Keep on the VeriFone Sidelines

Last month, VeriFone Holdings, Inc. (PAY - Analyst Report) announced that it completed its independent investigation into certain accounting and financial control matters. Earlier, on December 3, 2007, PAY announced a major restatement of its fiscal results for the first, second, and third quarters of FY2007, resulting in significant lowering of its nine-month operating results. The restatement involves both lower inventory levels and increase in cost of goods (lower gross and operating margins).

We estimate that the restatement impacted the nine-month period profitability roughly by negative 20%. It also opens up the possibility of restructuring within the company. As part of its renegotiations with its debt holders, VeriFone agreed to pay an additional 0.25% per annum on its term-loan and credit facility in addition to a 0.25% one-time fee. We believe that this translates to roughly $0.6 million a year of interest expense (on the July 31 balance of $237.5 million).

Although VeriFone remains a pure play on the rapid international emergence of electronic payments, the restatements negate the near-term probability of any bullish sentiment for its stock price performance. Additionally, the opening of its international headquarters in Singapore led to manual handling of certain accounting items as the software system was not configured to process the items automatically. Simply put, some of the items were double entered; the net result was some double counting of inventory and the resulting double counting of manufacturing overhead offset.
 
VeriFone now generates approximately 60% of its revenues in non-North American markets. This is critical to the investment thesis, in our opinion, as the company’s emerging Europe, Latin American and Asian markets are growing at least twice as fast as the United States. While North America revenue growth will vary, based on economic and upgrade cycles, we contend that international revenue growth will remain steadily above average.

Although it may be argued that the recent sharp stock sell-off offers long-term investors an attractive entry point, we would prefer to stay on the sidelines and wait until the accounting issues and its near-term impact is played out. Given the near-term uncertainty, we maintain a Hold rating with a reduced target price of $15, which is roughly 13.9X our FY2008 EPS estimate.

Read the full analyst report on PAY.
 
 

Read the full analyst report on PAY