|Shares Out. (in M):||899||P/E||9.5||8.2|
|Market Cap (in $M):||11,240||P/FCF||11.5||9.7|
|Net Debt (in $M):||19,461||EBIT||1,599||1,987|
|Borrow Cost:||General Collateral|
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First Data is a payment solutions company for merchants, financial institutions and card issuers. It enables merchants to accept credit card payments, also offering processing and ATM services. FDC also helps banks and retailers issue and manage credit cards, among other services.
“Cloud computing is lowering the barriers to entry for software firms seeking to provide merchant services. It is easier today to develop inexpensive payments solutions and to connect various systems and platforms than it was just five years ago…These changes will intensify competition and result in accelerating price competition.” Innovation and disruption in US merchant payments; McKinsey, May 2014
As the quote above indicates, First Data competes in a competitive sector with no shortage of innovative and well-funded competitors, ranging from startups to international banks. This is challenging for any business, but especially one with massive debt incurred from a top-of-cycle 2007 LBO. The level of innovation required just to keep pace when KKR bought this business was much different than today. There have been nifty inventions such as iPhones, mobile payments, Square readers, to name a few of the innovations proliferating in the payment processing sector. FDC appears to trade at an unrealistic valuation, and unless fundamentals drastically improve soon, equity holders will likely be impaired. My understanding of the bull thesis is that it involves “strong, predictable” free cash flow and debt paydown. While headline FCF yield is predictable, it’s insufficient for meaningful debt paydown where ~$19B of the company’s EV is debt. KKR overpaid for a business with too little cash flow to rescue equity holders. FDC trades at 26.1x EV/EBIT and 13.2x EBITDA. These are premiums to historical comp multiples, despite margins already at the high end of historical levels and a competitive environment that has gotten much tougher since 2007.
Assuming 31% EBITDA margin (currently 28.5%), equity would be just below $6/sh at 10x EBITDA. That is a premium to the 10yr median of Fiserv, a more successful competitor. The risk/reward seems very unattractive.
Well capitalized and focused companies such as Paypal and JPMorgan talk about their focus on spending and innovating in this space, and it would seem difficult for FDC to compete on equal playing field when they spend $1B a year on interest payments, let alone debt paydown. It also seems difficult for FDC to recruit the most coveted fintech employees when there are numerous startups that could hire them with potential for much greater equity upside. The company talks a lot about its API, breezily compares itself to Apple, Facebook and Alibaba in news articles and interviews while Barron's comps it to Mastercard, but First Data is in a much less attractive scenario than any of these companies. A quote from a Feb 16 earnings call was telling:
“Can you discuss the competitive nature of the acquiring market? Specifically, we hear that [Chase] Payment Tech is looking to gain scale for their vertically integrated solution and Chase Pay is getting extremely aggressive on blended acquiring rates.” Craig Maurer, Autonomous Research
“We have a number of items that we believe are very, very compelling for clients, right. And so to us, that’s how we think about it. On any given day, there will be different offers and different pricing. We’re maniacally focused on how we’re going to deliver value to the client that actually helps them grow their business, right. We’re not in a pricing war in our mind. We’re in a solutions and services opportunity to help people grow, and that’s the approach we’ve taken.” Frank Bisignano, First Data CEO
One of the bull cases is that CEO Frank Bisignano is a star. He was Jamie Dimon's right hand man at Citi and JPMorgan and is credited with running a superb IT and operations group at each stop. He is a very capable executive. I just think with the capital structure, there is not much he can do to save shareholders. Taking nothing away from Bisignano’s track record, other CEO’s with strong pedigrees have been at the helm under KKR/FDC ownership:
· Mike Capellas (2007-2010): 7/10/07: "We are confident that he will deepen customer relationships, and his leadership will be characterized by the same excitement and passion for success that he brought to his previous companies," said Scott Nuttall of KKR. 3/11/10: According to Kravis, “First Data has shown exceptional resiliency and continues to grow and invest during this economic downturn.” … Since 2007, the company has achieved its strategic goals of delivering solid organic growth, investing heavily in technology and realizing substantial cost savings. Capellas has recruited a world-class management team, reestablished new product development as a core capability and has realigned the company around two global lines of business…Other accomplishments that have strengthened market and financial position include dramatically improving service quality through the consolidation of data centers, call centers and merchant platforms.”
· Joe Forehand (Interim CEO Mar10-Sept10) 3/9/10: “Let’s face it, companies need different CEOs for different situations, and the process of going through an IPO is very unique. If First Data is headed for an IPO, you definitely want to have someone who is very savvy at managing an IPO process.” 5/28/10: Under Forehand, First Data is under pressure to cut costs, become more streamlined and “look for the next growth engine”
· Jon Judge (Sept10-Jan13) 9/28/10: “First Data’s future is taking shape now, and Jon has demonstrated the leadership and ability to take the company into its next stage of growth and development.” 12/9/10: Mr. Kravis’ only testy moment [at Goldman Conf] came when asked about FDC. “What they needed was real leadership,” Mr. Kravis said, adding that in Sept, KKR installed a new CEO, Jon Judge. 1/23/13: CEO Jon Judge plans to retire from the company for health reasons.
· Ed Labry (Interim CEO Jan13-Apr13) “Ed Labry has spent almost 30yrs of his career in the payments industry and most of that time at FDC or one of its subsidiaries…He is a natural fit for us as interim CEO and will do an excellent job to ensure that the company remains focused on driving its 2013 objectives.”
· Bisignano hired April 2013. “Our original investment thesis was that First Data was the largest credit and debit card company in the world, and that it would continue to grow if we could get the management right,” Kravis explains. “Quite frankly, we didn’t get it right until Frank came along. The first manager in Michael Capellas just didn’t work out. John Judge worked for a little bit, but not for that long. We were frustrated because we knew the capabilities on this platform. Had the new management continued on the same line that the company already was on, then Silicon Valley would have eventually sucked right off First Data and used the big pipes we had as an incumbent player. One day we’d wake up and wouldn’t have much left, so a real shot in the arm was needed in terms of technological innovation. We have that with this management and this plan…” --Henry Kravis, June 2014
I also find it surprising how many JPM execs have been hired to senior positions First Data. There are surely positives to Bisignano handpicking his team, but this seems extreme:
· Mr. Bisignano has recruited so many former colleagues that First Data agreed in January to pay millions of dollars to J.P. Morgan in exchange for a promise that the bank wouldn't contest new hires… WSJ 4/21/14.
One of the executives mentioned in the above article, tapped to drive international businesses, left the company in Feb16.
Other anecdotes also raise potential red flag.
· “When Bisignano joined, he insisted on issuing $300m equity split among each of the 23,000 employees, so they could “see the connection between their hard work and the outcome.” - Fortune profile. Update: On reading a WSJ article, the equity payout sounds less generous: “Mr. Bisignano has moved quickly to cut costs. He replaced 401k contributions to employees and cash bonuses with stock grants. The moves took effect 1/1/14 and are expected to save the company $60m in cash this year.”
· Prior to Bisignano’s arrival, a small group of executives had handed down its orders to its 23,000 employees…Visiting headquarters in Atlanta, he saw “these palatial offices far away from everyone else, including a suite for the CEO with a sitting room and bathroom.” Bisignano ripped out the offices, replacing them with 200 workstations. He also expanded the management team, giving more people broader responsibilities. Just as his mentor Dimon had drawn loyalists from Citigroup to JPMorgan, Bisignano recruited lieutenants from among his former JPMorgan and Citi collaborators…Bisignano also moved First Data’s executive offices to New York City, although headquarters remain in Atlanta. [WHY IS IT SUCH A GREAT THING THAT HE TORE DOWN THE OLD CEO’S FANCY OFFICES BUT MEANWHILE HE HIRED MANY OF HIS PAST COLLEAGUES AND MOVED THE EXECUTIVE OFFICES SO THEY COULD ALL STAY IN NEW YORK CITY???]
· SVP of retirement and international policy for American Benefits Council, and others said most companies have gotten away from offering stock to employees. She does not expect First Data’s move to spur other businesses to return to it… “You see it in younger companies. It’s common in companies that are turning themselves around. Companies like that have difficulty getting good people.”
· FDC’s entry level US employees will receive about 400 shares worth $3.50/sh as part of the award. “It probably would be a little too rich of a gift to give both the equity and the match,” [Bisignano] said of the struggling company. “Our intent is not to give something not worth anything to our employees. We’re giving them value today, and we believe it will have greater value in the future.”
Overall compensation of well over $100m for the CEO alone in the last 3yrs seems like a lot for a company that is in the early stages of a turnaround, to put it mildly.
RISKS TO SHORT THESIS
This is a highly leveraged enterprise, so any positive surprise will likely drive up the share price, as we have seen occasionally. If the company sold assets (STAR network possibly), showed growth in its nascent Clover terminal business, or achieved any other upside surprises, it could make a good trade for the longs. Conversely, with the capital structure here, takeout risk is minimal. Also, KKR has been trying to fix this company for nearly a decade with minimal success, and it is unlikely there is much they have not already tried.
In contrast to the ~$6/sh EBITDA multiple analysis, a more bullish DCF assuming 3% revenue CAGR (vs 2.1% last 5yr CAGR) and EBITDA margins growing from 28.9% LTM 3/31/16 to 32% for entire projected period, implies $13/sh. That seems like modest upside for a rosy scenario with steadily growing revenue and margins (no recessions). Even if that scenario plays out, interest rates are likely to rise due to the strong economy, and each 100bps increase in rates is ~$44m higher interest expense.
On 5/21/16, Barron's wrote a profile on the company suggesting it has 70% upside, and shares have traded +10% in recent days. While anything is possible, there are several aspects of the article that I disagree with. Investors should look into the assertions and judge for themselves, but below are article excerpts and my take:
1) New management ->>. Seems like a competent group but pay on the very high side for an early stage turnaround ($51m for CEO FY15; $137m aggregate FY13-15)
2) Clover: technology offering similar to Square or some of the products offered by Oracle (Micros) and a host of others. Also often highlighted as a major growth platform, but appears below initial plans.
· From 2/19/15 Bloomberg TV Interview with CEO: Q: “How many of [Clover units] have you sold?” A: “Well we have about 50,000 out in the market right now…We’ll actually come up with a mini-Clover and a mobile Clover. And we think we’ll do 400,000 units this year.” Q: “This year?” A: “Yes.” Update from 4/25/16 earnings call: "I appreciate the question. And as you had said, it's still the early innings, but as Himanshu said, over 200,000 units have been shipped. And we've -- from where we started to where we are, we have a full product suite in there."
For what it's worth, app store ratings for Clover are well below Square.
3) Refinancing term loans pushes out debt obligations: That is true, pushing back a $4.9B maturity from FY18 to FY21 reduces refinancing risk but does not change the fact that FDC has $8.4B debt due by 2021 and $19.6B by 2024 and its aggregate FCF over the last decade was $7.2B. Its maximum single year free cash flow in history was $2.1B, right before the LBO. Investors are still relying on a very favorable debt market.
PRIOR VIC WRITEUP
There was another writeup on here from 2006 that was bullish and worked out well, as KKR bought the company at a premium. However, in the last decade, several things have changed.
1) FDC alliance with Chase Paymentech that gave them 49% market share has dissolved, Chase is a competitior now and comprised over half of that 49%
2) Banks in general view merchant acquiring as more of a core business and have increased focus on it
3) Noted no new entrants disrupting pricing dynamics, and mix shifting to small and midsized accounts which are more profitable. >> Today companies like Square are very focused on this business.
4) Obviously completely different capital structure
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