First Data or Square: Which Payments Company IPO Looks Best?

Stocks are roughly unchanged early on Friday afternoon, with the Dow Jones Industrial Average and the S&P 500 up 0.10% and 0.04%, respectively, at 12:40 p.m. EDT.

Mobile payment terminal operated by NFC technology in Fornebu, Norway. Telenor.Image source: Halvard Lundgaard, republished under CC BA-SA 3.0.

The electronic payments industry is heating up, as changes in consumer habits and technology create risk and opportunity for incumbents and new entrants alike. Furthermore, the universe of payments companies is expanding by two with the initial public offerings of payments veteran First Data Corp and Silicon Valley upstart Square Inc.

Successful payments companies, with their toll-keeper business model, can be fantastic engines of wealth creation. For proof, just look at the share price performance of the two of the sector's brightest stars, Visa and MasterCard, since Visa's March 2008 IPO:

V data by YCharts.

Clearly, investors aren't expecting that type of performance from First Data. The market's vote on yesterday's offering was unambiguous: Despite the underwriters pricing the shares at $16, 16% below the midpoint of the $18 to $20 expected range, the stock traded no higher than $16.41 during its first day and actually closed below the offering price.

That's an embarrassing result for the largest U.S. IPO of the year, but it's not altogether surprising. Despite its scale -- it processed $1.7 trillion in U.S. payments last year -- First Data has not produced a profit in any year going back (at least) to 2010.

First Data was saddled with an exorbitant debt load by KKR & Co. L.P.as part of its April 2007 leveraged buyout at the height of the LBO boom. The acquisition was the second-largest leveraged buyout in history and, predictably, it has been a disaster.

(The largest buyout, that of Texas utility TXU in 2007, turned out horrendously, too, and KKR was one of the buyers.)

Meanwhile, payments start-up Square filed for its highly anticipated initial public offering on Wednesday. It isn't profitable, either, but that isn't what concerns this columnist most.

First, it has a part-time CEO in co-founder Jack Dorsey, who was just named the permanent chief at Twitter Inc. Dorsey has gotten off to a cracking start at Twitter, but there is no reason a prospective shareholder of Square should accept a part-timer guiding the company at a crucial time in its development.

Another problem: There appears to be a lack of focus and clarity regarding Square's value proposition (much like Twitter, in fact). A devil's advocate might counter that it's just part of remaining agile in an industry that is mutating -- but it's not an argument I find convincing.

If neither First Data nor Square look particularly attractive, are there any other opportunities in the area of payments? As it happens, there is one, and it's another newcomer to the public markets: PayPal Holdings, which was spun out of eBay Inc in July.

PayPal is profitable, its management is very capable and focused, and it looks well-positioned to capitalize on the changes in its operating environment. Best of all, at nearly 23 times next year's earnings estimate, the shares look, if not exactly cheap, at least reasonably valued. For a growth business of that quality, that's an attractive proposition.

The article First Data or Square: Which Payments Company IPO Looks Best? originally appeared on Fool.com.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool owns shares of and recommends eBay, PayPal Holdings, and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.