Description

Key Thesis Points: (1) Durable growth of at least 7% top-line. This is driven by (a) Worldpay’s Merchant Solutions (~34% of Sales / ~37% of EBITDA) having ~45% of exposure to mid-teens growing e-commerce vertical and (b) Legacy FIS Banking Solutions growing L/MSD as they continue to win large banking clients / industry needs to outsource modernization efforts (2) Company should continually meet and/or raise synergy targets. Management team at FIS and WP have consistently achieved ~130-160% of stated targets in the past and are being paid on execution (3) Too cheap on a growth adjusted basis vs. merger-payment peers GPN / FISV and market. You don’t need multiple expansion to win but it is not unreasonable to see FIS work its way out in front of this pack. The business is setup well to take advantage of both long-term secular trends (harmonization of capital market technology sets, outsourced banking IT, and a recovery in merchant solutions with great e-comm exposure) and idiosyncratic levers (increased synergy realization, cost restructuring) which yields an algorithm of HSD top-line and ~16% EPS growth that deserves a low-to-mid 20s multiple.

Price Target: Assuming ~$9.50 of 2023 earnings power, at the historical ~22x NTM EPS, and assuming an exit at December 2022, the implied IRR is a 16% IRR, or ~45% gross upside with a Px of ~$215. With multiple expansion due to the market’s recognition of the too-wide delta that is where the Networks trade (mid-30s EPS) vs. FIS, then the IRR approaches +20%. This is all irrespective of accretive M&A which likely returns over next 18-24 months post further deleveraging.

Business Overview

·         Business History

o    FIS is HQ’d in Jacksonville, FL and founded in 1968 as Systematics. It was later acquired by ALLTEL Information Services, and then bought by title insurance giant Fidelity National Financial in 2003, who renamed it Fidelity Information Services (“FIS”)

o    Over the course of the next few years, FIS acquired several other financial technology firms, including Certegy in 2006, eFunds in 2007 and Metavante in 2009.

o    In 2015, FIS acquired SunGard, whose complementary offerings brought FIS into new markets for financial technology services, including asset managers, traders, custodians, treasurers, third-party administrators and clearing agents. This created the Capital Markets Solutions business we have today

·         Legacy FIS

o    The business operated in two segments (1) Integrated Financial Solutions “IFS” and (2) Global Financial Solutions “GFS”. The former focused on NA clients for transaction account processing, fraud and risk management with compliance, and treasury software products.

§  IFS: Its core processing and ancillary apps were catered to regional and community banks as well as larger players, acting as the system of record for any processed activity. Banks (+5,500) also used them in combination with V, MA, or AXP to issue branded credit or debit cards. On top of this platform FIS built a loyalty/reward program which has recently garnered them wins with clients like PYPL

§  GFS: Served financial institutions such as asset managers, buy and sell side firms and insurance companies. Products included trade clearing / execution, post=trade processing and settlement and regulatory compliance.

·         Worldpay

o    Payments technology company processing over 40B transactions annually and supporting +300 types of payments across 146 countries and +125 currencies. On a number of transactions basis, WP is the largest merchant acquirer and largest PIN debit acquirer.

o    The business had been predominantly brick-and-mortar which yielded a lower-than-industry top-line, but its integrated software and omni-channel solutions had been catching up, with e-commerce and tech-enabled payments moving to just under 50% of the business

Q1’20 Earnings & Business Review

·         Key Summary: Numbers came in-line with pre-announced guidance, but the call lacked forward looking guide, and the mgmt. team vs. other payment players did not come off as bullish (although I’d note the trend commentary is exactly in-line with others). The business is highly recurring with only low-double-digit revenue exposure to transactional and thus COVID impacted segments, so the lack of Q2 guidance is frustrating. Q2 color given is that EBITDA margins will sequentially contract as payment processing contribution margin is above company average (+75%) and this has been hit the hardest, while there will be 2020 margin expansion (in-line with expectations on a 2020 basis). A more one-off modeling point for Q2 is that despite volumes bottoming 30% in April, they’re expecting a 40% decline because of the deferral of the tax date from April 15th to July 15th, thus you will see a catch-up in Q3, so this isn’t lost whatsoever, but shifted (they process collections). What was impressive is the remote capabilities FIS has been able to implement. Banking Solutions are really intensive, hands-on implementation processes and they are running these 100% remotely and bagging big institutional wins (another 3 this Q, growing backlog 6%). Sell-side kept trying to coax the answer out of them that going forward they have a real opportunity to run at an even lower opex level, but mgmt. didn’t want to really go there. My take on this is that the way you get to the lower opex is by reducing the amount of headcount you used to have running the implementation, and so they’re not too incentivized to talk this up yet. This back and forth was emblematic of the entire call – sell-side trying to help these guys out but mgmt. being very even keel & steady vs. a GPN and PYPL call with different tones.

·         Key Results: Numbers at highest end of pre-announced range, with revenue growing ~2% and EPS growing ~10%. Intra-Q commentary and management call will be key as the release doesn’t have much on forward look, but some points of interest from the release: (1) Revenue and Cost synergies run-rated 25% sequentially higher and they are taking up the 2020 exit-rate cost synergy number by $120M to $700M. This roughly adds an incremental 13c to EPS or ~2.5% accretion to estimated 2020 EPS (2) They have a slide splitting out the recurring nature of the business. Shows that total revenues impacted by COVID are in the low-double-digit range. Expect this to be talked about more on call (3) Net debt reduced sequentially by ~689M and the company will be building cash going forward (has $3B of liquidity today with next maturity being 500M Euro in Q1 2021) which results in the net leverage target being hit in late 2020 now being early 2021.

·         P&L & Synergies: FIS revenue came in exactly in-line with our estimate, and beat by a penny on EPS. Recall that they had just lowered and narrowed their guide via a pre-announcement on 4/13, and numbers came in at the high-point of this adjusted range. Revenues increased 2% organically while Adj. EBITDA margins expanded 510bps to 40.5% from merger related synergies vs. our Total FIS Adj. EBITDA margin estimate of 40.2%. Similar to GPN taking up cost synergies, FIS put up some pretty impressive numbers on this front. They achieved annual run-rate revenue and expense synergies of ~$100M and $580M respectively, while also announcing that they are increasing annual run-rate expense synergy target to at least $700M exiting 2020, an increase of $120M. Note that the revenue synergies of $100M are up 25% sequentially, with a key thesis point in this name being that they continue to prove out that they can execute here. The incremental $120M of after-tax cost synergies would yield EPS accretion to numbers of ~13c. Exiting 2020, FIS will now have ~$900M of run-rate synergies across revenue and costs. In the PPT presentation they have a slide laying this out, and I imagine this is going to be a focus on the call which I think will be a net positive. The punchline of this slide is that (1) Banking Solutions / Merchant Solutions / Cap Markets Solutions are 46%/32%/20% of revenue mix respectively (2) Moderate and significant impacts per segment will be ~some / ~40% / ~zero which yields (3) Total FIS revenue expected to be hit from COVID is ~12-15% of total revenues.

Q2’20 Earnings & Business Review

·         Key Summary: FIS beat top and bottom-line expectations by ~2%, and I would characterize their tone on this call as materially better/more upbeat than the last. Management was able to provide investors with a hand-hold to their original 7-9% organic top-line growth rate in a post COVID world after a 7% organic rise in backlog of $21B, a reacceleration of growth in its Banking and Capital Markets solution businesses and a recovery in Merchant Solutions that through July is now back to growing M/HSD, ahead of consensus. The print today showed great execution on synergies, linear improvement through the quarter on the merchant solutions piece while Banking & Cap Markets continue to be L/MSD organic growers and synergy realization chugs along, up another 15-20% sequentially

·         Key Results: On consolidated basis, revenue decreased 7% organically or 6% excluding corporate & other which beat internal expectations and consensus. . Revenue was $2.962B vs. consensus’ $2.87B. Merchant Solutions declined 25%, better than feared, and was down 19% excluding the tax filing delays. The tax impact came in 30M (i.e. ~50%) better than expected as some consumers decided to keep the tax schedule and get it over with. Cap Markets beat expectations modestly and reaccelerated to +3% organic growth, coming in at ~$629M vs. ~$605M consensus. Banking came in at $1.48B, in-line with expectations and accelerated growth to 4% organic. With integrations running ahead of schedule and management executing well on cost take-out plans, EBITDA margins jumped 150bps to 39%, well above expectations. Flowing down the P&L, this yielded EPS of $1.15 vs. consensus estimates of $1.09. Lastly, the backlog increased 7% organically to $21B. This has given management confidence that capital allocation and investment dollars have been, and will continue to be, well spent as this is one of the higher growth rates on backlog they’ve seen

·         P&L & Synergies: Well ahead of the 3-year synergy target and when they will realize this. Cost synergies were up 20% sequentially and revenue synergies up 15% sequentially.

Key Thesis Points

·         +7% Revenue Growth Durability with Optionality to 9%

o    Merchant Solutions and Banking Solutions are bulk of revenue drivers here at ~33% / 46% respectively for a total contribution of ~80%

o    Management has told us that in Merchant Solutions, ~45% of the business is e-commerce where industry growth rates from the national retail federation are reported in the mid-teens rate

o    Assuming LSD growth on more traditional retail and an in-line industry growth rate for WP, than we can back into reasonable parameters to believe in vs. what we are underwriting

o    Note there are two sets of synergies flowing through the model on the revenue side: (1) FIS/WP revenue synergies with a guide of $550M run-rate and (2) WP/Vantiv revenue synergies of ~$125M run-rate which has also been taken up per mgmt. commentary on recent calls

o    Assuming 75% achievement, below shows what we are implicitly underwriting on the top-line as an organic/inorganic mix split; 2021 demands the greatest belief in inorganic achievement at ~13% of 8.5% underwritten growth for that year.

§  Note that the organic is lower in FY2021 as this is when the synergies begin to run-rate more aggressively due to management reinvesting the incremental dollars in the beginning of 2020 so the YoY comps are minimal to zero

·         Highly Achievable Cost Synergies While Revenue Synergies Seem Reasonable

 o    Revenue Synergies (Originally 500M, now 550M – at least 150bps of growth)

§  Driver: (1) Global expansion in India and Brazil where there is presence today (2) Enhancing Fraud solutions and Increasing authorization rates which drives clear incremental dollar volumes in processing (3) Cross-selling of payment processing (4) Enabling alternative payment types

o    Cost Synergies (700M - 300bps of margin expansion)

§  Driver: (1) Combining issuing and acquiring capabilities from both companies (2) Technology integration / ridding of duplicative tech and data center costs (3) General corporate costs (4) Int. Expense Savings

o    In most situations the revenue synergies tend to be heavily discounted while cost synergies have more actionable plans, but in early days of the merger management has taken these up from $500M to $550M (10% jump) and are run-rating at 80M as of Q4’19

o    This may be a rarer occasion where underwriting even a 75% achievement level of synergies is warranted as (1) Management has done this in the past. Precedent deals show that they have executed at ~130-160% of originally stated synergies (2) ~50% of performance comp is tied to revenue synergies (3) The pace at which they have hit numbers a few quarters in is impressive and at 75% achievement we are saying they can do half of what they have done in the past

·         Cheap Valuation

o    FISV trades 23x/19.5x and GPN at ~26x / ~21x respectively vs. FIS at ~25x / ~21x

o    While FIS has the slowest 3-year forward EPS CAGR outlook at ~17.5% outside of Visa (who trades ~31x) although I’d note there is some optionality here with synergy realization and higher organic growth such that our bull case suggests it could reach ~20%

o    On a growth adjusted basis, it is trading at a PEG of 0.9x on 2021 vs. the S&P at +1.5x, and FISV/GPN at ~1.1x 

o    The upper-bound 2021 multiple is set by payment players V/MA/PYPL in the ~32-35x range 

 Key Risks / Mitigants

·         Bank Upgrade Cycle Doesn’t Have Legs

o    Bear Case: In a low-interest rate environment, customers are being squeezed and so the budget TAM is ultimately constrained.

o    Mitigant: The Banking IT budget is a GDP +50bp-100bp grower. There is no end in increasing regulation in the sector and mid-to-upper size banks will not become technically competent overnight. Modernization of infrastructure is in a different category than say marketing – it is a necessity for companies, not a nice to have.

·         Competition from Growing FinTechs

o    Bear Case: Well-funded private fintechs are increasingly capable and taking share in the e-commerce vertical such that Merchant Solutions HSD/LDD growth could be at risk.

o    Mitigant: Enterprises are increasingly looking to consolidate the amount of software they subscribe to, especially on the payments side. Worldpay offers over 300 options for payment acceptance, and now has a potential edge on authorization rates moving higher as they leverage FIS’s data. They are well positioned to be continue growth here.

·         Integration / Synergy Realization Risk

o    Bear Case: Outside of SunGard, this is the biggest deal FIS has done and revenue synergies are notoriously difficult to give credit to, which the market seems to be doing.

o    Mitigant: Management has executed at 130-160% of synergy targets in the past. Even giving them ~50% credit despite an uptick in guide in the most recent quarter due to strong execution would still arguably make the investment tenable. 

Catalyst

Continued execution on synergy realization and organic growth acceleration

Potential M&A and buybacks as FIS delevers

Investor realization of Network vs. Payment Deal Stocks multiple gap