2023-09-26 11:03:53 ET
Summary
- Fiserv's fundamentals are expected to outperform the S&P 500 over the next 5-10 years, driven by EPS growth, margin expansion, and revenue growth.
- The merger with First Data has resulted in better-than-expected performance, with cost synergies achieved ahead of schedule.
- The Merchant Acceptance segment, particularly Clover, is poised for significant growth and margin expansion, while the Payments and Networks segment is expected to benefit from regulatory changes and real-time payment systems.
In this article, I will discuss why I'm assigning an initial buy rating for Fiserv ( FI )
Fiserv vs S&P 500 stock price (Seeking Alpha)
Despite having a similar valuation to the S&P 500, I believe that Fiserv's fundamentals will outperform those of the S&P 500 over the next 5-10 years, in turn leading to long-term stock outperformance as they have done in the past. This outperformance will be driven by EPS growth with contributions from margin expansion and revenue growth. In this article, I will focus on the 2 drivers of why I believe the fundamentals are set to grow faster than the S&P 500.
Merger Integration
In July 2019, Fiserv and First Data completed the merger between the two companies, creating the Fiserv that we see today. At the time First Data was making positive steps in turning itself around under CEO Frank Bisignano, First Data had stemmed market share losses, accelerated revenue growth to the high-single digits, and improved margins back to its 2007 levels. Fiserv was comprised mostly of a core bank processing business, which is now classed as the Fintech segment, despite high recurring revenues and strong margins, the business didn't grow very much.
Up until 2022 Fiserv had been focused on integration , the merger reduced the leverage of First Data while giving Fiserv greater exposure to merchant acquiring and payment areas which accounts for 80% of revenue, while reducing the exposure to the slow growth Fintech segment which I expect to continue to decrease.
Since the merger the new business has outperformed management's expectations, evidenced in their initial guide of achieving $900 Million in cost synergies during integration, later achieving over $1.2 Billion in synergies well ahead of schedule. At Fiserv's Investor Day in December 2020, Fiserv laid out medium-term targets for each business segment:
- Merchant acceptance segment growth of 9-12%
- Payments and networks growth of 6-8%
- Fintech growth of 4-6%
Since then, Fiserv has consistently beaten guidance with consolidated organic revenue growth of 11% annually with the Merchant acceptance segment achieving mid-teens plus growth rates, despite the integration of the two companies. I expect Fiserv's growth rate to increase over the coming years as management allocates full attention on growing the business, driven by the Merchant Acceptance and Payment segments contributing an increasing percentage of revenue. I believe these views along with updated and increased mid-term targets will be laid out at Fiserv's Investor Day in December 2023.
1. Merchant Acceptance
I expect Fiserv's Merchant acceptance segment to grow at growth rates exceeding their 9-12% target for the next 5 years and increase margins as software services penetration reaches 25%.
Fiserv revenue breakdown (Fiserv Investor Day 2020)
Fiserv's Merchant Acceptance business accounts for 45% of Fiserv's revenue, however, it only accounts for 37% of Operating income as of Q4 2022 despite having a 35% operating margin, this is meaningfully lower than the other two segments with the Payments operating margin at 47% and Fintech at 41%.
Merchant Acceptance growth rate (Fiserv Investor Day)
The Merchant acceptance business is 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. At the 2022 Merchant day, Fiserv laid out its 2025 targets of achieving $10 Billion in revenue and I believe Fiserv is on track to exceed this goal.
The Merchant acceptance business consists of 4 parts:
- Clover
- Carat
- Legacy Merchant Acceptance
- Processing
The legacy Merchant Acceptance and the Processing businesses are meaningful parts with the Processing business accounting for roughly $1 Billion in revenue with no growth, while the legacy Merchant Acceptance part is not disclosed their growth rate is known to be significantly lower than Clover and Carat. Over time I expect these businesses to contribute less as a percentage of the overall segment as the processing business remains flat and the legacy customers slowly transition over to Clover.
Clover and Carat are significant growth opportunities, these businesses are still relatively small with Clover expected to account for 35% of the Merchant acceptance segment revenue in 2025 while only contributing 25% today, Carat's size is not disclosed but it is smaller than Clover. I expect these businesses to continue to grow at high rates and account for a larger share of the segment this will increase the overall growth rate to the high teens.
Clover
Clover growth rate (Fiserv Investor Day)
Clover is a POS and operating system for small and medium-size businesses, I expect Clover to be the biggest driver of growth and shareholder value for the company over the next decade. Acquired in 2012 for $56 Million Clover has turned into a home run acquisition for First Data and now Fiserv, with $267 Billion of annualized GPV as of Q2 2023. Over the past two years, Clover has grown revenues 20%+ as they have increased software penetration and optimized sales channels. Clover has several near-term and longer-term opportunities which I believe sets them up for 20%+ growth for many years to come.
Clover has been growing in 3 ways:
- Attracting more merchants, Clover merchants grew 9% in 2022.
- Increasing software penetration, software penetration grew to 16% of merchants in Q2 2023.
- Increasing ARPU, average revenue per Clover merchant expanded by 12% in 2022.
Going forward I expect Clover to continue attracting more clients as Fiserv leans on its distribution advantage to increase the number of sales channels allowing them to expand internationally and continue adding ISVs at a healthy pace. Fiserv's International growth rate is reportedly double that of the US and I expect that to continue as they add new distribution partners. Longer term, I expect the International segment to contribute a significant amount of growth to Clover as under-penetrated areas like India and Argentina continue adopting Clover at high rates.
Software penetration by year (Fiserv Investor Day)
Fiserv's software penetration continues to grow and I expect this to accelerate over the coming years to reach the 2025 target of 25%. In 2023 Fiserv has been emphasizing its 3 pillars of software growth: restaurant, retail, and services. Fiserv has been building out a full suite of vertical-specific software products, for example. In the restaurant vertical, Clover plans to offer a comprehensive suite of value-added services and point-of-sale solutions for restaurants and Quick-Service restaurants (QSRs) of all sizes. Furthermore, specialized software solutions are being developed for retail and professional services, including inventory management, SKU-level analytics, and appointment scheduling partnerships. Over time are these software solutions become more sophisticated I expect the adoption rate to increase.
As Clover attracts more merchants each year the number of software solutions merchants take also increases, not only does this accelerate revenue growth it substantially increases the margins of Clover, at a recent conference Fiserv CFO Robert Hau claimed Clover experiences incremental margins of 75%.
I think our incremental margin in the second quarter was 75%.
Over the long term I expect Fiserv to expand beyond the 3 verticals they are targeting today which extends the opportunities Clover has to grow, I also believe that the currently under-penetrated International segment provides a huge opportunity to increase software penetration beyond the 2025 goals. These 2 growth drivers will provide Clover with a long road of growth ahead.
Over time as Fiserv attracts more merchants, increases software penetration, and applies strategic price increases which they have been doing recently Fiserv will achieve their third goal of increasing ARPU. That increased ARPU in turn will continue to increase the margins of the Merchant Acceptance business to close to 40% with Clover playing a significant role in Fiserv's margin expansion strategy all while continuing to outgrow Square.
Carat
Carat is Fiserv's large enterprise acceptant solution, over the past 3 years Carat has sustained 20% growth rates, however in 2023 Carat has seen a significant slowdown in revenue growth to just 6% as they lost a large E-Commerce customer, in the past Carat has had previous losses including Stripe several years ago, despite this they've managed to still growth at attractive rates and I expect the same to happen again this time.
2. Payments and Networks
Fiserv has a 6-8% growth rate target for the Payment and Network segment. Since 2020 the segment has outgrown these targets with success from major client wins, most notably winning 3 of the top 25 credit issuers this has caused the growth rate to steadily increase. At the December '23 Investor Day, I expect Fiserv to increase their medium-term guidance for this segment to over 10%.
There are 2 reasons I expect this growth rate to accelerate. Firstly the debit network which accounts for 1/3 of segment revenue, Fiserv has the third largest debit network behind Visa ( V ) and Mastercard ( MA ). Recently A new rule ( Regulation II) clarified that at least two debit network routing options are required for card-not-present transactions. This has led to more than 80 issuing clients onboarding the STAR and Accel debit networks in Q2 presenting a new growth opportunity for Fiserv. Although it's too early to quantify the kind of growth Fiserv can expect from this, I do expect Fiserv to be a beneficiary and therefore see growth in this segment accelerate.
Secondly Real-Time Payment Systems: The Federal Reserve recently launched its real-time payment system FedNow with Fiserv being an early participant of this and Zelle. This gives Fiserv the potential to onboard more financial institutions leveraging the NOW Network and Zelle to facilitate integration and drive adoption. They are now live with six banks in the pilot phase of FedNow and more than 70 committed to go live so far this year. In Q2 the number of Zelle customers increased 29 % and transactions 44% demonstrating the traction Zelle and FedNow are gaining. Fiserv's ability to offer a single point of integration for financial institutions to add new payment rails positions it as a major differentiator and I expect it to lead to more FIs choosing Fiserv as a partner like Lyft, ADT, and T-Mobile all did in Q2 2023.
I expect the growth rate of this segment to accelerate as Fiserv gains traction in these 2 areas.
Risks
As with any company, there are always risks to the story and Fiserv is no different.
The first risk is Clover, the majority of the growth story depends on Clover, and if Clover can no longer successfully attract new merchants and take share like it has in the past, this could cause the growth rate to drop significantly and be a thesis breaker. Carat losing more clients is also a potential risk albeit much smaller, management has described the loss of the E-Commerce client and Stripe as unique events however if these become more common it could cause Carat to stop growing and lower the future potential growth for the segment. At the moment I consider these risks to the Merchant segment unlikely given the acceleration of growth in Clover.
The second risk is to the Payments segment, Fiserv's debit network is a distant third and it could stay that way if clients choosing a second network choose Visa or Mastercard, although I'm not expecting Fiserv to overtake the 2 largest players, I do expect Fiserv to take some incremental share as the playing field has been levelled and customers can leverage the full product suite Fiserv has to offer beyond just debit networks. If my thesis is wrong on the Payments segment it could once again lead to a lower growth rate than I expect it to produce.
Conclusion
In conclusion, I believe Fiserv is a buy as the market is overlooking the potential for revenue growth acceleration thanks to the increasing contribution Clover and Carat are making in the Merchant Acceptance segment that I believe will continue for many years to come. The regulation changes are also a key growth driver as they set the Payments segment up for future growth opportunities as they continue to onboard more clients and features as Fiserv can leverage its vast distribution and single point of integration for institutions.
For further details see:
Fiserv: Growth Set To Accelerate