2023-11-27 07:37:19 ET
Summary
- Fiserv reported strong Q3 earnings, leading to a 4% increase in stock price.
- The company showed impressive revenue growth and margin expansion.
- Fiserv also displayed continued capital allocation discipline.
I initiated my coverage of Fiserv in September 2023 with my article, Fiserv: Growth Set To Accelerate. In this article I outlined my thesis. I believed that Fiserv's fundamental performance would outperform that of the S&P 500, leading to long-term stock outperformance. I concluded that although the valuations were similar, the merchant acceptance business would drive overall growth thanks to rapid growth from Clover and to a lesser extent, Carat. I also came to the conclusion that recent regulation changes in the payment network industry provided Fiserv with additional upside optionality. I'm revisiting this stock after strong Q3 earnings and their recent investor day.
Fiserv (FI) reported Q3 earnings at the end of October, the company demonstrated strong revenue growth, margin expansion, and continued capital allocation discipline resulting in the stock rising 4% on the day.
Fiserv vs S&P 500, 1 year price chart (Seeking Alpha )
The business has outperformed the S&P 500 this year as fundamentals have remained strong, margins have expanded and the company has continued to invest in growth. I expect this strong fundamental performance to continue outperforming the market.
Revenue growth
Since Frank Bisignano took over as CEO after the merger between Fiserv and First Data, revenue has accelerated from a mid-single-digit growth rate to low double digits. The company handily beat its last 3-year revenue target laid out at the end of 2020 during the investor day, demonstrating the strong execution of the company, The company previously expected 7% to 9% organic revenue growth, instead, the company achieved 11%. In Q3 2023, Fiserv grew organic revenue by 12%, accelerating from 10% last quarter. The main driver of this growth came from a 20 % organic growth rate in the merchant segment, while payments and Fintech both grew 6%, these results beat analysts' expectations.
Fiserv revenue per share ( Stratosphere.io )
Merchant Acceptance
Historically The Merchant acceptance business has been the fastest growing segment growing 17% annually over the past 2 years and I expect that to continue going forward, this segment also has the largest opportunity to increase margins over time. At the 2022 Merchant day, Fiserv laid out its 2025 targets of achieving $10 Billion in revenue and Fiserv is on track to exceed this goal. As mentioned before the Merchant business grew 20%, with year-to-date revenue growth of 17%, Fiserv expects another strong quarter. Clover and the International segment drove this strong growth. Volumes for the segment grew by 2% or 6% when adjusting for the wholesale client loss. Transactions were a similar story with growth of 1% or 9% when excluding the wholesale loss. Over recent years Fiserv has been transitioning from providing processing services to a full-service acquiring solution. This business model shift means revenue growth will continue to outperform volume growth as the business earns more per dollar volume, I expect this to continue as the business continues to increase the penetration of value-added services.
Clover
Clover revenue growth (Company presentation)
Since 2021, Clover has grown revenue by 27% annually, as they have increased software penetration at a 33% CAGR, grown clients at a 23% growth rate, and increased GPV by 11% annually. Clover contributes 25% of revenue to the merchant acceptance business and is growing 3x faster than the segment at 27% vs 8%.
Clover posted a great quarter, with revenue accelerating to 26%, up from 23% in Q2. Clover's annual GPV reached $272B, up 15%. The 11% difference between volume and revenue is due to the increasing penetration of value-added services of Clover, in the quarter VAS penetration reached 17% and is on track to reach the 27% target by 2026. Clover still has many opportunities to increase revenue growth to the targeted 28.5% through 2026.
Clover is growing in 3 ways: client growth, software and services penetration ((VAS)), and expansion into new verticals. Since 2015, Fiserv has grown its client count by 30% per year, however, this has decelerated to 23% over the past 2 years. Fiserv is working to reaccelerate this growth in a number of ways;
First, Fiserv redesigned its website Clover.com to create a more seamless signup process. Fiserv has also increased the number of hardware options, creating options for every type of business. The company has also added more sophisticated software solutions to attract larger and multi-location clients. The last growth area is International, currently, Fiserv is present in 8 markets, over the next 2 years Fiserv will be expanding to an additional 5 markets; Brazil, Mexico, Australia, Singapore and Hong Kong, along with scaling countries that have been launched just recently.
The second pillar of growth is VAS, Fiserv is focusing on increasing penetration of software solutions after selling the customer an operating system, such as Clover, this increases revenue per user and provides incremental margin opportunity along with making the customer far stickier. Fiserv is able to pursue this strategy as customers typically sign up for long-term contracts with high amounts of recurring revenue. Since 2019 Fiserv has increased VAS penetration by 2.7x, in the quarter penetration reached 17%, and the company remains on track to reach 27% penetration by 2026. The company has plenty of growth remaining within VAS that will increase revenue faster than the industry, along with providing incremental margins of up to 75%.
Finally, Clover is focusing on new verticals, Clover has historically focused on the restaurant, retail and services verticals by building out a suite of software solutions for these sectors, for example, In the restaurant vertical, Clover has been building out a comprehensive suite of value-added services and point-of-sale solutions for restaurants and Quick-Service restaurants (QSRs) of all sizes. Clover is now planning on branching out to new verticals, such as; B2B, healthcare, education and government. Fiserv believes this adds an extra $36-$47B in TAM. As a result of this market expansion, Fiserv believes it can sustain a 30% growth rate in this area.
Carat
Carat showed some progress in the quarter, In Q3 Carat grew 14% when excluding the loss of a large merchant aggregator in Q2 2023. On an unadjusted basis, Carat's revenue grew 2%. Growth was driven by multiple new wins in the quarter, including PayPal and several new clients on the recently launched Commerce Hub, demonstrating the demand the new operating system is garnering. The results this quarter demonstrate that demand is still strong for Carat solutions and the client loss in Q2 was likely to be a one-time event and not the new norm. Going forward Carat will likely be able to sustain growth as the business still has many opportunities to grow: including international expansion and value added service penetration. VAS remains less than 1% penetrated, despite the 20% contribution to revenue.
Latin America: strong growth and future slowdown
The Latin American region represents 10% of merchant acceptance revenue. Over the recent quarters, the region has experienced rapid growth as countries such as Argentina have experienced inflation of 100% and rising interest rates, this has driven Merchant revenue to grow faster than initially expected, and at some point I expect this revenue growth to slow down to a more normalised level, the result will be a slowdown in merchant acceptance revenue that will be more in line with medium-term guidance. Despite slower growth going forward, Latin America still remains a great opportunity for the company as the company rolls out Clover in several LATAM countries in 2024.
Payments and Network segment
The Payments and Networks segment had a softer-than-usual quarter, growing organic revenue by 6% in Q3, this is a slight slowdown from the first half of 2023. Fiserv's slower revenue growth was due to 2 factors; tougher comparisons from a year ago, where the company onboarded several large clients. The second factor was a slowdown in new account growth to 3%. The segment did show some green shoots though, Zelle clients grew 26% in the quarter while Zelle transactions grew 44%, demonstrating the value of the networks for clients. The debit network also added some new clients in the quarter, the networks are continuing to benefit from the REG II rules that I expect will help drive more new client wins over the coming quarters. Fiserv remains confident that will stay at the top end of their 5-8% guidance for the year, this represents another potentially softer quarter as the company continues to go up against tough comparisons. In the long term, the company still has a strong pipeline of new clients which I expect to drive the business growth between 6-8%.
Fintech
The Fintech segment re-accelerated revenue to 6% organic growth in Q3. The business has been affected by the divestiture of the financial reconciliation business at the beginning of the quarter. The segment continues to win new clients with 8 core wins in the quarter, with 2 of them upgrading to DNA, showing the demand for the next generation of banking solutions. The company expects further acceleration of revenue as new client onboarding that began in Q3 ramps up in Q4, this will lead to the segment reaching their guidance of 4-6% for the year.
Margins
Since Frank Bisignano took over as CEO after the merger between Fiserv and First Data, adjusted operating margins have expanded from 33% to 38.1% in Q3 2023, this handily beat the goal laid out in 2020 to expand margins by 500 basis points. During this time the company achieved 540 bps of expansion through cost discipline and operating leverage.
In Q3 the company demonstrated great margin expansion, adjusted operating margins grew 290 basis points to 38.1%, with all three segments contributing to margin growth. Fiserv was able to expand operating margins faster than revenue by demonstrating strong operating leverage, resulting in high incremental margins. At the 2023 Investor Day, Fiserv has laid out plans to reach 40% adjusted operating margins by 2026, this is a 300bps margin expansion in 3 years. The main driver of this growth will be from the Merchant solution segment which is currently lowering consolidated margins. The Merchant solutions business will achieve this growth target through increased penetration of high margin value-added services. Management has demonstrated that they have the ability to be a disciplined operator, I believe this new 300bps margin expansion is therefore achievable in the time frame laid out.
EPS & FCF/share ( Stratosphere.io )
As a result of strong revenue growth and Margin expansion, the business is on track to reach its 38th year of double-digit adjusted EPS growth, in the quarter EPS grew 20% to $1.96. Free cash flow grew 60% in Q3 as capex has stabilised, demonstrating the true earnings power of the business.
Capital Allocation
Fiserv has proven in the past that they have the ability to allocate capital in a fashion that enhances per share value, I expect this to continue in three ways: First, organic investment in the business. Second, small acquisitions where Fiserv has the ability to integrate or accelerate the growth of the business. Third, operate a leveraged buyback strategy while maintaining debt/EBITDA below 3%. Over the past several years annual capex has increased from $900m in 2020 to $1.479B in 2022 as the business invested in innovation and product development, Fiserv has invested $4B in total; modernising its technology, developing new products, entering new markets and acquiring new technologies. In Q3, capex came in slightly below expectations, this was due to timing. Fiserv still expects to maintain capital expenditures at $1.5B while growing revenue, the result of this will be capex as a percentage of revenue decreasing to a more normalised 7% of revenue. Fiserv is very capable of making small acquisitions, for example, Clover was acquired 10 years ago when it only had 7 engineers and 3 patents. Today Clover is on track to hit $2.1B in revenue for the full year 2023. Other notable acquisitions include; Finxact, Onto and BentoBox. Fiserv's advantage in acquisitions is its ability to retain the original management teams for many years after the initial acquisition, they do this by making the companies safe, secure and trusted. Since the merger of Fiserv and First Data, Fiserv has deployed $2B through acquisition, adding 18 businesses, these business acquisitions have been focused on digits. In Q3 2023, this progress continued as Fiserv Acquired the remaining 49% ownership interest in their European Merchant Services joint venture. In October, Fiserv also acquired Skytef, the largest distributor of software express in Brazil. Both of these acquisitions fit in with their strategy to acquire solutions that enhance the client experience. Fiserv has historically generated a lot of free cash flow and has committed to running a leveraged buyback with debt to adjusted EBITDA remaining less than 3x. In Q3 Fiserv bought back $1.2 billion in stock, bringing LTM to $4.5B. This has resulted in 5.5% of shares being bought in the last twelve months, I consider this a good use of capital.
Fiserv ROCE ( Stratosphere.io )
I consider ROCE as a good proxy for evaluating the management's investments. Prior to the merger in 2019, Fiserv had a ROCE of 17%-18%, which decreased to the low single digits, Since that time Fiserv has continued to grow ROCE by 50% annually. In Q3 2023 ROCE reached 7.89% growing 46% from a year ago. Going forward, I expect ROCE to continue increasing as the company demonstrates operating leverage, superior execution, and capital allocation, and reduced amortisation expenses.
Conclusion
I believe this was a very strong quarter for Fiserv, with strong revenue growth driven by the merchant segment, margin expansion across the board, and disciplined capital allocation that is increasing per share value faster than business value. Fiserv's strong fundamental performance coupled with a reasonable valuation of 20x and slightly depressed free cash flow lead me to believe this stock is worth holding onto for the long term.
For further details see:
Fiserv: Executing Well As Clover Accelerates.