Stamps.com, Inc. (STMP)

aparker385 (68.07) Submitted: 5/12/08 3:52 AM

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I agree that the PE seems high but let me shed some light on some interesting facts.

1) No debt and over $4.5 per share in cash means you are buying the business for less than $10 per share at today's price. Essentially, the true PE is currently 33% lower than stated. This excess cash is being used largely to repurchase shares

2) The PC postage business, which has over 80% gross margins, grew at 11% last quarter from a year ago. The increase in revenue growth is a direct result of increased marketing expenditures. The increased marketing expenditures which are driving this growth hurt operational margins. This short-term tradeoff, however, is adding significant long-term value.

Put this in perspective: PC postage marketing spend was approximately $25 million in 2007, which is resulting in PC postage growth of 11% equating to a return in excess of 20% on that expenditure. Management will continue investing in PC marketing so long as these returns remain robust. If management did not grow, imagine what would happen to margins. Add $25 million to the $6.5 million from operations in 2007 and you're at $31 million. Therefore, if stamps.com were not investing in growth, it would be earning around $30 million per year, making its current P/E less than 9! Would you rather own that company or the current one, which is earning returns well in excess of 20% on advertising expenditures, which will pay larger and larger dividends to the firm for years to come?

3) Revenue growth overall was weak because revenue from photostamps has been decreasing. The slowdown in this business is good news for shareholders! Photostamps earns gross margins of around 30% vs. 80% for postage. With marketing and related expenditures included, photostamps has lost money for stamps.com until recently! Management recognizes that this business is not very good and they have cut back heavily on marketing. As a result, revenue is way down, but the business is finally profitable.

Actions like this plus its wise repurchasing actions demonstrate management's understanding of and commitment to value creation. If for some reason advertising the PC postage business were not creating value, then I believe management would stop, and you'd get your $30 million right now. However, this would be incredibly foolish. The returns on advertising are stellar to say the least, and the market opportunity for stamps.com is enormous.

Finally consider these points that stamps.com has working for it in the long-run
a) Pricing power. As the only current provider of this service, there is substantial room to increase prices given the cost savings generated for the typical customer. Imagine even a $3 increase in the monthly fee. That would grow PC postage revenue by 17% without increasing costs! This is not realistic in the short-term, but prices will go up over time and stamps certainly has the ability to raise rates without losing customers

B) SG&A leverage. Stamps.com is getting more and more efficient with both operations and marketing expenditures. As the company grows, SG&A will be an increasingly smaller portion of revenue - increasing margins

c) Growth potential from enterprise and multi-user customers. Stamps' R&D is not being thrown out the window. They have and are continuing to develop solutions for large corporations. As administrators become aware of the service, it's a no brainer to sign up for corporations of all sizes.

d) Negative working capital. Excess cash aside, working capital will be increasingly negative as the firm grows. Basically they receive cash from their customer faster than they have to pay it out to suppliers, or to employees, landlords, etc. Returns on capital for stamps are going to increase as the firm grows! This is incredible and true only if...

e) Stamps.com enjoys significant barriers to entry in its business. Getting approval from the USPS is a multi-year process. Entrepreneurs or corporations wanting to compete would have to invest significant time and money just to get approval. Next, consider the amount of money Stamps.com has spent and will spend in developing its technology (R&D) and promoting its business (advertising). A competitor will have to match this in order to compete. The fact that people are not all aware of stamps immediately may actually be advantageous to the firm in the long-run because it means that potential user will also not act quickly to switch. Consider how many people still use postage meters. If someone simply offered the same product as stamps, why would anyone switch. Also, what over domain or brand would be trusted over Stamps.com? Finally, as far as competition goes, who wants to enter a declining industry? Mail use is on the decline. With the internet, email, and electronic communications, mail volume is significantly shrinking. This bodes well for stamps because it will keep competitors out of the industry. It is also not bad for stamps because their customers are less than 1% of their potential market. Despite shrinking volume, the room for growth is still huge.

Please share your thoughts.

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fredmahnke (58.43) Submitted: 5/14/08 4:24 PM

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I appreciate your message and decided to change my pick to neutral as you are right on the balance sheet valuation issues. I still don't see much upside to this stock until they can start to grow revenues. Good Luck.

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bullshiite (81.56) Submitted: 6/15/08 4:49 PM

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Aparker,
Nice research but I wish you had included some price targets. I don't think STMP should go above $14, IMO, because the income/revenue growth is too weak. Pro: No debt and thats makes STMP an almost zero risk play at the right price; as they will always be able to generate a profit. Con: Low RoCA ( return on current assets) for Dec 2007 it was 3% and Mar 2008 it was 7% (perhaps the increase can be attritbuted to #3 of your pitch).
I made the mistake of rating STMP as an underperform at $8.60 but the reason I have chosen to hold this position is because I feel confident that it won't be able to maintain it's current price. STMP will return to the $9-$10 range where I will probably close my position for a minor loss of points. It is within that price range that your logic is the most applicable to recommend STMP as a buy.

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aparker385 (68.07) Submitted: 8/25/08 12:20 PM

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Growth: what you have to pay attention to is the growth in the PC Postage business. It is in this business that most of the marketing dollars are spent. PC Postage is now growing at 15% annually. This growth is hidden by the declines in photostamps. As an investor, I am happy to see that management is spending significantly less advertising photostamps becuase this business is not profitable. Revenue declines is unfrotunate, but I do not mind seeing stmps out of this buinsess. Each quarter, the photostamps revenue decline will be less substantial, allowing the PC Postage growth to shine through. In 4Q08 and into 09 you will see meaningful total growth both quarter over quarter and year over year. The opportunity exists because this growth is hidden. Again, understand that if stmp were not investing in PC Postage growth ($30 million a year adn 15% growth), then EBITDA would be closer to $40 million, which means earnings is close to $40 million because stmp pays no interest or taxes. So after subtracting out the cash, stmp is trading at around 5x earnings in a no growth scenario - or a 20% cash flow yield. sound cheap? Well, the even better news is that instead of adopting this approach, mgmt is profitably reinvestnig in the business. Each $1 spent on advertising PC Postage creates over $2 in shareholder value. The standard metrics makes stmp look expensive (P/E/ EV/EBITDA, etc). However, this is precisely why the opportunity to buy stmp cheap today exists - investors stay away from the high multiples without spending the time to understand the business. Look at and understand the numbers, and you will find that stmp is substantially undervalued. good luck

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