EUR 850.00 For Business Accounts Only

Morningstar | Fidelity National Information Services Sees Slowing Organic Growth in 2Q

Narrow-moat Fidelity National Information Services has performed within our expectations for 2018. During the second quarter, the company saw a material deceleration in organic revenue. Year-over-year organic growth was 0.8%, down from 3.3% last quarter. In addition, organic revenue in Global Financial Solutions declined 3% from last year. Previously, management had signaled that organic growth would slow as a result of accounting changes and customers’ increasing preference for outsourcing over licensing. Nevertheless, the company is still projecting GFS to generate organic growth of 4%-5% for fiscal 2018. For now, we aren't making any material adjustments to our model, though we have raised our fair value estimate to $75 per share from $74 to reflect the time value of money since our last update. For now, we believe the shares command a significant premium and investors should avoid them.

Despite this quarter’s slower organic growth, the company raised the low end of its GAAP earnings per share outlook to $3.08 from $3.04. For the first six months of the year, the company earned $1.18. To meet the low end of management's guidance, the company must see earnings growth of more than 60% in the back half of the year. It’s possible, but we will need to see more progress before we materially increase our 2018 EPS estimate of $2.83. Even if organic growth accelerates in the second half of the year, the new accounting standard means that any related expenses would increase as the revenue was recognized.

Per investor relations, the company is no longer recognizing revenue from contract renewals in the period the renewal is signed, but rather when the existing customer contract expires and the new contract begins. In our opinion, how Fidelity was previously recognizing revenue was aggressive. Given this, we are inclined to believe that the company’s adjustment to decrease 2017 revenue for comparison purposes should be treated more as a correction of a previously aggressive revenue recognition policy and 2017 revenue was as much as 5% lower.

Finally, we are beginning to see what a drag Fidelity’s Capco was on the company’s margins. Since the partial divestiture, Fidelity now owns only 40% of its consulting business. This quarter, the company posted a loss of $7 million in equity investment income which suggests the business may not have been profitable. Nevertheless, the company now adds back the loss resulting from equity investment to adjusted earnings to increase adjusted earnings by $0.02 per share. Though this is a small adjustment, this is why we believe investors should rely on free cash flow or GAAP earnings as better indications of Fidelity’s earnings power.