The payments and financial technology company Fiserv (FI 4.43%) recently announced that it intends to acquire Finxact, a maker of cloud-native core processors for banks, for $650 million. The deal pales in comparison to Fiserv's last acquisition, First Data, for $22 billion. But don't let the smaller number fool you: The acquisition could be a bigger deal than some think, and it could solve a key issue Fiserv has been dealing with for several years. Here's why.
The problem with core processing companies
Fiserv is a company that provides banks, credit unions, and other financial-oriented companies with the technology needed to carry out many of their daily functions. It has three main divisions:
- Its acceptance division enables businesses to authorize and settle payments and get data on those transactions. It largely provides these services for point-of-sale merchant acquiring and other digital commerce.
- The payments business helps banks and other corporations process digital payments from debit, credit, and prepaid cards, as well as transactions not made on a card, like bill payments, account transfers, P2P transfers, and electronic billing.
- Fiserv's fintech division provides the core processing technology that helps banks and credit unions carry out daily functions so they can process daily loan and deposit transactions.
Image source: Getty Images.
Fiserv is one of the leading core processing companies in the U.S., with 40% market share in 2020. The problem with the mainstream core processors is that they've been using legacy technology for a long time. Financial institutions have long complained about the difficulty of implementing more modern systems and how long it takes to roll out some of the new digital banking products that banks now need to compete with more nimble fintech companies.
James Mahan III, the CEO of Live Oak Bancshares, a well-known disruptor in the banking industry, described what it was like working with the mainstream core processing companies in a 2019 article in Bank Director:
It just seemed like every time we wanted to do something, it's impossible. It's "Stand in line and write a big check." And it's really, fundamentally, putting lipstick on a pig.
Fiserv's fintech division has struggled to grow revenue in recent years. Revenue in the segment essentially stayed flat between 2018 and 2020, while revenue in the company's acceptance and payments businesses has grown very nicely. Fiserv appears to be on pace to grow revenue in the fintech division this year, but not by much.
Where Finxact comes in
Finxact has been seen as one of the biggest disruptors (if not the biggest) to the mainstream core processing companies. The startup created a cloud-banking core processor based on application programming interfaces (APIs), which banks can use to digitize all of their operations and leverage machine learning and artificial intelligence.
APIs allow banks to better partner with fintechs because integrating their systems is easier. Furthermore, Finxact's core processor operates in real time, so transactions are always balanced, and manual processes are eliminated. Ultimately, Finxact's core allows banks to roll out new digital banking products much quicker than legacy processors, and enables banks to really take advantage of their data, whether by gaining insight from it or accessing past transactions quickly.
In announcing the acquisition, Fiserv CEO Frank Bisignano said: "Through this combination, Fiserv will create a streamlined path for clients to offer digital solutions to their customers. Finxact also enhances our ability to support a growing number of financial institution and business clients."
For many years now, it seems that some financial institutions have been frustrated by the larger core processing companies because they sign long contracts with them, and it can take a while to roll out new innovative products. Fiserv knows this because it actually invested in Finxact a few years ago. Not only has Finxact been seen as the main disruptor in the core processing space for financial institutions, but some banks like Live Oak and First Horizon have switched over to the cloud-based architecture.
The acquisition of Finxact helps Fiserv take out a potential competitor down the line, it better positions the company for the future, and it allows management to show clients that it has heard their calls for change and can now more adequately answer them.
Is Fiserv a buy?
With Finxact, investors can feel better that one of Fiserv's main business lines is now on a much better trajectory to grow, especially when you consider that the industry is heading toward API-first core processors like Finxact. Its other acceptance business line has also been showing strong growth with its point-of-sale technology.
Fiserv trades at roughly 16 times this year's projected earnings and about 4 times projected revenue. Considering that each of its business lines now has good growth potential, I would rate the stock as a buy.
