February 14, 2011 - 6:43pm EST by
2011 2012
Price: 61.00 EPS $3.27 $3.93
Shares Out. (in M): 150 P/E 18.6x 15.5x
Market Cap (in $M): 9,145 P/FCF 12.1x 13.4x
Net Debt (in $M): 2,963 EBIT 970 1,050
TEV ($): 12,108 TEV/EBIT 12.5x 11.5x

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Fiserv provides the "plumbing" for primarily small and midsize U.S. banks.  It operates in two equally-sized segments: Payments and Financial.  The Payments segment operates the leading online bill payment business for banks (formerly CheckFree) as well as the Accel debit network and several related businesses.  The Financial segment provides core processing for 50-55MM demand deposit accounts, check processing, and mortgage processing for banks.  In January 2010, jim211 wrote the company up, and that submission has some useful information.


Why is this attractive?

FISV generates stable cash flow from selling a mission-critical service with high switching costs to a diversified customer base under long-term contracts in an oligopoly market.  The company's management returns excess cash to shareholders.  The business looks likely to grow revenue due to both a cyclical improvement in bank spending as well as secular trends towards online bill pay and debit usage.  Margin expansion is likely due to operating leverage and cost reductions from rationalizing overlapping product lines and data centers accumulated from historical acquisitions.  Finally, at $62.50, the shares trade at an 8% yield on estimated 2011 free cash flow, which seems reasonably cheap for a business of this quality.

Investment Positives:

Stable Cash Flow

FISV generates stable cash flow due to the mission-critical nature of its services and the difficulty of banks' switching out their processing software and servicers.  Customers sign 3-7 year contracts, and FISV has retained 98%+ of customers annually.  FISV's >6K customers are diversified with its top customer (Bank of America, which uses CheckFree) accounting for 5% of revenue but its top 50 customers representing <25% of revenue.  In addition, FISV categorizes 85% of its revenue as recurring, since it is paid based on the number of accounts a bank customer owns and on recurring transactions (e.g. monthly bill pay).  Finally, FISV has low capital intensity with capital expenditures approximating 5% of revenue and minimal net working capital.

Oligopoly Competition

FISV competes with two main players in core processing and one in online bill pay.  The combined Fidelity National Information Services and Metavante ("FIS") and Jack Henry & Associates ("JKHY") are the other leading core processors; the three top competitors comprise ~60% of the market and >70% of new contract wins.  FISV's CheckFree dominates online bill pay, with more than 80% of large banks as customers, and a logical path to penetrate smaller banks as they increasingly offer online bill pay.  Online bill pay is a sticky business, primarily due to the disruption that switching would cause to customer payments reaching the right location.  CheckFree's systems correct the incorrect information entered by many customers, and FISV owns the corrected data, making a switch necessarily painful until the new provider could ramp up its corrections.


3. Opportunities for Revenue Growth and Margin Expansion

Organic growth has been modest recently, at 1% for the Financial business and 3% for the Payments business.  Bank IT spending has been depressed as a result of the financial crisis, and seems likely to accelerate, which would be good for both of FISV's businesses.  Also, FISV operates more than two dozen data centers, which are likely to be rationalized dramatically.  Finally, FISV's Financial business has multiple overlapping products and sales forces built up from multiple acquisitions.  While rationalizing these is difficult because of high switching costs, it seems likely to happen over time.  When data center and product/sales force rationalization are combined, it seems likely that management's promise to expand margins by 50 bps annually (which they have been meeting) will continue for the next several years.  So growth in free cash flow seems to be at least low single digits, and likely more.


4. Management Repurchases Shares

Management has historically repurchased shares with up to 100% of its free cash flow.  With the exception of its ~$4B CheckFree acquisition in 2007 and consequent debt reduction that should conclude by 2011, management will likely return excess cash to shareholders.


Investment Risks:

1. Customer Consolidation & In-Sourcing

From 2004-08, the number of U.S. banks and thrifts declined to 16,700 from 18,300 as banks failed and/or merged.  Further, large banks, which tend to in-source their core processing, grew larger.  FISV's customers gained scale, improving their negotiating leverage and potentially leading to in-sourcing or churn (if a merger led to a bank that used two different outsourced processors).  More recently, regulators have refused to approve applications for new banks, which is accelerating the natural decline in the number of banks outstanding.  However, FISV's customer base remains highly diverse; further, since FISV is paid based on the number of accounts and transactions - which have grown and will continue to grow - the threat from consolidation seems manageable.


2. Pricing Pressure

Despite the mission critical nature and high switching costs of FISV's services, FISV's offerings represent a material cost for its small bank customers.  Consequently, banks negotiate core processing pricing reductions of 2-5% when renewing contracts; online bill pay pricing may decline as much as 4-6% annually.  However, FISV tends to increase revenue at renewals due to cross-selling additional services; FISV's contracts also often have CPI-based escalators (leading to rising prices) and experience scale cost advantages (most notably in fast-growing online bill pay) that offset the impact of pricing pressure.


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