would be one of my favorite companies in the public markets." I penned those fateful words three months ago, when previewing Digital Insight's Q1 report. Last week, Mr. Market finally nodded in agreement and dashed DI's stock price to the ground. The excuse for lopping 30% off the firm's market value? You guessed it: slowing bill-pay adoption.

Although I don't pay a lot of attention to sequential changes in numbers, Mr. Market does. Here's what Mr. Market saw happen between Q1 and Q2:

  • DI lost a net six Internet banking clients.
  • End-users of DI's bill-pay service grew by only 66,000 -- half the expected number.
  • Potential end-users (i.e., customers at banks that are DI's customers) declined by 100,000.
  • Penetration of the potential user based increased 30 basis points.

See the problem? DI lost business as its small-bank customers were bought by bigger banks. Bill-pay users -- which DI considers the "most important" metric available for evaluating its progress -- didn't grow fast enough to make up the difference. Meanwhile, the pool of potential bill-pay customers shrank and moved closer to saturation. Mr. Market quickly concluded that DI was nearing the end of the "high-growth" phase of its corporate lifespan.

For the record, I think Mr. Market jumped the gun on this one. As CFO Paul Pucino pointed out during the conference call, only 4.4% of all customers patronizing DI's customer banks currently use bill-pay. So the potential for growth remains enormous. Sale of bill-pay services to current online banking end-users can still grow fourfold, even if no new customers discover the Internet -- and 25-fold if they do.

While I disagree with Mr. Market's reason for discounting DI's stock, I do agree with the result. DI was overpriced on Tuesday, but today's price looks much more reasonable.

Finally, in the "which of these things is not like the others?" category, we come to Sybase. In general, I like the company and its prospects. However, the bulk of the business has little to do with online banking. Sybase swam its way into my online banking software provider net by virtue of a relatively tiny portion of its business, the Financial Fusion unit.

Although the rest of the business is doing well, Financial Fusion appears to be the exception, and Sybase rarely speaks of it voluntarily. Review the firm's quarterly report, for example, and you won't find word one on the subject of Financial Fusion. Pressed for news on the unit in the July earnings conference call, CEO John Chen admitted that the firm has essentially farmed selling the division's services out to "a third-party channel." Which just bolsters my oft-expressed opinion: If Sybase isn't going to take an active interest in Financial Fusion, and the unit continues to underperform, Sybase should just sell it off to someone who can make better use of it.

Looking for other up-and-coming companies in emerging fields? Try out our Motley Fool Rule Breakers newsletter service. It'sfree for 30 days.

Fool contributorRich Smithowns shares of Corillian. The Motley Fool stores its disclosure rules in an iron vault in an undisclosed location. (No, not really. You can read them right here.)

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Rich Smith

As a defense writer for The Motley Fool, I focus on defense and aerospace stocks. My job? Every day of the week, I'm monitoring the news, figuring out the winners and losers, and tracking down the promising companies for you to invest in. Follow me on Twitter or Facebook for the most important developments in defense & aerospace, and other great stories.

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