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Morningstar | Fiserv's First Data Deal Entails Plenty of Execution Risk

Wide-moat Fiserv finished 2018 on the right foot, but this is really secondary to Fiserv’s $22 billion deal to acquire First Data announced three weeks ago. For full-year 2018, the company earned $2.87 per share in GAAP earnings and $3.10 per share in adjusted earnings. In 2019, management expects to earn $3.39-$3.52 in adjusted earnings per share. However, we’ll warn that may not be at all comparable. Once the acquisition is completed in the second half of 2019, we would expect Fiserv management to add back amortization of acquired intangibles from the First Data deal when calculating adjusted earnings. Given this, we would urge investors to do the opposite as we believe that amortization related to First Data is a real expense as Fiserv is choosing to grow through acquisition as opposed to investing to develop new products. We’ll be maintaining our fair value estimate at $66 per share until we get greater clarity on how Fiserv will be able to create value through this acquisition and what the merged company will look like. To us, it looks like a tall order and shares look expensive given the sizable execution risk.

During the quarter, Fiserv achieved internal revenue growth of 4.5%, a 50-basis point deceleration from the previous quarter and 1.5% lower than the internal revenue growth achieved in last year’s fourth quarter. It would appear to us that Fiserv’s deal with First Data is in part motivated by slowing growth in its existing business. What we find strange is that Fiserv believes the remedy to slowing growth is to buy another company that has struggled to grow. Though management said during the call, “Our collective enthusiasm about the combination with First Data is even greater now than it was on the day of announcement,” we are growing more skeptical. First Data has gone through years of restructuring, yet the merger anticipates $900 million in cost benefits. Other than the top executive staff, how many redundancies could there really be? In addition, Fiserv management intends to make a $500 million incremental investment into technology which we support. Nevertheless, we struggle to see how these cost synergies are achieved while increasing investment in technology.

While revenue slows in its core banking business, it does appear the company’s efforts in payments are starting to bear fruit as internal revenue growth accelerated in payments to 6%. However, we would expect that payment operating margins would expand as volume grows across its payment solutions specifically Zelle. So far, adjusted operating margins within payments were only modestly higher than the previous year. This inability to improve payment margins may be the result of Fiserv’s acquisition of Elan’s ATM and debit servicing business which would likely be temporary. However, if Fiserv can’t achieve greater operating leverage in its payments business then much of the bull argument would be in jeopardy.