Article

eFunds across America?

First American Express, then E*Trade and now eFunds. These non-deployers have all purchased ATM portfolios with the intent of using the ATM business to advance larger corporate strategies.

July 28, 2002

First American Express, then E*Trade and now eFunds.

These non-deployers have all purchased ATM portfolios with the intent of using the ATM business to advance larger corporate strategies.

American Express earned attention when it bought 6,500 machines owned by EDS, as well as some portfolios from smaller deployers, in the late '90s. E*Trade ratcheted up the hype level with its purchase of Card Capture Service's 8,500-machine network in March of 2000. In both cases, the companies announced their intent to use the ATMs to better serve their cardholders.

E*Trade has added another 2,500 machines in the past two-and-a-half years, many of them as part of a high-profile contract with Target. American Express culled some 1,000 ATMs from its portfolio during the same span of time.

In contrast to E*Trade's steady growth and Amex's divestiture, eFunds is on a buying spree that shows no signs of abating -- even after news of lowered earnings estimates rocked the company last month.

More is more

The company's first ATM acquisition was Access Cash. It paid the Arden Hills, Minn.-based ISO $20 million for a 24 percent ownership stake in March of 2000, then purchased the rest of Access Cash's equity interests for another $43.9 million in late 2001.

Then eFunds acquired approximately 2,500 ATM contracts from Peachtree City, Ga.-based Hanco Systems last February and an additional 1,000 contracts from Seattle-based Samsar ATM Company in May. The company paid about $11.4 million in cash for Hanco and approximately $3.3 million in cash for Samsar, according to its SEC filings.

The ATM business is largely run under the Access Cash name.

Reportedly eFunds has closed another deal to purchase another 1,000 or so ATM contracts from a West Coast ISO -- although no public announcement has been made. Persistent rumors also have eFunds finalizing negotiations with another ISO that would add an additional 2,500 contracts to its network.

Todd Hannon, formerly Hanco's national sales director and now eFunds' vice president of ATM management, would not comment on the two reputed deals, but he said eFunds remains strongly committed to a "bigger is better" ATM strategy.

"eFunds has made a very large commitment to this business. We still consider the ATM business a high-growth business, and we continue to aggressively seek acquisitions of ATM portfolios," Hannon said, adding that eFunds expects to grow its fleet to 20,000 machines by year's end.

Falling fortunes

While all of eFunds' businesses took financial hits in the second quarter, as detailed by Chief Executive Officer Gus Blanchard in a June 5 conference call, the ATM business fared better than some others.

According to TheStreet.com, some 34 percent of eFunds' revenues come from the transaction processing services it offers to financial institutions, retailers and e-commerce companies in the U.S., the UK and India. The company's identity verification and information technology and management consulting businesses each account for 26 percent in revenues. The remaining 14 percent comes from the ATM business.

Blanchard said eFunds anticipated $70 million in revenues from sales of existing products in its original forecasts for 2002, with another $40 million from sales of new products and $35 million from the ATM deployment and management business. The company's new estimates, Blanchard said, were $15 million to $30 million in revenues from existing products, no revenue from new products and $25 million from the ATM business.

Shares of eFunds' stock closed down 30 percent, at $9.32, following the call, which included a revised forecast for 2002 revenues of $520 million to $535 million, down from eFunds' original target of $624 million. (See related story Market reacts to eFunds report)

Despite the revision, and the simultaneous announcement of the unexpected exit of Chief Financial Officer Paul Bristow, financial analyst Jonathan Low believes eFunds is a fundamentally sound company, with a set of promising products and a good cash position.

Yet Low, a senior fellow at Cap Gemini Ernst & Young's Center for Business Innovation and author of a book called "Invisible Advantage," which pegs intangible assets to corporate values, wonders why eFunds didn't scale back its expectations -- and those of its investors -- sooner. "It's not as if the bad economy has been a surprise," he said. "They apparently didn't estimate customers' depth of resistance to investing in new technologies."

Indeed, customer reluctance was a reoccurring theme of Blanchard's conference call. "We have seen major financial and retail customers postpone or delay indefinitely decisions that were expected to collectively deliver more than $45 million in revenues in 2002," Blanchard said. "These delays have affected expected sales of our eCheck, customer acquisition and retention solutions, DebitReport and BPO offerings."

While eFunds is under investigation by the U.S. Securities and Exchange Commission for an accounting snafu during the Access Cash acquisition that resulted in a $4.6 million reduction in revenue for the first three quarters of 2001, Low said it appears to be a "minor issue" that only earned the attention of regulators because of heightened sensitivities to accounting irregularities in the wake of Enron and other corporate scandals. (See related story eFunds under SEC investigation)

Going vertical

ATM acquisitions are part of a vertical integration strategy for eFunds, seemingly hearkening back to the days when transaction processors like ACS and EDS also had ATM portfolios. The company's move comes at a time when many areas of the EFT industry, including networks, processors and ISOs, are consolidating.

"These guys are turning back the clock," said Bill Jackson, Triton's chief technical officer. "If things continue the way they are, in three years we'll have one processor and maybe three ISOs."

Don Jarecki, EDS' former business manager of retail ATMs for EDS and now president of network development for ATM advertising company CashPoint, said such consolidation is a common result when products and services become mere commodities. "At this stage of the game it's a land grab, a battle for market share," he said.

While eFunds may make seven cents to 10 cents for processing a typical dial-up ATM transaction, that figure rises to 40 cents or more including eFunds' share of interchange revenue and ATM management/service fees, Jarecki said.

Pass the gravy, please

"The management piece is what really makes the gravy," Jarecki said. "It can be a very lucrative return without a huge capital investment. The margins aren't going to be great on a hundred ATMs, but it makes a lot of sense if you aggregate it over 10,000 terminals."

In a business in which prices are largely based upon volume, eFunds will carry considerable clout with ATM manufacturers, armored car carriers, third-party service companies and others, Jarecki said.

Noting that eFunds lost a large chunk of business last year when its biggest processing customer, the Star network, was acquired by Concord EFS, Dale Dentlinger, former head of client delivery for EDS and now director of E*Trade Access, said, "If you now manage and operate those ATMs for a customer in addition to processing, there's a better chance they're going to stay with you."

Hannon said eFunds is beefing up its service capabilities, adding several new staffers to an Access Cash service desk in Minnesota and training staff at an eFunds facility in Milwaukee to handle ATM calls. The company currently has 10 direct sales representatives, 30-plus distributors and 20 to 25 independent contractors and is expanding that sales force, Hannon said.

"We're consolidating where it makes sense," he said, mentioning human resources, accounting, dispute resolution and help desk. "But we're not stripping everything down. We've gained a considerable amount of sales and service expertise with these acquisitions. We're keeping that expertise and extending our in-house sales and service support because we want to improve the existing service levels."

Following the loss of Star, eFunds now drives about 10,000 financial institution ATMs, many of them part of the Co-Op Network. About 5,100 of the 12,000 ISO ATMs that eFunds has acquired in the past year have been switched to the eFunds' platform. Hannon said eFunds hopes to convert the remainder of those machines by year's end.

Critical mass

Hannon hinted at the fact that eFunds' size, along with its in-house processing platform, may help the company roll out advanced functionality on at least some of its ATMs. "You have to have the mass to get to the next level, and be able to offer value adds on those terminals," he said. "If you don't have the mass, you're not going to be able to get anybody's attention."

"You have to have some scale to roll out new services," agreed E*Trade's Dentlinger, whose company hopes to introduce prepaid cell phone payment capability on at least some of its 11,000 ATMs before year's end. "If you have 300 ATMs in each of the top 10 MSAs (metropolitan statistical areas), that's going to make a huge difference.

With no cardholders, however, Dentlinger said it may be tough for eFunds to create a business model based around added functionality.

The brand's the thing

EFunds hopes to attract new financial institutions with branding programs similar to the deal it has with the Co-Op Network, in which the network pays a flat fee plus transaction-based fees to offer its members surcharge-free access to eFunds' growing retail ATM network. Hannon said another 2,000 ATMs would soon be added to the 6,500 currently in the branding program. The company would also like to take over the management of all or part of financial institutions' ATM networks.

"We want to leverage eFunds' good name with financial institutions to help open those doors," Hannon said. "We think we can offer the same level of service for less expense."

That claim is questioned by some smaller ISOs. One vice president of marketing for an ISO with about 2,000 machines under contract in the Southeastern part of the U.S., who asked that his name not be used, said, "When you get that big, the overhead goes through the roof. It's like a 10-headed monster versus a one-headed monster. Are they going to absorb that cost, or charge more?"

Smaller ISOs, unlike eFunds, can capitalize on a more personal approach to service, the VP added. "If I can't answer your question, I've got a CEO who can - and I can get him on the phone for you. That's why the smaller guys like us will stay alive," he said.

Eric Muller, vice president of business development for Bluewire Technologies (formerly Fibervision), said eFunds should be able to leverage its newly centralized management team to establish network-wide service levels, such as minimum acceptable response times.

"Not a lot of smaller ISOs can do that," Muller said. "They have to focus on bolting down machines, sometimes at the expense of quality."

Some in the industry have questioned eFunds' marketing of ATM outsourcing and branding programs in light of the fact that the company also sells software and consulting services to help financial institutions establish their own in-house ATM driving capabilities.

Jerry Silva, the Tower Group's senior analyst for retail banking, believes it's a smart strategy, however.

"They're covering all the bases there," Silva said. "When they walk into an institution, it's a safe bet they know whether the institution wants to use its ATM network as part of a differentiation strategy or looks at it strictly as a cost to be minimized. For some financial institutions, the primary differentiation strategy comes down to numbers. So as long as eFunds keeps the costs of its management program down, more and more financial institutions and retailers may turn their machines over to them."

While Hannon said he's encountered widespread skepticism about eFunds' ability to manage such a large network and control costs, he insists the company is up to the challenge.

"We're running this company large a like ISO; we're not running it like a large processor trying to run an ISO," he said.