|Shares Out. (in M):||155||P/E||12.4x||11.2x|
|Market Cap (in $M):||7,047||P/FCF||11.2x||10.1x|
|Net Debt (in $M):||3,499||EBIT||984||1,080|
Fiserv is a leader in a secularly growing business with a high percentage of recurring revenue, great cash conversion, high margins, double digit FCF growth and solid management with history of good capital deployment. Currently, Fiserv can be bought at around 10x 2010 FCF.
Fiserv provides electronic commerce solutions and transaction processing to financial institutions, including banks, thrifts, credit unions, lending institutions and merchants. The company has over 16,000 clients and processes 718 million accounts. Fiserv operates in two segments - Financial (47.5% of revenue, 48.5% of operating income excl. corporate) and Payments (52.5%; 51.5%).
The Financial segment provides services required to run day-to-day banking operations, including core bank processing, items processing, cash management and financial transactions support. Without these services a bank cannot operate. Fiserv is the largest core processor with 37% market share compared to 15% for Fidelity National Information Services (FIS) and 14% for Jack Henry. Core processing would include processing of banks' customer deposit and loan accounts. These solutions are offered on an outsourced basis or licensed in-house system. Mostly they are done on an outsourced basis, helping the banks avoid spending large sums on capex and their own in-house IT groups. These services are billed mostly per account on a monthly basis (in the case of customer accounts) or on a per transaction basis (in case of check clearing or lending solutions). One risk regarding this segment that people point to is consolidation in financial industry. While true, (the company points -3% CAGR in the number of financial institutions for the last 20+years), the more important data has been the growth in US deposit accounts which continue to grow (7% CAGR last 5 years).
The Payments segment includes e-banking, e-billing, credit processing, debit processing, and ATM transactions processing. The company became a leader in e-banking and e-billing through their acquisition of CheckFree Corporation in December 2007 for $4.4B in cash. Around 50% of Internet banking transactions run on Fiserv solutions. These systems can be also accessed from different mobile platforms - i.e. cell phone. Fiserv also provides credit card processing solution and credit processing platform to financial institutions. These are not merchant transaction processors (like TSS or GPN), which we would refer to as the front end of the transaction processing. Rather Fiserv's credit processing occurs in the back office of the financial institution. Fiserv also offers ATM and Debit transaction processing, Visa and master card signature debit processing, ATM driving and monitoring, etc. The company owns ACCEL/Exchange network that operates 20,000 ATMs. Here the large competitors are First Data (STAR) and FIS (NYCE). Most of the revenue in this segment is derived from fees based on the number of accounts and number of transactions processed.
The largest competitor in both segments is Fidelity National Information Services (FIS), which is slightly bigger than Fiserv following their acquisition of Metavante in October 2009. Both are very well run companies with appealing and similar characteristics. Both are smart competitors.
So why is Fiserv an interesting investment at the current price?
1)It's a great business. The services Fiserv provides are essential for running any depository/financial institution and are not very economically sensitive. They are difficult to replace. A bank will not jeopardize its core processing or ATM processing just to switch to a competitor to save a few bucks. It does happen but it's rare. Fiserv operates under long-term contracts with only 3% switch rate annually. The company generates revenue from fees based on number of accounts or transactions, making this a 85% recurring revenue model.
The company has high and expanding margins. LTM EBITDA margins (after taking into account the sale of the insurance business and lender services) were around 33%. The margins have been expanding and are expected to continue to do so by 50-100bps a year for a few reasons - benefits of CheckFree acquisition, shift to higher margin products (better mix), cross-selling of their products and leverage of existing infrastructure as the revenue grows. The company has a great cash conversion model. Fiserv requires only around $200 million of capex per annum. This represents less than 5% of revenue and around 15% of EBITDA. Around 50% of EBITDA is converted into free cash flow. The company generated around $630 million in LTM free cash flow (guided to $650 million for 2009 and we project $700 million for the current year).
The balance sheet is solid at 2.8x EV/EBITDA. The debt came from the Checkfree acquisition. Fiserv's business model (high recurring revenue and not economically sensitive) can support some leverage, but management has been paying down debt with excess FCF. There are manageable maturities near term- $375 million in both Dec. 2010 and Dec. 2011. Fiserv's notes ($1.25B) and the remaining term loan ($1.25B) mature in Nov. 2012. At that point these should be easily refinanced. Remember, Fiserv generates $650 million in FCF annually (and growing).
The company generates consistently high ROEs. On a GAAP basis, ROE is around 16%. On adjusted basis (excluding amortization of acquired intangibles) ROE is above 20%.
2. It's secularly growing. Top line revenue has shown high single digit growth. 2009 was an exception for obvious reasons but revenue was still essentially flat. Not bad. Longer-term, the company expects to grow revenue 6-9% per annum (2010 revenue growth rate is expected to be 2-6% due to continued tough economy). The top-line growth is coming from several drivers, including:
The company has been able to increase its margins consistently over the last couple of years, especially after the CheckFree acquisition. Currently we calculate around 33% EBITDA margin. Adjusted operating margin (management's preferred margin metric) YTD through Q3 was 28.9%, up 160bps from 2008. Management expects 50-100bps expansion per annum in the near future. The margin expansion comes from better business mix (sold off lower margin businesses, cross-selling higher margin solutions), operational efficiency (constant cost rationalization, especially after the CheckFree acquisition) and the benefit of scale from the top line.
The next piece of growth comes from smart deployment of capital. Since the CheckFree acquisition, the company has reduced its debt by $1.6B and brought the current net debt leverage to 2.8x EBITDA from around 3.8x at the time of the acquisition. Continued debt pay-down should lead to lower interest expense and higher FCF. The company also bought back $1.6B in stock since the beginning of 2006, bringing its total shares outstanding down by almost 16% since the beginning of 2006.
The combination of the aforementioned factors should lead to mid teen's FCF per share growth longer term. YTD through Q3 FCF grew 9% to $506 million (on normalized basis we calculated 17% growth) and FCF per share grew 15.6% (once again would be higher on normalized basis).
3. It's cheap. Fiserv should generate around $650 million ($4.20 per share) in FCF in 2009, giving it multiple of just 10.8x on 2009 numbers. We are expecting FCF of around $700 million in 2010 (around $4.50 per share if no additional shares are repurchased), yielding a multiple of around 10x. [GAAP EPS is not meaningful in valuation as it includes a number of noncash charges - the biggest one being amortization of acquired intangible assets. The company uses an adjusted EPS calculation (which excludes this amortization) and management expects to earn around $3.65 per share (still a low multiple of 12x for such a great business). There are some differences between FCF and adjusted EPS, such as non-cash comp, deferred taxes, etc. We prefer to look at FCF, as we think it better reflects the economic reality.]
4. The business is relatively safe. Risk quoted by the sell-side are a) consolidation (forced closure) among banks and b) slower growth in 2010 due to continued weak IT spending by the financial industry. Yes, that is very likely. As noted, in 2010 the company will most likely not reach its full growth potential. But at 10-11x FCF we are very well covered on this front. Also, what matters the most is the number of accounts and transactions, as opposed to the number of banks. As long as the closed banks' customers go to another bank that is a client of Fiserv the negative impact will be mitigated. Given their large market share there is a good chance that will happen. However, this risk is short-term.
Pricing appears to be stable. We would expect rational pricing with only few large, smart competitors and high switching costs.
Management has been stellar in the deployment of capital and we are not worried about them making an unwise acquisition or blowing the FCF they generate. They appear to have a good grasp of the industry, growth profile and competitive environment.
We believe that a company of this caliber and growth profile should be trading at 14-15x FCF. Historically, the stock has normally traded above that. We should benefit from both the expansion of multiple and the growth in FCF/share. Applying a multiple of 14x to 2011 FCF/per share ($5.35 or 13% growth from 2010 FCF per share) we arrive at 12 month target of $75 per share. Even if we are wrong, we believe we have a significant margin of safety, as Fiserv is trading only at 11.3x expected 2009 FCF and the probability of FCF/share decreasing substantially in the next 2 years is low in our view.
The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing. The author will not undertake to supplement, update or revise such information at a later date. The author may hold a position in the securities discussed.