Post-acquisition progress: FIS, Vantiv, and Worldpay
We think that Fidelity National Information Services (FIS) has made a major strategic move in acquiring Worldpay (NYSE:WP) for $43 billion recently, which presents an interesting upside opportunity for technology investors to receive exposure beyond the financial services technology market. In a nutshell, FIS pre-Worldpay acquisition is pretty much the largest core banking software provider for many large financial institutions.
FIS made the Worldpay acquisition just about a year after Vantiv (VNTV) acquired Worldpay and decided to change its name to Worldpay. With the acquisition, FIS also enables itself to tap into Vantiv’s strength. Vantiv itself is another payment technology player that has made a reputation as one of the few technology companies with a strong ability to execute M&A deals. Over the years, M&A has been the key avenue for it to grow and achieve the number 1 position in the US in terms of total processed volume of credit card transactions.
(Source: Worldpay 10-K Filing. History of Investment and Acquisition by Vantiv)
Over the last year, we have learned that in addition to the positive views surrounding the deal, it appears that the operational integration has progressed very well. In the Q3 2018 earnings call, the management expected to quadruple the already-achieved total cost synergies of $50 million in 2020.
In regards to Worldpay’s acquisition by FIS, Q3 2019 will be the first quarter that FIS reports a consolidated quarterly revenue from both companies. Recently in Q2 2019, FIS’s guidance for the combined revenue from FIS and Worldpay for FY 2019 would be somewhere around $12 billion. In our view, there will not be any significant post-merger issues in terms of revenue generation for both companies. As it stands, FIS is a pretty stable business as a standalone. It is a financial services technology firm with $80 billion market capitalization that in the last 3 years has been generating around $8 billion in revenue that has been growing around 2% YoY.
The upsides: What’s in store before and after
As a standalone, FIS itself is a large-cap company already with a steady stream of recurring revenue coming from their IFS (Integrated Financial Services) and GFS (Global Financial Services) segments. The main asset of FIS is its software applications, which are used by many large financial institutions primarily to store their customer records.
(Source: FIS 10-Q Filing Q2 2019. FIS Revenue Stream by Types and Geographical Markets)
FIS mainly generated 60% to 70% of its revenue through processing and service transaction fees incurred by its clients from both segments, while the clients themselves include North American and Global banks, government institutions, credit unions, commercial lenders, and others. An interesting thing about FIS from our point of view as technology investors is the fact that it has built a very high barrier to entry in the market where the switching cost is also really high for over 50 years. Such a critical moat proves important for the company to be able to build a steady and recurring revenue stream through predictable purchase patterns of its clients.
With such an established and large client base, we have seen that it would make sense for a very profitable and cash-rich business like FIS to focus its growth strategy towards acquiring new businesses with similar business models in other areas of the financial software market.
(Source: Stockrow. FIS Revenue growth Trailing Annual)
Over the last 2 years before the Worldpay acquisition, FIS’s revenue growth had remained between the 1%-3% YoY range, which also created an urgency to seek an acquisition target to boost its growth and also create a cost and revenue synergy.
(Source: Stockrow. Worldpay Revenue, growth, and Cash Flow)
We think that Worldpay’s acquisition will provide FIS with a good opportunity to achieve both due to its similarity in business model and Worldpay/Vantiv’s history of successful M&A deal executions. In FY 2018, Worldpay was acquired by Vantiv and kept its brand name as the surviving company after the deal, during which it spent almost the rest of the year realizing cost synergies. With a realized cost synergy of almost $50 million a year and expected revenue synergy of $100 million, the merger turned out to be successful. Worldpay grew at a slightly higher rate at 2.42% YoY than FIS, and it also was a cash-rich and profitable company with annual revenue of $3.8 billion-$4 billion.
(Source: Seeking Alpha. FIS’ Worldpay reporting segment Q2 2019)
In general, Worldpay’s core business is to provide a payment gateway solution for online and offline merchants and also a processing solution for credit card issuers, which in the majority are financial institutions. Given both companies sharing a very similar fee-based business model out of providing core software applications for large institutions in different markets, we expect that FIS will be able to realize various operating cost synergies on mostly SG&A expenses. Besides, FIS will also now be able to tap into the double-digit growth technology business segment Worldpay has and the $2 trillion global eCommerce and terminal (offline) payment gateway solutions.
It is not a secret that any M&A deal comes with a high risk of failure. On a more positive note, the fact that Worldpay and FIS businesses share a similarity in how both generate revenue would mean a huge step forward towards achieving synergy in how both management think of the combined company’s future strategies.
That being said, one thing that caught our attention despite Worldpay’s successful merger with Vantiv in 2018 was how greatly impacted its profitability was during that year.
(Source: StockRow. Worldpay Expenses in FY 2018 vs FY 2017)
We found that in order to successfully complete the post-acquisition integration, Worldpay had to spend almost twice as much SG&A and operating expense as it did in the previous year to realize the synergies. Most of these costs, as reported in Worldpay’s 10-K, were spent in transaction, consulting and third-party service fees.
This impacted Worldpay’s bottom line by a lot. In 2018, Worldpay was only able to record a net margin of 0.3%, which for a company of Worldpay’s scale was much lower compared to 3.8% in 2017. At the same time, revenue was also affected, though not as severe, with it being down almost 2.9% YoY.
Going into Q3 2019, where it would report its first-ever actual consolidated results post-acquisition, FIS would have to pay attention to the factors driving such integration costs as they would be going into Q3 with most investors expecting it to have taken notes and learned from Vantiv’s acquisition of Worldpay and proceed with more caution.
Valuation and takeaway
(Source: Google finance. FIS last 1-month historical price per share performance)
The market has so far viewed the acquisition quite positively as of Q2 2019. Given a strong Q2, currently, FIS trades at $129.95 per share with a P/S of 4.37 and P/E ratio of 51 as of Q2, the highest it has been in the last 5 quarters. The dip due to mostly trade war news affecting the broader market could actually provide a good buying opportunity given the upsides we have discussed previously. The guidance for the next quarter of $2.78 billion-$2.8 billion Q3 revenue and adjusted EPS, excluding all depreciation and amortization, of $1.69 - $1.72, seems to be more on the optimistic side given there is a risk of one-off depressed earnings due to the cost incurred for integrations.
As a large-cap company, the combined operation between Worldpay and FIS would generate a revenue of almost $12 billion a year and a market cap of more than $120 billion. On the growth perspective, it might seem that a lot would be needed to really move the needle. To us, the Worldpay acquisition is a major step towards that.
(Source: Seeking Alpha. FIS 2019 Q2 Earnings Call Slides)
With the revenue synergy driving an additional 1% to 3% growth rate, we feel that this would still be an interesting opportunity for technology investors to receive exposure to the broader global financial technology market. With total combined assets of almost $50 billion and consistent free cash flow generation at $1.3 billion annually, we believe that it would be possible for FIS to do more acquisitions by FY 2020 once the current operating integration is fully complete.
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.