Whether Willie Sutton said those words or not is actually irrelevant. In his book, he wrote that while he never uttered the famous "That's where the money is" line to a reporter, he easily could have. He just thought the fact was so obvious that it went without saying.
And indeed it is obvious. Banks are, almost literally, made of money, and everybody knows this. The downside to common wisdom like that, however, is that you can be pretty sure that most of the suits up on Wall Street keep a close eye on the banks and snap up their shares whenever they fall into bargain territory. Which poses a quandary: How do you make money on banks, without competing against the big Wall Street institutions that also want to make money on banks? Answer: by not investing in banks.
In through the out door
Or at least by not investing in them directly. I've identified five firms that offer you the opportunity to take the banks' money after it has already left the vault and is out from under the watchful eyes of Wall Street. Let me tell you a little bit about each of them, in chart form.
| Enterprise Value ($millions) | Free Cash Flow ($millions) | Projected Growth Rate (%) | EV/FCF/G | Return on Equity (%) | |
|---|---|---|---|---|---|
| Corillian (NASDAQ:CORI) | 70 |
11.7 | 20 | 0.3 | 41.0 |
|
Online Resources (NASDAQ:ORCC) |
140 |
3.2 | 25 | 1.8 |
18.3 |
| S1 (NASDAQ:SONE) |
400 |
-7.6 |
17 | negative |
3.5 |
|
Digital Insight (NASDAQ:DGIN) | 500 |
39.7 | 20 |
0.6 | 5.2 |
| Sybase (NYSE:SY) | 1180 | 134.0 | 10 | 0.9 | 9.4 |
And now a few words about each of these businesses, math aside.
Corillian
Although the smallest of the five on an enterprise value and market-cap basis, Corillian is the big dog when it comes to hunting elephants. (Then again, I'm not sure whether canines are much good at hunting loxodonta. The market certainly has its doubts, given Corillian's ultra-cheap valuation.) Corillian's Voyager software provides the backbone for the online banking and bill-pay operations of 14 of the 50 biggest banks in the U.S., including such names as JPMorgan Chase (NYSE:JPM), Wachovia, and SunTrust.
Corillian's next biggest competitor in this segment of the banking market is "none of the above," because 10 of the 50 biggest banks manage their online banking in-house. Third place goes to Sybase's Financial Fusion subsidiary, with seven big clients, and S1 comes in fourth with six elephants of its own.
Corillian's revenue streams derive almost equally from three sources: recurring revenue from maintaining and hosting banks' sites, fees for software implementation, and bulk sales of "seat licenses" (which permit a client to service "X" number of online banking customers).
Online Resources
If Corillian hunts big game in ones and twos, Online Resources is more of a deep-sea trawler, spreading its nets and harvesting the smaller denizens of the financial sea. Online Resources also has two other business segments, servicing credit card companies and e-retailers. But its specialty is banking, and Online Resources counts over 700 regional and small banks and similar lenders as its clients. While the stakes may differ in size, however, both companies play the same game: supporting Internet banking and payment services for their clients.
Just as big game hunters don't really consider fishermen their competitors, Online Resources probably doesn't consider Corillian a threat to its ability to attract and retain its smaller-fry clientele. That honor falls to Digital Insight and S1.
S1
As broad as Online Resources' business is, S1 -- the artist formerly known as Security First Technologies -- is broader still. This diversified provider of "enterprise software solutions" has a much larger client base, servicing over 4,000 banks, credit unions, investment firms, and insurance companies, both large and small. Plus, S1 doesn't stick to just online banking and bill pay. It has another entire division devoted to automating "customer relationships" for clients in both banking and non-banking industries and even owns an India-based software outsourcee.
Digital Insight
Digital Insight competes primarily with Online Resources for the favor of regional and smaller banks and other financial institutions. Three times Online Resources' size by market cap, Digital Insight also has three times its rival's customers, counting about 1,700 institutions as its customers. Of the two companies, Online Resources has more room for growth. But Digital Insight will do everything it can to keep Online Resources from doing just that. Its competitors tell me that Digital Insight is the stronger of the two companies, with an excellent business model tailored to its small bank clientele. Considering that its free cash flow is 10 times the size of Online Resources, despite having a revenue base only four times as large, the numbers seem to support that opinion. It's also worth pointing out that Digital Insight describes more than 90% of its revenues as "recurring." Impressive indeed.
Sybase
Sybase has a much more diversified business than the other companies mentioned above. In fact, only one of Sybase's two subsidiaries, Financial Fusion, competes directly with the other companies named above. Overall, the company is better considered a database software company and competitor to such big software names as Oracle (NASDAQ:ORCL) or SAP. So investing in this one is not really a pure play on the growth of online banking, as investing in any of the four companies already discussed would be.
Still, given that the company is No. 2 in the market for online banking for Top 50 banks (unless you count "none of the above" as one of the contenders), we'd be remiss in not at least mentioning this one. The Financial Fusion subsidiary serves over 200 clients, but overall doesn't measure up well against its competition -- actually losing money in each of the past three years.
Why are we here?
Now that we know the players, it's high time I explained why a Motley Fool Hidden Gems writer is looking at banking software companies in the first place. To see why, look back at the chart we started out with. There you'll see that each of the five companies dominating this market is still a small cap.
At Hidden Gems, we think small caps hold the key to your financial future. None other than the granddaddy of value investors, Benjamin Graham, opined that the market generally values small-cap companies at a discount, pricing them at smaller multiples to earnings than their large-cap brethren. Yet high-quality small-cap companies can be tiny packages of fiscal dynamite, ready to explode into mid-cap and larger valuations over the years.
You see, the best of these small companies are going to grow over time. And at some point, they're going to grow right out of the market's bias against small caps. Once a small cap becomes a mid- or large cap, that small-cap "discount" is going to disappear and the market may accord the company a better market multiple -- giving you a double-dose of profit.
From this Fool's point of view, online banking is a market that still has lots of room to grow, because the majority of individuals in the U.S. still have not taken their banking online. I expect several of these five companies to profit handsomely from that growth and encourage you to look into them and see if you agree.
Want to see this theory play out in reality? One of our Hidden Gems recommendations is closing rapidly on mid-cap territory already. Find out who it is and gain access to each of our other 31 active recommendations as your reward for trying our Hidden Gems newsletter. You'll have one full month to peruse our recommendations free of charge. Sure, we hope you'll stick around afterwards and work with us to build your financial future -- but if you prefer, you can cancel anytime, no questions asked. You have our word on it.
Fool contributorRich Smithowns shares of Corillian, but of no other company mentioned in this article.You can take The Motley Fool's disclosure policy to the bank, online or off.
