Initiating Coverage of Stamps.com (STMP)
Stamps.com (STMP) has amassed a stable of highly regarded software solutions targeted at e-commerce merchants and other high-volume shippers. In addition to providing the company with a significant recurring revenue stream, these solutions also leverage Stamps.com’s strategic relationship with the United States Postal Service (USPS), enabling the company to monetize a portion of its customers’ shipping volumes. In our view, the combination of steady subscription fees and transaction revenues tied to e-commerce provides a solid foundation for consistent double-digit organic growth and significant free cash flow generation. We project revenue growth of 15.6% and 13.6% in FY ’19 and FY ‘20, respectively, to $670.9MM and $762.4MM. We assume adjusted EBITDA margins expand in each of the next two years to 45% and 47%. We note that our estimates may well prove conservative considering management’s targeted five-year growth rate of 20% and the 49% adjusted EBITDA margin posted in FY ‘17. Our non-GAAP EPS estimates include $10.63 for FY ’19 and $12.08 for FY ’20, both of which assume a more normalized tax rate of 28%. Considering current peer group multiples, the company’s historical valuation range and our DCF analysis, we set our price target at $320.00, representing a FY ’19 EV/EBITDA multiple of ~20x.
Investment Highlights
The 800-Pound Gorilla in SMB Shipping Software. Stamps.com launched the first USPS-approved PC Postage solution in 1999, and quickly captured a significant share of the nascent market with its focus on small office and home office (SOHO) customers. In 2014, the company acquired ShipStation, a leader in the emerging market for multi-carrier shipping software, and quickly followed that with the purchase of ShipWorks, another multi-carrier shipping software provider catering to e-commerce merchants, warehouse operators and distributors. The company’s late 2015 acquisition of its primary competitor, Endicia, cemented its dominance in the PC Postage market and all but ensured the company had successfully transitioned from a mailing-oriented company to shipping. ShippingEasy was acquired in 2017, bringing yet another fast-growing multi-carrier shipping brand into the fold, and more recently, Stamps.com completed the acquisition of MetaPack, accelerating its push into international markets.
Recurring revenue stream with built-in growth. Pricing for each of Stamps.com’s software solutions is subscription-based with multiple pricing tiers dependent upon the features or transaction volumes required. Considering that low-volume shippers are unlikely to pay a monthly fee to manage orders or print postage, we believe Stamps.com’s paid customer count reflects a rising mix of e-commerce merchants or other high-volume shippers experiencing both significant growth and the logistics challenges that arise in concert. As such, we expect Stamps.com to deliver growth at or above e-commerce growth rates as increasing customer volumes drive a natural uptick in subscription pricing and provide more opportunities to monetize postage.
Robust margins and free cash flow generation. Prior to its acquisitions in the multi-carrier software space, Stamps.com was already generating adjusted EBITDA margins in the low-30% range. Subsequently, the company’s adjusted EBITDA margin reached as high as 49.1% in FY ’17 before settling into the low- to mid-40% range throughout FY ’18. The margin compression over the past twelve months coincides with the introduction of Stamps.com’s Global Advantage Program, which requires the recognition and pass-through of USPS postage within the associated revenue stream. This is in stark contrast to the vast majority of Stamps.com’s business for which postage generated on behalf of the USPS does not pass through the P&L. In other words, the margin compression is simply an accounting artifact as opposed to a fundamental change in the business. Regardless, even if growth were to skew more meaningfully to the Global Advantage Program, we expect adjusted EBITDA margin to remain in excess of 40%. Our forecasts at present call for modest margin expansion to 45.0% in FY ’19 and a more meaningful increase to 47.1% in FY ’20, which in turn supports free cash flow of $224.5MM and $255.3MM, respectively.
Highly defensible position. Stamps.com’s road to approval as a PC Postage vendor took approximately three years from the time the company first considered the opportunity. Only one other company, EasyPost, has become an approved PC Postage vendor since the dot com era when Stamps.com, Endicia (now part of Stamps.com) and Pitney Bowes were first approved. Granting the ability to print postage increases the potential operational risk to the USPS given the required oversight and disclosure of closely guarded negotiated rates. As such, we believe new entrants are likely to be limited for the foreseeable future, providing Stamps.com with a significant economic moat for both its PC Postage solutions and multi-carrier software offerings. In this regard, we note that to the extent competitors in the multi-carrier software market provide access to the USPS, many have historically done so via Stamps.com or Endicia, meaning Stamps.com is funded to an extent by its newer competition. While those integrations may well shift to another PC Postage competitor over time, any transition for a component as critical as USPS shipping poses risk and leaves Stamps.com well positioned to acquire affected customers.
Attractive valuation. STMP currently trades at just 11.8x our FY ’19 adjusted EBITDA estimate, a hair below the median of the company’s five-year historical trading range despite an organic growth rate in excess of 20%, management’s stated long-term growth target of at least 20%, an adjusted EBITDA margin well in excess of 40%, and consistent outperformance against quarterly and annual Street expectations. In our view, STMP’s valuation would be markedly higher today if not for persistent fears that the company’s relationship with the USPS could be in jeopardy, a notion first put forth in short reports published in 2016. While a mid-2017 contract renewal with the USPS on better economic terms put those initial concerns to rest, worries flared again last year as investors fretted about President Trump’s USPS Task Force, a whitepaper on postal partnerships published by the USPS Office of Inspector General that was not released for public consumption and a new risk disclosure in Stamps.com’s SEC filings pertaining to contract negotiations with the USPS. We believe that after a year in which the USPS was under significant scrutiny, any updates pertaining to the status of Stamps.com’s key contracts with the USPS consistent with management’s prior expectations for no substantive changes should remove much of the perceived risk and allow shares to re-rate higher. We therefore set our 12-month price target at $320.00, representing a FY ’19 EV/EBITDA multiple of approximately 20x. We note that this valuation is also consistent with our DCF analysis employing a 5-year CAGR of 15%, a terminal growth rate of 2.5%, steady expansion in adjusted EBITDA margin back to historical highs and a weighted average cost of capital of 8%.
Investment Risks
Acquisitions. While many of the company’s recent acquisitions have been successful, Stamps.com remains active on the M&A front. The company’s acquisitions could prove difficult to integrate or dilutive to financial results.
Competition. Although the PC Postage market is comprised of just three vendors, customers have many alternatives for purchasing postage, which include retail post offices, automated kiosks and traditional postage meters offered by Neopost and Pitney Bowes. Other electronic postage options also include the USPS’ Electronic Verification System (eVS), Shippo’s ePostage offering or obtaining labels from an online marketplace like Amazon or eBay, provided of course that the transaction occurred on said platform.
Economic conditions. During the Great Recession, Stamps.com’s revenues declined 3% Y/Y as the high concentration of subscription revenues and general need for mailers to maintain a postage metering solution provided some cover for the company. With the company’s increasing exposure to high volume shippers, however, revenues now include a higher mix of variable transaction revenues. As a result, poor economic conditions could have a more pronounced impact on the company.
Intellectual property (IP). Stamps.com’s business is dependent upon the licensing of its IP. Should the company infringe upon the IP of others or fail to protect its own IP, the company’s financial results could be negatively impacted.
Missed expectations. Shares of STMP may fall if the company fails to meet its own guidance and/or consensus expectations.
USPS contracts and regulations. As an approved USPS PC Postage vendor, Stamps.com is subject to USPS oversight. Thus, the company could incur incremental costs to comply with any changes to existing operating requirements mandated by the USPS such as the implementation of the Automated Package Verification (APV) system in 2017 for which PC Postage vendors are required to automatically debit or credit customer accounts for under or overpaid postage. The USPS could also eliminate PC Postage as a payment option for postage, although the probability of this occurring is minute, in our view, given that Stamps.com process over $6B in postage printed annually on behalf of over 700k subscribers. Workshare discounts like those received in the Global Advantage Program could also be eliminated and inhibit the company’s growth prospects. Also worth noting, the USPS could potentially block an acquisition of Stamps.com. In addition to its position as a regulator, the USPS is also a strategic partner. As such, the two parties have numerous agreements in place that could change for better or worse. While the company has not disclosed every agreement it has with the USPS, we are aware of contracts that govern the sharing of credit card fees (extended for a year in October 2018), that provide incentives for volumes associated with certain mail classes, that allow ShippingEasy to pay discounted rates on postage and that utilize Stamps.com for electronic postage purchased through the USPS’ Click-N-Ship service. Changes to these agreements, or those that Stamps.com’s customers and integration partners may have with the USPS, could impact the company’s results.
Disclosure(s):
The author holds a long position in Stamps.com (STMP).