Something fishy?

We are very sceptical about BPS Technology (ASX:BPS).

A market announcement caught my eye recently. It came from BPS Technology (ASX:BPS), the owner of Bartercard and a few other technology businesses.

In it, BPS noted that FY17 earnings before interest, tax, depreciation and amortisation is expected to be “between 3% to 7% below the guidance of $14.16m as per the investor presentation released to the ASX on 12 August 2016.”

It was that sentence that got my attention. A single point earnings estimate, to two decimal places, 10 months out from a result, says something about a business or its management.

The most positive explanation would be that BPS has a very predictable business, giving management confidence to provide a precise estimate far into the future. However, there are many possible explanations that are a lot less positive.

So let’s take a closer look at BPS Technology.

Bartercard

Most of BPS’s earnings come from Bartercard, which is essentially an alternative currency used by merchants. To join, merchants pay a monthly fee of $99 as well as 6.5% of every transaction. The buyer also pays 6.5% in each transaction.

After signing up, members lack the means to acquire anything because they don't have any "trade dollars", Bartercard's medium of exchange. To get started, they need to sell something in exchange for trade dollars or take advantage of the trade dollar line of credit offered by BPS.

I’ve always struggled to understand why merchants would sign up. Bartercard is competing with cash and conventional card transactions that are much cheaper and accepted everywhere. Whereas Bartercard is a closed loop system that is used by only 24,000 small to medium sized businesses worldwide.

Bartercard pitches that it’s a marketing solution. The company line is that by signing up, businesses can expect to see an increase in turnover, and that justifies the added cost. The thinking being that if you are the only Bartercard-using plumber in the area, then you get extra demand from captive Bartercard users who need plumbing services.

Yet despite its high cost, 54% of BPS’s users have been members for more than 5 years. So, they obviously see some benefit that I don’t.

Transactions

Businesses that derive revenue from recurring transactions can be good investments. Visa (NYSE:V) and MasterCard (NYSE:MA), for example, are fantastic businesses.

An important thing to know about them is the trend in underlying transactions. Yet BPS makes this information difficult to find. Page 28 of this presentation has charts without units and even axes, which doesn't add confidence in the reliability of the figures.

Another way to get an indication of Bartercards’s underlying transactions is by looking at revenue. As Table 1 shows, half-yearly Bartercard revenue has declined by 7% from 1H15 to 1H17.

Table 1: Segment half year revenue
$m AUD 1H15 2H15 1H16 2H16 1H17
Bartercard 24.91 23.24 25.05 25.12 23.16
EPANZ - - - - 32.75

Source: Company reports
       

But these figures include one-off sales for master franchise rights sold in new territories, such as those sold in the UK, China and the US recently. When those sales are excluded, underlying revenue from recurring use is much lower.

This means that one-off sales to new territories are propping up a declining business.

This highlights an age-old rule in investing. If important information is omitted, then it’s unlikely to be flattering.

Cold hard cash

BPS may preach the benefits of alternative currency, yet they still seek to be paid in cash. The question is: when your customers are attracted to Bartercard’s purported effectiveness at moving ‘excess stock and idle inventory”, is credit risk heightened? Typically, businesses that have trouble selling inventory are not flush with cash.

Table 2: Cash conversion
$m AUD 2015 2016 1H17
Net profit 7.89 7.35 5.56
Operating cash flow 6.09 5.13 1.02
Shortfall -1.80 -2.21 -4.54

Source: Company reports
     

For most of its listed life, BPS’s largest tangible asset has been receivables, and operating cash flow has consistently undershot reported profit, as shown in Table 2 shows.

For us, there are too many red flags.

So we'll stick with cash, for consumption and in our investment portfolio.

 

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