OK, that title needs some explaining. When you think "resources," you think drilling, right? And while Online Resources (NASDAQ:ORCC) has nothing to do with drilling (the "online" bit gives a clue) and everything to do with financial services, it nonetheless suffered the electronic equivalent of a sandstone-grade drill bit hitting granite when it reported Q1 2006 earnings numbers earlier this week.
Net income for the quarter fell 66% against the year-ago numbers, down from $2.2 million to $0.8 million despite 11% revenue growth. Meanwhile, free cash flow reversed from $2 million last year to negative $1.3 million this year.
The reason for the profits slump: Three of the firm's clients "done got et" by bigger financial institutions, thus taking them off Online Resources' system and giving their profit streams to another. That highlights one of my two major concerns about Online Resources and its larger competitors, S1 (NASDAQ:SONE) and Digital Insight (NASDAQ:DGIN). The first , obviously, is that these stocks have all gotten quite pricey since I first began researching the industry more than a year ago.
The second concern is what I call it the "bigger fish conundrum," and it comes in two parts. In part one, we see that the market values shops like DI and Online Resources quite richly. It does so because they have incredibly profitable businesses -- they target small financial institutions that can't afford to buy entire online banking systems and so choose to pay per transaction instead. That yields dependable, recurring sales and healthy profits, in contrast to a firm like Corillian (NASDAQ:CORI) -- a stock that I own -- which does much the same business but targets less profitable megabanks.
Part two of the dilemma is the risk that comes with targeting smaller banks rather than larger ones. Simply put, big banks eat small banks, and not the other way around. As a result, Corillian has an almost automatic growth rate built into its business, as its clients eat the other firms' clients and then buy licenses from Corillian to service these "new" clients. On the other side of the equation, the big banks are always nibbling away at the customer bases of Online Resources and its compadres.
This is a concern I recently raised in an interview with DI's CEO, Jeff Stiefler. You can read his response in full, but the Reader's Digest version goes like this: The solution to the conundrum, from DI's and Online Resources' perspective, has to be to grow a large client base. If no single client contributes too much revenue, then losing a client or two here and there won't unduly affect revenue and profits growth.
Monday's news out of Online Resources just illustrates how right Stiefler was.
For more Foolish musings on the online banking software providers, read:
- Bankers Are Bummed
- Rob Banks the Easy Way
- Online Resources: As Good As Its Word
- Online Resources Strikes Gold
Fool contributor Rich Smith owns shares of Corillian but of no other company named above. The Motley Fool's disclosure policy is as good as gold.
