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How to Make Money From Rubber Checks
Handling the dirty little details behind credit card and check processing
hardly seems like an exciting growth industry.
So it’s curious to see an insider at tiny Electronic Clearing House (ECHO)
snapping up shares recently in the $8.70 to $9.96 range. Especially when you
consider that the insider – an Electronic Clearing House board member named
Richard Field – used to be chairman of MasterCard.
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Given his credentials, he most likely knows a thing or two about this part
of the world.
So it’s worth asking: What’s going on at this company?
I put that question to Electronic Clearing House’s chief executive Joel
Barry earlier this week, and I took a peek at analyst research and corporate
filings. Here’s a look at some of the trends at this company which could
produce some exciting earnings growth in what seems like a sleepy sector.
The basics
Electronic Clearing House basically runs two lines of business. It manages
merchant accounts used by retailers to process check and debit card
payments. Next, it has a check processing service for retailers. This is
where the action is.
First off, it’s important to know that if you live on either coast, you
might easily miss the gist of this story. For you, processing checks for
retailers seems like an odd business because you never see many people in
front of you in stores with the check book out.
But the fact is, shoppers in much of the heartland and the south of the U.S.
prefer to pay by checks. This explains why there were 17 billion check
transactions in the U.S. in 2004 once you strip out bill paying, compared to
19 billion credit card transactions.
Electronic Clearing House has a hand in these transactions in a couple of
ways. First, it has a huge database with the names of people who like to
write rubber checks. Before finishing a sale, retailers consult this list to
see if the check writer at the counter has a checkered history, so to speak.
Electronic Clearing House systems also pings the customer’s bank to see if
there are sufficient funds. Finally, after a transaction goes through,
Electronic Clearing House helps transfer the money into the store’s bank
account. Electronic Clearing House counts big retailers like Gap (GPS)
and Burlington Coat Factory (BCF)
among its clients.
The growth
The company could see healthy growth in several areas.
* Visa point-of-sale check services Visa has teamed up with several
major banks to exploit Visa’s credit card network for check processing. The
Visa card network connects to about five million merchants, so the potential
is big. When a customer pulls out the check book at a retailer, the cashier
electronically runs the check number through Visa’s system. If the check is
from a Visa banking partner, Visa can confirm checking account balances and
check-writing history.
Many retail customers, however, show up with checks from banks that aren’t
Visa partners. So Visa needs an outside check verification service to do the
job. That is where Electronic Clearing House comes in. It also takes care of
electronic fund transfers, once a check clears.
So far, this partnership with Visa hasn’t provided the kind of growth you
might expect. But that should change once more large regional banks partner
with Visa, making its check cashing system more attractive to national
retailers.
* Wallet funding Electronic Clearing House has a hand in PayPal-like
services known as “wallet funding.” These are online accounts people load up
with cash to pay for purchases over the Internet.
* Casinos The company also collaborates with a top casino check
cashing service provider to assist with check verification and clearing.
On the bank card side, the company has a package of card and check
processing services it provides small regional banks who can turn around and
offer them to their merchant account customers. This is called Merchant
America.
Overall, these offerings helped revenue grow an impressive 15% in the most
recent quarter.
Costs to come down
Unfortunately, legal costs related to a patent challenge are weighing on
reported earnings. Last quarter, for example, overhead jumped 42% thanks to
a $518,000 legal bill in the patent matter, plus a one-off $100,000
executive search fee.
Those legal fees will likely be lower in coming quarters. A trial in the
patent challenge is scheduled for April, 2006 – when legal fees could rise
again. But don’t be surprised if the matter gets resolved on the eve of
trial. Electronic Clearing House believes it can prevail in the patent
dispute, and it doesn’t expect a material hit to earnings.
For now, however, the legal costs are a clear burden: Reported earnings per
share of six cents last quarter would have been twice as high, minus the
legal fees.
Electronic Clearing House is also putting in new technology to handle credit
card processing and reporting. They should come on line and begin reducing
costs in early 2006, around the same time the patent challenge costs may go
away.
The bottom line: Costs at this company could come down considerably
next year as revenue keeps rising. Meanwhile, Electronic Clearing House
looks financially sound with no debt and almost a dollar a share in cash.
The stock has advanced a lot since September. But it is still reasonably
cheap at 1.2 times sales. And given the potential changes ahead, buyers who
enter now should be rewarded by the end of 2006, even if there is a retrace
of the recent advance before then.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in
any of the companies listed in this column. Mr. Brush is an independent
columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About
Insiders Corner:
http://www.investorideas.com/insiderscorner. InvestorIdeas.com
Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp. InvestorIdeas is not
affiliated or compensated by the companies mentioned in this article.
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