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Prepaid Stock May be a Good Bet

August 7, 2012
Prepaid|Banking_Channels
Tim Sloane
Mercator Advisory Group
Before I dive into this topic, I have two disclosures to make.

First, I do not own any prepaid stock. I have mutual funds, but to my knowledge none of these have prepaid holdings. Second, I’m not great at predicting a winning stock. I dismissed Google when it went public; after all there were four major competitors breathing down Google’s neck and one had a much more capable search function (I still miss Alta Vista’s ability to find a term within X words of another term). But this blog post is not really about stock prices. It’s a rejection of the rationale stock analysts have given recently for shorting these stocks. This is my take on the major concern stock analysts have put forward.

The most common argument that drives a low valuation of prepaid stock is that prepaid products from banks will steal the business from existing prepaid programs. While certainly some cardholders and prospects may gravitate to a bank product, it will likely be a very small number. This concern regarding competition from banks fails to recognize the different demographics program managers target, the different deployment footprints the program managers support, and the many new use cases that are expanding the prepaid market well beyond the unbanked and underserved. Introducing a successful prepaid product today demands more than just a prepaid product. It needs to align with a demographic, provide the highest level of convenience in purchase and use, and meet a variety of existing and future use cases.

For example, consider the recent partnership between Green Dot and the Rush Card. Green Dot recognizes that the Rush Card targets a demographic better than the Green Dot card. Green Dot expects putting the Rush Card into retail distribution will be primarily additive to its existing sales. On the other side of the equation, Rush recognizes that the retail footprint for purchase and reload is sufficiently critical that it will forego some income in order to provide its cardholders better convenience and liquidity by delivering broad retail access. Banks have been slow so far to address the issues associated with demographics, convenience and new use cases.

Demographics

Banks are introducing prepaid products for a variety of use cases, from turn-down solutions to new checkless checking accounts that enable the institution to remain profitable on low-balance accounts and to deliver new services to existing account holders. But few institutions are actively targeting low income demographics outside of their branch footprint. They instead have introduced products that better support the customers and prospects that already walk into their branches. For the few that have actively marketed these solutions to new low income prospects, such as the Regions Bank Now program, they still require account holders perform these financial functions at the existing bank branches. This decision prevents banks that do have appropriate products for the LMI target market from directly competing with existing prepaid suppliers due to the financial institution’s relatively limited deployment footprint.

Deployment Footprint / Convenience

There is not a prepaid bank product in the market that can match the convenience and price delivered to low and moderate income neighborhoods by the existing retail-oriented program managers. Take for example the Mercator Advisory Group research that studied three zip codes in the hard hit city of Stockton, Calif. If you live in one of these three zip codes, you have access to three Bank of America locations (ATMs and branches) or 13 Green Dot locations (ATMs and Reload Centers). It is likely that this same ratio will hold true for the neighborhoods where the people work. Anyone holding down two or even three part-time jobs will find it much easier to “bank” at the convenience stores they already frequent rather than walking or driving to a bank. 

Expanding Use Cases

As described in our response to the Consumer Financial Protection Bureau’s advance notice of proposed rulemaking, consumers are discovering new use cases for reloadable prepaid cards at a rapid rate. One broad category of innovation is using prepaid to control spend, as with a hobby card or Fine Dining Card. While the teen products launched by banks a few years ago stalled in the market, parents and teenagers are finding many new uses for reloadable cards that provide parents visibility into the teenagers spend while making it simple to provide funds. One of the earliest use cases that evolved into unique products is bill pay. When program managers recognized that some cardholders were using the reloadable products just to pay bills, they created bill pay cards designed for that purpose. I am positive that similar innovative packaging will occur for the other use cases cardholders have already adopted. A good hobby card might highlight purchase protection while a dining card might offer discounts at national restaurants. These innovations will continue to drive use of reloadable prepaid well beyond the unbanked and underserved and marketing and convenience will be as important, if not more important, than if the product is from a bank or some other program manager.

Perhaps the largest wildcard here is Green Dot’s decision to become a bank and a processor. This positions Green Dot as an entirely new business, one that has no parallels. On the one hand it operates in a fashion similar to that of an Internet bank but it also has greater retail presence than existing banks minus the same capital investment. Instead, its costs for maintaining a retail presence are transactional in nature. Each cardholder transaction has a fee that is primarily used to compensate the retail operator that performed the transaction on Green Dot’s behalf. Converting a large fixed cost into a variable cost has changed many a business. This was the primary reason industries shifted to outsourcing; fixed cost staff became variable costs that could easily scale up and down as business conditions warranted. It is also the primary driver for cloud computing. While this may well be a long shot, the return should be huge if it succeeds. 

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