Higher One Holdings Inc. - Is This the One?
Founded by a couple of Yale students in 2000 and holding its IPO in 2010, Higher One is the only tech company designed specifically to meet the financial needs of higher education institutions and their students. The following chart gives you a better view of its businesses as well as its revenue breakdown:
In effect, Higher One is in a razor-blade kind of business targeting two groups of customers: It sells the razor (OneDisburse) to schools at low cost and makes money (80% of revenue) from the blades (banking services via OneAccount and to a less extent CASHNet) it sells to students.
The business has experienced explosive growth for the last few years. Its revenue, adjusted EBITDA and adjusted net income has all enjoyed above 60% CAGR for the last five and three years, driven by strong growth in OneAccounts (five- and three-year CAGR > 50%). All the while its EBITDA margin has climbed to an attractive 41%.
ONE has delivered all this growth with a squeaky clean balance sheet. In fact, it routinely operated with negative tangible equity (before 2011), and its ROE has stayed well above 30% since 2009 (it had negative equity before 2009).
But high-flying growth companies tend to suffer the same problem as middle-aged men: staying power. Not Higher One. Three things set ONE apart: 1) compelling value proposition to its customers, 2) niche market with sticky customers and limited competition and 3) asset-light business model.
The Magic of Win-Win
ONE offers great value to both groups of its customers, schools and students.
Schools benefit from its cost saving. Higher One disburses financial aids electronically to students, saving schools money on labor and compliance when compliance costs are climbing from increased regulation and schools are facing growing budget shortfalls. Higher One does it cheaper through electronic payments and leveraging its scale. Just to give you an idea of the potential for cost saving: Without Higher One, the annual staffing cost per each enrolled student runs anywhere between $30 and $150 (based on proprietary research), whereas Higher One charges schools on average $4 for each enrolled student. More than $30 vs. $4? You do the math.
To students Higher One offers convenience and low-cost standard banking services. Students will receive their financial aids on the same day when they are released by schools, rather than days of delay and fumbling with paper checks.
Attractive Niche Market
Higher One reports 98% retention rate because schools are averse to changes, especially when it involves potential for regulatory breaches. Once a school receives reliable service from Higher One at a reasonable cost, there is very little incentive to switch to a different vendor.
Moreover, Higher One enjoys favorable competitive dynamics. There is no direct competitor offering a similar product portfolio, nor is it likely to face stiff competition from new entrants. In a nutshell, Higher One’s market is like an extra small coconut: too little juice (a mere $2 billiob revenue industry) for larger competitors to bother, and too tough to crack open (due to sticky customers) for smaller competitors.
Asset Light Business Model
Higher One’s business doesn’t need much capital investment; in fact, it operated with negative equity until 2009 while delivering turbocharged growth. Part of it has to do with its software-based business. Part of it is a benefit of outsourcing banking services to third-party partners (e.g., Fiserv [FISV], Wright Express FSC [WXS], MasterCard [MA], etc.). In other words, future growth will not be dragged down by sharp increase in capex.
What is Higher One’s growth potential? To answer that question, we have to first take a look at how they generate revenue. Once a school is signed up, Higher One markets their OneAccount services to students, their main revenue driver (80% of revenue). Since about 67% of students eventually open their OneAccounts and growth in college enrollment is slow (just over 2% between 1970 and 2009, according to Department of Education), most of future growth will come from school penetration (i.e., signing up more schools).
By the end of the first quarter, 2012, total enrollment at Higher One’s client schools reached 4.3 million, roughly 20% market share; that leaves 80% to go. How much of the remaining 80% can Higher One gobble up? For a comparison, let’s look at Blackboard, another tech company serving the higher education community. Despite lackluster products and subpar customer service, its market share was 60% to 80% between 2009 and 2011 (before being acquired by a PE firm; source: Barron’s). With Higher One’s convincing value proposition and sticky customers, a 70% market share appears reasonable.
Growth in penetration is a function of its marketing spend. Between 2009 and 2011, Higher One added on average 0.8 million enrollment each year with marketing spend around 11% of revenue. Going forward, adding around 1 million enrollment per year seems achievable given its fast growing revenue stream.
If we assume that: 1) EBITDA margin stays constant at 41%, and 2) price increases just enough to offset any share dilution from stock-based compensation (2% so far), we can expect EBITDA per share just over $3 by 2016 and $5.40 by 2021, representing CAGR of 20% and 16%, respectively. With a multiple of 12 and 10, we can expect CAGR of 20.5% and 14% over the 5- and 10-year period (based on current price of around $14.5), well above the market’s long-term average of 11%.
Of course, Higher One can easily juice up the return by pulling one or more of the following levers: margin expansion through operating leverage, accelerated revenue growth through price increases, or getting students to continue to use their OneAccount after graduation, and additional revenue stream from new products. With the trust and good will of their client schools, these initiatives are not hard to implement. The table above runs through some such scenarios (B-D).
Is management motivated to deliver shareholder value?
In a word, yes. All three co-founders take senior management roles and are deeply involved in the operation. They, together with senior managers and the board, own 39% of outstanding shares (source: proxyfiling). Four institutional investors, including Glenn Greenberg’s Brave Warrior, own an additional 48.4% of shares. Based on press clippings, management appears very focused on execution and dominating the U.S. market.
Is management competent in capital allocation?
I would say, yes. The most significant acquisition is the IDC acquisition in 2009 where they paid some $27 million for the provider of payment services to higher ed institutions. The acquisition led to a 10-fold increase in their payment transaction revenue from 2009 to 2011. Going forward, the odds for major blowups in acquisitions are low because the large outside investors have good track record and have all the incentives to prevent the management from making a stupid acquisition.
Some macro risks (e.g., future trend in college enrollment and financial aid availability, etc.) are important but hard to forecast with any accuracy. There’s also the collateral risk from misbehavior at its partners. None poses a fatal threat.
Is Higher One the one for your portfolio?
Disclosure: I don’t own shares of ONE as of the writing, but I may be buying the shares now or in the future. Long MA.