More Business News:

Fiserv: A Solid Buy in the Financial Services Sector - cbl

By Bharat Ahuja

Fiserv (FISV) is the leading provider of products and services required by financial institutions to run their banking operations. Fiserv has over 16,000 clients and in 2009, generated $4 billion in revenues, $850 million in cash flow from operations, $668 million in free cash flow. Since the management change in 2005, Fiserv has been in a state of flux. Management has focused on strengthening the core financial services business via strategic acquisitions, improving operational efficiency and divesting non-core assets such as the insurance and health segments. Today, the company is organized under two segments -

1. Financial Services - This segment provides banks, thrifts and credit unions with core banking services such as account processing, item processing, loan origination / servicing products and other services that support many different financial transactions. These services are billed on a per account (general deposit account servicing and maintainance) or per transaction basis (check clearing, check imaging, etc). Many financial institutions choose to outsource their data processing operations in order to cut the costs needed to maintain in-house IT operations. Fiserv has a dominant market share of 37% in this business segment. This segment generates 47% of revenue and 48% of operating income.

2. Payment - This segment provides electronic banking, electronic bill payment and settlement, credit/debit processing products and other related services to support the electronic transaction processing needs of the financial services industry. In late 2007, Fiserv acquired Checkfree Corporation. This acquisition transformed it into a leader in electronic commerce services and products including electronic bill payment and internet banking. This segment contributes 53% of the company revenues and 52% of the operating income. This segment should also provide much of the future growth for Fiserv.

Approximately 80% of Fiserv's revenues are generated from account and transaction based fees typically under contracts that are 3-5 years in length. Since Fiserv supports core banking functions that support day-to-day operations, its business is fairly robust and not very economically sensitive. In addition, high switching costs and risks such as potential outages due to system changes result in very low client attrition rate of < 3% and hence stable, predictable cash flows.

Is this a growth story?

A common risk associated with Fiserv is the risk of consolidation within the financial industry. In the past 25 years, consolidation has resulted in -3% CAGR in the number of financial depository institutions. On the other hand, assets in the financial industry have grown by more than 5 fold over the same period. Also, in the last five years, deposit accounts in the US have grown at the annual rate of 7% and now total 718 million. Since Fiserv derives its revenues primarily from fees collected for deposit account servicing and transaction processing, the number of deposit accounts have a stronger influence on Fiserv's fortunes as compared to the number of depository institutions.

Fiserv is the leader in electronic bill pay processing and provides the largest network of places to pay them, both via the financial institution websites as well as billers' own website. An avenue of growth is the increase in adoption of electronic banking and electronic bill payment transactions. Electronic bill payments represent significant transactions volumes for financial institutions. This should further increase as mobile / handheld devices add to computers as a means to get online. Over time, the number of billable services that support our daily lives also continues to increase. Current electronic bill pay customer adoption among Fiserv's client base averages 10%. The company believes that this average adoption rate can be increased four to five fold.

In today's tough economy, the company forecasts 1-3% growth in revenue for 2010 with 5-8% growth in free cash flow. Longer term, Fiserv expects to grow its revenues in the range of 6-9% with 10-14% growth in free cash flow.

Management

The management continues to take steps to strengthen the recurring revenue or transaction based business model by strategic acquisitions (example - Checkfree) and new innovation (example - ZashPay - p2p e-pay). The goal is to make Fiserv a global leader in transaction based technology solutions.

In addition, the following points are noteworthy -

1. Management continues to eye debt reduction as a use of free cash flow though long term debt is a very manageble 2.8 times EBITDA. This debt was acquired during the $4.4 billion acquisition of Checkfree in 2007.

2. In the last 5 years, the shares outstanding have been reduced by 20%. In May 2009, a 5 million shares buyback was authorized (2.2 million shares authorization remaining by Dec 2009) . In Feb 2010, additional 5 million shares buyback was authorized. With solid free cash flow and low capex requirements, these buybacks should continue.

3. Management continues to own shares and align themselves with shareholders. The chairman owns ~ 2.2 million shares. Total outstanding shares are ~ 152 million.

4. Since the new management took over in 2005, improving operational effectiveness has been a focus. In the past five years, operating margin has improved by about 5.8% to end at ~ 23%. Management has stated that further gains in operating margins should be achieved. More news on this front is expected at the investors meeting this Fall.

Valuation

Fiserv competes in a market dominated by few players such as Fidelity National Information Services (FIS), and Jack Henry (JKHY). Few market players and high switching costs result in stable pricing and hence, predictable cash flows.

In 2009, $668 million of free cash flow was generated. 2010 free cash flow is expected to be $720 million. With a market capitalization of $6.9 billion, the company trades at 9.5 times 2010 free cash flow. Also, note that stock buybacks and debt reductions will further highlight the company's under-valuation.

Disclosure: Long FISV