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The Prepaid Card

Fed up with banks or spurned by them, millions of customers are turning to prepaid

 plastic that works like an ATM card. Two young companies could emerge as giants in

this space. By Michael Brush 

It took a financial meltdown and years of consumer complaints for politicians in

Washington to finally take up banking reform. We could argue about how well they did.

But innovators have been on the case for a while -- helping fed-up customers like

Clearwater, Fla., nurse Edna Jackson dump traditional bank accounts, and aiding many

consumers simply spurned by banks.

Jackson got frustrated years ago with a constant barrage of large bank overdraft charges

for overspending by just a few dollars.

So three years ago, she opted for what's now one of the hottest alternatives -- a reloadable

 prepaid card that lets her manage her money without ever dealing with a bank. "I really

enjoy my card. I use it for everything," says Jackson. She likes the card so much she tells

her friends to get one, too.

In fact, use of prepaid cards has been soaring, a trend that should continue for years both

in the U.S. and abroad. The Mercator Advisory Group, a research firm, estimates that the

$8.7 billion loaded onto reloadable prepaid cards in the U.S. in 2008 will grow to $118.5

 billion in 2012, or 92% a year.

"We think the market opportunity in the U.S. and globally is tremendous," agrees Stewart

Stockdale, who leads the prepaid card division at Western Union (WU, news, msgs). "It

is still in the early stages."

That's exactly the kind of multiyear trend in which it often pays to invest. And just as the

credit card world has Visa (V, news, msgs) and MasterCard (MA, news, msgs), this one

also has two leaders: Green Dot ( GDOT, news, msgs), whose stock you can buy now,

and NetSpend, a private company preparing to go public.

How they work 

With reloadable prepaid cards, users typically go to stores to put cash onto a piece of  plastic that works like a debit card. Usually bearing a Visa or MasterCard logo, these

cards can be used at most retailers. They also allow users to withdraw money from

ATMs, pay bills and do transactions online.

While formally issued by banks, they are managed and marketed by other companies, and

consumers never interface with the banks themselves.

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You might think Visa and MasterCard would feel threatened by reloadable cards. Instead,

they see them as a growth driver. These two credit card giants make money by licensing

their brands and taking a little piece of every transaction. That's why both companies are

also potential ways to buy this trend, along with Western Union.

The two newer names are the ones that show the strongest growth, though. Customers put$5.8 billion on Green Dot cards and $7.3 billion on NetSpend cards last year, and that

will rise sharply by many estimates.

Operating revenue at Green Dot, which practically invented this space, more than tripled

from 2006 to last year, to $234.8 million. Green Dot reported $15.5 million, or 29 cents a

share, in earnings on $92.8 million in revenue for the second quarter. NetSpend revenue

almost tripled from 2006 to last year, to hit $225 million. NetSpend expects to report $5

million to $7 million in net income on $65 million to $68 million in revenue in the third

quarter, about flat from the first two quarters of the year.

No fee-free lunch

Why are prepaid cards so popular? Simply put, a lot of people are fed up with banks, and

they're not taking it anymore. "The fees are what really pushed me away from the banks,"

says Jackson. "The fees can be outrageous. With the prepaid card, I don't have that

worry."

Mind you, reloadable cards do charge fees. It's just that they can be lower, with fewer 

surprises. Prepaid card issuers charge anywhere from $3 to $5 for a card. Monthly fees

run around $6, and it can cost up to $5 each time you put money on a card, though direct

deposit of paychecks is typically free.

JPMorgan Chase analyst Tien-tsin Huang estimates bank customers don't find prepaidcards attractive until they are getting hit with about five insufficient-funds charges per 

year, since prepaid cards cost about $150-$300 a year.

So who uses them? "Most of our customers make $30,000 to $50,000 a year," says Green

Dot CEO and founder Steven Streit. "They are folks who are living paycheck to

 paycheck. They are very cash-flow sensitive and fee sensitive."

Prepaid card users may not be able to get credit cards because of low credit scores, or 

they may have a hard time keeping minimum balances in traditional accounts. But they

need plastic for things like booking airfare or hotel rooms, and paying bills. "We are

living increasingly in a cashless society," says Streit. "If you don't have MasterCard- or Visa-branded debit card, you are going to have a rough day."

Another factor boosting demand for prepaid cards is the increasing use of direct deposit

to pay workers. Jackson has her paycheck deposited directly onto her NetSpend card; she

estimates that half the employees on her floor at the hospital where she works have their 

 pay deposited to a prepaid card.

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The potential customer base is big. According to government studies, more than 70

million people in the U.S. are unbanked or under-banked, which means they have

accounts but pay bills in other ways, such as with money orders or cash. "A large number 

of consumers today are living outside the financial mainstream," says Hyung Choi, head

of U.S. prepaid products at Visa. Less than 20% of this group has ever used a prepaidcard, says Choi. "So clearly it is early days."