Barely a year had passed since the merger between Vantiv Inc. and Worldpay Group formed a giant in the payment processor industry when Fiserv, Inc. (NASDAQ: FISV) and First Data Corp. (NYSE: FDC) announced their intentions to combine both companies. If the deal is completed, this would be the most important merger the industry has been seen to date. The combined company would dwarf the current Worldpay Inc. (NYSE: WP), making it the second most capitalized company within this space.
For its part, after Vantiv announced plans to merge with the European company Worldpay Group in mid-2017, the number of analysts who have given a purchase recommendation has rapidly doubled. The company’s new turn towards the growing e-commerce market has generated great expectations among analysts who made the value of the company appreciate quickly. However, as fears of overheating in the economic cycle weighed more and more during the second half of 2018, added to the doubts of a possible contraction in consumer credit, and quarterly results that did not meet the expectations of investors, caused the share price to lose part of this gain.
Even though the integration of both companies in the current Worldpay Inc. maintains a faster than expected course, we see that the merger has brought mixed results in the financial results during 2018. Taking this into account, we present the strategic position of the company in the industry after a year of the merger, and what would be its place in the medium term against the future Fiserv & First Data deal.
Worldpay’s Electronic Payment And E-Commerce Opportunities
The strategic reason that Vantiv pursued a merger with Worldpay Group stems from the need of its retail customers to expand through e-commerce; as part of the so-called "Amazon effect," in which many physical stores have looked for ways to market their products in digital channels. In our opinion, we believe that this trend is losing part of its momentum in the US, although internationally it still maintains strong growth.
The presence and reach that Worldpay now enjoys in the European market provides new opportunities for its payment technology to scale internationally. We estimate that trends towards the adoption of electronic payments, electronic commerce, and B2B transactions in its international market have become the main arguments for future growth for the company.
It is estimated that by 2021, annual growth in the global payments market will maintain a 7% pace. Most of this growth will come from regions such as Asia-Pacific and Europe, with a modest increase in the North America. According to the estimates of Wedbush Securities (paywalled), between 15% and 20% of Worldpay's sales come from the UK, so we believe that the company is well positioned to benefit from this growth.
Source: Extracted from Worldpay’s Investor presentation 2018.
Looking closely at the company's segments, it can be seen that the revenues of its Merchant Solutions have been stagnating in recent quarters. The services of this line of business that come from the previous Vantiv offer omnichannel payments to a diverse set of merchants, who are mostly concentrated in the North American region. This geographical concentration that kept revenue in a strong secular trend in the past seems to have vanished in recent periods, as the market reaches maturity.
Source: Data extracted from the SEC.
In contrast, the Technology Solutions segment that offers payment solutions for e-commerce has seen an accelerated growth during the same period. This line of business that comes from the previous Worldpay Group has maintained its double-digit growth thanks to the cross-sales that were achieved after the merger, as well as the addition of new customers in the international market.
We believe that the Technology Solutions segment will become the most important for the company in the medium term, and the main driver of growth. We estimate that offers such as eWallet still have room to expand in the international market, as the company's retail customer base adopts this payment method.
Fiserv & First Data Offer
Just as Worldpay saw synergies and cross-selling opportunities for its services following the merger during 2018, we estimate that the merger of Fiserv & First Data will bring similar benefits from a strategic perspective. The alignment of both business models will allow the future company to scale its Merchant Acquiring segment by offering broader solutions to its current customers.
Among the most notable synergies is the possibility of unifying First Data's digital commerce accounts with Fiserv's digital banking, creating a more complete system that will strengthen the relations with its customers by providing a more complete service. This unification would bring a competitive advantage to the company by maintaining a higher switching cost, giving more certainty to revenues in the long term.
Likewise, as part of the expansion of services, Fiserv's institutional clients will be able to offer to their commercial customers the First Data "Clover" cloud platform.
Source: Extracted from Fiserv’s Investor presentation 2019.
In terms of Fiserv & First Data geographical scope, it is observed that revenues are highly concentrated in North America, with a limited presence at an international level. Although this concentration is expected to bring some benefits in the short term since both companies are less exposed to fluctuations in the exchange rate, we see that the presence of Worldpay in the international market will be a determining factor for growth in the medium term.
In relative terms, we see that Worldpay's valuation suffered a rapid contraction from a PB ratio perspective, positioning the company at the lower end of the Business Services industry. Although at first glance the premium that exists between the market cap and equity makes the shares attractive, when looking closely at other income-based metrics, it can be noted that the company has lost profitability, while at the same time it has seen an increase in its price.
Source: Data provided by Ycharts.
Historically, Worldpay has been characterized for generating profits that has been superior to that of the industry. The operating margins that have previously been positioned above 15% are now contracted at a current 7-8%. The free cash flow that was usually in positive territory, has fallen well below the average of five years. Although most of these problems can be attributed to the integration process, we believe that the company has lost one of its strongest investment arguments, that of a higher profitability than the industry.
We see that this contraction in the margins and a high valuation in their price multiples, added to macroeconomic fears, caused the stock price to contract rapidly during 2018, bringing it to a more reasonable value.
Source: Data provided by Ycharts.
Looking to the future, we estimate that the company will recover its past profitability during 2019. The forward ratios such as PS and EV to EBITDA suggest that the company will recover its previous position in the industry at the end of this year. For the long term, as management focuses less and less on the integration of both business lines, margins are expected to expand considerably, even beyond the synergies projected by executives, making the company more attractive from a fundamental perspective.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.