Hunting for the Next Gorilla? Check Out CheckFree

Everybody's looking for the next gorilla.

That term, for those who aren't familiar with it, comes from The Gorilla Game: Picking Winners in High Technology (Harperbusiness, 1999), a best-selling guide to finding companies capable of totally dominating their fields. Think Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) and Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), which in the 1990s parlayed their respective near-monopolies in operating software and Internet routers into nearly a trillion dollars in market cap.

Where will the next gorilla appear? That's the subject of vigorous debate, which you can sample by visiting the "Gorilla Stock" boards at Silicon Investor.

But one possibility is online bill paying. Right now the business is embryonic, with most companies sending bills out the old-fashioned way, and 4 million or so people paying them via their computers. But as companies start digitizing their bills and delivering them as email attachments--and more people realize how much easier it is to click "pay" than to write checks and lick stamps -- the number of bills paid electronically will explode.

When your bank or broker tries to sell you on this kind of service, chances are they're running a platform supplied by CheckFree (CKFR Quote - Cramer on CKFR - Stock Picks), the oldest and by far the biggest player in the electronic transaction space.

Now -- here's where it gets really interesting - you'd normally expect competitors to be lining up for a piece of this action. And they are -- but CheckFree is buying them before they can cause trouble.

In December it acquired BlueGill Technologies, a maker of software that converts paper bills into computer code that can be read by your Web browser. Then it agreed to buy TransPoint, a bill-payment venture from Microsoft, Citigroup and credit-card transaction firm First Data. When the deal closes in September, it will give CheckFree its largest competitor's customer base and make TransPoint's founders part-owners of CheckFree, deepening their incentive to cooperate. Microsoft, for instance, will pay CheckFree $120 million over the next five years to provide bill-paying services on its network of Web sites.

An even bigger deal is CheckFree's agreement to buy Bank of America's (BAC Quote - Cramer on BAC - Stock Picks) online billing business for about $400 million. When it closes in late September, Bank of America will own about 16% of CheckFree and CheckFree will get exclusive access to Bank of America's customers.

Add these deals up and you get a dominant company in a market that's about to take off. As CheckFree president Peter Sinisgalli puts it, "This is the inflection point of increased consumer adoption."

So what can go wrong? Two things. The first, obviously, is new competition, of which there's some on the horizon. Most serious is Spectrum, a creation of Chase Manhattan Bank (CMB Quote - Cramer on CMB - Stock Picks), First Union (FTU Quote - Cramer on FTU - Stock Picks) and Wells Fargo (WFC Quote - Cramer on WFC - Stock Picks), that will, says its press release, "act as an exchange to route electronic bills between banks and their customers."

While declining to badmouth Spectrum's backers ("all three are valued customers, and in the last 12 months two have extended their relationships with us"), Sinisgalli notes that "Spectrum really doesn't have a product. ... We're not exactly sure what they're bringing to market. [In any event], we're confident that we can provide compelling reasons for them to stay with CheckFree."

On the consumer side, several startups aren't waiting for the big guys to put together a paperless billing system. Give PayTrust the relevant information, for instance, and it will have your bills sent to its processing center, email you when they come in and scan them into a Web page. You log on, click "pay" and you're done. (For more on PayTrust and similar services, see The Check's in the Email: A Look at Online Bill-Paying Services.)

With backing from Softbank, Citigroup and American Express this is a serious company with a great-sounding product. But with only 30,000 subscribers to its flagship site, its ability to dent CheckFree's franchise is questionable.

Another possibility -- and soon, the only other public company in this space -- is Metavante, the soon-to-be spun-off transaction processing division of Marshall & Ilsley (MI Quote - Cramer on MI - Stock Picks). Here again, it's too small to pose much of a threat to CheckFree. But with the Justice Department's antitrust lawyers as frisky as they are, it's often a good strategy to buy the little guys in the expectation that the giants have no choice but to let a few small players flourish.

The other potential problem is the impact of the past year's acquisitions on earnings. Between acquisition-related goodwill and the cost of ramping up new services like BlueGill's, what once looked like an 86-cents-per-share profit in fiscal 2002 has been scaled back to 4 cents. Maybe as a result, the stock is down about two-thirds from its recent high.

This is strictly acquisition-related, stresses Sinisgalli. "We'll see very good growth in core earnings in the next few years." Just not enough to offset the new costs.

Right now, however, market share matters more than earnings. If online bill paying really does explode, and CheckFree gets 80% of the business, profits won't be a problem.