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Morningstar | Fiserv's Zelle Transactions Continue to Progress Rapidly

Wide-moat Fiserv had a mixed quarter. Organic internal growth was strong year over year, but total growth still remains sluggish. For the quarter, year-over-year internal growth was 6% for the company, with payments growing 5% and Fiserv’s financial segment growing 7%. These are significant rebounds from the first quarter, which saw total internal growth of only 3%. Nevertheless, this still resulted in a sequential decline in revenue of about 1.3%. This is related to the company’s divestiture of its lending solutions business. While Fiserv’s adjusted earnings per share increased more than 30% from the previous year, this is due almost entirely to lower tax expense. GAAP operating income declined 3.8% from the previous year. We’ll point out that for the last several quarters, Fiserv has been steadily been excluding merger, integration, and other costs from its adjusted earnings. If we exclude these recurring costs, we calculate a 3.8% year-over-year decline in adjusted net income. For now, we're maintaining our fair value estimate of $63 per share, but will need to see some acceleration from Fiserv in the second half of the year.

Even though year-to-date net income has increased 44% from the previous year, operating and free cash flow have declined 11.3% and 20%, respectively. It would appear that the company has taken a significant amount of accruals during the first six months of the year, as accounts receivable and prepaid expenses have hindered better cash generation. We will be closely reading the company’s 10-Q to get a better indication of what’s driving this. In addition, Fiserv’s capital expenditures have increased more than 24% year to date. This is less concerning to us, though we wonder if increased capital spending will result in new offerings or product enhancements. During the call, management didn’t give many details, but seemed to suggest that payments was commanding some of the investment, which is understandable given Zelle's continued progress.

According to management, transactions using Fiserv’s Zelle solution grew 40% from the previous quarter, though this growth is coming off a small base. In addition, Fiserv said there were 35 Zelle signings during the quarter. Though the company many not be moving the needle for revenue yet, we think it will likely be a more significant contributor in the coming quarters. While this many client wins is an encouraging sign, CEO Jeff Yabuki did remind investors that there have been client delays in Zelle implementations. We would suspect any implementation delays to be a short-term problem as Zelle likely has a long runway ahead of it.