Valuation in the Payments Space and FIS as a Preferred Name

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Howard Mason

203 901 1635

hmason@ssrllc.com

November 5, 2015

Re: Valuation in the Payments Space and FIS as a Preferred Name

  • We are buyers of FIS following the sell-off from Tuesday’s Q3 report when the firm met eps consensus of 90 cents, but revenue of $1.58bn missed by $60mm. This was largely driven by the consulting business as large banks cut back on services given the “lower-for-longer” rate environment and can be mitigated in earnings by reducing headcount. Regardless, at just over 9x 2016 EBITDA (expected to grow ~9% in 2017), the stock has over-reacted particularly given the upside potential from the Sungard acquisition (expected to close in Q4) and FIS’ access to bank payment accounts which underpins its partnership both with the merchant payments consortium, MCX, on the CurrentC-branded mobile wallet (minimum contractual payments began October) and with The Clearing House on its real-time payments initiative (announced last month).
  • FIS will not gain processing fees directly from the recently-announced Chase Pay partnership with MCX (since debit transactions will settle over JPM’s ChaseNet rather than FIS’ PayNet) but there are network effects so that JPM’s participation increases the value of MCX’ CurrentC mobile wallet for the entire ecosystem including FIS. Furthermore, while JPM has indicated ChasePay will use Visa tokens until it can itself provide a vault, we believe there is opportunity for FIS, through Paydiant, to be involved in tokenization where Chase Pay is embedded in the CurrentC wallet rather than presented directly.
  • We expect Sungard and MCX to add ~2% to EBITDA CAGR for FIS and lift it from the “more conservatively-valued” tier of payment companies to the “more aggressively-valued” tier. We have discussed these opportunities in earlier research, and the focus of this report is the broader valuation framework for payments particularly the bifurcation evident in the Chart below.
  • Beyond FIS, our preferred names are VNTV and PYPL while we have concerns with V, ADS, and AXP. We prefer MA over V because it has signed key private-label card providers, including C, ADS, and SYF, to its token service and will therefore differentially benefit from the share shift to private label as retailers use “closed-loop” systems to combine item-level checkout information with customer-identifying authentication information so as to improve the targeting of ads and offers (and hence efficiency of trade-spend) and more generally personalize the shopping experience.

Chart: Valuation in the Payments Space

Source: CapitalIQ

Overview

As illustrated in the Chart above (where we include goodness-of-fit measures despite the statistical limitations of small sample size), valuation in the payments space appears to split the names into two groups. We refer to these as the “more conservatively-valued” tier and the “more aggressively-valued” tier and include the supporting data in Exhibit 1.

Exhibit 1: Valuation in the Payments Space

Source: CapitalIQ

We can find no satisfactory explanation for the bifurcation and, indeed, believe that three of the names in the more conservatively-valued tier (FIS, VNTV, and PYPL) have the strongest competitive positions in the industry: FIS because of access to over half of checking accounts in the US (which underpins its relationship with the merchant payments consortium, MCX); VNTV because of its leadership position in the ISV channel (which will become increasingly important as the portion of acquirer-processing revenue accounted for by software solutions, or so-called iPOS terminals, increases from ~one-quarter today to ~one-third in 2018); and PYPL because of its leadership position in gateway services across browser (legacy business), app (Braintree), and in-store (Paydiant). These ideas are discussed in detail in prior research notes.

Furthermore, we have concerns around some of the names in the more aggressively-valued tier. For example, ~60% of the “adjusted” EBITDA at ADS is generated from its subsidiary banks, Comenity Bank and Comenity Capital Bank, which support the card lending business; these businesses are more properly valued, as all US banks are valued including card lenders such as SYF, on a multiple of tangible book and, on this basis, would account for less than half of enterprise value (implying that the non-card businesses are being valued on EBITDA multiples of over 17x even though growing more slowly than the card business). At AXP, ~60% of revenue is generated from the fees paid by merchants to accept Amex-branded cards and these fees will be under increasing pressure now that, following a Court ruling in February, merchants have the ability to steer customers to alternative brands with lower acceptance costs.

While erosion of merchant fees does not directly impact V and MA (since these fees are largely passed through to banks in the form of “interchange”), the pricing power of the networks in the US – underpinned by their “honor-all-cards” and, in a mobile context, “honor-all-tokens, rules – is being threatened by disintermediation: the partnership between Chase Pay and the CurrentC mobile wallet from the merchant payments consortium MCX is a specific example and the share-shift to private label cards (see Exhibit 2) a more general example. The driver of this share shift is the opportunity provided by private-label cards to support targeted marketing by retailers through combining the item-level (a.k.a. SKU-level) transaction information available to a retailer with the authentication information (a.k.a. PII or personally-identifying information) available to the bank maintaining the payment account. Visa does not typically have access to item-level information and, except in the case where a shopper uses Visa Checkout does not have access to PII. We provide a detailed discussion of these investment theses in earlier research.

Exhibit 2: Share Shift to Private Label in Card Lending

Source: SYF Presentation, May 2015

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. The analyst principally responsible for the preparation of this research or a member of the analyst’s household holds a long equity position in the following stocks: JPM, C, BAC, WFC, and GS.

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