Shock and Awe Following Stamps.com’s Q4 ’18 Results

Stamps.com (STMP) finished FY ’18 with a flourish, comfortably exceeding our estimates and consensus top to bottom. The feeling of awe quickly gave way to shock, however, as management’s FY ’19 guidance reflected expectations for a revenue decline along with adjusted EBITDA at roughly half the levels we were projecting. The cause was an unsuccessful renegotiation of a long-standing commission agreement with the USPS, which we had assumed would be extended with relatively unchanged terms. Given that Q4 ’18 results will have no substantive bearing on results going forward, those interested in how the quarter came in relative to our expectations and prior periods should refer to our variance analysis. Our only other comment on Q4 is that we were pleased to see renewed growth in the paid customer count, which also coincided with lower monthly churn on a sequential and Y/Y basis. Our quarterly recap will instead focus on the company’s rationale for walking away from a historically lucrative arrangement, discuss the implications for our projections going forward and deriving a new valuation given the loss of a high margin revenue stream.

CEO Ken McBride spent a considerable amount of time during the earnings call discussing the evolving shipping landscape, highlighting Amazon’s major logistics initiatives, the rise of regional and same-day delivery service providers and the incumbent carriers’ investments in infrastructure and pricing to grab a larger share of e-commerce volumes. The point of it all was to depict an increasingly competitive environment in which significant package volumes may shift between existing and upstart carriers in the coming years. Amidst this heightened competition, the USPS remains hamstrung by regulations restricting its ability to respond quickly to competitive price actions and performance guarantees, deteriorating financials and an administration seemingly intent on reducing the organization’s role in “non-essential” services. With this as a backdrop, Stamps.com sought to remove an exclusivity clause from its commission agreement with the USPS to ensure the company could offer its customers the best possible shipping options and to enhance its partnerships with those that could benefit most from the changing landscape. Apparently, this created an impasse and Stamps.com’s longstanding arrangement with the USPS came to an end.

Although the magnitude of the contract loss was not quantified, we note that management’s guidance calls for FY ’19 revenues of $540.0MM-$570.0MM. With MetaPack likely accounting for $50.0MM-$60.0MM in revenues this year, guidance implies an organic revenue decline of approximately $66.6MM at the midpoint, of which just over $7.0MM may be attributable to reduced expectations for non-core Customized Postage. The remainder could represent a proxy for the lost commissions, but management also announced an offsetting 3% surcharge on volumes generated by USPS customers under negotiated service agreements (NSA), suggesting the amount lost is actually greater. Separately, we note that the USPS’ monthly trial balances show that $109.8MM in PC Postage service fees were paid during calendar 2018. The USPS’ filings describe the PC Postage service fees line item as follows: “THIS ACCOUNT IS USED TO PAY PC POSTAGE SUPPLIERS FOR PROMOTING THE USE OF PRIORITY AND EXPRESS MAIL SERVICES TO THEIR CUSTOMERS.” As we believe Stamps.com commands anywhere from 80%-90% or more of PC Postage market share, we suspect the associated commissions lost are in the ballpark of $90.0MM-$100.0MM. Thus, management’s guidance seems to imply a mid- to high single-digit organic growth rate excluding direct payments from the USPS. We also note that if the 3% surcharge on NSA volumes represents the entirety of the growth, this would imply paid customer postage volumes in excess of $1B. That said, the potential for growth in paid subscriptions, reseller revenue shares and other carrier agreements the company may strike suggest a lower volume of affected USPS postage.

For FY ’19, we now project revenues of $553.7MM, which assumes an organic revenue decline of 11.7% and $53.5MM in contribution from MetaPack. Our prior projection was $670.9MM. Between the loss of the high margin revenue stream, and higher expenses anticipated as the company invests across a number of growth initiatives, our adjusted EBITDA estimate falls from $302.0MM to $155.0MM, representing a 28.0% margin. Our non-GAAP EPS estimate falls in concert from $10.63 to $5.36. Management’s guidance calls for $145.0MM-$165.0MM in adjusted EBITDA and $5.15-$6.15 in non-GAAP EPS.

Beyond FY ’19, we believe the company’s primary means of returning to higher growth is to enter into economic arrangements with other carriers like Amazon, DHL, FedEx, UPS or other regional providers. While details pertaining to any potential agreements remain sparse, management indicated that the company processes over $11B in shipping volumes across its various platforms, suggesting approximately $4.5B in shipping revenues associated with other carriers. Were Stamps.com able to negotiate a similar 3% take rate in its agreements with other carriers, this would cover the lost USPS revenues and then some. The obvious question is why any of the carriers would pay for volumes that are already moving through their networks. We believe this is where management has placed its bet that Stamps.com’s highly regarded multi-carrier shipping solutions, large customer base and existing marketplace integrations leave the company ideally positioned to become an arbiter of volumes amidst an increasingly competitive environment. Said differently, Stamps.com has the ability to efficiently target shippers whose volumes may be ripe for competitive displacement, which may prompt carriers to extend generous terms to the company in hopes of acquiring or retaining said volumes. Whether that comes to pass, we shall see, but we have long anticipated the company could eventually leverage its position to move in this direction. Of course, we had thought this would be in addition to USPS monetization, not in lieu of it. In any event, our assumption is that the lost USPS commissions come back via other carrier agreements over a period of five years. We therefore project FY ’20 revenues of $613.3MM, reflecting growth of 10.8% Y/Y. Our adjusted EBITDA estimate of $182.7MM assumes approximately 200bps of margin expansion, and results in our non-GAAP EPS estimate of $6.05. Our prior FY ’20 estimates included revenues of $762.4MM, adjusted EBITDA of $359.1MM and non-GAAP EPS of $12.08. Our revised model is available here.

From a valuation perspective, the loss of a lucrative revenue stream significantly reduces our intrinsic value calculation. Reflecting a lower revenue base in FY ’19, a reduction in our CAGR target from 15% to 10% through FY ’23, a gradual return to a 40% adjusted EBITDA margin and a higher WACC of 9.1%, our DCF analysis yields a fair value of $145.00. From a multiple standpoint, we note that this is relatively consistent with a FY ’20 EV/EBITDA multiple of 15x and a FY ’20 P/E multiple of 25x, both of which we believe are reasonable should Stamps.com indeed return to a double-digit growth profile with a 30%+ adjusted EBITDA margin. We therefore set our price target at $150.00 based on a FY ’20 EV/EBITDA multiple of 15x. Our prior target of $320.00 reflected a FY ’19 EV/EBITDA multiple of 20x. Should the after-hours decline of nearly 50% hold when the market opens, we would buy the dip given the implied upside to our target. In terms of catalysts going forward, we now await word on new carrier arrangements as opposed to wondering about legacy contracts renewing.

Disclosure(s):

The author holds a long position in Stamps.com (STMP).