CAPScall of the Week: NetSpend Holdings

For years, satirical late-night-TV host Stephen Colbert has been running a series on his show called "Better Know a District," which highlights one of the 435 U.S. congressional districts and its representative. While I am no Stephen Colbert, I am brutally inquisitive when it comes to the 5,000-plus listed companies on the U.S. stock exchanges.

That's why I've made it a weekly tradition to examine one seldom-followed company within the Motley Fool CAPS database and make a CAPScall of outperform or underperform on that company.

For this week's round of what I like to call "Better Know a Stock," I'd like to take a closer look at NetSpend Holdings (NAS: NTSP) .

What NetSpend Holdings does
NetSpend is one of a small but growing class of financial-service companies that offers reloadable prepaid debit and payroll cards. At the end of 2011, NetSpend had roughly 2.1 million cards in circulation through a network of 600 different retailers, employers, and direct-to-consumer and online marketing programs.

In NetSpend's most recent quarter, the company reported a 15% increase in revenue to $85.3 million, and boosted its full-year sales and EPS forecast above Wall Street's consensus figures. The company's gross dollar volume on its cards jumped to $3 billion from $2.6 billion in the year-ago period, while the number of cards with active direct deposit jumped 24%.

Whom it competes against
A few years ago there were just a few notable competitors, but the line in the sand isn't as well defined as it used to be. Green Dot (NAS: GDOT) and Safeway (NYS: SWY) -owned Blackhawk Network Holdings offer NetSpend the most direct independent competition. Safeway has plans to spin off Blackhawk in the first half of 2013 to unlock value as it struggles with weaker grocery margins, while Green Dot has struggled mightily because of its non-diverse ties to Wal-Mart and increasing levels of competition.

The real threat is now coming from traditional credit card companies and banks that have seen some of their clientele ripped away by prepaid cards and poor credit ratings. Since anyone can qualify for a prepaid debit card, they offer credit card companies a relatively unexplored avenue of profits. As I highlighted last week, American Express (NYS: AXP) is one such company taking advantage of prepaid cards in an attempt to pander to a wider income audience. AmEx has also expanded perks that were previously offered only to credit card members to prepaid members, including purchase protection. Visa (NYS: V) and MasterCard also represent a unique challenge to NetSpend since they have no lending exposure and can use their beefy margins to strike retail relationships with big businesses.

One issue that could cripple the entire sector, though, is the potential for increased prepaid debit card regulation. According to research conducted by Pew Charitable Trust earlier this month, protections that are afforded to checking accounts are simply not there in most cases for prepaid debit card holders. An increase in regulation could have a negative impact on the industry as a whole.

The call
After carefully reviewing the prospects of NetSpend Holdings, I've decided to perpetuate the company's streak of CAPScall perfection and anoint it with a rating of outperform.

NetSpend is clearly going to face headwinds as larger credit card companies converge on the sector and threaten to use their clout to push smaller players like NetSpend and Green Dot out of the way. I happen to like both NetSpend and Green Dot, but NetSpend has much better retail pathway exposure and a more diverse clientele than Green Dot, period! As long as gross dollar volume and active direct deposits are heading higher, then NetSpend is going to be in great shape. It also doesn't hurt that consumer credit quality is still relatively poor, in my opinion, which should facilitate strong prepaid card usage for at least the next couple of years. Finally, NetSpend is financially sound, with $21 million in net cash. Although I don't need a prepaid debit card, sign me up for the NetSpend rally!

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Fool contributorSean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.Motley Fool newsletter serviceshave recommended buying shares of Visa and writing a covered strangle position on American Express. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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