First Data (NYSE: FDC ) buys and sells businesses constantly. Its biggest deal to date is the spinoff of Western Union (NYSE: WU ) , which represents 40% of total pre-spinoff revenue. Post-spin, Western Union remains a star business. Revenues for the latest quarter increased by 12% to $1.1 billion, with an operating margin of 29.6%. First Data reported on the same day, with a 9% increase in total revenue. Unwrapping the New First Data reveals three segments -- Commercial Services, Financial Institution Services, and First Data International -- each offering a different investment story and opportunity.
A dominant franchise business
First Data's Commercial Services segment is a $4 billion-a-year business. As the dominant processor of payment card transactions on behalf of merchants, it processes about half of the Visa and MasterCard transactions in the United States, according to The Nilson Report. First Data is also well-positioned against the industry's biggest trend -- moving to electronic payments from cash and checks.
Revenue is stable and sticky. Stable revenues come from customer contracts with terms between five and 10 years. Revenues are made sticky by selling through bank alliance partners and using revenue-sharing and joint investment arrangements.
Commercial Services is performing as planned. Long term, which means 2008 and beyond, First Data expects revenue growth of 8%-10%, with profits up to two points above this rate. Results for 2006 are tracking exactly to these goals.
An international growth opportunity
First Data International is a $1.2 billion business. This is a high-growth business juiced by multiple acquisitions, especially in Europe, where it is positioned to benefit from the single European payments area. Increasing consumerism in developing countries such as China, where First Data is the only third-party processor, will also drive growth.
For the September quarter, year-on-year revenues rocketed 45%, though operating profit was only up 9%, reflecting heavy investment as well as spin-out costs from Western Union.
Long term, First Data expects International to deliver revenue growth between 16% and 20%, with profit at least five points above the revenue rate. In 2006, it's far ahead on revenue goals, but behind on the profit target.
A tune-up opportunity
Financial Institution Services is a $1.8 billion business and is a leading provider of outsourced back-office services to credit card issuers.
This business is a little out of tune. Quarter-to-quarter results show a 4% drop in revenue. The main cause is losing the processing contracts for Bank of America and Wells Fargo to Total System Services (NYSE: TSS ) . Given that these processing contracts have terms between five and 10 years, this will depress revenue for years to come. Winning a contract with Sears balances out the bad news.
Total System Services remains a major threat to this First Data business. A key factor is the customer perception that TSS has a better system, called TS2. This system is strong enough for Total System Services to offer major clients -- including JPMorgan Chase (NYSE: JPM ) and Capital One (NYSE: COF ) -- long-term or perpetual licenses at the end of their processing contracts.
For 2006, First Data wants to keep revenue and profit in Financial Institution Services flat with last year. Long term, it wants 8%-10% growth in revenue and profits. Plans include $75 million of annualized savings by the end of 2007 and heavy investment in the sales force.
An investment for all seasons
On the results call, the First Data chief executive officer, Ric Duques, reiterated that the New First Data should produce 8% to 10% growth in revenue and earnings per share, regardless of economic conditions. He also stressed that the company is a free-cash-flow machine, expecting to produce more than $1.1 billion of cash in 2006 -- even after dividends and capital spending. Some of the cash will be used for stock buybacks of up to $700 million, but this huge cash flow may also attract leveraged buyout firms. Western Union left the First Data relationship with $3.5 billion of debt, leaving its former parent with around $1.5 billion. Both firms share a sparkling ability to generate free cash flow, so there is a possibility of a leveraged buyout to add debt and speed up some operational improvements. In the short term, this would be good for shareholders.
But what if you are a longer-term investor, rather than a merchant of debt? Again, First Data represents good value. Its trailing P/E is only 10, less than half of that of Total System Services and American Express -- which originally founded First Data. Total System Services is owned 80% by Synovus (NYSE: SNV ) , which means minority investor influence is limited.
In summary, the New First Data remains a good investment at a reasonable price, and is well-positioned against some powerful trends in the payments industry.