In a recent edition of Value Investor Insight, investor Larry Robbins offered insights on navigating today's skittish markets. Among specific ideas he believes the market is mispricing: Fidelity National Information (FIS).
Describe a non-healthcare idea you currently like, Fidelity National Information Services [FIS].
LR: We’ve owned Fidelity in various sizes for the last 18 to 24 months. The stock has fallen from the high-$50s to the low-$40s as a result both of market turbulence and potential misunderstandings about strategic developments at the company. Fidelity has two main service businesses, transaction processing and lender processing. The transaction-processing business earns approximately 65% of revenue and 60% of operating profit, and basically provides core internal systems for banks – from teller systems to online banking to check clearing and settlement. The lender processing business, which generates the remaining 35% of revenue and 40% of operating profit, offers a wide variety of information and default-management services to mortgage issuers. In October they announced a spinoff of the lender-processing business. The company feels – and we agree – that because that division serves the mortgage industry, the overall company has been unfairly branded as a deeply cyclical and negatively impacted provider to that industry.
Is that branding so unfair for the lender services business?
LR: The full portfolio of businesses is quite diverse, but was constructed to provide client value at any point in the cycle, not just during times of mortgage-origination expansion. In the third quarter, even as the mortgage market started to implode, revenues in lender processing grew 11.5%, from increased default volume and from more customer outsourcing of property-information services. A historical study of this business demonstrates that it has continued to grow through cyclical contractions in the housing market, and, in fact, toward the end of those contractions has had above average growth rates – the business tied to mortgage origination resumes, while the part tied to foreclosures remains high. That’s what happened to the business in the early 1990s and we expect that to recur over the next two to three years.
What prospects do you see for the transaction-processing piece?
LR: The company has been acquisitive, having recently bought eFunds, and the overall story is one of cross-pollinating an expanding roster of products to an existing installed base of customers. We believe the eFunds integration is on track, which will help transaction processing grow through the cycle at healthy rates even though the overall environment for financial institutions is challenged.
What growth do you expect?
LR: We expect revenues to grow 8% annually over the next two years, with excellent operating leverage translating into roughly 20% annual earnings per share growth. On a combined basis, we estimate the two businesses will earn around $2.95 next year and $3.55 in 2009.
How attractive are the shares at the current price of around $42.60?
LR: At today’s price, the shares trade at less than 12x estimated 2008 free cash flow. We consider that low for a company with this growth outlook and such high quality businesses, with high recurring revenue, customer stickiness, low capital intensity and high operating leverage without cyclicality. With only a modest increase in multiple, to 13-14x free cash flow, we’d expect the stock to be in the high-$50s a year from now. If investors overall start to consider revenue growth in high single-digits to be heroic – which is possible – the valuation upside could be higher.
How does the proposed spinoff impact your thesis?
LR: We believe the two businesses when eventually separated will either thrive as independent companies with efficient costs of capital and become acquisition platforms, or, if they remain undervalued, will themselves become takeover candidates. Either way, we expect that to be positive for shareholders. We’re particularly focused today on companies with moderate or better earnings growth, earnings stability, low valuations and management that cares. In this case, we think we have all four of those.