V - ACI Worldwide: Lots Of Near-Term Pressure On The Stock

Summary

• The future looks bright for the expansion of digital payment methods.
• Because of the nature of the items it sells, ACI Worldwide enjoys pricing power.
• Poor economic and FX performance will have an impact on near-term performance.

Thesis highlight

Although I have faith in ACI Worldwide (ACIW) long-term goal to boost organic growth and profitability, I believe the fundamentals will be tested further in the near and medium term by the present difficult operating environment. Moreover, I anticipate that increasing short-term interest rates will further drag on earnings and profitability for ACIW because of its significant variable rate debt sheet. Consequently, I do not anticipate any substantial near-term catalyst that would cause the stock price to re-rate higher. Hence, I suggest sitting this one out.

Company overview

ACIW creates, distributes, and maintains software for the international electronic payments transfer industry. Various forms of electronic payment (credit cards, debit cards, smart cards, etc.) can be processed through the Company's products.

Digital payments have long runway of growth ahead

I believe ACIW benefits from the trend towards digital payment methods, such as ACH, debit and credit cards, and mobile wallets, as consumers and businesses increasingly move away from traditional payment methods like cash. This trend is supported by the data: in 2020, there were 1.0 trillion payment transactions, and this is expected to grow to almost triple by 2030 , with an annual increase of 8%. It is also possible that the adoption of digital payments will accelerate as people become more accustomed to conducting business online, following habits formed during the pandemic.

One development hastened by the pandemic is omni-commerce. Customers now are more likely than ever to use a combination of in-store, internet, and mobile channels to research, buy, and return merchandise. This tendency has been sped up by COVID-19, which has led to more people using cashless transactions, via online purchase. Every type of retailer, from supermarkets to C-stores, is being forced to adopt new digital payment methods like mobile app payments. This development presents a substantial chance for businesses to provide customers with safe, individualized shopping experiences that increase repeat business, boost first-time purchases, and safeguard sensitive customer information.

In my opinion, ACIW's global reach and varied offering of digital payment solutions put it in a strong position to take advantage on strong secular trends and maintain its share-grabbing momentum. ACIW's management has even declared their confidence in the company's ability to grow its market share into the high teens (source: Shareholder meeting call on May 2019).

ACIW is a very sticky product which gives pricing power

The product that ACIW offers is integral to the success of its customers' businesses. The company's flagship product, Base-24, is well-known in the financial services sector as a payment switch that facilitates cross-channel financial transactions. It is typically adopted by payment network companies Visa ( V ) and Mastercard ( MA ) as well as other significant financial institutions. Important as it is, the program processes thousands of transactions each minute for a massive user base.

Financial institutions have shown such steadfast loyalty (i.e., low churn) to ACIW product is because it is a highly specialized payment switching software that works reliably. Increased dependency on Base-24 is a result of the intricacy of every customization and the high frequency of daily transactions. Since banking transactions are ongoing with little room for downtime, updating the software would be a major undertaking that may disrupt the flow of business. This ensures a constant flow of revenue for ACIW and keeps its customers coming back. The normal term for a license to use Base-24 is five years, and ACIW has the option to annually raise the price of the license by more than the rate of inflation.

Growth runway extended with real-time payments

Base-24's tackiness is both an asset and a liability. ACIW's strong rate of customer retention allows the company to charge more for its services. However, ACIW is having a hard time maintaining a steady stream of new Base-24 clients. I believe the way for ACIW to continue growing is by leveraging on real-time payments [RTP]. The term "real-time" alludes to the instantaneous nature with which money can be transferred between accounts. Numerous nations have previously adopted RTP schemes, with the UK, Thailand, and Singapore among those with the highest transaction volumes. In the US, the Federal Reserve plans to introduce FedNow , a system that will give instant RTP access to more than 10,000 US financial institutions.

In my opinion, it is increasingly common to use card payment as an alternative to cash around the world. However, in my perspective, RTP has been the quickest grower, increasing by 65% in 2021, shows the significant gap between the growth rates of different payment methods. Furthermore, the growing need for real-time payments is reflected in the greater emphasis on RTP by players like Visa and Mastercard . Considering the long-term nature of its expansion, ACIW should continue to prosper.

When it comes to RTP, ACI starts by working with scheme operators, who are often government entities, to provide technology for RTP scheme rails. After that, ACI offers the necessary software to the banks so that instantaneous transactions can be processed. As more governments, banks, and companies implement RTP, I anticipate an uptick in new business, volume, and income for ACI. Right now, RTP only accounts for a small fraction of ACIW's overall revenue. Despite its current insignificance, I anticipate that it will become a major contributor to the company's future success as a result of rising demand and other favorable trends. Management has been secretive about RTP's bottom line, but if it's anything like the Banks segment (which has 49% EBITDA margins) and hasn't changed much despite recent expansion, I think it will be very profitable.

3Q results were not as great as I expected

Unfortunately, ACIW's third-quarter earnings fell short of my expectations in both the top and bottom lines because of the unfavorable impact of FX and increased inflation. I still think the long-term trend is good, but I don't have high hopes for the upcoming quarters since I believe these headwinds will persist. As rates continue to climb, the company's near-term earnings per share growth could be further hampered by the fact that over 60% of ACIW's debt has variable rates. While I applaud management's efforts to drive organic growth and margin improvement and return cash to shareholders through share buybacks, I anticipate mixed results in the near term until the operating environment improves.

Guidance is not great

In response to pressures from inflation and FX challenges, management lowered FY22 top and bottom line guidance. The expected range for revenue in FY22 is $1.39-$1.405 billion, down from $1.40-$1.42 billion in FY21. The middle of this range is in line with the earlier expectation of 5% growth in organic sales measured in constant currency. On the other hand, management anticipate a decline in EBITDA, from $395-$410 million previously to $365-$380 million. Due to the effects of the recession and FX, my model (detailed below) forecasts modest growth in the future years.

Valuation

My model suggests a price target of $22.71 in FY23, which makes the stock fairly valued today. This assumes modest revenue growth in the near-term, and the forward earnings multiple will be 11x in FY23e.

Given the strong secular trend, I believe ACIW will be able to grow over the long-term, but there would be heavily near-term pressure. I am giving management the benefit of doubt that they can execute as guided, hence, ACIW should trade at the same valuation in FY23.

Risk

Recession / miss guidance

As mentioned earlier, the poor macro environment and FX pressure are the immediate concerns I have over the near-term. While guidance has already considered these, the impact may be larger than expected, which would further dampen the narrative of the stock.

Conclusion

I believe a better time to invest in ACIW is after the short-term volatilities. The current difficult operating climate will put the fundamentals to the test in the immediate and medium term, but I trust in ACIW and its aim to boost organic growth and profitability in the long run.

For further details see: