Fiserv

March 2011

Price: $59

Research Report by
Peter Hughes, Check Capital Management
Fiserv was founded in 1984
Adjusted Earnings Per Share*
and has become one of
$5.00
Americas premier outsourcing
companies. The firm provides
$4.00
integrated data processing,
$3.00
Internet banking, card processsing and online bill payment
$2.00
services to the financial indus$1.00
try. Since 1994, earnings-pershare (EPS) has grown at an
$0.00
18% annualized rate.
[As
described later, adjusted EPS is
* Adds back extraordinary items, including amortization of intangible assets
a superior indicator of Fiservs
financial condition and will be
used as a proxy for EPS throughout this report.]
THE BUSINESS
Fiservs formula for success is simple. It performs the back-office tasks critical to banks
success and does so more cheaply than banks themselves can do it. Banks operate on slim
margins, so keeping costs down is very important. Since North American banking institutions
spend $46B on information technology each year, reducing these costs by just a few percentage
points makes a huge difference to overall profitability. Especially for small and midsized banks,
which have fewer resources, it makes sense to pay another company to develop sophisticated
software rather than doing it themselves.
Fiserv has been successful at developing, acquiring and integrating financial software systems.
The firm has made over 100 acquisitions since its inception. Most of these acquisitions were
small, supplementing existing product offerings or adding new clients. Although Fiserv has
been very successful with this strategy, management has indicated that acquisitions are not
currently a high priority.
Financial Segment
There are a number of core operations which all financial institutions must perform: Processing
customer deposits, withdrawals, and checks; running accounting programs; processing
mortgages, etc. These tasks are very expensive but vital for effective operations. Half of all
North American banks outsource their core processing system.

Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579

(800) 710-5777

These core processing platforms (known

as the Financial segment) are used by
Core-Processing Marketshare (2009)
more than 16,000 different financial
38%
40%
institutions worldwide. Fiserv has a
32%
38% share of this market. Its two big30%
gest competitors (FIS and Jack Henry)
have just a 30% share combined. This
20%
gives Fiserv a scale advantage, allowing
16%
14%
it to invest more in research and spread
administrative costs over a larger
10%
revenue base. The Financial unit has
relationships with 99 of the top 100 U.S.
0%
banks, although it usually gets more
Fiserv
Jack Henry
FIS
Other
business from smaller banks. This unit
contributes 49% of revenue and operating income.
The dominance of the Finance segment will likely continue, with high switching costs providing
a wide economic moat. Changing software platforms is disruptive, time-consuming and
expensive, so customers are unlikely to abandon Fiserv for a marginally lower-priced competitor.
Furthermore, the enormous cost and learning curve to comply with regulations in the financial
industry discourages any new competition. Fiservs customer-retention rate is 99%, excluding
banks acquired or closed, and well above 90% overall. Most contracts run for periods of threeto-five years, with a termination fee for early cancellation, meaning the companys revenue base
is recurring and highly predictable. Because these functions are crucial to bank operations, the
expenditures are virtually nondiscretionary. During the 2008-2009 financial crisis, banks tried to
cut costs in every possible way. Yet during that time Fiservs sales dipped only slightly, and
earnings continued to grow. This is a testament to the strength and durability of Fiservs
business
Financials strong market position and high marketshare, however, actually constrain its growth
potential. There is simply not much opportunity to take business from competitors, especially
when they are protected by high switching costs and long-term contracts similar to those that
insulate Fiserv. Nonetheless, the firm has the highest new-business win rate (47%) in the
industry, which should provide marginal growth in coming years. Financials marketshare has
increased from 33% in 2005 to 38% today. But Fiservs future growth will be fueled mostly by
the secular trend towards increasing use of electronic banking.
Payments Segment
The banking industry is undergoing a dramatic shift. Paper checks and trips to the bank are
being replaced by electronic payments, debit cards and ATM machines. Fiserv is the dominant
player in the fast-growing electronic-bill-payment and online-banking markets. The firm catapulted itself to the forefront of these markets with the $4.4B acquisition of CheckFree Holdings
in December 2007. Payments provides the software for the banks end of online-banking
transactions. Its software helps process more than 17 billion digital payment transactions and
nine billion ATM/debit transactions annually. 75% of all online bill payments are processed by

Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579

(800) 710-5777

Fiserv, and eight of the top ten banks use the companys electronic bill-payment system.
Payments accounts for 51% of firm sales and profits.
Payments provides Fiserv with substantial
growth opportunities, as the unit benefits from
rising penetration of Internet banking and
online bill payment. The firm anticipates that
11 billion transactions will shift from paper to
electronic payment over the next five years.
The graph at right shows the dramatic
increase. These transactions are more profitable to Fiserv, so rising demand for such
services will increase the firms profitability.
Like Financial, Payments is characterized by
high switching costs, economies of scale and
over 90% recurring revenue.

Percent of Bills Paid Electronically

66%
54%
39%

2004

2009

2014*

* Projected Results

Fiserv is working to expand overseas. Many banks worldwide could eventually utilize the firms
services, although different traditions, regulations and current systems may delay adoption. The
company has forged relationships with several foreign banks, including some in Australia, China
and the U.K. Overall, Fiserv management believes it can generate organic revenue growth of
4%-8% for years to come.
Risks
There are several potential risks for Fiservs business. Industry consolidation tends to hurt the
company because, when a client firm is acquired, Fiserv often loses the business. This risk is
somewhat mitigated by the fact that the firm has thousands of clients, and consolidation itself has
declined since the financial crisis. Bank of America accounts for 4%-5% of Fiservs revenue, so
losing the bank as a client (it is up for renewal in 2013) would harm company results. Finally,
there is a risk that competitors may offer better products at more affordable prices. This is
possible but seems unlikely given Fiservs marketshare and scale advantage.
The risk of losing business to bank closures is not
high. Although 140 banks failed in 2009 and 157
more fell in 2010, most of the customer accounts
were transferred to other banks. Since Fiserv is paid
mostly on a per-account or per-transaction basis, it
loses relatively little business to bank failures.

Shares Outstanding
(in millions)

200
180
160
140

MANAGEMENT

120

Fiserv was managed by its founders until 2005, when

100
Jeff Yabuki became CEO. Yabuki had been the
2004 2005 2006 2007 2008 2009 2010
COO of H&R Block. Co-founder and former CEO
Donald Dillon remains Chairman. Yabuki is a good
strategic leader and a shareholder-oriented executive. The company has retired 24% of its stock

Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579

(800) 710-5777

since 2004, and most of that amount was repurchased under Yabukis tenure. The CheckFree
acquisition was done with cash alone, thus avoiding shareholder dilution. On a recent
conference call, Yabuki said that the company would consider making an acquisition but will
repurchase stock unless a really good opportunity comes along.
Yabuki has made big changes within the company. Most involve streamlining the companys 77
different business units, which were left over from dozens of acquisitions. Formerly, these units
operated autonomously, but now operations have been centralized. When Yabuki took the helm,
Fiserv offered as many as 24 different core-processing platforms; now it offers four. This has
helped the company improve its operating margin from 22.9% in 2006 to 29.4% in 2010.
Yabuki stated that one of his goals is Fiserv becoming the industry leader in every business in
which the firm is involved.
In January 2011 Mark Ernst was hired as the new COO. Ernst was CEO of H&R Block from
2001-2007, during which time Yabuki was COO. The fact that they have worked closely
together in the past suggests that the addition of Ernst will not negatively impact the Fiserv
management team.
FINANCIAL METRICS
Fiservs key financial metrics are
strong.
The companys return-oncapital (ROC) suffered with the acquisition of CheckFree in 2007 because
the debt added to the capital base.
After Fiserv paid off some debt and
realized the benefits of cost-cutting,
ROC has returned to its traditional
11%-14% range. Net margin has also
grown since the acquisition and is now
very impressive at nearly 15%.

Financial Metrics
15.0%
12.5%

10.0%
7.5%
5.0%
2.5%

0.0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
ROC

Net Margin

At $3.35 billion, long-term debt comprises 51% of total capitalization.

Key Statistics
This would be a greater cause for
(trailing four quarters ending 12/31/2010)
concern if not for the firms strong Revenue Net Income EPS Net Margin Debt Cash ROC
$4.13B
$614M
$4.05
14.9%
$3.35B $.56B 11.1%
cashflow and remarkable predictability. Fiservs GAAP earnings are understated due to the large amount of intangible assets ($6.3
billion) the company carries on its books. In 2010 the company recorded amortization expense
of over $140M, versus reported income of $506M. Because this expense is noncash and in no
way hurts shareholder value, one may add it back to get a clear picture of the companys
earnings power. Fiservs adjusted income includes other nonrecurring expenses, but
amortization is by far the largest among them.

[CONTINUES ON NEXT PAGE]

Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579

(800) 710-5777

By another measure, Fiservs

cash-generating power is stronger
still. The graph at right shows
growth in free cashflow per
share. In 2010 this metric was
$4.85, 20% higher than adjusted
earnings-per-share (EPS).

Free Cashflow Per Share

$4.85

$5.00
$4.30
$3.70

$4.00
$3.00

$2.54
$2.11

$2.00

Results were strong on Fiservs

2010 bottom line, while top-line
$1.00
growth was tepid. The years
adjusted EPS grew 11% to $4.05,
$0.00
2006
2007
2008
2009
2010
as revenues rose 3%. In Q4, EPS
increased 13% and sales grew
2%. During the year, free cashflow increased 10% and Fiserv bought back eight million shares
for $413M. Management expects 2011 adjusted EPS to be $4.42-$4.54, which would represent
growth of 9%-12%.
VALUATION
$70

As the P/E graphs show, Fiserv has

traded at a much lower valuation over
the past five years than it did in the prior
15. The stock has traded at an average
P/E of just over 16 since 2006, yet, from
1998-2002, the P/E often exceeded 35.
Its valuation is now 14 times earnings.
While the companys relatively heavy
debt load means that the stock is not as
cheap as it initially appears, it still
appears to be moderately undervalued.

Price

$60

16 times Earnings Per Share

$50
$40
$30
$20
$10
$0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
35

P/E Ratio

Fiserv enjoys high barriers to entry, a

recurring revenue stream and secular
trends likely to fuel its long-term growth.
In time, investors should realize Fiservs
value and potential.

25

15

5
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

CCM Research Reports are for informational purposes only and are not an offer to sell or a solicitation to buy.
They are not personal recommendations for any particular investor and do not take into account the financial
circumstances of any individual investor. Check Capital, or one of its officers, may have a position in the securities
discussed and may purchase or sell such securities from time to time. CCM Research Reports are created using
third-party data. While Check Capital believes such third-party information is reliable, we do not guarantee its
accuracy, timeliness or completeness.

Check Capital Management Inc.

Costa Mesa, CA.

(714) 641-3579

(800) 710-5777