VISTAPRINT

But long-term investors, as well as those who've ridden this latest wave of momentum, might want to cash out while they're ahead. While VistaPrint's core business of printing business cards and the like for small-business owners and consumers via its web site appears solid, third-party marketing partnerships, from which VistaPrint derives referral fees, are drawing the ire of some customers. Making matters worse, the company seems to count on the fees paid by these third-party partners for a big chunk of its operating profits.

Such partnerships are routine web fare. In general, a customer visits VistaPrint.com and sees a promotional offer from a third party. If the customer accepts the offer, the business pays VistaPrint a referral fee. The problems arise, claim some VistaPrint customers, when unexpected charges show up on their credit card and bank statements that trace back to these business partners of the company.

Many complaints have wound up with the Better Business Bureau, which says it has processed 351 about VistaPrint's U.S. operations in the last 36 months, making it one of the nonprofit organization's top 10 most complained about companies. Among these complaints, 158 were for credit and billing issues, including 106 for unauthorized credit charges and bank debits, and 47 for failure to correct billing errors.

Alison Sandford, who runs a business in the U.K. offering stress-relief services for people and animals, says she found an erroneous charge for about 10 British pounds ($20) on her credit-card statement after ordering business cards from VistaPrint. She says she had clicked on a link offering 10 British pounds free with her next order, but she didn't intend to sign up for any program authorizing the charge. She says she didn't receive her money back until after she complained to the Better Business Bureau, although she isn't sure whether her complaint prompted the correction.

Asked whether she will shop with VistaPrint again, Sandford says, "I'm torn, because I really like the business cards. They are eye-catching and easy to do online. But I certainly would try to avoid their rewards scheme like the plague in the future."

VistaPrint has more than 10 million customers in over 120 countries, making the number of complaints a drop in the bucket. Still, grumblings about unseemly business practices are rarely good for a stock, especially if the negative attention forces the company to shift away from, or tweak, a lucrative business.

In the one indication this is already happening, VistaPrint says its marketing partnerships are "becoming more strategic." However, the company says they are a sustainable part of its overall business.

"We think investors understand that we do a good job meeting customer expectations and work hard to ensure customer satisfaction," the company said in an email response to questions.

For its fiscal year ended June 30, VistaPrint derived less than 10% of its revenue from these referral fees. For the past year, the amount was $20.5 million, or 8% of VistaPrint's total annual revenue of $255.9 million, according to VistaPrint's annual report.

Unlike printed products that VistaPrint manufactures itself, the company says these co-marketing offerings "have minimal corresponding direct cost of revenue."

Under one reading, this could mean that nearly all the revenue VistaPrint receives from these co-marketing business partnerships goes toward its operating income. In that case, revenue from these business partnerships would account for something close to 75% of VistaPrint's $27.2 million in operating profit in fiscal 2007.

VistaPrint disputes this and says there are direct and indirect costs associated with each part of its business, and attributing a specific level of profitability to any single aspect of the business requires false assumptions. It says it hopes "investors will value our business as a whole."

Whether investors should value this lucrative side business separately from VistaPrint's core printing operations is a matter of debate on Wall Street. Some analysts believe the side business is generating the bulk of VistaPrint's operating profits, whereas revenue from the company's core printing business is eaten up by costs.

Brad Manuilow, an analyst at American Technology Research, said in a research note on July 24 that the "third-party referral fees inflate earnings and margins." Manuilow has a $30 price target and Sell rating on the stock.

Kevin Beech, an analyst at Dallas-based Behind the Numbers, which issues earnings warnings and sell recommendations to institutional investors and hedge funds, said in an Aug. 29 note that he believes VistaPrint "would like to quickly exit those relationships" with business partners garnering customer complaints. If the company did, it would need to make up for that lost revenue or else risk missing the Street's profit expectations, which would drag down the stock, Beech said.

Yet the vast majority of analysts covering VistaPrint have a Buy rating on the shares, and VistaPrint's strong results so far make it easy to see the bullish view.

The company's proprietary technology allows it to receive thousands of print jobs every day and process them in a more cost-efficient way than traditional printing shops. Last fiscal year, revenue grew 68% and earnings surged 41%. Revenue from repeat customers was 63% of total revenue, suggesting that a good number of customers are happy enough with VistaPrint to come back.

"We don't see any reason for concern in using third-party referral revenues to monetize brand equity," Longbow Research analyst Piyush Sharma said in a note on Sept. 14.

Sharma, who has a $42 price target and Buy rating on the stock, said VistaPrint's co-marketing business partners have included Vertrue and Webloyalty.com. Vertrue's web site says it offers consumer membership programs for discounts on things such as health care and cosmetic surgery, and shopping programs. Webloyalty.com says its consumer benefits packages include travel rewards and shopper discounts.

Manuilow, of American Technology Research, said in a research note on Aug. 1 that he believes such marketing programs typically charge customer's credit or bank cards $10 to $15 a month for discount programs until the customer cancels them. These programs "are widely criticized" by consumer watchdog groups as unfair or deceptive business practices, he said, "which calls into question their strategic importance and sustainability given the potential legal risks."

Bears also point out that despite strong revenue and earnings, VistaPrint had negative free cash flow of $8.6 million last fiscal year, as capital expenditures of $62.8 million outpaced operating cash of $54.2 million. The question is whether these capital expenditures are "growth" expenditures, which the company says will taper off as it matures, or "maintenance" expenditures required by a capital-intensive business that would likely keep free cash flow negative.

Another factor to consider: As of Sept. 25, 22% of VistaPrint's float is held by investors in short-interest positions, meaning they're betting the stock will fall.

Capital Growth Financial chief research analyst Howard Rosencrans has been skeptical of VistaPrint for months. As far back as April 2006, he noted that the company's weak free cash flow, combined with a low tax rate due to its being based in Bermuda, is "indicative of a low quality of earnings stream." He currently has a $25 price target and Sell rating on VistaPrint shares.

For its part, VistaPrint says, "We think we're building a sustainable business and that referral fees are a sustainable part of that business."

Maybe so, but if customer complaints about VistaPrint escalate, either damaging the company's reputation or forcing management to cut back on lucrative third-party partnerships, then shareholders could pay a stiff price. That risk alone should give investors pause.