Description
Fidelity National Information Systems (FIS)
Stock Price: $23.21
12 Month Price Target: $30.00
Shares Outstanding: 194M shares
Market Capitalization: $4.4B
Enterprise Value: $6.6B
EBITDA FCF
FY2008E: 880M (7.8x) FY2008E: $1.75 (13.3x)
FY2009E: 975M (7.0x) FY2009E: $2.20 (10.5x)
FY2010E: 1,100M (6.4x) FY2010E: $2.65 (8.7x)
Summary and Conclusion:
FIS, formerly known as Certegy Inc., is a global provider of core transaction processing services to financial institutions, retailers, and real estate professionals. FIS provides essential back office functions - such as technology support, customer account maintenance, and credit card processing - for over 13,000 domestic and international banks. FIS operates a business with attractive characteristics for long term investors: high recurring revenue (85-90%), long term contracts (up to 5 years) with automatic price escalators, and strong free cash flow in excess of net income.
We expect FIS to generate 6%-9% organic revenue growth and 20%-25% FCF growth over the next several years. This growth will be driven by favorable industry dynamics such as the ongoing trend toward core systems outsourcing by small banks and rapid conversion to card and other electronic-based payments as cash and checks are replaced in the payments stream. As additional processing volumes are spread across the platform, we expect EBITDA margin expansion of 200 bps over the next three years. Based on the current valuation of peers (8.9x EBITDA) and a 15% discount to the historical average of 10x, our 12 month target for FIS is $30, or 8.5x 2009 EBITDA of $975M.
Business Analysis:
Through 10 acquisitions since 2003, FIS has established a low cost transaction platform that is scalable, has high barriers to entry, and significant switching costs due to the mission critical nature of the service. FIS’ most recent significant acquisition, eFunds, closed in 4Q07 and boosts the revenue base by 20% - increasing the bundling and cross selling potential further. FIS has proved proficient at integrating businesses with a unique offering into FIS’ distribution network. Organically FIS has grown the top line a compounded 10% during the last three years, with an EBITDA growth CAGR of 12.5%.
While investors have contracted FIS’ multiple during the credit crisis – to a small degree deserved as FIS’ end markets are undeniably weaker – FIS will prove to be much more resilient than other derivatives of the financial sector and will demonstrate that the contraction was overdone (10-12x to under 8x EBITDA). During 2007, recurring fees from processing and maintenance totaled 86% of revenue – business that is secured in long term contracts where the cost to service the account falls every year and the prices realized automatically rise. Professional services are 8% of the business, and while the sales cycle here has slowed our checks indicate it has not stopped. The only significant pockets of weakness are found in the discretionary software and equipment sales business (5% of revs), where numbers could be down 20%.
After demonstrating 7.3% organic growth in 1Q08 and 6.6% growth in 2Q08, we believe the top line should remain in healthy shape for continued strong growth of free cash flow. Management is currently guiding to $1.60-1.80 in FCF for FY08, but has given indications this could be conservative due to a focus on lowering the capital intensity of the business. Using numbers in line with guidance laid out in detail during the June road show (leading up to the spinout of LPS in July), and confirming these trends with industry checks – we arrive at a 10% FCF yield next year at these prices. For a business where 85-90% of earnings power is protected 12 months out, and where the fundamentals are driven by expansion of international banking, conversion of customers to online services, and growth in credit card and ATM transactions – we are surprised to see the price tag of 10x FCF.
Valuation:
Of our two main pure play peers, Fiserv trades at 9.6x EBITDA and Metavante sits at 8.8x. Neither is forecasted to grow EBITDA faster than FIS’ rate of 10-12% for the next three years. FIS sells for 7.8x ’08 EBITDA. With less than a turn lift as FIS continues to prove organic growth, we arrive at a target of $30, or 8.5x 2009 EBITDA of $975M. FIS’ historical multiple is higher than 10x EBITDA.
To reconcile FCF growth of 20-25% with EBITDA growth of 12%, we predict reductions in NWC consumed as small but capital intensive businesses are sold. We also anticipate lower capex as a percentage of sales (’08 is at the high end of long term mgmt guidance of 5-7%), and significant pay down of debt ($600M in next 18 months, or 25% of net debt).
Our Financials:
|
|
2007 |
2008 |
2009 |
2010 |
|
Revenues |
2,950 |
3,523 |
3,778 |
4,054 |
|
Gross Profit |
673 |
863 |
945 |
1,034 |
|
SG&A |
252 |
335 |
351 |
369 |
|
R&D |
70 |
75 |
80 |
85 |
|
Operating Income |
351 |
454 |
513 |
580 |
|
|
|
|
|
|
|
EBITDA |
724 |
879 |
976 |
1,080 |
|
|
|
|
|
|
|
FCF/Share |
$1.15 |
$1.75 |
$2.20 |
$2.65 |
Segment Breakdown:
FIS partitions the business into the following three different segments organized by customer size and geography: Integrated Financial Solutions (IFS), Enterprise Banking Solutions (EBS), and International. Due to the intangible nature of the business, we have provided a detailed description of each major service. We also include the latest performance by segment.
Integrated Financial Solutions - 44% of 2Q08 Revenues
Integrated Financial Solutions provides banking systems for community banks, credit unions, and savings banks – generally institutions with less than $5B in assets. Here FIS provides core processing, credit and debit card account services, and online banking and bill pay. In 2Q08, IFS revenue grew 28.1%; 4.5% organically.
Core Processing - The core bank processing system, once outsourced to FIS, acts as the underlying infrastructure for financial institutions’ processing environment, maintaining the primary records of customer accounts. FIS also provides a number of additional services that interact directly with the core processing applications, including applications that facilitate interactions between its financial institution customers and their clients. Services are offered on a bundled or standalone basis through on-site outsourcing, remote processing, and a licensed software basis for installation on customer-owned systems.
Credit and Debit Card Services – As a card-issuance processor, FIS provides complete, turnkey card-processing services which span every component of the card lifecycle including application processing, clearing and settlement, fraud management, payment processing, and customer service. FIS can handle almost every single element of a credit card account, leaving the card issuer with only the responsibility for establishing cardholder criteria and putting up the capital to fund the cardholders’ receivables. FIS users typically utilize the full service option.
FIS’ card-processing operation is relatively evenly split between domestic and international accounts. While FIS is a smaller player in the U.S. market (vs. larger players First Data and TSYS) the U.S. remains a large and important market, representing over half of worldwide Visa and MasterCard purchase volume and nearly half of worldwide Visa and MasterCard accounts.
eBusiness – The eBusiness segment is the fastest growing of FIS’ Transaction Processing businesses, expanding at a solid double-digit pace, with pieces such as internet banking and bill payment growing closer to 20% or greater. FIS’ online banking product gives users the option of bypassing the time-consuming, paper intensive aspect of traditional banking in order to manage their finances more efficiently. Bill payment enables users to pay their bills electronically online.
Enterprise Business Solutions – 33% of 2Q08 Revenues
Similarly to IFS, in this segment FIS provides core banking services but to a larger customer, such as a top or mid-tier financial institutions and retailers in the US with greater than $5 billion in assets. In 2Q08, EBS revenue grew 15.9% to 284.3M and declined 7.3% organically. However, 2Q07 was a tough comp with $11.2M in fees from a large implementation during the quarter. Backing out a decline of $6.1M in the check risk management business (under review for possible sale) indicates the core business was flat on an organic basis in the period.
Core Banking - Currently, FIS services 4 of the top 10 and 44 of the top 100 U.S. banks with its deposit solutions. In commercial lending, FIS services all of the top 10 and 20 of the top 25 global banks. FIS is beginning to see some large banks explore its core banking solutions offerings, signaling a possible future move towards a replacement and consolidation of core operating systems in the large bank segment. Currently, large banks core systems are largely proprietary and utilizing older core technologies
International - 23% of 2Q08 Revenues
International accounts for all core processing and credit card services to customers outside of the US. In 2Q08, Int’l revenue grew 42.2% and 34.2% organically. Strong progress in Europe, the Middle East, and AsiaPac provided the growth.
Core Banking - FIS provides international core bank processing solutions on both a license and outsourced model. In the core banking market, FIS has several competitors internationally including SAP, Alnova, Oracle, Temenos, and TCS. In addition, FIS provides item and back office business process outsourcing to banks, primarily in Brazil currently, where it launched a BPO and item processing business in June of 2006.
International Card Services - FIS’ market share of international card-processing is on par with its major U.S. competitors, First Data and TSYS. Together, the top three U.S. processors only handle ~7-10% of the international credit card market compared to ~50% of the domestic market. The majority of the international market is processed in-house, but outsourcing has been gaining market share. While FIS targets smaller issuers domestically, the company tends to target mid-tier and large issuers outside of the U.S. With the growth in the number of cards issued expected to slow in the U.S., FIS’ large international presence is attractive. FIS has a particularly strong foothold in Brazil where the company formed a credit and prepaid card processing joint venture with Banco Bradesco and Banco ABN AMRO Real in March of 2006.
Management:
William P. Foley, II, Chairman
William Foley has served as a director of FIS since February 2006 and is the Executive Chairman of the Board. Mr. Foley has also served as the executive Chairman of the Board of FNF since October 2005. Mr. Foley served as Chief Executive Officer of FNF from October 2006 until May 2007. Mr. Foley served as Chairman of the Board and Chief Executive Officer of old FNF from that company's formation in 1984 until the FNF Merger.
Lee A. Kennedy, CEO
Mr. Kennedy joined FIS in February 2006 as a result of the merger between FIS and Certegy Inc. Prior to the merger, Mr. Kennedy was serving Certegy as its Chairman and CEO and from July 2001 to February 2002 as its President and CEO. His previous position was President and Chief Operating Officer of Equifax Inc. and prior to that he held the position of President of Equifax Payment Services, in St. Petersburg, Florida. In April 2004, Mr. Kennedy was elected to the Board of Directors of Equifax Inc. and presently serves on its Board.
Risks:
Bank Consolidation – if FIS customers are acquired by a financial institution with an internal system or a competing platform, we will be exposed to additional churn. However, banks have been consolidating for years, and as FIS tends to serve a greater share of larger banks, the business tends to stay with FIS. Consolidation of two customers generally doesn’t dramatically change the economics either, as individual customer accounts (what FIS is processing) are not merged.
Deferred Software and Service Purchases – as mentioned earlier, financial institutions are in cost cutting mode where possible. The discretionary portion of FIS’ business (14% of FY07 sales) can and should be sensitive to the health of the end market.
Lengthening Sales Cycle – for the recurring portion of FIS’ business, we believe the sales cycle tends to be lengthening on renewal. As competitors are invited to bid after five year contracts expire, we will likely see pricing pressure on the initial value of the new contract. FIS maneuvers this risk via adding services to the deal to lift the revenue realized, and maintaining price escalators throughout the contract.
Catalyst
Organic growth remains in LT ranges,
FIS initiates stock buyback,
Financial sector stabilizes (I'm not holding my breath)