Description

Thesis:

Fiserv is one of the largest third-party payment processors/merchant acquirers and provides an inexpensive and high quality way to play the payments secular growth theme and the re-open trade. The acquisition of First Data hasn’t gotten the credit it deserves in being a transformational deal that gives the company exposure to the faster growing merchant acquiring space which should bolster its long-term growth algorithm. The Clover POS system is a fast growing and underappreciated asset that would likely garner a higher stand-alone valuation than the entire acquiring business within FISV despite being just 15-25% of segment revenues. FISV has other under-appreciated assets and business drivers including the third largest debit network behind V and MA, and exposure to the Zelle P2P network. The long-awaited analyst day this coming Tuesday, Dec 8th, should be a soft catalyst that will help the investment community get better clarity over its business mix (tech-enabled, ecommerce, ISV, etc), growth drivers, cost synergies, and margin expansion in the coming years (500bps+). FISV’s transaction based processing businesses are economically resilient with recurring revenues and high renewal rates that should reduce the volatility of the legacy FDC acquiring business. Even with the pandemic and decline in brick-and-mortar traffic, 2020 should be the 35th straight year of double-digit EPS growth, and I see a 20% EPS CAGR from 2020-22E. 

Despite a business with secular growth drivers, a natural inflation hedge, margin expansion opportunities, low capital intensity, strong free cash generation, disciplined and accretive capital allocation, respected and highly incentivized management with over $1.25bn of economic value at risk, and a history of generating excess shareholder returns (2x the S&P 500 at similar beta), the stock is trading at a discount to peers, the market, and at the widest relative valuation gap to the S&P in about ten years. Leverage from the FDC deal is the key blemish but provides the opportunity to earn a levered return in a growing business that will rapidly de-lever while the company repurchases shares. FISV will likely generate over $8 of FCF in 2022E and should be worth ~$160 in a year (+35%), compounding from there as the market begins to better appreciate its growth profile and business mix. The large cap payments companies (V, MA, GPN, FIS, FISV) in general have lagged the market over the last six months but should all benefit from reopening, and technically look poised for a breakout (as FISV has recently done in anticipation of investor day). 

Brief Business Background:

FISV started the recent wave of merchant acquirer/payment processing mega mergers when it announced it was buying First Data (FDC) in Jan 2019 for $39bn in cash (closed in July 2019). FDC at the time was the largest third-party merchant acquirer/payment processor in the world (including JV’s) and actually was larger than legacy FISV in terms of Ebitda. The acquisition was complementary to legacy FISV as it gave the company exposure to the merchant acquiring and credit processing space. Legacy FISV was comprised mostly of a core bank processing business with significant exposure to small-medium sized (credit unions) financial institutions. The significant leverage on FDC enabled FISV to acquire the company for just 11.5x Ebitda (9.4x post-synergy), a significant discount to where FIS and GPN acquired WP and TSYS, and to where all of the companies trade today. FDC never got the full credit it deserved as a publicly traded company, primarily because of its high debt burden caused by the top of the cycle KKR-backed LBO in 2007. It floundered as a private entity as it lost share from upstart fintechs, but was in the middle of a successful turnaround by current FISV CEO, Jeff Bisignano, when it was acquired by FISV. Bisignano instilled a sense of technological innovation into the company and steered the successful rapid growth of Clover. FDC was growing HSD organic revenues and had improved its margins back to the 2007 levels when it was acquired by FISV in 2019. As shown below, which doesnt include updated synergies for FISV/FDC, I think FISV got a great deal in FDC by acquiring a scaled business at a below-market multiple. Without growth I think there was roughly $60/shr of upside from the deal.

Legacy FISV had a great business model as its core banking software was mission critical to banks, providing the backbone for bill payment, account transfers, check clearing, etc. Contracts were long-term in nature (3-7 years) with 90%+ retention rates and revenue was generated primarily based on the number of  transactions processed (not dollar value), and thus generated stable recurring revenues and cash flows. It effectively operated in an oligopoly with FIS and Jack Henry. FISV's bread and butter was smaller financial institutions, while FIS had the larger ones. Since 2005, there have only been six quarters (out of 78) where FISV's organic revenue growth has been negative and besides 2Q20, all of those were during the depths of the financial crises from 4Q08-1Q10. The lowest decline back then was -4%, and 2009 in total only was down -1%. Up until as recently as 2015, the core banking Fintech business comprised ~50% of operating income. With the introduction of fintechs and neobanks that could potentially remove the prior barriers to entry of being deeply entrenched in the financial institution distribution system, it became evident that the third-party processors/acquirers like FISV and FDC needed scale to compete across all facets of the payment processing and core bank processing landscape. The acquisition of FDC gave FISV exposure to issuer debit/credit processing, more larger banks, increased international presence, and most importantly provided a scaled entry into the faster growing merchant acquiring. It also reduced the exposure to the slower growing Fintech business to ~20% of operating income (2021E) and gave FISV a fast-growing SMB POS platform to go to market with in Clover.

FISV now has three businesses:  Acceptance, Payments & Networks, and Fintech. 

• Acceptance is the merchant acquiring business that is mostly legacy FDC. Merchant acquiring is basically the sales and distribution arm of the payments industry, with FISV going to merchants and offering them POS solutions that enable the merchants to accept and process electronic payments. FISV will take a percentage of the transaction value in exchange for its services. The business is more economically sensitive because of this fee structure but also provides a natural inflation hedge and leverage to the overall growth in commerce and electronic payments. It is expected to be the fastest growing business (HSD-LDD) within FISV and should be 40% of revenues and ~33% of profit in 2021. Its primary growth driver is the Clover POS system and ecommerce.

• Payments & Networks (“Payments”) is a combination of legacy FISV and FDC businesses and is where most of the overlap in the two companies is. It is commonly referred to as “issuer processing” as FISV offer products and solutions that enable the processing of debit, credit and prepaid cards for financial institutions/corporates (private label cards). It also offers some core processing services like bill payment and value added solutions like fraud solutions, data solutions, etc, and provides a turn-key offering for banks to participate in the Zelle P2P network. This business now also includes the third-largest debit network with the combination of the STAR and Accel  networks. Payments is a M-HSD grower and generates revenue mostly on a per transaction basis. It will represent ~40% of revenues and 45-50% of profits, with the highest margins in the company. The primary growth drivers are new accounts and all of the secular growth drivers behind the increased adoption of electronic payments, including ecommerce, tap-to-pay, etc.

• Fintech is a legacy FISV business providing core back office technology software systems to financial institutions to enable the processing of customer deposit and loan accounts. It also provides digital banking software solutions, financial and risk management, cash management, and item processing to those financial institutions (mostly small-medium sized). The Fintech business is effectively a slower growing SaaS business that generates revenues on a per transaction basis. It is a L-MSD growth business that will represent ~20% of revenues and profits in 2021E. Growth will come from the need for small and medium sized banks to offer digital banking solutions to its customers.

With FISV trading at a discount to peers, including FIS, which has a very similar revenue mix, I believe there is a misperception about the growth profile of FISV and the quality of its assets and competitive positioning. In an effort to get this out before analyst day tomorrow, the rest of the writeup will focus on the key reasons why I think FISV’s business and growth is underappreciated and some of the key drivers that will help the market appreciate the story better (with help from analyst day) which should lead to a re-rating over time.

Clover Worth as much as All of Acceptance and will Drive Growth:

Clover is a POS cloud-based all-in one payments platform that is capable of also offering ancillary business process solutions to help small and medium sized businesses operate. It was acquired by FDC in 2012 as a start-up and has grown from nothing to over $130bn+ of run-rate GPV over its platform in just a few years. Clover is actually growing faster than Square's seller solution offerings and as of 2Q20, eclipsed SQ's GPV. GPV grew >30% in 3Q20 for Clover vs just 12% for SQ. No one knows exactly how much revenue Clover generates within the Acceptance business but using an estimate of net take rate between 60-100bps and it should be ~15-25% of segment revenues. We will likely get some numbers around this at the Analyst Day. There has been a belief that Clover is cannibalizing the traditional ecosystem. I think this was in the presentation tomorrow.

With 15-25% of the Acceptance business growing >30% and competing against one of the most well respected fintech offerings, I think Clover's value is being underappreciated within the FISV consolidated valuation. On an EV to GPV valuation, SQ, PYPL, Adyen, PAGS, STNE, and Stripe (private value) trade for ~0.11-0.38x 2021E. Note that for SQ and PYPL I deduct ~$60bn of value for CashApp and Venmo (would be ~2/3 of SQ's valuation) to get an acquiring only valuation. At a 0.20x EV to GPV valuation, Clover would be worth ~$33bn, more than the entire Acceptance business at the current 15.5x consolidated multiple, and equal to ~33% of total FISV EV despite being just 8-11% of total revenue. There is potentially $40 of incremental value from Clover within FISV. I dont expect this value to be realized over night, but over time the market should start to give FISV some of this value via a higher multiple due to the growth potential from Clover. Neither FIS or GPN, FISV's closest peers, have a POS solution with the brand recognition and scale that Clover has. The ability to compete in the SMB category is critical as that is where the growth and profitability in the acquiring industry is.

Acceptance Mix and Growth:

FISV's acquiring business is perceived to lag behind peers and upstart fintechs when it comes to its business mix, ability to compete in the tech-enabled distribution system, and its ability to grow. Some of that is deserved given FISV/FDC's historical leverage to the traditional financial institution distribution channels and to brick-and-mortar merchants (over 6m merchant clients). But recent data points to the beginning of a successful transition under way. On the last earnings call, FISV noted that it grew new ecommerce clients by 41% YTD, ecomm transactions are +25%, and it signed more than 130 ISV's, a 40% increase this year. It is unknown how much ecommerce/ISV revenue is but most analysts believe it is roughly 15% of total acceptance revenue. While the likes of Adyen and Stripe are almost 100% ecommerce/digital acquirers, with FISV's scale and distribution channels, including Clover, it should be able to compete in ecomm. Its ability to mine value from existing clients with an omnicommerce solution is also underappreciated. Between Clover and ecommerce/ISV revenue, that is close to 30-40% of total Acceptance revenue growing well into the double digits. Even if the remaining part of the business is growing LSD, that should lead to a HSD organic growth algorithm over the coming years. It is likely to be in the double digits in 2021 as lockdowns ease and card-present transactions return.

The notion that FISV is disadvantaged relative to at least FIS, its closest comp, doesnt hold much weight when looking at the numbers over the last two years. In 2019, FISV grew its Acceptance business at roughly a 10% organic growth rate. It has grown faster than FIS three of the last four quarters, on a pro-forma basis, and faster than even GPN the last four quarters. Some of that could be pandemic related, but looking back to FDC's historical growth, it is evident that the issues that plagued the company from 2010-2014 were largely corrected as the company had been growing M-HSD before being acquired. Forrester recently ranked FISV quite high in ecommerce acquiring offerings and strategy relative to both digital and traditional peers.

Zelle and STAR/Accel in Payments:

The Payments business (issuer processing) is a big mix of different types of sub-businesses. I expect FISV to give a more detailed breakdown into the core issuer processing (mostly larger banks) landscape, the international opportunity, the cross-sell opportunity with the Fintech business, and importantly the Zelle and debit networks opportunity. One of the primary sources of revenue synergies and motivations behind the FDC merger was the ability to cross-sell products and processing capability across FISV and FDC's 15,000+ financial institution base. I dont think any revenue synergies are being capitalized by the street in this regard despite the $195m of actioned revenue synergies and $600m forecast or the recent big win of Alliance Data's processing business (4th largest issuer by accounts). The pandemic has also negatively impacted this business in the last two quarters, hiding any potential progress made on the revenue synergies. As economies reopen and in-person commerce accelerates, the Payments business growth profile and recent wins should begin to be reflected in the numbers.

FISV is the largest turnkey provider of enabling banks into the Zelle P2P ecosystem. Zelle is the third largest P2P electronic payment system behind Venmo and CashApp and should represent a source of growth for FISV. More detail into the economics of this relationship as a turnkey provider should help frame the growth outlook. FISV will never get the valuation that Venmo and Cash App do within PYPL and SQ because it doesnt own the platform, but it should get some more value within the Payments business than whats currently embedded if it is able to capture processing revenue growth inline with P2P transaction growth over Zelle.

I view the payment networks (V, MA) as the best businesses within payments. FISV now owns the third largest debit network behind V and MA (STAR legacy FDC, and Accel legacy FISV). It is a distant third, but it should be able to capture better network economics as it combines these networks and as it grows this business (recent WMT win). It is unclear what the strategy is to win new business or how large the business is or could be, but any clarity over this should also help to frame the growth outlook in Payments. Neither FIS or GPN has an asset like this.

Fintech Return to Growth:

The Fintech business has been negatively impacted by the lapping of some termination fees and client losses over the last few quarters. That should stop being a headwind come 2021. FISV has 40% share in the mid-lower end of the market and there is concern that Jack Henry and/or FIS are taking share, plus the continued fear that the overall TAM is declining as financial institutions merge and demand lower pricing on core account solutions. Expert calls have indicated that FISV's offerings are not disadvantaged relative to FIS and JAck Henry's. FISV's DNA platform (cloud based, open API) recently had a big win with NYCB and FISV indicated it signed 12 new clients in the quarter and 41 for the year, including on DNA. A focus on how FISV plans to combine some of its disparate offerings and go to market will be key for growth in this business. it will also be critical for FISV to highlight the cloud based open architecture nature of its platforms to dispel any notion that its offerings are merely traditional systems that have been upgraded to try and fit in with modern architecture. With banks closing branches and/or eliminating hours opened as a result of the pandemic, digital and mobile banking will be critical for the survival of those smaller banks and credit unions. This should drive growth in the Fintech business over the coming years as smaller banks shift budgets to more IT spending. This business has proven resilient despite years of forecasts for it impending doom and has been a steady LSD grower, and even so, is a much smaller piece of overall FISV now (and will continue to get smaller).

Consolidated Organic Growth Underappreciated:

FISV is viewed to be a slower growing business than its primary comp, FIS. However, when looking at history, and at the opportunities for growth above, I think FISV's growth is underappreciated versus at least FIS. FISV has outgrown FIS in 12 of the last 16 quarters. Street estimates for organic growth CAGR from 2020-22E have FIS just 100bps more than FISV. This could be due to the perception that FISV is a core account processing business as opposed to a business with just 20% of its revenue now tied to the slower growing Fintech business. As that perception changes FISV should start to trade back to its historical premium to the market and to at least parity with FIS.

Synergies + Organic Growth = Operating Leverage:

FISV is about 4 years ahead of it ssynergy expectations. The pandemic accelerated alot of these synergies and the cost savings are expected to be permanent. At the time of the deal announcement, FISV forecasted $900m of cost synergies over 5 years. It raised that to $1.2bn earlier in 2020. On the recent 3Q20 call, management noted it has actioned $875m of the 1.2bn in cost synergies, almost four years ahead of the original schedule. They expect to enter 2021 with $800m of net cost savings. I expect the synergy target to be raised at the analyst day and for more details to be provided as to where they are coming from and how that will impact the long-term margin of the business.

I expect operating margins to increase >700bps from pro-forma 2019 levels by 2022E. This is due to a combination of cost synergies and operating leverage. Companies that go through a merger during a downturn that have realized significant cost synergies often surprise to the upside in margins when revenues eventually inflect out of a downturn. I epxect that to be the case here and suspect that the street could end up being low in their medium and long-term margin targets. Operating margins should expand by 500bps+ from 2020-2022. Stocks dont often go down when revenues and margins are growing. FDC was dilutive to margins initially, but I expect 2021 to be the first year that margins are higher than legacy FISV.

Incented Management with History of Value Creation:

FISV announced in May 2020 that former FDC CEO, Jeff Bisignano, would assume the role of CEO on July 1, 2020, taking the place of long-time CEO Jeff Yabuki, who was well liked and respected by the street. More recently it was announced that Yabuki would also be stepping down as Chairman on Jan 1, 2021. There was concern from the market over the transition during the pandemic but the writing was clearly on the wall given Bisignano's role in the pro-forma company. While Bisignano proved himself an operator and visionary at FDC (and JPM prior to that) by turning that business around, the analyst day should be a pivotal moment for Bisignano to lay out his vision for the pro-forma company in terms of operational strategy and capital allocation. There had been some concern that FISV would stray away from its share repurchase capital allocation strategy, but that was laid to rest with the mid-Nov 60m share repurchase authorization. Management should be highly incented to generate shareholder returns. I estimate that senior management has over $1.25bn of value at risk in FISV, with Bisignano having about $1bn alone between stock and net option value (he has never sold a share). While Yabuki is no longer with the company, and has been selling shares, he still owns a significant ownership stake and I would expect him to keep an open line with Bisignano given his large financial interest. 

In addition, KKR (along with its other partners through New Omaha Holdings) is still the largest shareholder with ~16%. KKR has only sold ~35% of its original shares from the LBO and even put more money into the company in 2014. In late August, FISV sold off as KKR sold some shares at $98. I estimate that was just 3% of its original shares and not a signal of where they saw the company headed. At $117, I estimate that KKR has generated just a ~7% IRR (2.2x ROIC) on its total investment in FISV since its original investment in 2007. To get above an 8% IRR the stock would need to be >$135. Most of KKR's investment is still in the company ($12.3bn of its total $16.2bn FMV/realized proceeds). They should also be highly incented to get the stock price higher. Any periodic sales by KRR should be used as a buying opportunity.

Valuation Too Cheap Relative to FIS and to the Market:

Merchant acquiring and payment processing are above average businesses due to their secular growth, recurring revenues, high incremental margins, low capital intensity, and cash flow generation. These businesses deserve to trade at a premium to the S&P 500, as they historically have (20-25% for FISV and GPN and ~10% for FIS). Whether due to leverage from the mega-mergers in 2019 or due to the post-covid "new normal" outlook for anything digital/ecommerce, FISV now trades at a slight discount to the S&P and FIS is roughly at parity. FISV is trading at the lowest relative valuation to the S&P in about ten years on both a P/E and Ebitda basis.

FISV trades at close to a 2.5x Ebitda multiple discount to FIS and 3.0x to GPN, and 1.0x P/E discount to FIS and 3.0x to GPN. I believe FISV should eventually trade at parity with FIS which means there is multiple expansion opportunity both relative to the market and relative to FIS. If all three deal stocks eventually get the same multiple, FISV should have the most upside. One could argue GPN deserves a higher multiple because of its higher growth coming out of the recession, but historically FISV and GPN traded at similar multiples.

I expect a re-rating to occur as the market better appreciates the growth story and underappreciated assets embedded in FISV, coupled with the consistent de-levering of the business while the company repurchases shares. FISV stopped repurchasing shares in 2H20 to focus on paying down debt (after buying ~$2bn since the FDC deal closed). It announced a 60m share repo program in mid-Nov (~8% of market cap) which I would expect the company to start in earnest come 2021. FISV should generate over $4.5bn of FCF in 2021 for close to a 6% yield (7.0% in 2022, too cheap for a secular growth company). I would expect management to clarify that most FCF will go towards share repurchases in the future (4-5% reduction per year). Even being conservative and assuming $1.5bn in 2021 and $3bn in 2022, FISV could reduce the share count by >4% while bringing leverage down to just 1.8x at the end of 2022E (vs 3.8x 3Q20, and ~3.4x 4Q20E). The reduction of leverage should also enable FISV to go back to strategic M&A accretive to growth, which is what some analysts want it to do.

Catalyst

Analyst Day tomorrow, December 8th, which should provide the first comprehensive look into the pro-forma business and the key growth drivers, synergy opportunities (cost and revenue), underappreciated assets, and capital allocation strategy. The re-opening of the economy and more card-present spending should materially increase the growth in the business with 2021 looking to have >20% EPS growth coupled with significant buybacks.