FISV - Reasonable Probability That Fiserv Will Underperform The S&P 500 In The Future

2023-06-05 08:41:31 ET

Summary

• Fiserv is a diversified company in the growing payments industry, but its current valuation may only offer high single-digit annual returns to investors.
• The company's merger with First Data in 2019 has improved net income and FCF, but its ROIC has suffered and needs to improve for efficient capital allocation.
• Fiserv's peers, such as Adyen and Shift4, have superior growth rates and balance sheets, making them more attractive investment options, but also more risky.

Thesis

The payments industry is a really interesting one, especially as more and more governments are trying to reduce the use of cash, so I think it will offer the opportunity for strong returns. And the two heavyweights, Mastercard (MA) and Visa (V), have shown what could be possible for the next generation, although of course it will be very difficult to match their level of pricing power and market dominance.

And even more established companies like Fiserv (FISV), with their highly diversified business, could play a bigger role as they improved in this area through the First Data merger in 2019. However, if you have high expectations for future returns such as 15%+ per annum, I do not think that Fiserv is the right investment for you as I would think that they are more likely to have a return in the high single digits per annum.

Growth rates and growth opportunities, combined with management's capital allocation skills, make some of their peers more likely to deliver strong returns. Fiserv is still a strong company, but I would prefer other peers at the moment for the reasons I will explain in the following sections.

Analysis

I think the decision to merge with First Data in 2019 was the right one, as it led to good synergies between the two companies and created a company with better prospects for the future.

The increase in revenue is clearly visible in 2019 and the following years, and now stands at almost four times the pre-merger level in 2023.

Gross margins were the same for some time, but improved in 2021, while EBIT margins initially fell and also started to recover in 2021.

But if we look at net income and FCF, we see that both have improved drastically since 2019, and therefore I would argue that the merger has been successful as of today. In particular, Clover , a business management platform for SMBs, is an interesting asset for future growth.

Otherwise, Fiserv has their online and mobile banking software where they serve a couple of thousand SMB banks that use them to operate their business and that is a great business for them because the revenues are relatively stable because the switching costs for their customers would be enormous and therefore their revenues are protected in that area. Also, regulatory and compliance requirements, combined with their acquired knowledge, act as barriers to entry.

And with Star Network, they also have the third largest debit network behind the two behemoths, which have a market share of around 80%.

All in all, Fiserv focuses mainly on SMBs and likes to grow through acquisitions, which makes it relatively similar to Shift4 Payments (FOUR), which has a comparable strategy and partly competes with Clover. If you are interested in Shift4, you can read an article I wrote about it here .

In addition, Fiserv has their Carat product where they serve larger companies, so as I said, one of the strengths of Fiserv is that they are a very diversified company with many different products and potential customers.

And I should add that Fiserv will begin trading on the NYSE on 7 June under the new ticker FI, having moved from the Nasdaq.

Comparison

As competitors I have chosen PayPal (PYPL), Adyen (ADYEY), Block (SQ), Fidelity ( FIS ) and Shift4 Payments. What is remarkable is that all of them are more or less dependent on Visa and Mastercard, which should give us an idea of the enormous market power of the two giants. And if you are interested in a more in-depth analysis of Adyen, which I believe is the highest-quality company in the peer group, you can read it here .

At first glance, it is noticeable that almost all of them trade at high multiples, and PayPal is the only one where it could be argued that it is fairly valued on an EV/EBIT level. In particular, the high-flyers Adyen, Shift4 and Block are quite expensive.

And the rich valuation on the previous chart is explained by the superior growth rates of Adyen, Block and Shift4. However, it should be noted that Fiserv has had really strong EBIT growth over the last 3 years.

And if we look at net debt, we see a common criticism of Fiserv, which is its debt load, and particularly with the old established companies like Fiserv and Fidelity, they have a lot. But it is mostly debt with low interest rates. And well, a quick ratio of less than 1 for Fiserv, PayPal and Fidelity is interesting when high-growth companies like Adyen, Shift4 and Block have a more robust ratio while still growing much faster.

But the biggest point where I would say that Adyen is the best of its peers is the FCF margin combined with the very high net income per employee. This shows that they have a strong competitive advantage due to a lower wage base and fewer employees. American companies have generally been overstaffed and overpaid compared to European companies where you probably have the same level of talent but you don't have to pay them as much. But many American companies have realized this and are likely to improve.

You can see the comparison by following this link to the Search Alpha Peers tab.

Reverse DCF

To see what is priced into the shares to get a 10% return, I took the TTM diluted EPS of $3.78 . As a result, EPS would have to grow by 14% over the next 10 years to justify the current price. The historical growth rate over the last 10 years has been 13.23% per annum , so the stock is probably a bit overpriced if you want to get a 10% annual return. Therefore, I would argue that at the current share price you could expect a high single digit return, and probably as a result Fiserv could underperform the S&P 500, as the total return for the index is around 10% per annum.

Conclusion

Fiserv's ROIC has suffered somewhat since the merger in 2019, so I'm interested to see if they can improve this metric going forward, as I think it's one of the best indicators of efficient capital allocation. And normally, after almost 4 years, you should start to see signs of improvement in ROIC.

In summary, Fiserv is a highly diversified business with some sticky revenues in the banking sector in an industry that is poised for growth. As they do not have much room for multiple expansion as they are not a fast growing company in terms of revenues, they need to grow by increasing earnings and using capital efficiently. But this is where they are struggling a bit at the moment, and combined with the growth rate that is priced in, we see them as a company that is likely to reward shareholders with a high single-digit annual return over the long term.

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