Today's Buy Opportunity: Fiserv

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Like pandas, capital-light businesses with high switching costs are majestic, powerful, and refuse to mate in captivity. They're rare specimens that spew profits thanks to their captive customers and low reinvestment needs. We have two such animals on our Inside Value scorecard, Microsoft (Nasdaq: MSFT  )  and Paychex (Nasdaq: PAYX  ) , and today, I'm presenting a third: Fiserv (Nasdaq: FISV  ) . Sadly, Fiserv has nothing to do with pandas.

Fast facts on Fiserv

Market Capitalization

$7.3 billion

Industry

The exciting world of data processing

Revenue (TTM)

$4.1 billion

Earnings (TTM)

$494 million

Cash / Debt

$416 million / $3.5 billion

Pandas Harmed in This Recommendation

0

Source: Capital IQ, a division of Standard & Poor's. TTM is trailing 12 months. Cash total includes long-term investments.

It's good to be needed
Founded in 1984, Fiserv helps keep banks (mega and mini), credit unions, retailers, merchants, and government agencies in business by processing your money. Fiserv's 16,000 clients rely on the company's practically nondiscretionary services. Think account and check processing, credit and debit card services, electronic transfers and bill payment, and more.

The two largest slices of Fiserv's $4.1 billion revenue pie are its account processing and electronic banking services, and it's a market leader on both fronts. In account processing, Fiserv boasts a 37% market share, and nearly 70% of U.S. Internet banking transactions run through one of the company's technologies. Fiserv's leading position in electronic payments leaves it sittin' pretty in a business primed for strong long-term growth thanks to more and more financial transactions taking place online.

You might think the banking industry's struggles over the past couple of years would upset Fiserv's mojo, but the company's clockwork-style, transaction-centric revenue stream and multiyear contracts with its clients have kept free cash pouring in. In addition, the company has cut $200 million or so in costs, and its streamlined sales force is focusing on cross-selling to its relatively captive customer base. Not only are the incremental dollars from cross-selling relatively easy money, but the extra services further solidify Fiserv's relationship with its customers.

Medium risk, big upside
But back to that free cash flow. The company rakes in several hundred million dollars in free cash flow annually, and it has poured $2.3 billion of that cash into share buybacks over the past five years. Those repurchases lopped off 22% of shares outstanding, and I'm happy to see the company has an authorization to gobble up another 4% or so.

I think Fiserv's stock is worth about $66 a share, making for about 38% upside from recent prices. That's assuming 4.5% annualized revenue growth for the next decade, a 10% cost of equity, and that the company hits its cost-saving targets for this year. Frankly, I consider those assumptions to be fairly conservative given the sticky nature of Fiserv's client base, its fat cash flow, and that revenue targets are bouncing off a recessionary floor.

Fiserv isn't without risk, of course. Tenacious competitors -- recent Blackstone target Fidelity National Information Services (NYSE: FIS  ) among them -- might start cutting prices aggressively, or invent a better widget. Data integrity is paramount in this industry, and a breach would undermine the company's credibility and bring out lawyers in droves. Finally, bank consolidation is also a threat. Fewer, larger banks mean a smaller customer base that has more leverage in negotiations with Fiserv. These are all credible risks, but I'd still peg this as a medium-risk investment, if that.

Foolish conclusion
Keep perspective: This is a capital-light, competitively advantaged business with a long growth runway, and it spins off tons of cash. If you're looking for a great value in today's market, I think Fiserv is a top stock idea.

Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well!

The "11 O'Clock Stock" is sponsored by Motley Fool Stock Advisor. The Motley Fool will wait at least 24 hours after this publication before purchasing shares of Fiserv. To see an FAQ on "11 O'Clock Stock," click here.

Joe Magyer owns shares of Paychex. Paychex and Microsoft are Inside Value recommendations. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (65)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 27, 2010, at 11:03 AM, TMFJoeInvestor wrote:

    Hey Fools!

    I'll be fielding any questions you'd like to throw out on Fiserv over the next hour or so. Questions, comments, musings? Hit me!

    Joe

  • Report this Comment On July 27, 2010, at 12:19 PM, dargus wrote:

    Upon quick inspection, the cash to debt looks a little worrying. Should I not be so worried because of the cash flow? How do you think Fiserv will fair if we see another credit crunch?

  • Report this Comment On July 27, 2010, at 12:37 PM, TMFJoeInvestor wrote:

    Hey dargus,

    Fiserv does have a decent slug of debt, but I'm not too concerned about it given the consistent cash flow that pours in. Operating profits cover interest expenses about 4.5 times over right now, and the first sizable rollover doesn't occur until November 2012.

    Good question on a second credit crunch. Like virtually anyone else, Fiserv would suffer in that scenario, but certainly not to an extent anywhere nearly as badly as banks themselves. The biggest risks there are a consolidation among banks (which reduces the size of the customer base), a weakening of pricing power, and that it’d be more difficult to cross-sell services. For perspective, though, Fiserv posted a very healthy 20% operating margin in 2008. Not too shabby given the state of the banking industry at the time.

    Joe

  • Report this Comment On July 27, 2010, at 1:10 PM, PLReagan wrote:

    I would assume that Fiserv will be watching with some concern as more and more banks are closed or consolidated.

  • Report this Comment On July 27, 2010, at 1:44 PM, ChasingGreen wrote:

    Fiserv Revenues have been declining for a couple years. Is this not a concern? All the moving to India leaves the future cloudy also as eventually regulation could come if the U.S job market ever concerns our goverment.

    The cash flow is outstanding.

    Sales need to improve, if revs were going up, debt paid down I would agree more with your article. Maybe even a dividend :-)

  • Report this Comment On July 27, 2010, at 1:49 PM, plange01 wrote:

    GM is just trying to take advantage of the $7,500 tax credit. they over price the car pocket the money and the foolish US taxpayers pay extra for the get hit with higher taxes to fund the credit and icing on the cake is US taxpayers are keeping bankrupt GM open with welfare checks!!

  • Report this Comment On July 27, 2010, at 2:08 PM, WallstreetKnight wrote:

    If bulge bracket banks snap up small banks like they have in the past, won't this diminish Fiserv's profitability?

    I know you touched on it above, but what is Fiserv's plan in this scenario?

  • Report this Comment On July 27, 2010, at 2:21 PM, TMFJoeInvestor wrote:

    @ChasingGreen,

    The softening of sales isn't in and of itself a concern. I'm more interested in what Mr. Market has priced into the shares going forward and what I think is achievable from here. And based on what I'm seeing, that's very little.

    I agree on the dividend policy, though. Share buybacks are a better use of capital than, say, frivolous R&D or acquisitions, but I'd rather see Fiserv pay out a portion of its free cash to keep itself a little more honest capital allocation-wise.

    Joe

  • Report this Comment On July 27, 2010, at 2:24 PM, TMFJoeInvestor wrote:

    @ChasingGreen,

    I should clarify on my last comment. My read is that the market is pricing in extremely low growth from Fiserv off a recessionary base, essentially extrapolating what has been a tough market environment well into the future. That's short-sighted, in my opinion, but not too surprising.

    Joe

  • Report this Comment On July 27, 2010, at 2:36 PM, TMFJoeInvestor wrote:

    @WallstreetKnight,

    I think Fiserv's strategy is probably much the same whether we see a ramp-up in consolidation or not: Take good care of and retain existing clients, cross-sell them on new, relevant offerings, and try to leverage the Fiserv brand and host of offerings to win new business. I agree that consolidation will slowly chip away at the size of the customer base, but I also think the present valuation more than reflects that. As Buffett once said, you pay a very high price in the stock market for a cheery consensus.

    Joe

  • Report this Comment On July 27, 2010, at 4:24 PM, ChasingGreen wrote:

    Based on just released earnings the forward numbers just got better. We'll see how the analysts and market reacts but it should be a little bit favorable. At worst FISV will probably still trade by following what the market does which means $66 may be a far reach and $50 may even be difficult as the market does not have the economy to support it.

  • Report this Comment On July 27, 2010, at 5:17 PM, Joemit wrote:

    Why does the 11:00 stock enter my box at 5:12?

  • Report this Comment On July 27, 2010, at 5:38 PM, brokeasstrader wrote:

    oh come one you blew the call... we can't win them all...

  • Report this Comment On July 27, 2010, at 6:22 PM, mountain8 wrote:

    I don't understand. One of TMF's prime tenents is low debt and high cash/debt. If you haven't misprinted, I get a cash/debt of about .1??? I can see the large cash flow but can you give me anything else that would ease my paranoid fear of excessive debt? What have they borrowed that much for? Use small words, please. I'm financially challenged :-).

  • Report this Comment On July 27, 2010, at 6:30 PM, oldengineer wrote:

    I don't understand why -- If they have such high cash flow, why haven't they paid down their debt?

  • Report this Comment On July 27, 2010, at 9:27 PM, lowmaple wrote:

    11:00 is that 2:00 qn west coast so we may have to pay 1 day's more upside for these stocks?

  • Report this Comment On July 28, 2010, at 9:07 AM, TMFJoeInvestor wrote:

    @mountain8 & @oldengineer,

    I chirped in on the cash flow and debt questions in an earlier comment, but here's for more color. Like many companies with very consistent cash flow, Fiserv carries a fair slug of debt because funding your business with debt is cheaper than with equity. If I'm an equity holder, I'd rather fund my business' growth with capital that has a required return by investors of 6% (by selling debt) than 10% (by selling equity) so that I can keep a larger slice of the profit pie for myself.

    All things equal, yep, I absolutely would prefer more cash on hand then debt. Then again, I'd prefer strong, consistent cash flows with a levered balance sheet than a cyclical business with shaky cash generating prowess and a sturdy balance sheet. The best of both worlds are businesses that offer consistent cash flows and a sturdy balance sheet, though you usually end up paying a dear price for those businesses. There are obviously countless cherry-picked examples of companies using debt that ultimately ended up hastening the sinking of their ships, but that's typically because such businesses grossly underestimate the cyclicality of their businesses. I don't think that's the case here, as borne out by the consistency of the cash flows.

    Hope that helps, and thanks for the questions!

    Joe

  • Report this Comment On August 03, 2010, at 10:41 AM, x937 wrote:

    also note: Banks are giant slugs, that dont like to make any changes quickly. The exception was "check-21" changes which the banks enacted in light speed because THEY SAVED SOOO MUCH MONEY. While some banks went with good companies to reach this goal, which likely hired fiserv, then there was a huge shake-out, as the volume of checks is decreasing every year. Companies strated leaving the business which created a second boom for the successful companies. This second wave of "perceieved" growth, was where banks readjusted their check-21 partnerships, etc. This is a strange artificial growth, which is not substainable. FISERV handles some services for other companys which store, or exchange checks for the banks.

    for the record....this is only PART of fiserv's business, and I'm only commenting on what I know, but this highly successful piece, is not long term substainable growth.

  • Report this Comment On August 03, 2010, at 10:45 AM, x937 wrote:

    Also note: Since the check volume is actually decreasing, it is unlikely that they will get new competition (the business environment is rewarding large players in check processing - check storage-check exchange.), and perhaps this part of their business should be viewed as a Utility since the volume errodes and their future returns will be from cost savings, not increased volume.

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