Don’t Rule Out the Whole Financial Sector
11/20/2008 11:00 am EST
Paul Larson, editor of Morningstar StockInvestor, finds one financial services firm that is beating the odds.
We think bank technology provider Fiserv's (Nasdaq: FISV) new focus on cost-cutting will drive some incremental improvement in its already-solid performance, and the acquisition of CheckFree improved Fiserv's competitive position. Although the near term could be difficult given the stress on its bank customers, we think Fiserv is well positioned for the long haul.
Fiserv's main business, which accounts for more than 70% of pro forma revenue (excluding pass-through items), is core processing and related products for banks, and it holds a leading 34% market share. Banks rarely switch core processing systems, due to the potential for interruptions, and the need for employee retraining with a new system. Customer retention is very high, about 99% annually, excluding customers lost because of acquisitions by another bank. Fiserv's sticky customer relationships and cost advantages add up to a wide economic moat, in our opinion.
The company has sold its nonbanking businesses and acquired electronic bill payment provider CheckFree. We think this will allow Fiserv to focus on its most attractive segment and the combination of leading positions in core processing and electronic bill payments will cement its position as the leading bank technology provider. As the first mover into the electronic bill payment industry, CheckFree has been able to build a huge lead and a marked cost advantage. Furthermore, CheckFree has a big growth runway in front of it as electronic bill payment adoption ramps up.
Stewardship is fair on the whole. CEO Jeff Yabuki 2005's focus on cost control and integration of the company's products makes sense. We also like the divestitures and acquisitions that he has overseen. However, we do not like the fact that incentive compensation is largely driven by earnings-per-share goals, an easily manipulated number that doesn't necessarily correlate with long-term value creation. We do like that the company has returned much of its free cash flow to shareholders through stock repurchases. We also like that CheckFree chairman and CEO Peter Kight-largely viewed as the founder of the electronic bill payment industry-stayed on and joined Fiserv's board.
Our fair value estimate is $64 per share. We project revenues to increase at a 10% compound annual growth rate during the next five years, largely because of the addition of CheckFree. We expect Fiserv's legacy businesses to grow at a 3% rate, with a difficult banking environment weighing on near-term results. We expect operating margins to improve from near 24% to 27% during the next five years because of the falloff in amortization as a percentage of revenue and cost-control efforts.