As I've shared in The Motley Fool Select (now Hidden Gems), I've been a fan of banking and financial stocks my entire investing life. Few companies know how to make money better than banks, and my interest in them really developed out of a love affair with banks themselves.
No doubt you've heard the famous line from bank robber Willie Sutton. He was a bright fellow really, capable of succeeding at more than just thievery. So, when someone asked him, "Willie, why do you rob banks?" he replied, "Because that's where the money is." Indeed.
I first researched and purchased shares of Synovus Financial (NYSE:SNV) in 1995, and have continued to build my position ever since. The conservative Columbus, Georgia financial services company doesn't exactly jump out at you. So, if you counted yourself among its shareholders, you either had to be seriously looking for a small but successful banking operation, or just plain lucky. I was lucky.
When I attended Auburn University, I worked as a lowly assistant in the dean's office. At that time, the Dean, Dr. Wayne Alderman, was responsible for bringing together some of the best and brightest minds in the business world to participate in Auburn's Business Advisory Council.
Among the impressive members of this council were two gentlemen by the names of Richard Ussery and James Blanchard, who just happened to be the CEO's of Total Systems Services (NYSE:TSS) and Synovus Financial, respectively. These fellows were very impressive individuals, and meeting them inspired me to investigate their companies.
In so doing, I immediately learned that Synovus owned 81% of Total Systems, a transaction processing and credit card services company, so I was able to quickly focus my attention on both firms at once.
The skinny
Synovus is an interesting blend of both old and new. In a world of Internet banking and impersonal service, the company takes a small town relationship approach, and makes it work remarkably well. That isn't to say the bank isn't technologically savvy. In fact, the firm has been very innovative in enhancing its business through technology, and Total Systems is constantly pushing the envelope on the tech front as well. It's just their simplistic approach to banking that warrants the comment.
The company owns 40 bank subsidiaries spread across Alabama, Florida, Georgia, South Carolina, and Tennessee, many of which it has acquired over the years. As part of its strategy to keep the small town relationship, the firm generally chooses to operate each subsidiary under its original name, meaning you won't see a big Synovus sign hanging in front of each branch, but rather a sign for "The Bank of Pensacola," or "Charter Bank and Trust."
The approach has proven to be a great success, which could be attributed to the fact that the strategy allows the company to enjoy all the synergies of a large-cap bank without imparting that creepy "big brother is watching you" feel on its customers.
Some of the muscle under the hood is provided by Total Systems, one of the world's largest credit, debit, commercial, retail, and smart card processing companies. Total Systems basically provides all the services -- from card production to risk management -- that a firm needs to outsource its credit card operations, and is the largest third-party processor for international payments.
The unit has seen steady gains in transaction volume and stable pricing, which bodes well for second-quarter results. Further, demand for card issuer outsourcing services has been increasing of late, which should benefit the company in the year to come.
Numbers don't lie
Synovus has a return on assets (ROA) of 2% (an excellent figure in the banking arena), and it has a return on equity (ROE) of nearly 20% (a strong number in any arena). The firm also has an impressive 35% profit margin. This is a well-managed financial conglomerate. It has $15.6 billion in average earning assets -- assets that generate interest-income -- and $20 billion in total assets.
Synovus has long had a reputation for maintaining exceptional credit quality. The company has a current loan-loss reserve that is more than twice the size of its miniscule percentage of nonperforming assets, which represent just 0.65% of all outstanding loans. In addition, the company should be able to grow its loan portfolio 12% to 13% over the next few years.
The trust and brokerage divisions continue to provide solid growth with their proven ability to attract high-net-worth clients. Also, the banking division has been able to squeeze out modestly higher credit card fees. The strength of these business units should allow the firm to achieve over 7% growth in non-interest income over the next year.
Total Systems should increase profits by about 12% this year, as it expands into new markets and launches new products. Overall, I think the combined firm will be able to produce earnings per share of $1.31 for 2003, compared to 2002's $1.21.
And if all that doesn't create enough shareholder value for you, the company recently announced a $200 million stock repurchase plan.
Love connection
Though the company has long claimed that it is not for sale, its unique presence in the most desirable markets in the southeast, coupled with the added diversity and revenue growth provided by its Total Systems unit, makes the firm an attractive target for a number of large regionals.
Though there are plenty of differences between the companies, the price that First Data Corp (NYSE:FDC) paid to acquire Concord EFS (NYSE:CE) recently demonstrates the immense strategic and monetary value placed on credit card processing in today's market. The stable cash flows generated by this business are a welcome addition to any company in lean financial times. As a result, further consolidation in this segment is also likely.
Concerns
This low interest rate environment has been tough on banks, and many analysts have abandoned the banking sector due to predicted challenges. While a bank's flexibility is limited by extremely low rates, I think these fears are overstated. The low rates continue to spur refinancings and loan growth, and the banks that take advantage of this while keeping a watchful eye on credit quality and a tight rein on expenses should continue to perform.
Beyond concerns about interest rates putting a crimp on profits, there are some risks for Total Systems that are worth consideration. Bank of America (NYSE:BAC) and Providian (NYSE:PVN) Financial represent 19% and 13% of the unit's total sales. If the company were to lose these contracts, revenues would obviously take a noticeable hit, at least in the short term.
Valuation
Some dismiss Synovus at first glance because its price-to-earnings ratio appears higher than its competitors. However, most of these individuals fail to acknowledge that the bank's PE is muddied by the high-growth component of Total Systems.
The shares are up about 20% so far this year, which leaves them trading at 22 times free cash flow. At that multiple, and with a couple of challenging quarters ahead, they're not likely to set the world on fire in the next 12 months. However, the firm will pay you a juicy 3% dividend yield why you wait. Even at that level, the company pays out just 69% of free cash flow in dividends, which is very reasonable for a regional bank.
Synovus has seen a handful of downgrades from some of the large brokerage firms in the past few months, most of which were around fears of slowing revenue growth and valuation. But these folks might just be helping us achieve a better purchase price.
It might be a good idea to build a position over time -- and reinvesting that dividend will help in this regard. Though reasonable now, the shares would be particularly attractive if they were to fall below $20 a stub again.
Fool On!
Mathew Emmert would like to wish everyone a most happy 4th of July! He owns shares in Synovus Financial. The Motley Fool is investors writing for investors.
