NetSpend A Purchase Target? Struggles Suggest It’s A Possibility

Marketing to underbanked consumers is not easy. Selling to them is even more difficult.

Greet Dot Corp., NetSpend Corp. and other companies that specialize in so-called alternative financial services are scrambling to win their share of the 60 million U.S. consumers with limited exposure to mainstream bank products.

They tout the market’s vast size, but prepaid companies’ success at attracting these consumers has varied, and some have been less successful than others at expanding into new distribution channels.

One of the stragglers is NetSpend, which has struggled to grow its business since a successful initial public offering last year (see story). Now it is increasingly being talked about as an acquisition target.

The Austin, Texas-based company operates prepaid debit card programs and partners with sponsor banks, which issue its prepaid cards largely to low-income consumers.

Since completing its IPO in October–on the heels of Green Dot’s own initial public offering–NetSpend has had to seek new bank partners because of regulatory pressures on its largest partner, Meta Financial Group Inc.’s MetaBank (see story).

NetSpend also recently said it lost three of its distributors in the check-cashing industries that sold its cards. Two of those distributors were acquired, and one decided to create its own prepaid card program in-house (see story).

And while NetSpend management and other industry executives like to say regulators in Washington, D.C., love prepaid cards because they promote financial inclusion, consumer advocates have chided the company for charging customers high fees (see story).  The company contends its fees are in line with industry averages.

Some equities analysts have grown equally disenchanted with NetSpend’s growth performance.

“Most investors appreciate the opportunity in the overall prepaid space, [with] 60 million unbanked and underbanked Americans. But it doesn’t seem like you’re executing on it,” Bank of America Merrill Lynch analyst Jim Kissane told NetSpend CEO Dan Henry during the company’s earnings conference call earlier this month.

“What is NetSpend not doing right to take advantage of the opportunity?” he asked.

Disappointing results have prompted speculation that NetSpend may get bought out, perhaps by Green Dot or Capital One Financial Corp. The McLean, Va.-based bank backed away from a deal in 2007 to buy NetSpend for $700 million.

“We continue to have conviction that the” market for general purpose prepaid cards “is a large, early-stage growth opportunity,” Andrew Jeffrey, an analyst with SunTrust Robinson Humphrey, wrote in an Aug. 4 research note to clients. “As a result, NetSpend’s core distribution channel may represent an attractive acquisition candidate for a company seeking to expand its footprint.”

Investors, at least, seem to like this idea. NetSpend’s shares rose more than 8% on Aug. 23, after a Reuters article said the company is looking more and more like a buy-out target.

A NetSpend spokesperson declined a request for comment by email.

Henry said in an interview this month that the market for NetSpend’s products is as wide as ever, noting the company was taking steps to forge ties with the right partners to accelerate sales.

The issue facing NetSpend, he argued, was a lack of awareness about the benefits of prepaid debit cards.

But others are not as convinced that consumer awareness is the problem.

“I think that the issue is more that people get it and they understand it, but they’re not necessarily sure about the value proposition,” Ben Jackson, a senior analyst with the prepaid advisory service at Mercator Advisory Group, said in an interview this month.

The real problem, in Jackson’s eyes, is the companies have not done an effective job of marketing their uses to consumers.

Jackson in the past also has questioned whether the size of the market is as large as prepaid card companies think.

Take the Federal Deposit Insurance Corp.’s definition of an underbanked household. To fall into this category, a household would have had to use a nonbank money order (such as one obtained from a post office), a nonbank check-cashing service, a payday loan, a rent-to-own agreement or a pawnshop once or twice a year, or a tax refund anticipation loan once in the last five years.

Many consumers who are well-entrenched in the mainstream banking world use money orders obtained from nonbanks, Jackson says. Yet they may not be the type of consumer to pick up a prepaid card to use as their primary spending tool.

Meanwhile, it is conceivable that NetSpend would be an attractive asset for a bank looking to get into the prepaid business without having to build a program from scratch, which NetSpend itself has said is difficult to do because of the multiple parties involved.

Mainstream banks have talked about adding prepaid cards to their own product rosters, especially in light of the Federal Reserve Board’s new fee caps on debit interchange fees (see story).  Although an exemption to the caps for prepaid cards has more requirements than the banking industry initially anticipated, experts say interest in the product remains high as banks look for new opportunities to generate revenue (see story).

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