March 20, 2000

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Taking $tock:
CheckFree Seeks Merger Payoff
The company's acquisition of TransPoint would make it the market leader in electronic bill payment and presentment, if the Justice Department gives its OK

By William Schaff

any readers of this column have asked me when the tech-stock roller-coaster ride will end. It won't happen any time soon. If you want to invest in vision and projections, you have to live with volatility when these issues bump up against financial realities. The other side of the coin, however--and the main reason we invest in more-speculative stocks--is when opportunity meshes with execution to form a powerhouse company. I believe we have one of those stories in the making with CheckFree Holdings Corp. (CKFR--Nasdaq).

CheckFree's planned acquisition of its leading competitor, TransPoint LLC, promises to make CheckFree the big kahuna of electronic bill payment and presentment. The company would also get new partners in TransPoint backers Citibank, Microsoft, and First Data Corp., a leading electronic-transaction and credit-card processor.

As with most new platforms--remember the PC and cellular markets when they were young?--the acceptance rate and adoption of electronic-bill-payment technology must hit a critical mass before customers and merchants converge. The economic advantages of electronic bill payment are clear. The cost of processing an electronic bill is about 5 to 6 cents, compared with around 20 cents for a paper bill.

The biggest barrier to acceptance has been the reluctance of many consumers to pay bills online because of security issues. Having First Data's tie-ins to merchants and the Microsoft Network to attract more technology-savvy users should help CheckFree expand the overall market. Ironically, many consumers may not realize that they're already using CheckFree's electronic-bill-payment service because it's usually labeled under a banking institution's own name or another leading financial brand such as Intuit.

CheckFree is also adopting a transaction fee-based business model to replace its current license-fee setup. By exchanging the near-term profitability of license fees for the longer-term value in transaction fees, CheckFree's scale-up of its platform will lead to greatly expanded revenue as adoption of bill-payment technology accelerates.

The big hitch in the near term for CheckFree is consummating the TransPoint deal. The combined entity would dominate market share--some estimates are as high as 90%. Competition in this market is still emerging, however, and includes Spectrum, a bill-payment service put together by Chase Manhattan, First Union, and Wells Fargo. But if the Department of Justice looks at CheckFree/TransPoint's combined market share as a snapshot of the electronic-bill-payment universe, it may raise the red flag. I think CheckFree will allay the Justice Department's concerns, but investors should be aware that this isn't a given. In addition, the company's subscriber growth rate is still sluggish, hanging in the single digits last quarter.

There are 54.8 million shares of CheckFree outstanding at around $75, giving it a pre-merger equity market capitalization of roughly $4.1 billion. Book value is around $3.80 per share, and long-term debt is around $177 million. The TransPoint deal would cost CheckFree an additional 17 million shares to Microsoft, Citibank, and First Data. On a fully diluted basis, this would be about 23% of the combined company.

In exchange for its interest in the new company, the Microsoft/Citibank/First Data consortium will put in $100 million in additional capital prior to closing. Microsoft and First Data also have guaranteed $180 million and $120 million of revenue and cost savings, respectively, during the next five years. This is a big win for First Data, which has been shoveling money (more than $40 million in the past three years) into TransPoint with little benefit.

The merger would be done by purchase accounting, so the recent change from pooling accounting will have little impact on financial reporting. Both the CEO of First Data, Ric Duques, and TransPoint CEO Lewis Levin would join the new board, setting up a strong management team.

My estimates for fiscal year 2000, ended June 30, is minus 42 cents earnings per share on $310 million in revenue. The risks are high, but so are the potential rewards.

William Schaff is chief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 Stock Index. You can reach him at bschaff@bayisle.com.

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