We see yesterday (01/16/19) morning’s announced FDC acquisition by FISV as strategically sound for numerous reasons, including: (1) merchant bank referral with FISV banks now being able to refer FDC’s acquiring services (both FISV’s customer banks and FISV should see revenue opportunity), (2) issuer processing and bill-pay cross-sell, (3) STAR network scale, and (4) digital distribution, with FISV’s banks acting as a digital onboarding network for Clover. Under the agreement, FDC shareholders will receive .303 FISV shares for each share of FDC stock, which values the company at ~$22bn or $22.74/sh based on 1/15/19’s closing price (14x 2019 P/E, ~11-11.5x NTM EV/EBITDA pre-synergies). The transaction is expected to close 2H19 (FISV shareholders will own 57.5% of the combined company).
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This morning (1/16/19), FISV and FDC announced that Fiserv and First Data would combine to “create a global leader in payments and fin-tech.” Under the agreement, First Data shareholders will receive .303 Fiserv shares for each share of FDC common stock, which values the company at ~$22bn or at $22.74 per share based on January 15, 2019’s closing price (14x NTM P/E, ~11-11.5x NTM EV/EBITDA pre-synergies). Once the transaction closes Fiserv shareholders will own 57.5% of the combined company and First Data shareholders 42.5%. The transaction is expected to close 2H19 and will be tax-free to First Data shareholders. While the price Fiserv is paying for First Data looks to be extremely low, FDC shareholders are now owners of Fiserv stock so should benefit from the combined business in the long run. We see this deal as a net positive for FDC shareholders given material synergies on the revenue and cost side, quick deleveraging, and opportunity benefit from accretion as forward shareholders. Further we believe the combined businesses should make for a powerhouse on the issuer processing side while finding meaningful synergies in many other areas around FDC’s STAR network, merchant bank referral acquiring, Clover Platform/digital onboarding and more. While the FISV multiple may decrease slightly, we note that the accretion of 20%+ in year one with material upside longer term (40% at full synergy run-rate) should more offset any multiple compression for FISV shareholders over time.
While our 2019 outlook report (link here) assumes no recession, we have received a fair amount of investor questions around recession-based scenarios. Within our outlook, we upgraded Square based on valuation and our view around solid momentum in the business, particularly subscription and services, that may drive notable upside to consensus revenue growth. That said, we also highlighted SQ as among the more cyclically sensitive companies in our coverage. While we continue to believe SQ trends would be pressured given exposure to micro-merchants and credit, incremental data points suggest it could be more resilient vs. our prior expectations. We highlight that recessions are typically met with net employer count declines and C&I loan contractions, however we also point out that SQ’s business model is already reflective of higher closure rates at micro sellers and SQ capital remains a relatively small contributor to both its top- and bottom-line.
While we recognize that V and MA have plenty of levers to pull to meet expectations on any given quarter (i.e. rebate and incentive levels, pricing, expenses, buybacks, etc.), we highlight these data as slightly worse than our prior estimates and weaker compared to other datapoints around spend. In particular, we are a bit surprised by the weakness in the bank data given that Mastercard recently reported holiday season SpendingPulse data that showed the strongest growth in 6 years with holiday sales up 5.1% Y/Y from 11/1/18 through 12/24/18 (vs. 4.9% Y/Y growth in ’17 and 4.0% Y/Y growth in ’16). It’s worth noting that eCommerce metrics were among the stronger standouts in recent checks.
Average NCOs for 4Q18 were 5.5% versus our estimate of 5.4%. For the year ended 2018, NCOs were 6.1% (vs 6.0% in FY2017), in line with the 6.1% in our model and management’s guide of approximately 6%.
For this week’s Sunday’s Spotlight we conducted several channel checks across geographies to get an update on consumer spending trends. While U.S. and Canada data points highlight healthy spending during the holidays, our U.K. checks suggested otherwise, with some pointing towards a deceleration of 200-300 bps during late 2018, to a rate of flat to LSD growth. With the Brexit overhang and high levels of uncertainty, the Pound has seen a steep decline over the last year and there has been a noticeable economic slowdown. Total U.K. retail sales are projected to slow significantly from 4.7% Y/Y growth in 2018E to 2.6% Y/Y growth in 2019E and then eventually 1.1% Y/Y growth in 2022E. As such, we look at U.K. exposure by company across our coverage to see most/least exposed. See Exhibit 2 for estimates of U.K. revenue exposure per stock within our coverage.
This morning (01/07/19), DXC announced the acquisition Luxoft (LXFT), for $59 per share, representing total equity value of ~$2B, (48% premium over the 90-day average closing price). The purchase price represents ~20x consensus NTM earnings and ~16x consensus NTM EBITDA (pre-synergies). Importantly, Luxoft will add ~$900mm in annual revenue, which outside their two largest accounts (DB and UBS, ~30% of revenue) has grown +20% over the last few years. While DB’s associated revenue to LXFT (less than $100mm) may continue to be slightly down Y/Y, management anticipated this in its outlook and expects relative stability on that account after this year. Over the next 3 years, management expects stand-alone Luxoft to grow at a 15% CAGR and drive estimated revenue synergies of $300-400 mm by 2022. Further, by leveraging DXC scale, management is targeting Luxoft margin expansion of 200 bps by 2020. With this transaction, DXC expects to revise revenue and earnings expectations upward (assuming a timely close process). The Company will target a 4-6% revenue CAGR through FY2022 (up from 2-4%) and FY2022 EPS range of $12.25-13.00 (up from $11.75-12.50). We also highlight on the call, management noted $800mm in shares had been repurchased within the quarter. Overall, we recognize a lofty premium was paid for LXFT relative to the Friday’s closing price, but also believe the incremental value and potential multiple upside created through enhanced growth and expanding talent pool from this deal will outweigh near-term questions.
While our 2019 base case does not call for a U.S. recession, we recognize incremental macro risks and potential implications of being later in a cycle. FX has been a headwind, oil volatility has created noise and the Fed raised interest rates 4x in ‘18. U.S. and Canadian consumer spending trends remain sound while cracks are apparent in the U.K. and China. Short-term, we believe 2019 consensus estimates likely need to be adjusted lower for a number of names (see Exhibit 2 for comparison of our estimates and consensus) given FX, gas prices, and rates.
While ADS shares underperformed in 2018 (-41% vs S&P -6%), we see limited upside near-term, as negative market sentiment has weighed on consumer lending valuations and investors reposition away from credit sensitive names ahead of an economic downturn. We continue to believe value could be unlocked in shares from potentially accretive divestitures of Epsilon and/or Loyalty One, however, timing of a sale remains uncertain and given the market correction in 4Q, valuations for comparable assets have likely come down from mid-summer highs.
We are downgrading FLT to Peer Perform from Outperform given growth concerns and a greater reliance on organic trends given a lack of actionable M&A opportunities. The FleetCor story has shifted away from acquiring complimentary and mismanaged assets to one more reliant on organic trends in the business to drive HSD-LDD organic growth. In our view, this dynamic, coupled with some portfolio losses and macro trends, drove the stock’s relative underperformance in 2018. We anticipate this dynamic will limit relative outperformance potential in 2019. Despite management continuing to prioritize its M&A strategy, valuations remain full and FLT’s management team continues to be disciplined with its capital allocation. As a result, and given shares are currently trading at ~15-16x NTM EPS, management has leaned on buybacks with its recently announced ASR (~3 mn shares in 4Q) to drive shareholder value and help support EPS growth. All that said, the company remains under levered and well equipped to facilitate an acquisition across its Corporate Payments, Tolls and/or Lodging solutions businesses, however, private company valuations remain rich.
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