Written by Gracious Mashila – Associate Analyst
Founded in 1984 and listed on the Nasdaq in 1986, Fiserv has grown consistently to become one of the largest and most diversified US financial technology (fintech) companies. The company significantly increased its scale following the acquisition of First Data in July 2019 and is now seen as the world’s largest merchant acquiring business (handling over 15% of global transaction volumes). We consider Fiserv’s product offering – highlighting the best performing segments and exploring future opportunities.
Dynamic payment landscape
The payments industry can be broadly broken down into global payment networks, merchant acquirers, digital banking, business-to-business related payments and money transfers – with the largest end markets being payment networks and merchant acquirers. The chart below highlights some of the major players.
The industry has changed meaningfully in the last five years, with a substantial number of business combinations, aimed at creating integrated and comprehensive product and service providers. Recent notable industry transactions have included (i) Square acquiring Afterpay to expand their ‘buy now pay later’ offering – made available to online merchants, and (ii) Visa acquiring Tink to obtain an open banking platform that enables financial institutions, fintech companies and merchants to build financial products and services. Fiserv’s First Data acquisition in 2019 was transformative in that it enabled the business to materially scale its merchant acceptance and payments capabilities (lowering costs to serve clients) and created a leading portfolio of software to merchants through its highly successful Clover and Carat operating systems.
Intersecting commerce and banking
The digital payments process sees Fiserv intersecting commerce and banking through their merchant network, real time account processing and digital banking capabilities. The chart below illustrates the different stages of a credit or debit card transaction and the participants involved. After its initiation, a payment moves through various channels involving authorisation, bank-end processing and settlement – achieved through communications by the large card associations (Visa, Mastercard or Fiserv in the US) who are the backbone of the electronic payment system.
Fiserv has built strong positions in very profitable segments and through the many services offered by its three divisions – merchant acceptance, payments and networks, and fintech – the business plays an integral role in this process.
A differentiated merchant offering
Merchant services constitute Fiserv’s largest division accounting for over 40% of group revenue. The division supplies software and hardware to merchants globally, which is used to securely accept electronic payments. Key services include payment authorisations and settlement solutions that secure payment data from end to end. Payment transactions incorporate credit, debit and loyalty payments either through a physical point of sale (POS) device, a mobile payment device (smartphone or tablet) or an e-commerce internet transaction.
Fiserv’s merchant acceptance division has delivered strong growth over the last three years (over 20% per annum since 2019). The future of this division is even brighter as the company strategically shifts away from commodity POS hardware to hardware with a custom operating system. New software focused products include Clover (for small to medium-sized merchants) and Carat (for larger enterprises), both of which have shown sales growth of over 30% per annum since their launch in 2017.
This customised operating system approach is a unique differentiator for Fiserv, allowing them to develop and sell additional software to merchants (managing a wide range of functions ie appointment making, inventory checking and overseeing employees). Their open platform enables them to provide third party developers with the tools to create new software and resell it onto Fiserv’s large global client base. The strategy has resulted in the creation of a valuable platform, now accounting for almost half of the division’s revenue.
Furthermore, the shift to Clover and Carat has materially expanded Fiserv’s addressable market and we expect an acceleration in future growth and profitability as a result. The organic growth opportunity is large as the company’s industry-leading platform attracts more merchants, who then purchase more higher margin software services from the group. An analysis of past customer cohorts shows consistent growth in the number of software applications that each merchant purchases and we expect notably higher future profitability as average revenue per merchant grows, with little incremental cost to the business.
A well-positioned business in payments and payment networks
In addition to operating systems, small and medium-sized banks are also supplied with digital banking solutions. Fiserv’s payments and payment networks division has exposure to fast growing international markets and includes services such as real-time processing of card transactions, and security and fraud protection products. Non-card digital payment software and products enabling bill payments, account-to-account transfers and person-to-person payments are also offered.
The company owns the world’s third largest payments network behind Visa and Mastercard. Through its subsidiaries STAR, Accel and Money Pass, Fiserv connects US banks and US merchants (online and offline), allowing customers to purchase via debit or credit card and withdraw cash at any one of 300 000 ATMs across its network. The growth outlook for this division stems from increasing transaction activity and high profit margins from high barriers to entry.
Within the payments division, Fiserv also has exposure to legacy bank services that are threatened by the shift to online and to the medium-size banking segment in the US, where consolidation has seen the number of independent banks fall from around 7 300 to 4 800 over the last decade. Fortunately, these headwinds have been more than offset by the growing IT spend across Fiserv’s remaining banking customers as they focus on modernising their systems, bolstering cybersecurity, expanding the use of data and improving the overall customer experience. The non-discretionary nature of the demand for Fiserv’s products and the expected increase in IT spend by banks should result in this division growing at a healthy mid-single digit rate over the medium term.
Through the Fintech division, Fiserv supplies global banks with back-office operating systems that allow them to process customer deposits, loan accounts and manage general ledgers and central information files. Though currently small in the mix, the division is expected to grow similarly to the payment networks division.
Strong growth at an appealing valuation
As illustrated below, Fiserv has an excellent track record, having grown sales and earnings consistently over the past two decades. The expansion brought about through Fiserv’s First Data acquisition not only improved scale and lowered operating costs (over $1.2 billion synergy savings), but also improved the company’s global footprint and combined geographic mix. The growth outlook is robust given Fiserv’s unique positioning and strengths across key markets. This includes sizable opportunities outside the US as Fiserv looks to expand its world class service offering to previously lowly-penetrated markets such as Latin America and India. International revenue has grown to 13% of group sales compared to 6% in 2018.
At first glance, Fiserv looks expensive as earnings are distorted by the First Data acquisition that resulted in a large non-cash charge. Excluding these charges reveals a significantly more profitable company and we estimate that investors can purchase this world class business at a deep discount to competitors who deliver similar revenue growth rates. Although the company is currently highly geared, we expect strong cash generation to see to a reduction of debt to optimal levels.
Compared to “digital only” payment businesses (eg Ayden and Square), Fiserv’s fast-growing Clover and Carat businesses stand out as equally strong and already at scale. Relative to Square for example, Fiserv’s transaction volume is already larger and profitability higher. If we apply Square’s rating to Clover and Carat (approximately 25% of group sales), these two businesses would account for over half of Fiserv’s current market value. This provides optionality for future value unlock if management were to unbundle or sell those businesses.
