Higher One's High Potential Reward

*this was originally published on September 29 on SeekingAlpha and share price was ~$2.50. All figures are based on a ~$2.50 share price

  • Higher One generates roughly $40 million a year in free cash flow & trades at 3 times FCF.
  • Higher One has issues than can be worked through.
  • If Higher One can work through these issues it could be a $10 stock again.

Higher One's Business

Higher One (NYSE:ONE) operates in two related lines of business. Higher One's first line of business is providing software to universities. One of their software tools facilitates the transmission of financial aid to students. Financial aid is paid directly to the university from the government & private lenders. The universities take out tuition, room & board and then give the remaining amount to the student. Higher One's software facilitates these transfers and the processes associated with them. Roughly 35% of revenue comes from their software.

Higher One's second line of business is related to the software they provide for the transmission of financial aid. A student can choose to get their financial aid money in an ACH transfer to their bank account or receive a check. A third option is to open a Higher One account, mainly for students that do not have bank accounts. Higher One partners with banks to provide students with a debit/ATM card so that they could access their financial aid money. Roughly 65% of revenue comes from the Higher One account.

There are numerous ways Higher One earns money through their Higher One account. 45% of Higher One account revenue comes from interchange fees, which is the money merchants are charged when somebody uses their Higher One card to buy something. The other 55% of revenue is earned on fees charged to the student. These are typical fees banks charge such as a $2.50 fee for using the ATM of other banks rather than the ATMs provided by Higher One.

Higher One's Profitability

Higher One has an extremely profitable business. Over the past few years Higher One has generated roughly $40 million a year in free cash flow excluding the construction costs of their headquarters, which is completed, and similar onetime costs. Higher One is on track to produce a similar amount of cash this year excluding a onetime $15 million payment to settle a lawsuit.

So why does a company generating $40 million a year in cash trade at a market cap of less than $120 million. Higher One has two major overhangs:

The Federal Reserve

The Federal Reserve has told Higher One that they will seek up to $35 million from Higher One for misstatements & omissions related to the marketing of the Higher One account. Higher One believes they will be responsible to pay the FDIC an equal amount so the potential liability is $70 million. Currently the two parties are in negotiations. Higher One has taken a charge of $8.75 million relating to this matter but it will likely cost them more.

Higher One has ample free cash flow to cover a $70 million fine over time, even though the ultimate fine is unlikely to be that high. The issue is that Higher One has $16 million in cash and owes $94 million on their credit line. Paying a large fine would put Higher One in breach of one of their debt covenants. Additionally, they may need to borrow more money to cover the fine. Higher One's management says that their lenders want to work with them but want to know the amount of the fine first.

I believe the fine by the Federal Reserve is the biggest risk to Higher One as their destiny is not in their own hands. With that said, the most likely outcome is that Higher One's lenders work with them. It does not make any sense for Higher One's lenders to force a default. Higher One is not highly levered and is producing a lot of cash. I believe Higher One will have close to $40 million in cash by year end.

The Department of Education

The Department of Education (DOE) is attempting to make new rules concerning student bank accounts. The earliest these rules will come into effect is July 2016 if they are passed by November 2015. This year's rule making session ended without a vote as banks don't believe the Department of Education has the right to govern them. They believe any rules should come from their regulators. It is possible that this fight ends up in court and it takes years, if ever, for the new rules to come into effect. The good news for Higher One is that for the next 2 years their ability to continue to generate cash is unlikely to be impeded.

The original rule changes proposed by the DOE were draconian and would have been a tremendous hit for Higher One. The DOE proposed forcing banks to give students two free ATM withdrawals a month at other bank ATMs and curbing debit card fees. By the time the rule making session was over the DOE was open to allowing Higher One to charge ATM fees as long as they joined a larger ATM network. This would cost some money but ultimately is unlikely to hurt profitability much. Higher One may have to remove debit card fees but is seeking offsets to the debit card fees.

The bank lobby is fighting tooth & nail against the DOE regulating them and the bank lobby doesn't want to make any concessions. I would be surprised if anything passed but in the investing community I seem to be in the minority. The bank lobby also has the tools to punt this issue to the next administration by suing the DOE. The private colleges have delayed regulations by the DOE with lawsuits.

The Hyperbole

There is a lot of hyperbole directed at Higher One as an evil company that profits at the expense of students. In reality Higher One largely charges fees similar to their competitors. The two fees that critics are loudest about is the ATM fee & the debit card fee. Higher One charges $2.50 for using a competitor's ATM. Bank of America and Wells Fargo both charge $2.50, while Chase charges $2. Why this makes Higher One evil is beyond me.

Higher One charges 50 cents when using the debit card. However, the fee can be avoided by simply selecting credit when the cashier asks "debit or credit". I used to use a Chase debit card. But once the Fed limited debit card interchange fees Chase started charging me $15 a month to use my debit card. Their intention was to make me switch to credit so they can collect a higher interchange fee from the merchant, so I switched. All the student needs to do is to say credit to avoid the 50 cent fee and Higher One will earn their money from the merchant instead. And 50 cents is a lot better than $15 a month.

Cost Cutting

Higher One should be able to cut at least $10 million in costs. General & administrative costs as a percent of revenue have risen from 21% a few years ago to 28% today. This is partially due to merger integration costs and partly due to increased professional fees in related to the outstanding regulatory issues. The merger integration should be completed some time in 2015. Eventually the regulatory issues will be settled as well. Higher One management says that all costs are on the table. I suspect there are many costs to cut as Higher One was once a hot "payments" company that built themselves a fancy headquarters. I see no reason G&A can't go back down to its historical level which would save over $15 million a year. This would likely more than offset any revenue hit from new rules by the DOE.


Higher One is not without risk. It is possible their lenders or the government will put them out of business. This outcome is unlikely as it does not make sense for lenders to bankrupt a company that is able to pay. Debt covenant waivers are granted all the time and that is the most likely outcome here as well. The government doesn't generally put real companies providing a real service out of business. Despite the hyperbole Higher One provides a needed service for a similar price to its competitors. If Higher One can get through this mess at their current earnings level the company can one day trade at $10 again and be a multi-bagger.

1 comment:

Paige Smith said...

It is interesting that you point out that the Higher One software is not without risk because it is possible their lenders or the government will put them out of business. However, I think it is great that Higher One does provide a needed service for a similar price to its competitor. post merger integration software