Description

Event Type:

Short Duration Value Catalyst/Broken LBO/Dutch Tender

Timing: ~45 Days

Trade Recommendation:

• Long FIS stock, long October 35 conversions for the Company's early/mid-August $2.5bn "Dutch" tender with a tender price range of $29-31 per Company press release and slide presentation. Stock to conversion ratio set to result in a flat stock position post tender on our proration assumptions.
• Current IRR yields ~ 20-35% including cost of conversions
• ROR% provides the largest risk-adjusted arb spread with an early 3Q close with a much safer risk profile.

Overview / Entry Catalyst:

FIS announced on 5/26/10 that it intends to commence a $2.5bn recap with proceeds used to repurchase shares through a Dutch tender (minimum 21-22.6% of the total float at the min/max tender ranges).  Chronology prior to the tender announcement is below:

• 5/7/10: WSJ reports that a Blackstone-led consortium is in discussions to acquire the Company at ~ $32/share (~ $14.8bn, 9.3x EBITDA, 16x eps)
• 5/9/10-5/17/10: Numerous reports citing the largest shareholder, Warburg Pincus (10.8% holder via sale of Metavante to FIS in 2009) and TH Lee (4.38% holder), will not agree to low $30's price (David Faber of CNBC reported a price of $43/share).
• 5/17/10: FIS announces it is exploring options to create shareholder value, including a recap and a buyout by a 3^rd party
• 5/25/10: FIS presents at Stephens conference and announces that buyout talks have ceased, announces $2.5bn tender with a range of $29-$31/share
• 06/07/10: Debtwire reports that FIS meets with lenders to amend and extend its existing bank facilities to accommodate new HY raise and increase bank borrowings
• 06/08/10: FIS presents at RBC Tech, Media, and Communications conference reiterating debt capital raise intentions and expectation that it will be completed by early/mid August.

Despite recent weakness in the HY markets, we believe the market will easily absorb a new $2.5bn offering for FIS:

• FIS business is highly stable, sticky and predictable (14k clients, consistent organic revenue and earnings growth, high barriers and switching costs, largely insulated from financial reform legislation, 85% of revenues maintenance and processing, 16% international including Europe, Asia, LatAm)
• Day one earnings accretion supports front and back-end valuation
• Current leverage is de minimis and proforma leverage is moderate at 3.2x (7.9x interest coverage, no maturities)

• Proration and accretion analysis, FIS has previously recapped and de-leveraged the balance sheet
• Management always open to creating value

Risk Protection

Four primary risks exist with this trade: (i) FIS decides not to complete the tender; (ii) proration assumptions are miscalculated, resulting in a net long or short position post tender; (iii) tender size is reduced and (iv) cost of new financing eliminates accretion.  We believe these risks are highly quantifiable and provide a strong risk/reward set up

• HY markets, despite a slowdown in new issues, remain supportive for highly predictable businesses with reasonable leverage characteristics
• Back end valuation reasonable at ~13x 2010 earnings. Single digit revenue grower with consistent and proven margin expansion
• We believe the street would still applaud an accretion result of 5% or better which equates to a $1.75bn offering or $750m lower than announced. Under this scenario, participation increases thereby reducing the overall return, but backend valuation still results in a profitable trade
• Highly accretive transaction (8%-10% accretive) under our base case ($2.5bn tender, 7% interest rate) with substantial inelasticity to interest rates on the new financing. Transaction remains earnings accretive to the back-end valuation with a 30% higher interest rate than we anticipate (+200 bps).

Exit Catalyst:

• Tender completion or renewed LBO discussion

Tender Overview

As shown below, the proposed $2.5bn Dutch tender results in the repurchase of 86.2m shares at a $29 tender price.  Based on consensus estimates and our interest rate assumption for the proforma net debt at ~ 7%, the Day 1 earnings accretion ranges from 8% in a $31/share tender price to 10% under the minimum $29/share assumption. 

Applying the pre-tender P/E valuation to the back end (post tender) results in a $26.84-$27.34 share price.

Current share holder roster is characterized by insiders and legacy PE holders (Warburg and THL), arbitrage accounts and other institutions, retail, and passive indexers.  A summary of our tender assumptions are as follows:

• Institutions: 53% of shares outstanding, increasing build of arb accounts leading to ~ 43% of total shares tendered at the low-end tender price of $29 to capture a spread
• Insiders (FNF & management), Warburg, & THL: 16.4% of shares outstanding, none of which should tender given prior rejection of Blackstone's $32/share bid
• Passive indexers: 13.3% of shares outstanding, none of which tender at the $29/share low-end price given limited premium to current price levels
• Retail: 17% of shares outstanding, 15-20% of which tender

In total, we believe the total proration will measure between 40%-60%, with a minimum proration of 22.6% and a midpoint of 50%.

Trade Set Up

Based on our tender assumptions and resulting back-end valuation, a current, "risk-free" spread of 2-4% is created, leading to a 20-35% IRR (including conversions, based on a mid August close). 

 Probability Analysis:

As illustrated below, assigning a probability weighted price (assuming zero net exposure on back-end on tender scenarios) yields a range of $28.49-$30.14 (7%-14% above current levels) and an IRR range of 56%-112%.

Summary

FIS represents a compelling risk/return profile that is largely isolated from daily market volatility ahead of the tender launch.  While the trade is still subject to the successful bond launch, the Company has a long history of creating shareholder value and represents a highly attractive debt issuer given its sticky and recurring revenue base.  Trading at a 20-35% rate of return with a reasonable valuation and quantifiable downside risk represents a solid investment in a highly volatile trading environment.

Catalyst