In particular, the report levies the following charges on Higher One and its banking competitors:
· High fees
· Lack of transparency as a result of limited disclosure, student education, and/or misleading marketing
· Privacy concerns
Recommendations to policymakers:
1. Eliminate fees for financial aid disbursement cards.
2. Increase transparency and tracking.
3. Enforce the laws and the rules “to make sure firms comply with the laws and that students receive every protection afforded to them under the higher education and financial services laws” (USPIRG, p. 30).
So what should we make of the negative publicity? Has the company come to the end of its life, or is it a PR storm which the company will survive unscathed?
Let’s take a look at the charges and recommendations. I totally agree with the report that lack of transparency and privacy protection should not be tolerated. No one likes to be gouged, and no one should be. Firms may fear that improving transparency and privacy protection may intensify price competition and increase cost, but they will also improve the value proposition of the financial aid disbursement services that Higher One and the likes are providing.
The principle of the market system is to reward the best value proposition. So I’m all for it, and I don’t believe that will change the competitive position of Higher One. Remember Higher One offers full service and enjoys significant scale advantage (it’s more than twice the size of its nearest competitor in term of enrollment at client schools; see USPIRG report, p. 6). Management appeared quite comfortable with future regulations and willing to work with regulators on resolving these issues (see recent webcast and presentation).
So the real issue is the fees. The report explains that students are charged a plethora of fees, including overdraft fees, foreign ATM fees, debit interchange fees, wire transfer fees, dormant account fees and account closing fees, among others. The report indicates that OneAccount holders at Higher One campuses pay, on average, $49 per year for their OneAccount and seems to attribute Higher One’s explosive growth to its excessive fees.
Are the fees excessive? In a word, NO. The report mistakenly compared Higher One cards to a completely free alternative, which doesn’t actually exist. If you compare Higher One’s fees with those of student checking accounts at other banks, they are about average. For example, you can check the fees at TD Bank, SunTrust, Wells Fargo, or the median fees from a Pew report (pp. 38-39).
We can also compare the average account revenue (including service charges and interchange fees) at Higher One to that of other banks. Wells Fargo (WFC), for example, collects on average $113 per account in 2011 (according to 2011 annual report, p. 37, Table 7), with 54% from service charges and 46% from card fees. In contrast, account fees at Higher One averaged about $80, 27% less than Wells Fargo. Granted that Wells Fargo accounts probably have higher balance and more transactions than student accounts, Higher One’s fees do not seem excessive, as the report suggests.
Table 1: Fee comparison with Wells Fargo
|Wells Fargo||Higher One (2010-2011 average accounts)*||Higher One (2011-year end accounts)**|
|Services Fees ($mil.)||$4,280|
|Card Fees ($mil.)||$3,653|
|Total Fees ($mil.)||$7,933||$142.6||$142.6|
*Accounts = OneAccounts at 2011 year-end.
In addition, some figures in the USPIRG report raise questions about its factual accuracy. For instance, the report indicates that the 18-to-25-year-olds are most likely to overdraft their accounts and be charged non-sufficient fund (NSF) fees (USPIRG, p. 32, Table 5). Using their numbers, I conclude that an average person will incur 3.70 NSF fees, which totals to $100 (with the average NSF fee at $27 per USPIRG report, p. 32), well above the total revenue for Higher One when the Higher One management states that the bulk of their account revenue come from interchange fees (webcast from William Blair Growth Stock Conference, June 12, 2012).
In addition, the 3.70 NSF incidence is actually lower than the 4.2 per capita figure for 2008 across a broader population, according to a Bretton Woods report (p. 10). It’s not clear why the numbers are different, which is more accurate, and the actual NSF incidence among Higher One customers. We know for sure that the actual incidence has to be well below 3.7.
As another example, the report cites other research that the “annual median cost of maintaining each of the 2 million OneAccounts was $49 per student” (U.S. PIRG report, p. 18), when in fact each OneAccount holder pays on average between $70 and $80 a year for the services (depending on how you calculate the number of OneAccounts; see table above) and those students who don’t have an active OneAccount do not pay for it.
So is this the end of the story for Higher One, or a temporary storm from which it will survive?
I believe that Higher One’s business model is not broken and that the shares are unfairly beaten down by all this negative publicity and the fear of regulatory choking in the future. I believe that fear is unfounded. At current price of $10.57, the shares are very cheap, trading at 13.2x lower guidance of 2012 adjusted EPS, and offers attractive future returns even if we assume that account revenue drops by $10 (approximately 12 to 14%) per OneAccount. If you believe in the Higher One story, it seems a good buy.
Table 2: Return expectations
|EBITDA per share||$2.73||$4.83||$5.05|
|b) Annual 40bps Increase in EBITDA Margin||26.6%||17.5%||12.1%|
|c) 2% Annual Price Increase||27.9%||18.7%||13.2%|
|d) Margin Expansion + Price Increase||29.2%||18.9%||14.2%|
Note: Percentages are CAGR based on current price of $10.57.
Disclosure: Long ONE.