Merrill Slaps a Rare Sell on CheckFree

CheckFree's(CKFR) stock is overpriced because too much of its revenue stream is of a finite nature, and much of it is concentrated with a big shareholder, an analyst said Thursday.

Merrill Lynch downgraded the electronic checking company to a relatively rare sell from neutral. About 8% of the stocks in Merrill's coverage universe are currently rated sell.

The brokerage noted that CheckFree gets a large amount of revenue and probably a quarter of its operating earnings from guaranteed "minimum" arrangements with Microsoft(MSFT) and First Data(FDC). If the deals are considered a "finite" source of cash flow, however, the stock starts to look expensive, Merrill said. It said a better price was $15 to $20.

"We believe investors may be severely overvaluing these minimums by assuming they will continue into perpetuity," Merrill said. The brokerage provided a cash flow analysis assuming the deals expire in 2005 that suggests the deals are worth $68.8 million of undiscounted cash flow to CheckFree -- far less than the valuation seems to imply, it said.

"While we recognize it is possible that CheckFree could improve its business relationship with First Data and Microsoft before the revenue minimums expire, we also note that this would imply the company's expenses would be increasing in order to account for the additional services required," Merrill said.

The stock fell $1.72, or 6.5%, to $24.52 Thursday.

Moreover, about 19% of the company's revenue comes from Bank of America(BAC), which is also a large shareholder. That's up from 12% last year. While generally a positive, the concentration creates risks that, when adjusted for, suggest to Merrill that the company's organic rate is only 3%, "this despite a booming bill-payment market and the addition of many new customers."

Another source of concern, according to Merrill Lynch, is the increasingly strong presence of larger banks in the online bill-payment arena. Competitors could include Wells Fargo(WFC) and Wachovia(WB), although it isn't clear when that threat will materialize.

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