The Green Sheet Online Edition
December 28, 2009 • Issue 09:12:02
Should you buy stock in a terminal manufacturer?
Terminal manufacturers, usually in the background of the card processing world, have been in the news recently. Ingenico purchased an acquirer, VeriFone told Heartland Payment Systems Inc. merchants they would have to bypass their acquirer if they wanted to get their equipment serviced, and a company called Inner Fence LLC advertised it can process credit card transactions without a terminal and without a bank.
Looming in the background is the July 1, 2010, deadline for merchants to meet security standards for transaction processing dictated by the PCI Security Standards Council. The solutions will come from the terminal manufacturers, who are struggling with answers, including end-to-end and point-to-point encryption, chip and PIN technology, and dynamic authentication for contactless cards.
Making sense of it
Since the 1980s, credit card terminals have been routinely unexciting; they've all had the same basic features. For most of this time, three players have dominated this industry: VeriFone, Ingenico and Hypercom Corp.
Plenty of Zon Juniors and Tranz 330s are still out there, and they are so reliable they could probably run forever. (Once we took a Zon Jr. to the parking lot and drove a car over it, just to see what would happen. It still worked just fine.) There wasn't much need to replace old terminals. Some had more functionality: they could read a check or a driver's license, or download software from verification, guarantee or gift card companies.
Very large enterprises required the ability to network terminals, as well as the telecommunications necessary to provide an open line for online, real-time verification. When you have 1,000 stores and 10 lanes per store, this is pretty intimidating, but there was always a solution.
Feeling the POP
Until the advent of check conversion, manufacturers adhered to a policy of strict neutrality so as not to favor one processor or ISO over another. That changed when NACHA - The Electronic Payments Association established the point of purchase (POP) standard entry class code in 2000.
POP allowed a merchant to take a check at the POS, run it through an imager, get a signed authorization from the consumer, give the check back and clear it as an automated clearing house debit. At that time, VeriFone was out in front with a solution: its Eclipse terminal, which was the first all-in-one (single footprint) device that handled both card and check transactions.
VeriFone gave an exclusive to Telecheck, and for a fairly long time. It turned out that the POP was a failure in the marketplace (back-office conversion is widely seen as a do-over for POP).
This was NACHA's problem, not VeriFone's. Yes, the Eclipse had some teething problems, but the interesting thing is the exclusive arrangement with Telecheck. Other companies in the guarantee space had to scramble to make their software work with this application, and it was a long and painful process to catch up with VeriFone here.
Adapting to RDC and security
The next significant development came with the advent of remote deposit capture (RDC). Well before the Check Clearing for the 21st Century Act, NetDeposit LLC was doing RDC in conjunction with Electronic Data Systems. They scanned a high-dollar check, reprinted it at the drawee bank's location and did a direct presentment.
However, this required industrial strength printers not normally found at merchant locations. When RDC started, another big change occurred: the big three terminal manufacturers were "eclipsed" by new players such as Panini, RDM Corp., and Digital Check Corp., which became the early leaders in this space with their stand-alone check imagers.
It was just a matter of time before the advent of the all-in-one terminal: RDC was seen as the motivating factor in replacing millions of old terminals. That didn't happen, in part because RDC wasn't adopted to the degree originally predicted.
Meanwhile, something else did happen: the Payment Card Industry (PCI) Data Security Standard (DSS) or, more to the point, the threat to acquirers of being defendants in class action lawsuits because their merchants did not secure cardholder data properly.
This is causing processors and ISOs to seek a foolproof solution that will compel, not ask, merchants to handle data properly (for example, a tamper-proof security module). Ultimately, merchants will be required to purchase new terminals, because the card brands will require them to be PCI compliant.
At the end of 2009, the three major equipment manufacturers are still Ingenico, VeriFone and Hypercom. (In 2009, they partnered to form the Secure POS Vendor Alliance, a development best left to another story.)
Acquiring an acquirer
Ingenico, a French company, sold 3 million terminals worldwide in 2007. It has an installed base of over 15 million terminals and offers an extensive variety of equipment.
In November 2009, it acquired a German payment processor named easycash GmbH. The press release says, "Easycash covers the whole payment value chain in POS terminal services, transaction processing and loyalty solutions." In other words, it is an acquirer.
Until now terminal manufacturers have not acted as acquirers. To do so would have meant competing directly with the ISO sales force selling their products.
Meanwhile, Christopher Justice, President of Ingenico North America, stated that this is the start of a "refresh cycle" for merchants to replace their terminals. He said, "If you're going through a refresh of your terminal estate ... the incremental cost is not all that significant." This was news to me.
There are 21 square feet of retail space for every man, woman, and child in the United States; 10 percent of the 1,100 malls in the country are either in bankruptcy or closing; and many other malls look like ghost towns. All this commercial real estate will have to be refinanced in the next year or two, and the traditional lenders in this space have already taken the last train for the coast.
It strains credulity to think a large retailer will commit millions of dollars to replace terminals in this environment, or that it will be a nonevent from a cost standpoint. When I speak to retailers about replacing terminals, they get defensive and explain that this is not a high priority because "everything works just fine now."
Encroaching with apps
Recently, I saw an article about a "terminal" that doesn't require POS equipment or a bank. It is an iPhone application. You can read about this at www.innerfence.com. In the United States it uses Authorize.net; in the U.K. it uses PayPal Inc.; in Canada it uses something called Beanstream (who thinks up these names?).
Merchants establish gateway and merchant accounts at Authorize.net; they pay a $99 set-up fee, a monthly fee of $25 plus 24 cents a transaction, and a discount rate that can vary between 2.09 and 3.79 percent. Merchants buy the program (Credit Card Terminal) on iTunes; it costs $49.95, which is offset by a $50 iTunes gift card.
The program uses the secure sockets layer protocol to securely transmit card numbers directly to Authorize.net; card numbers are not stored anywhere by merchants. The next release, version 3.4, will support signature capture and enable merchants to e-mail PDF receipts. As for using mag stripe card readers for swiped transactions, representatives said, "Not yet, but we're working on it." I'll bet they are.
Looking at VeriFone
The 2008 VeriFone annual report is on its Web site, www.verifone.com, under "About Us," and then "Investor Relations." Here are several things I found interesting:
- Since 1981, VeriFone has provided electronic payment devices that run proprietary operating systems; third-party operating systems; security and encryption software; certified payment software; and third-party, value added applications. In 1984, it provided the first electronic ticket capture solution. The company was publicly traded in 1990, bought by Hewlett-Packard Co. in 1997 and sold to a venture capital investment management firm in 2001. Then it did an initial public offering in 2005.
- Outlining the risks of being in this space, VeriFone identifies factors that characterize its environment: rapid technological change, frequent product introductions and enhancements, and evolving government and industry performance and security standards. On top of these, it is impacted by a weakening economy and declining global demand.
- VeriFone has seen a substantial decline in its stock price, market capitalization and estimated cash flow. This, and other factors, caused it to take a charge against good will of $262 million last year versus the $799 million acquisition of Lippmann.
- The company had incurred $41 million in expenses through October 2008 in responding to a U.S. Securities Exchange Commission investigation and derivative lawsuits related to restating its income and delays in filing financial statements, a result of previously inadequate internal processes and controls in the financial accounting area.
As you can see, VeriFone has a lot to deal with right now. But recently, because of a patent dispute, VeriFone informed Heartland merchants that if they want any support for their terminals, they will have to come to VeriFone directly. This is a big change in the payments landscape.
On the surface, choosing a terminal would appear to be a pretty simple decision, but it is more complicated than just hooking up a piece of hardware. Here are some things set in motion when a terminal is ordered: inventory management, programming and testing, deployment, shipping, rental, PIN pad injection, equipment configuration, asset history management and reporting, supply provisioning and order desk, buy-back of used equipment, leasing, help desk, and tele-training. Phew! The question of "a refresh of your terminal estate" (perhaps the goofiest phrase of the year) is complicated.
Finally, a study released in July by Aite Group LLC points to a couple of trends that do not bode well for terminal manufacturers. The study showed that 28 percent of merchants surveyed steered customers away from cards and to cash and checks, and that another 5 percent said that they are likely to do so.
Eleven percent of merchants said they refuse card transactions below a preset minimum, and 8 percent said they are likely to do so (I know this violates the rules).
Among all merchants, electronic cash registers and other PC-based POS devices claim a whopping 30 percent share of market, with stand-alone card terminals accounting for 70 percent. The Aite analyst stated, "Getting to 30 percent is quite remarkable." The upshot is that in many cases terminals are being replaced by other devices.
In researching for this article, I found this quote. The first person who can identify the source will get a decent bottle of Sonoma County, Calif. wine from me.
"We sell a significant portion of our solutions through third parties, such as independent distributors, ISOs, and value-added resellers and payment processors. We depend on their active marketing and sales efforts. These third parties also provide after-sales support and related services to end-user customers.
"When we introduce new applications and solutions, they provide critical support for developing and porting the custom software applications to run on our various electronic payment systems, and internationally, in obtaining requisite certifications in the markets where they are active.
"Accordingly, the pace at which we are able to introduce new solutions in these markets in which these parties are active depends on the resources they dedicate to these tasks.
"Moreover, our arrangements with these third parties typically do not prevent them from selling products of other companies, including our competitors, and they may elect to market our competitors' products and services in preference to our own. If one or more of our major resellers terminates or otherwise adversely changes its relationship with us, we may be unsuccessful in replacing it.
"The loss of one of our major resellers could impair our ability to resell our solutions, and result in lower revenues and income. It could also be time consuming and expensive to replicate, directly, or through resellers, the certifications and custom applications owned by these three parties."
VeriFone, Ingenico and Hypercom employ many smart people, and they have decades of experience with millions of merchants processing billions of transactions. You can bet they are studying these trends intensively. They will spend millions of dollars in research and development, anywhere from 5 to 10 percent of their revenues, to keep innovating.
The question is, what unexpected, unforeseen innovation will occur in the next few years that they don't know about now?
That kind of thing happens in the technology industry all the time, and when we look back 10 years from now, that is likely what we will find has occurred.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at firstname.lastname@example.org.
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