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Morningstar | Fiserv Paying Nearly $22 Billion for First Data Strikes Us as Expensive

In a surprising move, wide-moat rated Fiserv announced its intention to acquire First Data Corporation in an all stock deal, offering up 0.303 Fiserv shares for every First Data share outstanding. Based on the Jan. 15 closing price for Fiserv, the offer values First Data at $22.74 per share, or about $21.8 billion in total equity. As First Data is the product of a KKR leveraged buy-out, the company's balance sheet still has approximately $17 billion in net debt, so Fiserv is ultimately paying an enterprise value/operating income multiple of around 19.5 (based on trailing 12-month GAAP operating income), which strikes us as expensive. While we think Fiserv faces an uphill battle to extract sustainable value from this deal, we are maintaining our $66 per share fair value estimate for the firm until we have more concrete details to work with in our valuation model. Given the size and price of the deal, though, investors should expect some downward adjustment to our fair value estimate.

While both management teams provided rosy projections for the combined entities, we'll need more information before we can buy into managements expectations that the merger will increase free cash flow by $900 million through cost synergies. Since they don't intend to consolidate operating platforms for the combined companies, the cost-cuts will have to come from reducing corporate overhead. Fiserv already announced a plan in 2015 aimed at achieving cost savings of $250 million over five years, so it seems to us that realizing cost savings of more than $900 million is a  dramatically more ambitious undertaking and carries risk with it. Add to that the fact that First Data's total operating expenses have barely moved since CEO Frank Bisignano became CEO in 2013, suggesting to us that First Data's operations are already pretty lean. Though these are just our initial impressions, we are skeptical of the deal given the price and difficulty integrating two companies of this size.

Overal, this First Data deal reminds us of Fiserv's 2013 acquisition of Open Solutions--albeit on a much larger scale. In that deal, Fiserv bought a company burdened by debt resulting from a leveraged buy-out. Fiserv was able to refinance the debt at lower rates while providing Open Solutions with badly needed capital for high-return reinvestment. Most importantly, the Open Solutions deal yielded Fiserv its DNA real-time core processing platform. With First Data, it appears that Fiserv is going back to this playbook, although it should be noted that the First Data acquisition is about 38 times the size of Open Solutions (which had an estimated enterprise value of around $1 billion). Fiserv's cost of financing is currently around 3.7%, while First Data’s cost of debt is closer to 5%. If Fiserv can refinance First Data's existing debt at around 4.25%, that alone would lead to pretax savings of around $170 million. As such, it will, in our view, take a lot more than just refinancing First Data's existing debt at lower rates for this acquisition to be a winner.

Just as it did with Open Solutions, Fiserv expects to inject some additional investment into First Data, which could potentially liberate orphaned intellectual property that First Data might not have been able to adequately fund. The company's CEO, Jeff Yabuki, commented during the conference call that Fiserv will spend an additional $500 million on its technology platforms, which we feel is value add for the firm. Yabuki believes that Fiserv is "making a very clear statement to the client community and to the market that this [deal] isn't about overlaps and services, it's about finding unique and innovative ways to bring our platforms together." Our hope is that this means investing in some new intellectual property that can be monetized to fuel growth. While Fiserv lauded the technology First Data has been building under the leadership of Frank Bisgnano, it is not apparent to us that First Data has some hidden assets that Fiserv can readily exploit or marry with its existing intellectual property. If First Data does have exciting intellectual property that the company hasn't been able to adequately fund, then we'd likely become more positive on the deal. However, we've yet to see evidence that this is true but do expect it to be a focus of our ongoing research.

Finally, we think it's worth mentioning that First Data's Glassdoor employee ratings are alarming. According the employee review website, First Data has an overall rating of 2.8 out of 5 and Frank Bisignano has an approval rating of 49%. In comparison, Fiserv has a rating of 3.3 with Jeff Yabuki earning a 78% employee approval rating. To put this in perspective, the average rating for all firms that Glassdoor monitors is approximately 3.4. In July of last year, Glassdoor released its 18 worst companies to work for (with First Data's score of 2.8 leaving it just outside of that dubious list of employers). While we recognize that these reviews can be falsified and may not give a totally accurate picture of a company, we think it's instructive and warrants further attention in our ongoing research.