Going for a Checkmate

Cover Story

Going for a Checkmate

VeriFone’s buyout of Hypercom will further its dominance of America’s POS terminal industry, which is in the throes of rapid change. Is there life beyond the box?

BY JIM DALY

It’s not your father’s point-of-sale business any more. It’s not even your older brother’s.
The traditional countertop terminal for accepting credit and debit cards is on its way to becoming just one more device to access the card networks. That’s the state of affairs No. 1 U.S. POS terminal maker VeriFone Systems Inc. finds itself in as it works to close a nearly $500 million buyout of long-time rival Hypercom Corp.
Today, the payments scene is rapidly evolving into one where smart phones, virtual terminals, electronic cash registers, and sophisticated POS devices for managing multiple aspects of a business are the starting point of an increasing number of card transactions.
More merchants are mobile, e-commerce is booming, and even traditional merchants are looking beyond the box. See that waiter over there with the iPad? You could almost say the standalone terminal some day will be little more than a peripheral, demoted to just a rank above a PIN pad or receipt printer.
The Big Two
San Jose, Calif.-based VeriFone has embraced this transformation of the payments world beyond the countertop terminal that once symbolized it.
The other major trend U.S. terminal makers are dealing with is market maturity, with the big growth now occurring in Asia, Latin America, and European countries that remain cash-oriented.
Scottsdale, Ariz.-based Hypercom fits into VeriFone’s plans mainly because of its strong presence in European markets where VeriFone is weak. VeriFone, which in its fourth fiscal 2010 quarter ended Oct. 31 generated 41% its business in the U.S., down from 64% in 2004, even says it’s not all that interested in Hypercom’s U.S. operation and would sell it if that’s what it takes win the approval of antitrust authorities.
Still, while growing more slowly than many foreign countries, the U.S. remains VeriFone’s single biggest market. While an estimated 13 million terminals dot American stores, restaurants, and other businesses, the replacement market and new technology assure the U.S. will remain a critical source of revenues for VeriFone once the all-stock Hypercom deal closes. The companies hope that will happen in 2011’s second half.
Assuming no spin-off of Hypercom’s domestic operations, the U.S. would be left with only two big, full-line POS terminal makers: VeriFone and Ingenico North America, an Atlanta-based unit of France’s Ingenico S.A., the world’s largest terminal maker.
In contrast to VeriFone, whose terminals sit on the countertops of millions of mom-and-pop merchants, Ingenico’s equipment is found mostly at multilane retailers.
Acquisition Itch
A few years back, the thought of VeriFone buying Hypercom might have been the payment-industry equivalent of GM gobbling up Ford or at least Chrysler during the tailfin era. Not any more.
“I don’t care,” says Jared Isaacman, chief executive of United Bank Card Inc., a big independent sales organization based in Allentown, Pa. “I think credit card terminals are dying in the U.S.”
United Bank Card has a unique perspective. In 2004, it started giving free terminals to merchants and later electronic cash registers. Just this year it moved up the ladder, offering free, high-function business-management POS systems to merchants developed to its specifications by a contract manufacturer. Under the hood, 80% of the software is UBC-developed, according to Isaacman.
Payment-enabled business-management equipment from specialists such as Radiant Systems Inc., Micros Systems Inc., and others, and now mobile-payments technology, is changing the old equation, according to Scott Rutledge, chief executive of O’Fallon, Mo.-based The Phoenix Group, the leading independent distributor of VeriFone equipment.
“I don’t believe there are going to be regulatory issues,” says Rutledge, whose firm also distributes other manufacturer’s products. “VeriFone’s share, if you look at the whole market, is not that big.” Any attempt by a bulked up VeriFone to “mess with supply” and raise prices, he predicts, would be met by “a resurgence” in the secondary market of niche players and sellers of used equipment.
A modest price increase, however, “is not a bad thing” for original-equipment manufacturers (OEMs), according to O.B. Rawls, senior vice president of North American sales at Tasq Technology, the supply unit of leading merchant acquirer First Data Corp.
“I don’t expect [prices] to skyrocket,” he says. “In fact, with the investment the OEMs have to make in hardware today, they probably deserve a little bit more.”
Surprisingly, some of the more than 40 POS terminal companies worldwide, many based in Asia, see new opportunities in the U.S. market despite its maturity.
“People want to have choices,” says Michael Mulcahy, president and chief executive of PAX Technology Inc., the U.S. arm of the fast-growing Chinese terminal maker PAX Technology Ltd.
Mulcahy, formerly chief executive at terminal maker ExaDigm Inc., says PAX has little hardware deployed currently in the U.S. but is getting certifications from processors this year in advance of a push based on highly reliable but low-cost offerings. The first will be a mobile terminal.
“If we pick up 10% or 15% of this market, this is large growth for us,” he says.
The Hypercom buyout would be the latest in a series of acquisitions VeriFone has made under chief executive Douglas G. Bergeron, who has a reputation as one of the payment industry’s most aggressive leaders (chart). It’s not just Bergeron, however, who has the acquisition itch.
In December, U.S. manufacturing conglomerate Danaher Corp., whose subsidiaries include Greensboro, N.C.-based petroleum dispenser maker Gilbarco Inc., reportedly made an offer for Ingenico, according to accounts in the financial press.
But Danaher’s bid ran into interference from Safran S.A., a French electronics company that owns 22.5% of Ingenico. The French government, in turn, owns 30% of Safran. French officials have identified Ingenico as a “strategic” business, and likely put pressure on Safran to stymie the transaction, Reuters reported.
‘A Very Doable Metric’
Thus, it seems likely that VeriFone and an independent Ingenico will be duking it out for some time for the heavyweight POS terminal championship of North America.
By revenues, VeriFone commands an estimated 56% of the top three makers’ market share versus 23% for Ingenico and 20% for Hypercom. Both VeriFone and Ingenico find lower-hanging fruit overseas, but Canada, where Ingenico is No. 1, and especially the U.S. represent the laboratories where they’ll test survival and growth formulas where it is hard to find retailers that don’t already take cards.
VeriFone would not discuss merger issues with Digital Transactions, though Paul Rasori, senior vice president of marketing, agreed to review the company’s broad strategy. Hypercom declined to comment, and Ingenico didn’t respond to several interview requests.
VeriFone continues to refresh its hardware lines, but its most notable developments in the past few years have come in the form of new services involving online and mobile payments and fraud-control services built on the Payment Card Industry data-security standard (PCI). The whole idea is to develop steady, and growing, recurring revenue streams to counter the volatile sales cycles of POS hardware.
“There is not a terminal vendor in the marketplace that hasn’t looked into the future and said, ‘We need to get out of the terminal business,’” says merchant-acquiring researcher and consultant Paul R. Martaus, president of Martaus & Associates, Mountain Home, Ark. “They desperately need recurring revenue, and terminals are not it.”
VeriFone’s services revenues grew 47% in fiscal 2010 to $172.6 million versus $117.1 million the prior year. At the same time, so-called System Solutions—payment terminals and related products—grew 14% to $828.9 million from fiscal 2009’s $727.7 million. Services now account for 17% of VeriFone’s revenues, up from 14% in fiscal 2009.
“Our new services offerings are not only meaningfully increasing our growth rates, but are also driving competitive differentiation for a whole suite of point-of-sale solutions,” Bergeron told analysts at VeriFone’s fourth-quarter earnings conference call Dec. 2.
When an analyst asked if services could hit 30% of revenues by the end of fiscal 2012, not factoring in Hypercom, Bergeron called that figure “a very doable metric.”
Hypercom and Ingenico aren’t sitting still on their services ventures, either. Hypercom generated $74 million from services for the nine months ended Sept. 30, or 23% of its $327.8 million in net revenues.
Much of VeriFone’s services revenues come from old-fashioned terminal repairs, but the growth areas include gateway and mobile services, the VeriShield Protect transaction-encryption services, and VeriFone Transportation Systems, which offers card payments and digital content to taxicab passengers in big cities.
Blurring the Lines
VeriFone’s venture with eBay Inc.’s PayPal online-payment service puts the company squarely at the locus of where mobile and physical payments meet. PayPal has consistently denied that it has ambitions on the physical point of sale. But thanks to its new PayPal X platform for third-party software developers and companies such as VeriFone and mobile-payments provider Bling Nation Ltd., PayPal is going there anyway.
The multifaceted deal VeriFone has with PayPal includes enabling merchants to accept PayPal through VeriFone’s PAYware Mobile application for Apple Inc.’s iPhone, beginning early this year. PAYware Mobile, which includes a card swipe that fits onto the iPhone, had supported only swiped transactions previously.
To complete a transaction from a PayPal accountholder with an iPhone, the merchant will touch his iPhone to the customer’s. The PayPal app’s so-called “bump” technology allows the transaction to go through. Transactions go to the PAYware Connect gateway, VeriFone’s front door, so to speak, for enabling online transactions and a key part of the company’s recurring-revenue initiative.
“One of the very major drivers that we’re looking at—we’re very confident it’s going to happen—is the lines are blurring between the online and offline world,” says Rasori. “You marry on to that the American love of mobile phones.”
VeriFone is enlisting its network of 400-plus ISOs and resellers to sell PayPal to merchants that are current or potential users of PAYware Mobile. PayPal, meanwhile, this year is expected to market PAYware Mobile to its merchants that have the potential to conduct both face-to-face and online transactions, such as eBay sellers who hawk goods at street fairs and trade shows. VeriFone is looking to expand PAYware Mobile to other smart-phone operating systems such as Google Inc.’s Android.
Mobile-payments provider Bling Nation Ltd. will give a further boost to VeriFone’s mobile-payments aspirations, and simultaneously expand PayPal’s presence at the point of sale. Bling has painstakingly built a number of local closed-loop networks involving customers of community banks and small merchants. Merchants use Bling’s contactless card terminals, called “Blingers.” Consumers pay by passing their cell phones equipped with “Bling tag” stickers close to the readers.
After PayPal launched PayPal X, Bling Nation developed an app to enable its merchants to accept PayPal and has been testing the system in Palo Alto, Calif. In September, Bling said it would replace its incumbent terminal supplier with VeriFone, with transactions to be routed through PAYware Connect.
VeriFone will remarket Bling acceptance through its ISOs and resellers. In addition to driving more traffic to VeriFone’s gateway, the deal could open up PayPal acceptance to more physical merchants.
PayPal and Bling aren’t the only players blurring the lines between traditional and online and mobile payments, Rasori notes, mentioning the Isis mobile-payment venture involving three wireless carriers, Discover, and card issuer Barclaycard.
“It’s very, very clear that they’re going to be driving a lot of change in the brick-and-mortar, physical world where we have a lot of presence,” says Rasori. But merchants don’t like to deal with a plethora of payments systems, he adds. “We feel like we’re extremely well positioned” to help companies “cross that bridge,” he says.
Another key part of VeriFone’s services future is fee-generating transaction-data encryption through the VeriShield Protect and VeriShield Total Protect products.
VeriFone offers VeriShield in PAYware Mobile and through merchant acquirers, including such big names as Chase Paymentech, WorldPay, First Data, and Elavon. Bergeron said the services are live at more than 4,200 locations and are processing 13 million transactions per month.
The increasing spotlight on data breaches and the need for merchants to meet PCI and its related standards for payment software and PIN-entry devices are the forces behind VeriFone’s VeriShield Protect push and secure new hardware and software. The security well looks like it runs deep. “We’re actually in very, very early days in terms of that revenue curve,” says Rasori.
At the same time, a subsidiary, VeriFone Transportation Systems, is driving in new services revenues with combination payment terminals and media systems in the back of taxicabs that accept cards and also generate advertising revenues.
Some 14,500 cabs in New York, Miami, Las Vegas, Boston, and Philadelphia are using VTS equipment in addition to 600 of London’s trademark black cabs that will soon have the terminals. Fleets in six or seven more cities will add VTS systems this year, Rasori says. The taxi-media business will generate more than $72 million a year in revenues for VeriFone, and the New York cabs alone are handling more than $150,000 a day in electronic transactions.
VeriFone sees another big opportunity in the growth of so-called EMV, or chip-and-PIN cards, as the more secure successor to magnetic-stripe cards. The EMV card is now in use or being implemented in every industrial country except the U.S., which means there is a big future market for EMV-accepting terminals.
That’s one reason why VeriFone created what it calls a partnership with Amsterdam-based smart card producer Gemalto NV. “The partnership entails cooperative efforts in EMV chip card solutions,” says a VeriFone release. The first efforts will include education for U.S. merchants about chip cards, says Rasori.
“If nothing else to maintain compatibility with the rest of the world, chip cards are going to have to be supported,” says Rasori.
Indeed, chip cards seem likely to become a part of the U.S. payments future, though some observers say America is so far behind the rest of the world that it might make sense to wait for whatever technology that succeeds chip-and-PIN. But for VeriFone, no matter what happens, it’s an at-your-service future.

Behind VeriFone’s Hypercom Buyout
He came, he saw, he bought.
Doug Bergeron has been saying ever since he became VeriFone’s chief executive in 2002 that the point-of-sale terminal industry needed to be consolidated. He practices what he preaches. VeriFone, the leading domestic POS terminal maker and No. 2 globally, has embarked on a string of acquisitions in recent years (chart, page 26). Now the company has a $485 million, all-stock deal pending for Hypercom Corp., the second-largest U.S.-based terminal maker.
But it was Hypercom, not VeriFone, that first proposed marriage, according to a registration statement VeriFone filed with the Securities and Exchange Commission in December. Hypercom has struggled with profitability in recent years and has restructured.
“During the second quarter of 2009, Hypercom’s board of directors became concerned with Hypercom’s cash balance and global economic and market conditions and their potential impact on Hypercom’s operations,” the filing says. “The board requested an evaluation of Hypercom’s strategic alternatives and, based on this evaluation, elected to solicit interest from three companies that participate in the same or a similar sector, including VeriFone, to discuss whether a combination or other strategic alliance might be appropriate.”
That led to VeriFone making an offer for Hypercom in June 2009, an offer Hypercom rejected as too low. Thus ensued on-and-off negotiations, offers, and rejections. VeriFone finally made the negotiations public in September 2010 with a hostile, $283 million cash offer that Hypercom rejected as inadequate. Finally, in November, Hypercom accepted a richer VeriFone bid.
The deal needs approval from Hypercom’s shareholders and U.S., European, and Brazilian regulators. VeriFone, which mainly wants Hypercom’s sizable European business, says it is willing to sell Hypercom’s U.S. operations to gain antitrust approval. VeriFone values the potentially divested business at $124 million in revenues for 2009.
Some observers wonder who would buy Hypercom’s terminal business in the mature U.S. market, but O.B. Rawls, senior vice president of North American sales for First Data Corp.’s Tasq Technology unit, says he has heard through second-hand sources that two or three investment groups may be interested. He wouldn’t identify them, but says the U.S. market is still there for POS terminals.
“I think there’s a bright future for terminals in the next few years,” Rawls says. “Tradition takes a long time to go away.” And if smart cards come to the U.S., that will give merchants more of a reason to buy new terminals, he adds.