delivers the goods

Disclosure: Long STMP, SFLY

When (STMP)  announced earnings on October 25, the company didn’t just deliver a great performance. It delivered a rebuke to a lot of people who think the company is a left-over dinosaur.

Some of these detractors are short sellers who have sold short nearly 6% of’s outstanding shares. But, like another of our holdings in the Crabtree Technology model on Covestor, Shutterfly (SFLY), has used this misperception to its advantage. It has carved out a dominant niche in a huge and profitable segment: electronic postage.

The bulk (93%) of’s business is its core Internet-based PC Postage offering. This enables businesses both large and small to print U.S. Postal Service-approved postage with just a PC, printer and Internet connection. Although similar services are offered by both the USPS itself as well as competitors like Pitney Bowes (PBI), customers seem willing to pay about $21 per month for a better user experience. This might include, for example, its unique ability to natively integrate with Microsoft Word in order to use that program’s automated mail merge and envelope printing functionality.

We’ll discuss’s specific quarterly performance in a moment, but first let’s place the company in some context. First, compare’s Q3 year-over-year quarterly revenue growth of 16% with that of its arch-rival, Pitney Bowes, which reported its own 3rd quarter on November 1. Pitney’s revenue of $1.22 billion represented a decline of 6% from its year-earlier quarter. Looking “under the covers” at Pitney doesn’t increase one’s confidence, either: equipment sales (mostly its traditional postage meters) declined 4% year-over-year and its more modern software offerings declined 17%.

OK, so it looks to me that is taking share from Pitney Bowes. But what kind of share is there to take? Consider that according to the United States Postal Service’s own 2011 Annual Report, $43 billion of the total $66 billion in USPS postage is represented by types of mail that can handle. That includes not only traditional First Class mail, but also Priority Mail, Media Mail and Parcel Post bulk shipping.

According to’s own figures, we estimate that its customers will use their PC-postage services to print $1.1 billion in postage in 2012. So this represents roughly 2.6% market share. There’s plenty of room to grow and share to take.

So what were the highlights from’s third quarter and why do we think the company is positioned to keep growing profitably?

Growth: Core PC-Postage revenue growth of 20% in Q3 certainly compares well with not only Pitney Bowes’ revenue decline but also with a 2% GDP growth overall.
ARPU: Average revenue per user rose again to $21.62 in Q3, continuing its steady ascent. Consider that six years ago, prior to the financial crisis, ARPU was $17.18.
Profitability: Non-GAAP operating margin was 28.8% compared to 21.8% in the third quarter of 2011. This illuminates’s operating leverage driven by software innovation.
Corporate Uptake: Total Printed Postage of $293 million in Q3 was up 78% year over year. We view this as solid proof that customers are getting more and more value out of their flat monthly subscription fees.
Earnings Power: Fully diluted shares outstanding has dropped from 24.4 million at the end of Q1 in 2006 to just 16.7 million at Q3 2012. During Q3, bought another 961,000 shares back, and on October 17, authorized the re-purchase of another 1 million shares.
Outlook: Can the good news continue for Management certainly thinks so. When they announced Q3 earnings, management raised its guidance for the balance of 2012. They expect full year non-GAAP earnings per share to be in a range of $1.55 to $1.75; this compares management’s own prior guidance of $1.35 to $1.55 and was above the then-consensus of $1.50 per share (according to I/B/E/S Estimates).

So what are the risks to’s continued run of excellent performance?

Total Mail Volumes:  As noted earlier, there’s plenty of market share for to take profitably, but total U.S. domestic mail volumes continue a slow decline. Total USPS revenue was $70 billion in 2005 and declined to $66 billion in 2011 and that occurred despite rising postage prices. So the trend is not in the right direction.
Customer Acquisition Costs: The cost per gross new registered customer has risen from $63 at the end of Q1 in 2006 to $115 in the quarter just ended. As noted earlier, Stamps is getting more revenue per customer, but not enough to fully offset this trend. Fortunately, monthly churn remains steady in the low- to mid-3% range and improving margins mitigate the effect somewhat.
PhotoStamps:’s PhotoStamps revenue and profitability continues to decline. Although the segment only represents about 4% of total revenue, it continues its drag on performance with no improvement in sight. The logical thing would be to discontinue this product line, and we expect this to happen sooner rather than later.

Despite’s recent corporate success, it seems likely to continue facing doubts about its business model in a world full of electronic mail. But as you weigh whether or not is a good investment, consider that until someone invents teleportation of physical goods, no one will be e-mailing grandma a box of cookies any time soon. Or a pump for her flooded basement. Or an iPod, on which she can read, yes, your e-mails.

Disclosures: The investments discussed are held in client accounts as of October 31, 2012. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.