Before First Data Corp (NYSE: FDC) released its third-quarter earnings in late October the payment processing company was enjoying a banner year: Shares of the company were up 30% year-to-date, and the company's mobile point-of-sale (POS) solution, Clover, was showing real traction with customers. Since reporting its third-quarter results, however, shares have plunged about 13%; the numbers failed to impress Wall Street, and management revised full-year guidance downward.
After reviewing the company's conference call, however, there appear to be other big takeaways beyond just the quarterly numbers, including management's big plans for Clover and its debt burden. Let's dive in and take a closer look at First Data's quarter to see if shares might now be a buy after their latest drop, or if it's just the first sign of more bad news to come.
The numbers don't tell the whole story
The quarterly numbers were a decidedly mixed bag. In Q3, First Data's adjusted total segment revenue rose to $2.16 billion, a 5% increase year-over-year, and adjusted earnings per share (EPS) fell to $0.35, a 13% decrease year-over-year. Earnings fell due to unfavorable foreign currency headwinds and a more normalized tax rate, according to management.
First Data's largest segment, Global Business Solutions, saw modest growth. This division offers point-of-sale (POS) and e-commerce payment offerings to merchants. In Q3, this segment's revenue grew to $1.38 billion, a 4% increase over last year's total on a constant currency and adjusted basis. The Global Financial Solutions business division, which provides loan processing, card issuing, and other technological assistance to banks and credit unions, saw revenue rise to $407 million, a 6% increase year-over-year.
The most troubling aspect was the company's reduced full-year earnings guidance. With just one quarter to go in the fiscal year, First Data is now guiding for full-year adjusted EPS to fall in the range of $1.38 to $1.40. The previous guidance called for adjusted EPS to be within the range of $1.42 to $1.47. Management blamed adverse foreign currency impacts and recent divestitures for the reduced outlook. That's not a calamitous drop in and of itself, as the reasons given for the reduced guidance seem plausible and short-term in nature. Yet given the market's recent volatility and its inherent bias toward short-term results, it was not terribly surprising to see the stock price fall in response.
Clover's explosive growth
The good news for First Data is that its Clover business continues to show real growth and traction with customers. This quarter the tablet-based POS solution processed about $17.5 billion in payment volume, a 45% increase year-over-year. This number has more than tripled since early 2016, when it was processing about $20 billion on an annualized basis.
First Data is not sitting still regarding Clover's success. This quarter the company announced that merchants can now register their accounts online, allowing them to research the platform and get up and running almost instantaneously." Clover will also be launching in additional markets -- it is already in Canada, and will be in Argentina by the end of the year. Most important, perhaps, is its move to launch a POS software solution specifically designed for full-service restaurants. In the conference call, CEO Frank Bisignano stated:
Clover will shortly launch a tightly integrated full-service restaurant software solution. Clover has always been strong in small, quick-service restaurants, but the FSR segment needs much deeper functionality and is a large addressable software market that enables Clover to increase its revenue per merchant. FSR is just one example, but we have an exciting pipeline of both horizontal- and vertical-specific software solutions at Clover, all intended to increase our revenue per merchant.
This follows similar moves from competitors like Square Inc (NYSE:SQ), which launched Square for Restaurants earlier this year, and Global Payments Inc (NYSE:GPN), which recently acquired SICOM Systems, which it plans to integrate with its own in-house restaurant software solution Xenial. While First Data never seems to be the first to offer innovative solutions, it also never seems shy to follow others in a promising direction.
First Data's debt burden
This quarter First Data reported net debt equal to about $17.2 billion, a number almost equal to its $17.5 billion market cap. For investors not familiar with First Data, that number probably seems impossibly high -- yet it actually represents a marked improvement since the beginning of the year. In Q3, First Data paid off $855 million in debt and $1.44 billion since the beginning of the year. The company was also able to refinance part of its debt in a way that will save it about $90 million in interest payments in 2019. This brings First Data's leverage ratio, defined as segment EBITDA to net debt, to about 5.3, and management believes this ratio can drop closer to 4.0 by the end of 2019.
The problem with this debt is that it eats First Data's cash flow. During the course of the conference call, management was asked about possibly buying back shares or additional acquisitions; both times, management said paying down debt has to be the company's biggest priority, saying it currently consumes about 80% of the company's free cash flow. Given the company's situation this is absolutely the right call, but it's impossible not to wonder just how much First Data can innovate, spend on R&D, or return money to shareholders with such a huge debt burden hanging over its head.
Why First Data's not best-in-class
First Data is an interesting company with many positives and negatives for investors to consider. On one hand, based on the midpoint of its new, revised guidance, shares trade at an adjusted P/E ratio of just 13.5, well below the ratios of peers such as Global Payments and Square. Given the discounted valuation, it's possible the market is taking into account the debt burden hanging over the company.
But I still cannot get behind buying shares. While First Data's Clover is showing strong growth, I cannot help but think First Data will fall further and further behind its rivals in the payments arm race to release more innovative solutions to its customers. Because of this, both Global Payments and Square seem better positioned to capture future upside in this industry.