Since announcing the acquisition of WP on 3/18/2019, investors have continued to ask: 1) why is WP selling now, 2) are the revenue synergies real, and 3) does this deal improve FIS/WP’s positioning longer term? We think the ‘why now’ was related to timing factors and strategic opportunities for both companies, combined with an increasingly competitive global backdrop (see our recent webcast for more on this topic). More importantly in our view, following our time with both management teams (see our FIS/WP post deal NDR note), and subsequent conversations with a variety of industry executives, we have incremental detail and confidence around the timing and sizing of revenue synergies as well as the long-term opportunity. Through a combination of $100mn of ‘low-hanging fruit’ such as NYCE network share and card production, $400mn of cross-sell around rewards programs, data/auth rate improvements, and eComm opportunities, we see the $500mn of revenue synergies as potentially achievable, and longer term see upside to that number from incremental partnerships with FIS bank clients in emerging markets. With shares at only ~15x our 2021 pro-forma estimate (vs. our view that shares will trade at 20x), and incremental conviction in revenue/cost synergy potential, we continue to see shares of FIS as among our top picks.
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In this week’s Sunday Spotlight, we provide an overview of ADS’ strategic initiatives around Epsilon and an accretion/dilution analysis based on a hypothetical selling price of $5B (10. 5x LTM EBITDA). Our math suggests that to maintain a well-capitalized financial services entity post-spin, a significant percentage of the sale proceeds would need to be earmarked for debt repayment versus buybacks, limiting accretion potential (see Exhibit 4 for base case analysis). Many have often questioned the strategic fit of ADS’ business lines, and we’re constructive on the Company’s efforts to divest the non-lending assets and simplify the corporate structure. Over recent weeks, headlines have indicated the Epsilon process is nearing the finish line with multiple strategic /sponsor-led bidders and purchase price approaching $5B (10.5x LTM EBITDA). Following a hypothetical sale of Epsilon, we suspect ADS would begin a process for LoyaltyOne as well.
While BR often falls between the cracks of Services and FinTech companies, a volatile ride in shares during 2018 (climbing to nearly $140 in August (29x NTM EPS), followed by a slide back to $90 in December (19x NTM EPS)) has led to renewed interest. This volatility stemmed from revenue acceleration on short-term items followed by an EPS miss on tough event-driven comps, GTO declaration concerns amidst broader market volatility. That said, we believe the highly-recurring revenue story with multiple avenues for growth remains intact, and at current levels are incrementally constructive on shares. Further, we see the potential for a reacceleration off easing comps and improved conversion trends as a potential catalyst in 2H 2019 (calendar). In this note, we revisit BR’s business model and outline the various growth opportunities. We provide 1) a detailed revenue flowchart by business line, 2) an overview of the GTO opportunity and compelling value proposition in capital market utilities, 3) a look at the underpenetrated opportunity in Wealth Management, and 4) outline the secular ICS growth drivers, which include tailwinds from passive investing and ETF’s supporting sustainable position growth over time. While recognizing some risks, we believe MSD revenue growth, low double-digit EPS compounding supplemented by strong FCF and capital return is achievable and see optionality around revenue acceleration driving multiple expansion.
In this week’s Sunday Spotlight, we look at contactless payments in the United States. With 1) 78 of the top 100 merchants now accepting contactless payments, 2) 95% of all new terminals being contactless ready, 3) over 60% of “face-to-face” transactions occurring at contactless enabled merchants, and 4) issuers representing ~66%+ of network volume expected to begin issuing contactless cards by 2020, we expect contactless to become a dominant form of payment in short time within the U.S. Visa also set a goal to get 100mn cards to be contactless in the U.S. by the end of 2019 (vs. ~1.4bn total according to The Nilson Report with ~875mn being Visa). We highlight that 55-60% of U.S. PCE is carded with ~$6.1tn of payment volume hitting credit, debit and prepaid cards in 2018 (up 10.5% Y/Y).
ACN shares outperformed today (+5% vs. S&P flat) as F2Q told a business as usual story. Revenue topped the street, led by “strong DD” growth in the New (60% of total revs) and an EPS beat, largely on tax. While revenue guidance was raised 50bps to reflect the beat, guidance continues to imply a meaningful organic revenue deceleration in 2H19 although we see conservatism in that outlook. On a LC basis, revenues were up 9% Y/Y including 1.5% of inorganic contribution. The Company has spent ~$515mm on acquisitions YTD, vs its full year target of $1.5B. Macro questions continue to be a theme as management noted existing risks have the potential to drive an economic slowdown (considered in guide, to an extent). That said, underlying demand for ACN appears intact as 2Q bookings showed a strong rebound from 1Q levels (>1.1x book-to-bill). Overall, we expect ACN to maintain MSD/HSD revenue growth longer term (including M&A) led by a leading digital franchise and massive scale. That said, potential for select headwinds and increasingly challenging comps may limit further multiple expansion at current levels. For reference, after today’s close, ACN was trading 5.6x above the S&P NTM P/E, relative to its 3-and-5-year median spreads of 3.8x and 3.2x, respectively. Reflecting our revised model and market valuations, we raise our YE19 PT to $165 from $155, or 20x (4x above S&P) our CY2020 EPS estimate of $8.10.
Total revenues of $10.45B were up 5.5% Y/Y reported and 9.1% LC, beating our $10.28B and the Street’s $10.31B. Adjusted EPS of $1.73 beat our $1.58 and the Street’s $1.57, driven primarily on tax vs our model (~15c). Adjusted operating margins of 13.3% were below the 13.6% in our model and up 20bps Y/Y (on a comparable basis). Bookings of $11.8B were up 15% Y/Y and 20% LC, reflecting a book to bill of 1.1x. By segment (in LC): Communications, Media and Technology was up 12% vs 8% in our model and 14% in 1Q; Financial Services was up 2% vs in line with our model above the 1% in 1Q; Products was up 10% vs 9% in our model and 10% in 1Q; Health & Public Service was up 3% vs 8% in our model and 5% in 1Q; Resources was up 22% vs 18% in our model and 20% in 1Q. Overall, business trends continue to be sound for ACN and questions around bookings should abate considering the strong rebound this quarter.
F3Q19 Results: Overall, F3Q was in-line with our/consensus expectations on the bottom-line with revenues coming in slightly better than expected. PAYX reported F3Q EPS of $0.90 vs. our model calling for $0.89 and the Street’s $0.88. Revenue of $1,070.4mn compares to consensus of $1,041mn. Revenues grew 14% Y/Y (7% Y/Y organic). Management Solutions (MS) grew 4% Y/Y to ~$802mn and PEO & Insurance Services (PEO & IS) revenue of $246mn was up 65%% Y/Y (up 17% Y/Y ex. Oasis). Interestingly, management noted that the PEO space is LSD-MSD penetrated with the top 4 PEOs barely touching ~2mn worksite employees vs. “multiple tens of millions” in the market within the 20+ employee client base. Our $82 PT reflects ~21-22x CY20E FCF of $3.83.
When Accenture reports F2Q19 earnings Thursday (3/28), our primary focus will be on whether the last several months of macro volatility has added to the recent revenue deceleration, albeit against challenging comps. While ACN beat on the top/bottom line in 1Q, bookings were softer than expected (<1x book to bill), revenue decelerated slightly and management communicated a more cautious outlook, noting macro uncertainty was incorporated into the Company’s full year guide. However, management noted 2019 client budgets were in place and that differentiated pricing on digital supported modest margin expansion (+20bps Y/Y). Based on our prior research, large enterprise IT spending decisions have become increasingly integrated with strategy and areas tied to growth, rather than purely cost centers. This dynamic is particularly true in value-add digital services, which have shown the most resilient on pricing (60% of ACN revenues). We expect ACN to maintain MSD-HSD revenue trends through CY2019. That said, at 5.5x above the S&P (on an NTM P/E basis), relative to the 3-year median spread of 3.8x, we believe multiple expansion may be limited at current levels. On page 3 we highlight ACN shares have historically outperformed leading into earnings and underperformed immediately thereafter (7/10 previous Q’s). That said, shares have shown resilience as investors look for consistent, high-quality FCF growers longer term.
In this week’s Sunday Spotlight, we look at mobile banking adoption, including penetration rates, reasons behind the lack of adoption, and the revenue/attrition benefits of mobile users. Coming out of the recent Wolfe FinTech Forum, it has become more evident that digital adoption by consumers in the U.S. remains under penetrated (~35-45%), as evidenced by our fireside chat with CEO of FISV, Jeff Yabuki as well as some industry estimates. Our recent day of meetings with FIS and WP CEOs, CFOs and IRs also confirmed this. Despite retail mobile banking being ubiquitous, with ~90%+ of Federal Reserve FI respondents estimated to be offering mobile banking services, eMarketer’s analysis suggests that only ~45% of the U.S. population is estimated to use mobile phone banking services. Importantly a Federal Reserve analysis suggested that >80% of banks and credit unions rely on core deposit processors (FISV, FIS, JKHY, etc.) to deliver mobile banking services.
Wolfe Research Senior Payments, Processors, & IT Services Analyst, Darrin Peller, hosted a webcast to discuss key takeaways from NDR with CEOs, CFOs, and IR of both FIS and WP; updated thoughts on timing and strategy; and incremental thoughts on merger model.
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