While Crikey regrets having sold out of ERG at just $1.35 a share in 1996, we agree with Ian Rogers that the stock is now overhyped and over-priced. And they by no means have Sydney’s ticketing contract in the bag as they would like to suggest.

Much is at stake for this Perth-based torch bearer of good old Aussie know how, not least the management stresses of living up to a $2.2 billion valuation; six times its revenue and 45 times forecast profit for 2001!

ERG didn’t return Crikey’s calls or emails this week and as the company hasn’t published at its internet site the material distributed to the big end of town on Tuesday (contrary to ASIC and ASX policy), this column depends on second hand accounts of the briefing and the ASX 4B report.

Headline Figures Look Okay

The key numbers are that in the year to June ERG boosted operating revenue 36 per cent to $360 million, the market’s preferred profit of EBITDA by 59 per cent to $61 million, net profit by 73 per cent to $35 million and earnings per share by 72 per cent to 16.6 cents.

Management’s key theme is that its strategy is on track, its core smart card software product of smart card applications is proven in the market, customers are coming on board and that prospects are rosy for maybe dozens of prospective ticketing contracts in a smorgasbord of cities, from rich northern Europe to trying-to-get-rich China, south Asia and South America.

ERG’s trying to turn a dollar by grafting a modern software application (known as MASS, for multi-application smartcard solution) onto smart cards, neat self-contained computers on a single chip and commonly found in Telstra’s phone cards and mobile phones. The software holds the key to ERG’s prospects; the business of making and selling smart cards is turning into a commodity business and in any event the technology is approaching its twentieth birthday.

ERG’s ambition is to create a mass consumer use for this technology. Its plan – in conjunction with US giant Motorola – is to employ its technology to satisfy the ticketing requirements of city transport systems and to have one of their smart cards do the job of the magnetic striped piece of cardboard which does the job now for most Australian commuters, and the tokens and coins which serve as ticketing systems in many other cities.

The multi-application leg of the strategy is that the smart cards which replace magnetic striped cardboard tickets can be put to other uses; such as make small value payments at retailers, store data for loyalty schemes, security, identification and anything else the promoters can dream up.

Justifying A Massive Multiple

The basis of valuations of ERG by big brokers largely depends on assumptions about how many big cities are likely to reform their ticketing systems over the next decade, what proportion ERG/Motorola will win, what proportion’s left for ERG after selling down its stake in the regional franchise and then what kind or margin, including royalties, are left to trickle down to ERG shareholders.

Big assumptions about the state of reform of city transport systems probably justifies ERG’s share price. Even so, quite generous assumptions about ERG’s chances made by Ord Minnett in research circulated last month ion what it estimates to be a $31 billion market (measured by gross receipts on city transport systems) produced a valuation for ERG of a bit more than $8 a share, which contrasts with $10.35 last week. Brokers more closely associated with ERG, in Deutsche Bank and Salmon Smith Barney, favour double digit valuations.

ERG also has telecommunications interests, but it’s selling out

These observations largely restate points raised by this columnist in a Shares feature back in May. ERG seemed to dislike conclusions that time around, and perhaps explains why nobody called back this time.

Never mind; Crikey retains an interest and wonders how ERG’s sold itself and its story to the market in recent months.

Gilding The Lily On Wannabe Contracts

The focus of ERG’s recent sales pitch depends on two Australian contracts. The NSW and Queensland governments about to award ticketing contracts – specified as contactless smart cards – for their trains, bus and ferry networks in Brisbane and Sydney. ERG is naturally anxious to win the work if it can.

The company is on a short list of two in each city and competition with a consortium of San Diego-based Cubic, Commonwealth Bank, Philips and EDS, with that perennial underachiever of Australia’s smart card world, Keycorp, as a supplier.

Both tenders stand a serious chance. ERG is supplier of Sydney’s ferry ticketing system; Cubic that of Sydney’s City Rail ticketing system. ERG’s just completed an overhaul of the ferry ticketing system and Cubic just completed installation of its system in Sydney’s airport rail link.

The strange aspect of this story is the steady waves of rumour, and even written broker reports, which contend ERG’s bagged the Sydney contract, and that Brisbane will fall into line.

Those asserting this line may have better information than Crikey and perhaps its true that the NSW Department of Transport favours the Perth entrepreneurs. However, as far as Crikey can tell there is no decision and indeed Sydney’s transport planners are somewhat overworked rechecking the city’s arrangements to shuttle Olympic enthusiasts around a network showing clear signs of disrepair.

Pumping Up Analyst Expectations

What’s stranger is that ERG apparently told Tuesday’s analysts briefing that first, the Department of Transport had picked ERG and that two, the decision was going to NSW Cabinet either that day or the next. Crikey is pretty sure it’s yet to reach Cabinet, but couldn’t ask ERG to clarify these claims.

The Cubic consortium thinks its well in the running, that price is as likely to settle the winner and that the transport authorities aren’t that interested in the multi-application side of the show; Sydney just needs a ticketing system that works for trains, buses and ferries.

A key question for ERG’s boosters is whether smart card systems engineered for multi-applications will ever handle more than just a single ticketing application.

It’s really up to banks – not transport operators and not their ticketing system suppliers – to make additional applications for smart cards a reality. Smart cards may play a role in security and identity, especially online, but it looks like it will be banks which will push this, not transit systems. And the “electronic purse” applications – using your smart train ticket to buy a morning coffee – all depends on merchants and their banks finding a reason to invest in the equipment to make payment possible from stored value cards.

As far as Crikey knows, the business case for such an application remains unproven anywhere and not for want of effort by dozens of big banks, credit card associations and others investigating the technology to test the case.

The worldwide payments club seems to hold this view of the prospect for smart cards as a payments tool.

Patrick Gauthier, vice president for smart card applications at Visa USA said last week that merchants have little incentive to support a move to smart card systems for payments.

The online edition of trade newsletter Card Technology quotes Gauthier, speaking to the Electronic Transactions Association in Chicago, as saying that a system-wide switchover to chip-based payment in the US would cost merchants $US12 billion over 10 years.

“At the end of the day, there are only two reasons” for a switch to take place, Card Technology quotes Gauthier. “Alliances between financial institutions and acceptors or if fraud explodes.” Fraud, Gauthier said, was not a big enough issue to warrant the change.

“Chips need to increase usage and retention to gain the attention of both financial institutions and merchants,” Card Technology said Gauthier concluded.

Finally, with no firm Sydney and Brisbane contract news to pump the group’s share price in the last week, ERG included one more innovation in its full year report; the old standby of a share split (three for one) which will reduce the share price to less than $4. This strategy, widely employed by listed companies, seems to help attract small investors attracted to nominally cheap shares without much regard to their relative value.

Mark Drummond, writing in the weekend’s Financial Review said of ERG that “it relied on sharemarket hype to inflate its share price”.

Drummond was writing of ERG in the mid 1980s, but Crikey reckons it’s an apt summary of the company’s business strategy in September 2000.