In this week’s Sunday Spotlight, we provide an update on the money transfer landscape and highlight key initiatives launched by the large incumbents (WU, Ria (EEFT) and MGI), and digital providers (Xoom-PYPL, TransferWise, and Remitly). While expecting cash-to-cash remittances to face secular challenges in the long-term, the money transfer market as a whole remains sound, as physical remittance declines have been offset by robust growth in the digital market. For reference, World Bank projections call for $739B in principal remittance flows in 2020, an increase of 4.5% Y/Y, up from the projected 3.5% Y/Y increase in 2019E (exhibit 2). While the shift to digital remittances is expected to weigh on pricing longer term, near term trends have been stable, noting the global average cost per remittance in 3Q19 (as a % of total principal) was 6.8%, consistent with 2Q19.
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We are issuing minor updates to our prior note to clarify two points. With regard to the sale process, the Company will begin the execution of separations next week vs. our prior comment of a sale process. We also point out that the Horizontal BPO business has slightly above Company margins vs. our prior comment of slightly below company margins.
ADS reported its October credit data this morning with NCOs of 6. 6%, down 90 bps Y/Y and up 100 bps M/M (relative to the 5-year seasonal average of up 82 bps M/M). While NCO’s came in slightly above seasonally higher levels, the Company reaffirmed its guided approximately 6% for the full year (in line with our model), implying a material step down sequentially over the next two months.
Yesterday (11/14), we had the opportunity to host DXC’s CEO Mike Salvino, CFO Paul Saleh, and Head of IR and M&A, Shailesh Murali for meetings with investors in NYC. Overall, we came away with incremental confidence in DXC’s commitment to change from a cost cutting narrative towards one of strategic actions to unlock value while reinvesting in its people and culture to realign for long-term top-line growth.
While DXC’s 2Q results came in below sell-side estimates, we believe the bigger takeaway from last night’s earnings release (11/11/19) was the revised long-term outlook, which emphasized revitalizing the core ITO business, divesting several industry solutions businesses and restoring investor confidence in the Company’s ability to achieve stated targets. Notably, the Company outlined a plan to divest ~25% of total revenues (U.S. State & Local HHS, Horizontal BPS and Workplace & Mobility businesses), with assumed after-tax proceeds of ~$5B. Coupled with a targeted ~80-85% FCF conversion, management expects to return $4.25B to shareholders in the form of dividends and buybacks by FYE22 and repay $2.5B in long term debt.
Last week we hosted a meeting with Infinicept’s CEO and Founder, Todd Ablowitz. Infinicept is a Payment Facilitator (PayFac) in a box, that fully supports merchant acceptance, underwriting, boarding, and back office. Below are our key takeaways with incremental detail on page 2.
DXC reported F2Q results after today’s close (11/11/19), highlighted by another quarter of relatively soft results. Total reported revenues of $4.85B were down -3.2% Y/Y on a reported basis and down -0.8% CC, slightly below our $4.86B and the Street’s $4.91B. Adjusted EBIT of $529mm was below our $583mm and the Street’s $596mm and represented margins of 10.9%. GBS revenues of $2.29B (up 8.2% Y/Y reported, and up 10.5% CC), came in above our $2.27B, and the Street’s $2.21B. GIS revenues of $2.57B (down 11.6% Y/Y reported, down 9.1% CC), came in below our $2.59B and the Street’s $2.71B. GBS bookings were $1.9B, down ~$500mm QoQ while GIS bookings of $1.8B were up ~$0.1B QoQ. Adjusted EPS of $1.38 was behind our $1.40 and the Street’s $1.43. Notably, management highlighted several action items following the CEOs strategic review including enhancing the technology stack, divesting industry solutions and adjacent non-core businesses and focusing on the existing customer base.
Following the CEO change in September, we continue to receive questions from investors around expectations for FY20 guidance, and the potential for a significant margin reset within F2Q. In our view, tempering near-term earnings expectations would provide newly appointed CEO Mike Salvino additional runway to assess the underlying health of DXC and/or investments required to stabilize revenue near-term. As a reminder, DXC lowered FY20 revenue and EPS guidance within 1Q noting (1) delays closing several large deals, (2) an accelerated transition to cloud weighing on legacy, (3) stranded costs attributed to the Luxoft transaction, (4) investments to scale the digital practice, and (5) incremental FX headwinds of $150-200mm. With valuation at a significant discount to historical averages (on an absolute and relative basis), we believe shares are pricing in FY20 results well below the current guide.
In this week’s Sunday Spotlight, we highlight investor sentiment and feedback on each name in our coverage (see page 2). Overall, while the market back-drop continues to weigh on our names, investor sentiment remains constructive on the long-term thesis on most of our Fin-Tech coverage, and slightly less optimistic on IT Services. Similar to what we saw this time last year, many of our names have contracted over the last several weeks and are now trading in-line or below their 1-year median P/E spreads to market, however most are still slightly above the 3-year median spreads to market given the substantial outperformance seen over the past three years in Fin-Tech and Services.
Overall 3Q was solid, and 2020’s outlook for “at least” 7% Y/Y CC organic growth came in 100bps+ ahead of expectations. We expect ongoing stability in trends across the core businesses of ~6% growth, combined with 1) ~60-75bps of incremental revenue growth in 2020 from the deconsolidation of FDC JVs (as JV growth was likely slightly negative by our estimation vs. ~7% Y/Y CC organic FDC growth and around $1.3bn+ in JV revenue), and 2) ~60-75bps of top-line benefit from ~$100mn+ of revenue synergies, to make the company’s 7%+ guide very achievable. In addition, we view the $200mn of cost synergies expected to be realized thus far in the first year post close as conservative and would not be surprised by an upward revision to that number and the 5-year synergy targets at the March 2020 Investor Day. We see upside to our $6.20 ‘21E EPS from 1) capital allocation (FISV already initiated share buybacks earlier than expected), 2) revenue synergies, and 3) FISV organic growth acceleration.
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