FOOL ON THE HILL
Stamps.com's Promise

After falling from glory with the other dot-coms in Spring 2000, Stamps.com has emerged with a strongly rising stock price over the past half-year. The bullish wave is in anticipation of a new technology, currently in beta testing, for secure-ID postage that could be purchased online and printed on any standard printer. Even with this promise, the stock trades at only a 22% premium to its cash per share.

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By Matt Richey (TMF Matt)
May 7, 2002

It's not too often you find a company with Rule Breaker characteristics and a stock selling at only a slight premium to its net cash per share. That's what got me interested in Stamps.com (Nasdaq: STMP), the market leader in Internet postage.

The stock has doubled over the past eight months, rising from around $2.25 in September up to the current price of $4.60. Yes, be wary, this is a "penny stock." Any stock below $5 should receive your utmost caution. That said, Stamps.com has a market cap of $234 million, so this is not a penny company. The low share price is a result of the radical drop in valuations since the Internet bubble popped in Spring 2000.

Prior to the bubble bursting, however, Stamps.com went to the public markets and raised a ton of cash. The company did an IPO in June 1999 and then did a secondary offering in December 1999, raising a total of around $400 million. For a while it was "Burn, baby, burn!," but today the company still has $192.1 million in cash and long-term investments, or $3.78 per share. On a net net working capital basis, the company has $3.73 per share in liquid value. As such,  the stock currently trades at only a 22% premium to cash and a 23% premium to net net working capital.

Is the stock a value? Let's take a closer look.

Stamps.com launched its Internet postage service in 1999 and was the first company to enable consumers and businesses to print postage 24/7 using just a computer, printer, and Internet connection. As the first mover, Stamps.com captured the lead in Internet postage and continues to dominate the segment today with an estimated 80% market share.

Internet postage is most attractive to small businesses that can save time and money through a software-based method of sending out bulk mailings. Here's how it works: When a customer purchases postage through Stamps.com, they pay face value and the funds are transferred directly to the U.S. Postal Service (i.e., no float for Stamps.com). For this convenience, customers pay Stamps.com a monthly user fee, ranging anywhere from 10% of the transaction value (the "Simple Plan") up to a flat fee of $15.99 for unlimited use (the "Power Plan"). Customers do, however, have to endure two major inconveniences: 1) the postage must be tied to the destination address; and, 2) the postage expires in 24 hours' time.

Despite these inconveniences, Stamps.com got off to a quick start, going from nothing to $15.2 million in revenue for 2000. But this didn't prove to be a hypergrowth story -- 2001 revenue grew only 28% to $19.4 million. Gross margin expanded to above 70% by the final quarter of 2001, but the company has yet to turn a profit. Also troubling is the fact that the number of total active customers has declined over the past six months, even while the company is still gaining new customers -- thus indicating churn:

             Customer           Total
Quarter    Acquisitions    Active Customers
Q3 01         29,000            285,000
Q4 01         27,000            280,000
Q1 02         28,000            279,000

If the story ended right here, Stamps.com would appear to be entirely unpromising. But the story may be set for a promising twist because of a new technology for generic postage (anytime, to-anyone postage) that's in late-stage beta testing. Stamps.com's new technology overcomes the two inconveniences (mentioned above) affecting the current product, and thereby allows customers to print sheets of generic postage that are not tied to a destination address and have no expiration date. In other words, the new technology will allow customers to print a sheet of electronic stamps, just as functional as the stamps you buy at the post office but with the added security afforded by having the sender's identity embedded in the stamp's "intelligent" bar codes.

Think about how this technology could help prevent terrorists from being able to send anthrax-laced letters. Even if generic electronic postage isn't a huge hit with customers, it's conceivable that this new sender-ID postal technology could one day be required of all U.S. mail for security reasons.

Stamps.com is currently beta-testing the new technology with over 300 users. As of yet, there's been no indication of when the technology could be released for commercial use, but the beta test itself is the ninth of 10 stages that are required by the U.S. Postal Service for Internet postage certification. The entire approval process for Stamps.com's original and existing Internet postage technology took two-and-a-half years, with the final beta market testing stage accounting for one year of that time. Considering that the new generic postage technology began testing in January of this year, it's conceivable that it could be released for commercial use by January 2003.

Until then, Stamps.com is in cost containment mode. The company has reduced its cash burn from operations each of the past four quarters ($ millions):

              Cash Burn
Quarter    from Operations

Q4 00          $43.5
Q1 01           24.9
Q2 01            8.6
Q3 01            3.2
Q4 01            2.1

The cash flow statement for the first quarter of this year is not yet available, but the cash balance between December 31 and March 31 almost remained the same, declining only slightly from $192.9 million to $192.1 million.

What's a fair price for a company with promising but uncertain technology, $192 million in the bank, very low cash burn, and about $16 million in run-rate annual revenue? One way to look at the situation is to subtract out the cash from the current market cap -- $234 million minus $192 million � to arrive at an enterprise value of $42 million. That's about 2.6 times current annual sales. That could prove a small price if the new technology delivers a significant boost to revenue and an arrival of profitability. Clearly, however, Stamps.com at the current price is a speculative investment. Given the uncertain potential of the new technology, the risk/reward profile would be much more palatable if the stock price were closer to the cash per share of $3.78.

In addition to the technology risk, investors should consider the following negative factors I found in my research:

  • A large and profitable competitor in $10 billion market cap Pitney Bowes (NYSE: PBI).
  • Pending litigation with Pitney Bowes.
  • The departure of four Stamps.com senior managers during 2001.
  • A $6-million outstanding loan to the former CEO, which was supposed to have been paid by June 30, 2001.

I find Stamps.com to be a very interesting investment possibility but a bit too speculative at the current price. I'd be interested, though, in getting your opinion.

Matt Richey is a senior investment analyst for The Motley Fool. He wishes he could buy postage for his Mom's Mother's Day gift using the Internet, so he wouldn't have to face those blasted lines... but it's worth it for Mom! At the time of publication, he had no position in any of the companies mentioned in this article. Matt's personal portfolio is available for viewing in his profile. The Motley Fool is investors writing for investors.