Taking Stock: CheckFree Looks For Growth As Electronic Billing Comes Of Age

How do you feel these days when opening the mail? Have latex gloves become a permanent part of the mailroom? The presence of anthrax in the United States makes receiving bills in the mail even less pleasant than before. That anxiety might benefit companies that let you pay bills online, such as CheckFree Corp. (CKFR-Nasdaq), the leading provider of electronic billing and payment services.

Many banks offer their customers the ability to pay bills online. The easiest items to pay this way are probably regular bills such as the mortgage or utilities. However, almost any bill can be paid online. The biller doesn't have to be part of an electronic network, which means a bill can be paid by a regular check sent out by CheckFree. Bill payment is aimed at both the consumer and business markets.

E-billing is just starting to catch on. Instead of receiving a paper copy of a bill, you receive the bill as E-mail. Sending a regular bill, including the inserts, can cost the billing company more than $3 per bill, making this an area of potential savings. And you as the recipient save on latex gloves.

CheckFree has three divisions generating a total of $433.3 million in revenue. The largest is E-commerce (electronic bill presentment and payment), which accounted for 70% of revenue for the fiscal year ended June 30. Investment services accounted for 16% of revenue, while software contributed the remaining 14%. Investment services provide portfolio-management services such as portfolio accounting. The software segment sells applications that let a company independently set up E-billing and payment.

The E-commerce division is the main driver of the company. The customers of this division are nine of the 10 largest U.S. banks (including Bank of America, Bank One, First Union, and Wells Fargo), eight of the 10 largest brokerage houses (Charles Schwab and Merrill Lynch, among others), Internet-based banks, Internet financial sites such as Quicken.com and Yahoo, and personal-finance software such as Microsoft Money and Intuit's Quicken. The combined subscribers from these customers reached 5.6 million this past quarter, up 7% from the previous quarter and up from 3.8 million subscribers last year. CheckFree also sent out 600,000 bills electronically in September, an increase of 100,000 from June. The billing market isn't exactly small. Every year, ordinary Americans pay an estimated 17 billion bills, with more than 80% of those paid by paper checks.

CheckFree's competition comes from banks developing electronic bill presentment and payment services in-house. Another source for potential competition comes from a company called Spectrum EBP LLC. Several of CheckFree's customers are backing Spectrum, including First Union, J.P. Morgan Chase, and Wells Fargo.

CheckFree reported disappointing results for the fiscal first quarter, ending Sept. 30. Growth in subscribers came in at the low end of projections, and management lowered the projected subscriber growth rate further, to 6% to 8% from 7% to 9% from quarter to quarter. As a result, revenue for the first fiscal quarter was less than expected. Part of this lower growth was due to the slow economy, and part was due to banks purging inactive accounts. Since a user company is charged a fee by CheckFree per customer, banks have an incentive in these tougher economic times to eliminate inactive users. Cash earnings per share came in at a loss of 2 cents per share.

Frequent readers know I focus on cash flow and take profitability seriously. CheckFree has produced little in terms of profit and cash flow. Gross margin in the last quarter was 41.6%, but other expenses ate up the remaining profit. The company believes that it can break even this fiscal year.

However, CheckFree has yet to demonstrate that it has a superior financial model with sustainable high margins. Given the lack of profitability, CheckFree, which is trading at around $15 per share, appears to be fairly valued.

William Schaff is chief investment officer at Bay Isle Financial Corp., which manages the InformationWeek 100 Stock Index. Reach him at [email protected].

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