Fiserv – A Legacy Financials Player With An Embedded Growth Business (NASDAQ: FISV)

Stock Market


Young woman using credit card reader at coffee shop counter

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Thesis

Fiserv (NASDAQ: FISV) is valued as a legacy financial player by the market, with modest growth and steady margins seemingly implied in its current price. However, embedded in this financial conglomerate is a faster-growing business unit. Carat and Clover, these merchant acceptance platforms have experienced rapid growth. The market not properly valuing Carat and Clover presents a chance to buy FISV at a discount.

The Clover Platform

Two things separate Clover from legacy merchant acceptance options in my mind. First Clover is an open ecosystem with an app store, like the iOS or Android app stores. In fact, the Clover operating system is built on top of Android. This means third-party developers can create additional functionality that increases the utility of Clover to FISV’s customers. Somewhat related Clover is positioned as a business operating system. Even though merchant acceptance is the primary selling point of the Clover ecosystem it offers additional functionality such as scheduling, hiring, and inventory management.

You can see Clover deepening its relationship with merchants by the number of “modules” each merchant uses increasing over time. A module is a software as a service functionality the Clover merchant pays for.

Clover modules per cohort 2017-2021

Clover modules per cohort (FISV investor relations)

What separates Clover from its competitors

Many competitors have a product similar to Clover. Block (SQ), Toast (TOST), PayPal (PYPL), and Shopify (SHOP) all offer their versions of next-generation merchant acceptance solutions. A big differentiator for FISV is its distribution channels. Clover has several different distribution channels: bank partners, individual software vendors, and direct distribution. Other competitors only offer direct distribution. The partnership with banks is especially interesting. Banks can sell Clover devices to maintain the valuable relationships they have with a merchant. If a merchant chooses a provider like SQ, the bank may end up losing that business relationship. This strongly aligns FISV’s interests with the banks it partners with to distribute Clover.

FISV has leveraged this unique distribution strategy to grow its number of merchants at a 22% CAGR over the past five years.

Number of Clover merchants over time 2017-2021

Number of Clover merchants over time (FISV investor relations)

Comparing FISV merchant acceptance to competitors

Let’s take a look at how FISV’s acceptance segment compares to SQ’s seller ecosystem and TOST’s ecosystem.

FISV acceptance Square Toast
2019 Gross Profit $ 1595M * $ 1390M $ 62M
2021 Gross Profit $ 2555M $ 2316M $ 314M
CAGR (2019-2021) 26.6% 29.1% 125%

* Calculated based on PRO FORMA First Data and FISV combined removing 1-time gains.

FISV’s acceptance segment is slightly larger than Square’s ecosystem but growing slower. SQ has two main drivers of profit the Square seller ecosystem and Cash app. Square made slightly more than Cash app, but Cash app was growing slightly faster in 2021. For some quick back-of-the-envelope math let’s assume that SQ’s value is broken down in the following way, 47.5% Cash app, 47.5% Square , 5% everything else. This would value FISV’s acceptance unit at about $ 30B based on a comparison to SQ.

Payments and fintech

FISV’s other two segments are fintech and payments.

Fintech is ambiguously named. The fintech segment provides an operating system for banks. The primary customers are smaller banks who leverage the platform to build out their technology stack on top of FISV. This is a mature but sticky product, both past performance and management guidance show it growing 4-6% a year.

Payments contain a wide variety of businesses centered around digital payments. This includes debit card networks, bill pay, credit card processing, and gift card issuing. Once again this is a mature business with management and past results forecasting it to grow in the 5-7% range.

Who else has been buying FISV?

FISV originally got on my radar when looking at “super investor” purchases after 2021 Q4. Three names I follow and respect bought FISV, Bill Nygren, Seth Klarman, and Value Act investing. In addition, several insiders including the CEO bought shares on the open market in Q4. FISV’s lowest closing price in Q4 was $ 95.55. If you buy the shares for less than $ 95.55 you are buying at a price lower than all three of the above “super investors” and all insiders.

I do not believe in buying a stock solely because someone I respect bought it. But I have no shame in watching what they do and listening to their reasoning. Both Bill Nygren and Value Act’s thesis revolve around the market not respecting the value of the Clover platform within FISV.

Debt

FISV carries a large amount of debt. The good news is that the debt is well delivered over a long time and primarily fixed rate. FISV’s cash flow is much larger than any single year’s debt obligation. I do not think it is inappropriate that FISV carries so much debt given the size and stability of their cash flows. But if something were to go wrong and their cash flow was threatened, things could snowball on them.

FISV debt maturities schedule

FISV debt year end 2021 (FISV investor relations)

I’ve seen investors complain about the fact the company is doing share buybacks rather than aggressively deleveraging. If you examine this from a pure capital allocation perspective the company’s decision makes sense. The shares currently have a forward cash flow yield of 8.8%, while the most expensive debt they could pay down only yields 4.4%. Buying back shares instead of paying down the debt is risky though.

KKR selloff

In 2019 FISV acquired First Data in an all-stock deal. Due to this acquisition, KKR (KKR) became a large shareholder of FISV. KKR originally acquired First Data in a leveraged buyout and the 2019 acquisition by FISV represented an exit strategy.

Since FISV closed on their acquisition of First Data the stock price has underperformed. Even worse, since the company has been buying back shares the overall market cap has declined by more than the share price.

Chart
Data by YCharts

KKR has already reduced its holdings in FISV twice. In December 2020 they sold 20 million shares or about 3% of all outstanding shares. In May 2021 they sold another 23 million shares or another 4% of outstanding shares. KKR still owns 9% of all outstanding shares.

In the short term, these large sell-offs create downwards pressure on the stock price. I expect KKR to eventually fully exit its position, which should create short-term headwinds for the stock price.

Risks to my thesis

As noted above FISV is not the only player trying to create a next-generation merchant acceptance platform. They are competing against new tech companies to capture the market opportunity. It can be hard for legacy players to innovate and build disruptive technologies. The market seems to favor disruptors like SQ over incumbents like FISV.

On a macro level, FISV is currently benefiting from a movement away from cash and towards card-based transactions. There may have been some pull ahead in this trend due to COVID. It’s also possible the digital payments space could be disrupted. I’m watching the following trends: cryptocurrencies, a move towards digital wallets, and nationalized payments infrastructure such as RuPay in India.

Valuation

I’ve done a discounted cash flow valuation based on a mix of my assumptions, historical growth, and guidance provided in FISV’s investor presentations. To better understand the cash flow growth of the company I broke down its cash flow by its three operating segments.

Based on historic performance and FISV guidance I’m modeling the following:

  • 5% revenue growth in payments
  • 4% revenue growth in fintech
  • 11.5% growth in acceptance
  • cash flow margins for the acceptance division growing by a static 150 basis points per year

Based solely on historic performance I’m modeling the following:

  • 4% growth in corporate costs per year
  • Cash flow margins equal the average of the last three years for the payments and fintech segments

Based on my valuation assumptions I’m modeling the following:

  • a required rate of return of 10%
  • a desired margin of safety of 20%
  • a perpetual growth rate of 2.5% after five years

Static interest payments could go up or down based on paying off or taking on more debt. But for the sake of this DCF, I consider these to not be included in cash flow to equity.

Discounted cashflow anlaysis of FISV

Discounted cash flow analysis (The author)

I’d like to focus on one input of my DCF: the margin expansion of the acceptance division. When I ran the DCF with static margins for the acceptance division FISV appeared to be much closer to fairly priced at about $ 107. In the last year, they grew the cash flow margin for acceptance by over 400 basis points. If they grow the cash flow margin of the acceptance business by 400 basis points a year they appear to be even more undervalued with a fair value of $ 135. In their recent briefing on the acceptance platform, they hammered on the expected margin improvement. When asked for guidance on the expected margin improvement CFO Robert Hau dodged giving actual guidance but said:

This is a scaled business every incremental dollar of revenue does not mean an incremental dollar of cost. As we add more merchants, we add more software as a service, you see the value of that scaled model really paying off. … As a point of reference from 2019 to 2021 we expanded operating margins in this business segment 340 basis points. We continue to see opportunity to expand that margin moving forward.

Closing thoughts

Investors in FISV must be willing to take a long-term view. No short-term catalyst for a price increase is apparent. As with all of my investments, I’m looking at a 5-year time horizon with FISV. I’ll be watching for revenue growth and margin expansion in the acceptance division to monitor my thesis.

I’m buying FISV whenever it trades at $ 95. $ 95 is slightly above a 20% margin of safety from my fair value estimate. $ 95 is also cheaper than all the “super investors” and insiders bought FISV at during 2021 Q4.



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