Diebold gains some fans on cost cutting plans, ATM upgrades

NEW YORK Tue Apr 15, 2014 4:22pm EDT

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NEW YORK (Reuters) - The expansion of mobile banking may one day spell the end for large bank branches in the U.S., or even curtail the use of cash altogether. In the meantime, though, fund managers are buying Diebold Corp, the automated teller machine maker whose stock has underperformed bigger rival NCR Corp since 2009, on signs it may post better returns than NCR this year.

Banks are sprucing up branches with new ATMs that allow customers to decide what denominations of bills they receive as well as accept cash and checks without deposit slips. Some are already introducing video teller technology into the machines and not far behind are ATMs that are activated by smartphones and offer check cashing services. Diebold's regional-bank customers, in particular, are cutting branches and investing in new machines to save money.

Diebold's management, led by former Hewlett-Packard Co executive Andy W. Mattes, 53, is focusing on the same cost-cutting its customers are. Mattes, named chief executive officer in June to replace Thomas W. Swidarski, who was fired in January 2013 after the company said it wouldn't meet its 2012 profit target, promised to trim $150 million in expenses and improve profit margins.

"This has been one of those laggard stocks, and with new management in place there could be a lot of upside left," said Ann Miletti, portfolio manager of the $1.6 billion Wells Fargo Advantage Common Stock Fund.

Miletti boosted her Diebold stake late in 2013, before the North Canton, Ohio-based company's shares jumped 18 percent this year, and said she thinks the stock is worth at least 10 percent more than Monday's closing price of $39.29.

NCR has trounced Diebold in the stock market since 2010, gaining about 270 percent compared with Diebold's 68 percent and the 63 percent rise in the Standard & Poor's 500 Index. The last time investors did better with Diebold was in the fourth quarter of 2009.

WINDOW OF OPPORTUNITY

Now, though, money managers at funds including the $3.1 billion Gabelli Small Cap Growth fund and the $2.1 billion Victory Small Companies Opportunities fund are betting that a window of opportunity is opening for Diebold. That is despite the number of ATMs in the branches of 11 of the largest commercial banks falling 0.6 percent during 2013, to 53,985, according to an estimate by Meghna Ladha, an analyst at Susquehanna Financial Group based in New York.

While ATMs are slipping slightly, full bank branches are disappearing faster, down 2.8 percent at the 11 big banks surveyed to 20,964 at the end of last year, Ladha said. She expects that number to fall farther as mobile banking becomes more popular and customers avoid taking a trip to the local branch, allowing banks to rid themselves of fixed costs. A transaction that involves a teller costs three times more than the same transaction completed on an online app or at an ATM, Ladha said.

Diebold's newest line of ATMs can help speed the decline of large bank branches, she said. Soon, "when you walk into a branch it will not be 10,000 square feet but more like 1,000 square feet, and you will see more of these next-gen ATMs where a teller will pop up on screen who is actually sitting at a call center somewhere else," Ladha said.

Regional banks may have to buy new ATMs because of deadlines imposed on them from Microsoft Corp and MasterCard Inc, Ladha said. Microsoft has said that it will no longer service Windows XP, the operating system upon which many older ATMs operated by regional banks still run. MasterCard, meanwhile, has said that it will no longer be liable for fraudulent transactions involving a credit or debit card with a magnetic stripe after 2016 as part of an effort to spur the adoption of so-called EMV cards, which are based on digital chips and are thought to be more secure.

The developments add up to a "warm breeze" that should boost Diebold's shares, Ladha said, though she has a 'hold' recommendation because she wants to see more evidence that its turnaround plans are working.

Reinvestment in ATMs is expected to help drive a 4.5 percent increase in technology spending by North American banks to $59.5 billion in 2014, according to a report by Celent, a research and consulting firm. While Diebold does not break out its largest customers, Bank of America and US Bancorp are among the biggest, while regional banks contribute about 60 percent of its revenue, Ladha said.

Four of the seven analysts tracked by Thomson Reuters who cover the company have a 'hold' on the shares, while one has a 'sell' rating. Only one has a 'strong buy', while the other has an 'overweight' ranking. Together, analysts have an average target price of $38.42, a price 2.2 percent below its most recent closing price.

A LOT OF RUNWAY

The chance to make money on Diebold should last for three or four years, said Brian Keeley, head of the $3 billion Keeley Small Cap Fund.

"Banks are under pressure and want to get better returns,'' Keeley said. "Diebold is in the early stages of a turnaround, and it has a lot of runway ahead of it." Keeley had invested in NCR and only sold it once its market value rose above $5 billion. He's been buying Diebold because he likes to focus on turnaround stories, he said.

Banks face challenges including low interest rates, higher lending standards and increased capital requirements in the wake of the financial crisis, all of which have cut profit.

Keeley is encouraged by Mattes' plan to cut up to $150 million in costs by 2015. The company has laid off more than 700 employees, expanded a voluntary early retirement plan, and is working toward offering more standardized machines that reduce the cost of making customer modifications.

"We're not investing in the company for huge top line growth, but we think it's a margin improvement story," Keeley said.

Diebold, which is scheduled to announce first-quarter results on April 29, lost $41 million, or 65 cents a share, on revenue of $811.4 million in the fourth quarter. After adjusting for one-time expenses, including a pension charge and restructuring costs, the company posted an operating profit of $56.8 million.

Ladha, the Susquehanna analyst, estimates that the company will post net profit margins of 3.8 percent in 2014 and 4.7 percent in 2015. That level would still lag NCR, which posted net margins of 12.2 percent in its most recent quarter, according to Thomson Reuters data.

Elliot Cunningham, a co-portfolio manager of the $833 million SouthernSun Small Cap fund, began buying Diebold after meeting with Mattes and hearing his plan to cut costs. That, along with the company's history of increasing its dividend, prompted him to add to his position this spring. To be sure, the company has said that this year will be the first in 60 that it won't boost the dividend, which now stands at $1.15.

"It's clear that there was a lot of excess fat in the organization," Cunningham said. "(The company) doesn't have these grand plans for taking over the world. But there are plenty of ways for them to win."

(Reporting by David Randall; Editing by John Pickering)

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