Fidelity National Information Services, Inc. (FIS) Earnings Call Transcript & Summary

Okay. Hello, everyone. My name is Nik Fisken. I've been at Stephens 27 years. And our new fintech analyst, Chuck Nabhan, is hosting another company right now, so he asked me to sub him and host Nate Rozof from FIS, EVP of Corporate Finance and Investor Relations. I run our Institutional Equities division right now. Sorry, my Bloomberg is going crazy. The reason Chuck asked me to do this is I used to be our fintech analyst and I covered FIS when it was part of FNF, way, way back. As I read Chuck's notes to prepare me for today, I had flashbacks to 15 years ago when the niche Internet banking and payment companies like Digital Insight, Online Resources and CheckFree were going to take significant share from FIS, Jack Henry, and what was known as Metavante and InterCept and all the other casts that they were going to take share and break into the core market and take customers.

So my first question for Nate is to provide us with some color and outlook for Merchant Solutions.

Thanks. Sure. Thanks, Nik, I appreciate it. And I appreciate you subbing in and I look forward to the time we have together. But yes, I'm happy to talk about Merchant Solutions. I mean clearly, similar to what you described 15 years ago, it's an area where there's a lot of concern about technology change and potential for disruption risk. And what I think investors may have missed 15 years ago and may be missing today is really the importance of scale and the competitive advantage that comes from being a global provider, the ability to serve large, complex merchants and then take those capabilities downstream. What really differentiates Worldpay from FIS, our Merchant Solutions business, is our global e-commerce channel. We're the leading provider of e-commerce solutions to leading global brands around the world. It's about 27% of our revenue. The market is growing double digits. And as we continue to win not only market share but share of wallet with our large clients, we expect to outperform that market share growth in e-commerce, really looking for growth of 20%-plus from that business. And we've seen a significant opportunity there to take the capabilities that we've developed for the enterprise clients and move downstream to serve more SMB clients in the e-comm space. We've got our new acquiring platform back and done. We've got our brand-new access Worldpay gateway done. So we have a lot of the technology we need to do that. So we're going to be chasing downstream. I think the second part of our business that folks like to understand and focus on is our enterprise business, which serves leading retailers and large companies in the U.S. and U.K., folks like Walmart or Kroger, Tesco in the U.K. A strong set of capabilities there, vertical specific, have enabled us to consistently win share from predominantly banks in that space, similar to e-comm. It's about 45% of our business, growing mid-single digits. We expect to grow like the market in that segment with potentially some upside there as we continue to win large clients and/or expand that business internationally. And then the last piece is our SMB business. It's about 28% of revenue. It's really where the disruption fears focus. SMB in the U.S. is about a 7% to 9% growth business in terms of the TAM. And it's one that has very low barriers to entry, very high attrition rates. Pricing is really rich. And so it makes it relatively easy for new players to enter that space and compete based on a new technology. Our approach to serving that market is to leverage our strength in enterprise to enable technology providers to do just that, provide the back end and/or the payments processing capability to software developers who come in and serve that space. We've got an ecosystem of well over 3,000 partners that have very deep vertical expertise not only in restaurant and retail but really across the gamut of verticals there that have enabled us to win share in that business. I think with the churn there, we think we can grow upper single digits in SMB, similar to the TAM. To the extent that we pivot downstream with e-comm, then obviously that provides upside there as well. So we actually feel really good about our position in Merchant Solutions. We think that, that enterprise-led capability, the fact that the consumer is moving online and we're a leading player there and our ability to enable new entrants into the SMB space give us a lot of arrows in the quiver to continue to outgrow the total market TAM, which is about 8% to 10%, across our merchant business and grow the total merchant business low double digits. So a big area of focus, but one where I think there's a little bit of misunderstanding of the importance of scale, positioning and the ability for some small players to grow in a -- in different niches of the market.

And I don't know this because I haven't followed you closely. Do you all disclose churn? And if so, kind of talk about the trends there.

Sure. We don't provide specific data, but we talk about it to give folks an understanding of the way the business works. And I think what's important to understand is churn is directly correlated with merchant size. Large merchants almost never leave. Our attrition rates are low single digits, probably less than 1%. I think we've lost 1 large merchant in the time that I've been with this company over the past decade or 12 years. Moving down to the SMB space, churn rates across the industry can be 20%, meaning you're losing 1 in 5 clients each year. You've got to reload those in order to then grow on top of it. And it's kind of a linear progression between the large and the small, with the midsized clients kind of churning in the middle high double digit -- or high single to low double digits. So it's just an area where you've got 20% churn in that SMB space. It makes it easy for players to come in and offer a cheaper rate or a new technology that can grab someone's interest. They can try it out for a while. And then very possibly, they'll be moving on again within the next 3 to 5 years.

And then on capital allocation, what's the appetite for M&A today? And how do you compare and contrast that to dividends, buybacks, et cetera?

Yes. FIS has always been an M&A-first shop. We focus on M&A, and our priority for M&A right now is acquiring assets that can accelerate or enhance our revenue growth profile. So as we look at M&A in this market, specifically given where valuations are, I think it's more likely that you'll see us doing more tuck-in-size deals, buying assets or capabilities or distribution channels to enhance our growth, focused on the areas of the market where there's outsized growth relative to the TAM. So I think you'll see us continue to be active as we look for assets to continue to bolster and augment our e-commerce businesses, for example, or potentially digital banking capabilities within the traditional FIS core space. Those are the types of assets that are interesting and exciting for us. And so we've been -- and we'll continue to be active in that market. As it pertains to dividends and share repurchase, we recently announced an increase in the growth rate of our dividend. We'll be growing our dividend 20% per year over the next several years to increase our payout ratio from 25% to 35%. That probably takes close to a decade to do based on our EPS growth. But it will cost us about $100 million next year in terms of incremental spend. So it's really not that significant. But it is a point that differentiates us from the rest of fintech because we do have an above-market dividend payout ratio and it's growing quickly. So I think relative to players like Accenture, ADP, Paychex, we grow faster at less than half the multiple. So we think that makes FIS really attractive. In terms of share repurchase, that's where we've been sinking the majority of our capital because obviously, deals are lumpy in terms of M&A. We have been, as this sector has been continuing to face pressure and sell off, been accelerating our pace of share repurchase. I think we bought back $2 billion of shares through the end of the third quarter, accelerating that to $1.2 billion in the third quarter, for example, relative to about $400 million in the first and the second. So we'll continue to be active buying back stock. I think to the extent there's a deal, we'll do those. And then share repurchase will be what we do with the remainder of our capital. You won't see us paying down debt from here, certainly not at these rates, but rather investing in ourselves and investing in FIS.

And can you characterize what the M&A pipeline is like? Are there lots of candidates? Are they all 2% growers? And then like you alluded to earlier, the faster-growing assets want 26x revenue and [ something and hope ] you like that?

There -- the M&A pipeline is actually really rich. The financial technology space has received massive amounts of capital over the past decade and has generated a ton of innovation and a lot of new companies coming into the space. There are certainly players that are more mature and growing slower and then there's players that are growing very quickly and looking for significant multiples. I think for us, what's important is finding an asset where we can justify a rich multiple because it can enhance the growth rate of FIS in total and, therefore, even if dilutive for a short period of time, can be value-enhancing to our shareholders because really that's what we're doing here.

I should have said this when we started. This is the first time I've hosted one of these. So I don't know, are we going to open this up for any Q&A?

Happy to open it up for Q&A if you'd like.

[ Farrah ] or [ Rocky ], is that typical? Or do you want me to keep on going on my list?

It's your call.

Let's go ahead and open it up, I don't want to be the only one talking. While we're waiting, Nate, if you look at the -- this next-gen hype that we talked about on the onset, are you -- is FIS developing their own products to take on these? Or are you relying on acquiring it?

No. We actually invest really heavily in new product and R&D. As I mentioned, that we've developed a brand-new and have the newest kind of back-end acquiring system in market that just came live in March, our Access Worldpay gateway. It's a single point of entry, easy to integrate into, a dynamic set of APIs that makes the full breadth of our capabilities available but in a way where coding to the spec is very easy. On the banking side, we've been investing in moving a lot of our traditional technologies to the cloud. We recently launched a new cloud-native Modern Banking Platform, which is a totally cloud-native core, the first to market. We've moved our issuing technology to the cloud. We had PaymentsOne, which is cloud native; spans credit, debit, prepaid gift, virtual cards; can dynamically approve and authorize transactions at SKU level. And then we roll out innovative, new things like RealNet, which is a network of networks to enable real-time payments. It really sits across the top of real-time networks in countries around the world to facilitate cross-border, account-to-account-based payments or domestic ATA payments. And there's really not anything like that in the market today. So we've been investing pretty heavily there as well. I think where we differ from some of these newer players is, in many cases, they found a niche of the market that's underserved or that's been created whether it's from the pandemic or something else. They tend to be monoline, meaning that they focus explicitly on that market. And then they're growing very rapidly in an area where there's less competition because either it's new or, like I mentioned, we had underserved it, whereas we -- with $14 billion in revenue, we are serving a breadth of fintech capabilities. And really what we focus on is, how do we unlock the strength of the banking business to our merchants and vice versa, right, in order to really be the enabler of kind of next-gen fintech technologies across the space? And a great example of that would be Klarna, right, which is a buy now pay later provider, BNPL. I'm sure, Nik, you've heard there's been a lot of talk there. Klarna is an important client for us across all 3 of our segments. Within our merchant business, we enable them as a payment-type e-comm merchant around the world, which is critical to them generating revenue. We also are their merchant acquirer, enabling them to accept debit card payments on the installment loans as consumers pay them back, which is obviously also critical for them. But then within our banking business, they buy compliance services. And within our capital markets business, they buy treasury capabilities. So we're creating that platform based on our migration to the cloud, and the component ties kind of cloud-based architecture that we've been developing and rolling out over the past several years in order to be able to make all those capabilities consumable to new players like a Klarna or new players that aren't so new like an Amazon.com, where we enable acquiring, they buy treasury services, et cetera, et cetera. So they also buy from across all 3 segments. It's an interesting space. And then to the extent that one of those niches is interesting to us, then we have a build or buy decision as we continue to round out and enhance that enablement platform to the extent we think that there's something there that's relevant. Nik, I'd be -- if I can turn the tables on you a little bit, unless there's any questions from the audience. As the Head of Equities, you see investors across the spectrum, right? And you're watching flows into a lot of high-growth names. You're watching flows between sectors. And you're watching sectors like fintech, which had been traded at a really strong premium to the S&P, as a -- for example, for quite some time, really devalue. I'd be interested from your perspective what you hear and how you think that players like FIS should participate in the space in order to maximize value for their clients.

I'm a true believer in reversion to the mean. And right now, the hype is growth rates and how much money can you lose and -- especially if it's got SaaS in it. But I'm a big buyer of cash flow and cheap valuations, and I truly believe that there will be a reversion to the mean. Oh, I got a question from somebody down in Bloomberg. "Can you talk about the impact of border closures due to the Omicron variant? Can you try and quantify the impact to the Worldpay business?" Beautiful.

Yes, I'll be happy to. Good question. So obviously, the -- COVID-19 affects the merchant business given that effectively what we're doing is we're enabling consumer transactions and for consumers to transact. The question specifically was cross border, which, for us, we have a lot of exposure as it pertains to the COVID virus relative to cross-border travel. Our cross-border business has been effectively cut in half from what it was prepandemic. There were periods of time where our cross-border business was down 90% during the pandemic. And we've begun to see cross-border travel reopening. To the extent that a new variant slows that down or reverses border openings, then it has the potential to affect the pace at which our cross-border travel business resumes. Sitting here today, cross-border travel contributes 2% of the revenue to our merchant segment. That used to be 6%. So we're looking to get that 4% back and, frankly, to even grow it. To the extent that we see a new variant, it delays the time from which we can take that 2% back to 6%. But we haven't seen an effect thus far because, obviously, it's primarily today in South African countries. We have expanded recently into Africa but primarily enabling e-commerce rather than physical. So we haven't seen a significant effect there. And then across our domestic markets, where folks are out and transacting, clearly we continue to see and have continued to see recovery in U.S. and U.K., as a -- for example. But we'll watch that closely to the extent that we see COVID level spike again, as they did with the Delta variant then, obviously, a year or 2 ago when it initially kicked off.

Next one, and I found out while Nate was talking that I get the questions emailed to me or...

Oh, great.

Instant Bloomberg. . Okay. "How about the impact on volumes from supply chain issues?"

Yes, it's another good question. We've been watching that closely. I think what we've seen thus far is I think some consumer spending a little earlier to try to get ahead of that. Last year's holiday season was really pretty weak. So we're paying attention to see, is the consumer able to find alternatives and buy what they need? Or will it affect our business more broadly? I think the jury is still out on that. As I mentioned, we've seen continued recovery in the U.S. and U.K., strong growth in e-commerce, for example. So thus far, we haven't seen a significant impact. But it's certainly something that bears watching here through the end of the year.

Now I'm getting questions every 20 seconds.

Good.

"Can you please address the impacts buy now pay later is having on the industry and you?"

Happy to. Buy now pay later, contrary to popular belief, is a tailwind or a benefit to the industry. The reason why is pretty simplistic. It turns, for a merchant acquirer like us, 1 transaction into 5. I mentioned that for Klarna, as a -- for example, we enable them as a payment type to our merchants. So to the extent the consumer uses Klarna to pay on an installment loan versus a traditional credit or debit card, we're frankly indifferent on that initial transaction. And then we can enable Klarna as their merchant acquirer to receive payments on the installment loan. So if there's 4 installment payments, then we see the initial transaction up front and the 4 installment payments as well. I think it's one of the areas of the market, quite frankly, that's least understood. I certainly can understand some concern relative to owning a major credit card network if, for some reason, more transactions move to a buy now pay later from the initial network. But at the same time, as I mentioned, most of those payments are made with a debit card. So the network should just see it as a debit transaction or for debit transactions on the back end. So I think even there, it's a little bit -- the risk is, I think, somewhat overstated. There's also, I think, fear that certain players will be able to use buy now pay later to create a closed-loop ecosystem, which I think is certainly possible. But from an acquirer's perspective, the ability to enable any and all transaction type is what we do. It's our fundamental role. And to the extent that transactions move between networks, we're indifferent. And in fact, if we can lower the cost of acceptance, we'd appreciate it. Buy now pay later is, like I mentioned, primarily a e-com payment type today. So a lot of the discussion about it having some major impact on SMB point of sale, today we don't see that, and it seems unlikely to us. But quite frankly, if it was Square, as a -- for example, that was doing that, they're processing those transactions anyway, so it really has no effect on us there either. So we view the buy now pay later concern as one that was borne out of some volatile trading immediately following the announcements of Square's acquisition of Worldpay and folks thinking that the market must know something they're not. I don't think that's true. I think as they become educated, they'll realize that it's effectively a loan, no different than loans that have been extended, whether it's private label or whatnot, and a payment type going back to the beginning of merchant acquiring.

On the interchange change in the U.K. and EU, how does this affect FIS? And did you guys modify price for it?

We don't earn revenue from interchange. So to the extent that interchange rates move, it's largely irrelevant to us. I think some small merchants prefer a simple pricing model. Charge me 2.5% on every transaction, and I don't want to know anything else. To the extent that interchange rates decline, then it can create incremental revenue for us. In some cases, we pass that through and in some cases we don't. But I think what's happening right now is potentially an increase in interchange rates in the U.K. To the extent that interchange goes up, we'll pass that through. We always have.

And kind of going back to one of your earlier comments about consumers just spending ahead of the holiday season, are there numbers you'd like to share with us like compared to '19 or anything where you could specify that or quantify the increase?

Yes. I mean we -- no, we're not updating our guidance. We provided fourth quarter guidance on our recent earnings call. So I think we're -- the trends we're seeing in the market were contemplated in that guidance and...

Okay, okay.

We're staying there.

Okay. What else do you want to ask me, Nate?

So I appreciate the mean reversion commentary. I think that's relevant. From your perspective, you mentioned that you're a buyer of kind of free cash flow and the ability to generate consistent earnings growth. Certainly, FIS has that in spade. We generate $4 billion in free cash a year right now approximately and yet there is wide disparity in valuations. Now we did certainly increase our dividend growth rate with the goal of looking more like ADP, Paycheck (sic) [ Paychex ] and Accenture. I think our view was since we're a bit of a rare bird in terms of being a fintech that pays a dividend, we wanted to show us a very strong, growing company that can pay a growing dividend versus being another fintech when there's more and more choices there. So I guess my question back to you, Nik, I'll put you on the spot, is, do you think that works? And what would you think about that strategy? You're welcome to agree or disagree, but it was certainly an approach that we took recently.

I'm thinking back to when FNF spun out a company. I don't remember the name. We had so many spin-outs and take-backs and whatnot, but there was one that got spun out with a -- it's supposed to be a dividend story and ultimately it did not work out and they ended up buying it back. FNT, I think, was the ticker. But it was a micro-cap comparative to where you guys are today. To me, it's all about -- in the strategy that you guys are deploying, it's all about attracting certain long-only, very sticky shareholders that like a dividend growth story. And I've put up the shareholders. You got some but not all. So that's -- that would be my answer, is getting more of them and see if it works. But I think complementing it back -- complementing with a buyback is essential.

Yes, we'll certainly remain aggressive there. What are you seeing from your sales force? Where are they focused in terms of serving their clients at the end of the year and going into 2022 in order to maximize the value that they can deliver? Meaning, clearly, there's a need to help to enable the buy side to continue to participate in high growth, but also there's a need to give folks ideas. So I'm just interested how you're thinking about and kind of driving your sales force over the next few quarters as we kind of go through this period of dislocation, potential mean reversion, to the extent that, that happens at some point in the next 12 months.

At the core, we like to think, and I'd say we do, is -- our primary goal is to provide alpha. So what clouds that is we got our big investor conference this week, and we have, it seems like, 2 to 4 offerings every week. So our clients tell us they're not getting great ideas from the sell side because everybody is working on the deal today. So hopefully, I know we will, we'll come out of this conference with some great ideas for the next 12 months. And we have 30 very hungry sales staff that'll be out pitching those ideas starting, well, really this week because we'll get some of those out Thursday, Friday.

Great.

To me, the big question is, how much are they going to travel on a go-forward basis? We're still down 70%, 80%, and I don't think it's ever going back to where it was. But to me, there's nothing better than a face-to-face meeting. I think we're all zoomed out. So I think travel will start again.

Yes. When do you think your sales force gets back to traveling more heavily?

We had a good amount this month, but I'd say it's next year. But we have 200 companies and 500 buy siders coming to Nashville in person this week. So I -- definitely, it feels like it's -- we're on the cusp of some kind of new norm.

Great.

Well, I think that does it. Let me make sure. Yes. I'd like to check my email. That's it. Well, Nate, on behalf of Chuck and Stephens, we greatly appreciate you participating in our virtual Monday. And tell all my friends, especially Gary, hello for me.

Will do. Thanks, Nik. Appreciate it.

See you.

Bye-bye.