Points International (PTS.TO) Reported Yesterday: Earnings Miss

Although sales were ahead of consensus expectations, margins were compressed and the Company missed on EBITDA and earnings. Based on the conference call, it sounds to me that the low margin Delta Airlines (DAL-NYSE) principal contract dominated sales for the quarter. Not only that, I think that Management increased its payment to Delta Airlines to induce the airline to promote Buy/Tranfer services more aggressively, which drove higher sales at lower margin.

The company needs to continue to sign large principal contracts and get them rolled out rapidly in order to diffuse the margin compression impact of Delta Airlines. This condition could become more acute as Delta rolls Northwest airlines into its loyalty operations over the next few months. The Company continues to announce new clients including three more during the conference call, although these are dwarfed in size by Delta.

During the conference call, Management adjusted its 2008 guidance towards the high end of its original guidance range of between $65 million and $75 million. I think that revenue could exceed its guidance for the year. However, due to the impact of a weakened economy on the airline sector, I don't believe that the earnings leverage is as strong as I had hoped for and forecasted at the beginning of the year.

Management has stated that it expects to return to EBITDA positive during Q4. This is due to an increase in sales from its dominant clients and the emergence of some of its newer, higher margin clients in its revenue mix. The mid-term outlook for the Company remains positive as consumers continue to leverage their loyalty points to get rewards during a U.S. recession.

We expect expenses to increase as the company invests in marketing for its core business, and for the launch and expansion of its GPX secondary trading platform. I think that the success of GPX will be dependent on the trading fees. Lower fees by the participating airlines would help drive more liquidity. Despite the investment, we still have a wait and see stance on this part of the business.

The Company has approximately $37 million of cash on its balance sheet and no debt, so it is in a very sound position to fund its growth towards market dominance during a period of constrained access to capital worldwide. During Q3, the Company invested in growth by sacrificing margin for market penetration.

In terms of earnings growth potential, cash, and cashflow, Points International ranks among the top 30 small cap tech stocks on the Toronto exchanges. I continue to think that Points International is great buy at current price levels. For long-term value investors, the stock is probably worth between $2.00 and $3.00 within 12 to 24 months. In the short-term, there is a greater than 50% chance that the stock could trade down to the $0.50 level again before recovering.