Fiserv, Inc. (FISV) Earnings Call Transcript & Summary

Good morning, everyone. I'm Rayna Kumar, and I lead US Payments, Processors & IT Services Equity Research. Today is the final day of UBS' TMT Conference. And we are lucky today to start with Fiserv's CFO, Bob Hau. Bob, thanks for joining us today.

Thank you. Thanks for having me, Rayna.

Great. So [ often ] [indiscernible] it is really the macro environment that are now [ Black Friday ]. Can you talk a little bit about what you're seeing out there in consumer spending? And if we do end up with a potential slowdown next year, how should we think about the impact to -- on your business?

Sure. So as you might suspect, within our position in the marketplace, we're seeing -- what you've heard from everybody else at this point. So far, the quarter or the month in line with our expectations. Consumer continues to prove to be quite resilient, spending patterns continue to be good and the world including ourselves is watching for the shoe to drop. And so far, spending has held up. So consumer continues to spend, people are working off a strong balance sheet and personal balance sheet, savings rates are good going into what has been a rough patch from an inflation standpoint, mortgage rates obviously went up significantly are now easing. But we'll continue to remain cautious and watching closely. In terms of resilience and opportunity for next year, macroeconomy is a big question mark. I think many people anticipate a recession next year. From my perspective, that's one interesting data point. But the real data point is how deep and how long, that matters a lot more, because back when I went to school a few years back, a recession was the definition of 2 quarters of negative GDP growth. So we had one already this year and we spent right through it. So we'll see what happens. We remain vigilant and watching closely as we work through our 2023 planning cycle, a lot of scenario planning, a lot of levers being watched and understood in terms of our ability to manage discretionary spending and whatnot. If you look at Fiserv over the last 37 years, 37 consecutive years of double-digit earnings, that's through some pretty tough cycles. And as I have reminded people of that, I frequently hear, well, that was pre-merger, this was okay. But 2020 wasn't pre-merger. In a year where revenue was flat given the pandemic and the impact on the economy, flat revenue, A, I think performed well relative to our peers, and B, double-digit earnings, 12% EPS growth. So we've proven an ability to be quite resilient and operate the organization, the company quite effectively and we expect to do that through whatever cycle comes at us in '23.

A few thoughts about which businesses are more resilient than others at Fiserv?

Yes. Relative overall I think generally, very resilient. But within the company, if you look at 3 segments, first, I would say our fintech and payments segment combined have about 85% of recurring revenue. So long-term contracts, highly recurring revenue and have performed quite well through a number of different economic cycles. And so we -- I would expect those 2 be the most resilient. Fintech, probably, a little bit more than payments, but generally quite resilient. Obviously, our merchant acceptance business is very dependent upon what's going on with the consumer. And so we'll see some impact to that. Again, I think we have demonstrated the ability to manage the company quite effectively in a variety of economic outcomes or economic conditions and we'll do that again in 2023. The other thing important to recognize is, within our merchant business, we have a great client base, we have a great distribution channel, we have a great geographic breadth and spread and so a lot of different factors will help balance that out. And roughly half or more than half of our spending is non-discretionary spending and so proves to be a bit more resilient than you might think.

Great. As the merchant acquiring industry remains extremely competitive, despite that, Clover and Carat continued to perform very well. What strategies do you think are working for Fiserv that supports this growth and do you think the merchant segment remains on track to achieve $10 billion of revenue in 2025?

Yes. I might rephrase your question a little bit, instead of despite that, maybe it's because of that, because I think Clover and Carat are part of that competitive dynamic. We're the number one merchant acquirer in the globe. And we continue to invest in new capabilities in ways to combat an ongoing always present competitive threat. I don't know that today is any worse than it was a year ago, any worse than it was 2 years ago, any worse than it was 5 years ago. There is always upstarts. There is always new companies making investments, some do well, some do not, all of them drive innovation. And to be honest, I like participating in that sort of an industry where we are challenged to continue invest and given the scale of our company and the breadth of our company, we're able to do that. Clover and Carat, 2 great examples of that capability, and we continue to invest in those capabilities and bring value-added services to our client base, whether it's the largest merchants in the world, down to [indiscernible] down the street. We are continuing to invest in different verticals in the merchant business. We continue to invest in different capabilities, so that we further the position that we think we have today, which is being the operating system for our merchants. We will look for ways to help them operate their business more effectively. And it's the secret sauce to Clover, it's the secret sauce to Carat and it will provide continued growth. In terms of our ability or our progress towards the $10 billion, back in March of this year, we spent -- had an Investor Call on our merchant business where we laid out our path to that $10 billion by 2025, which is an order of magnitude about 11% CAGR over the time period, we're headed to beat that this year. Our medium term guidance for the merchant segment had been 9% to 12%. We'll exceed that this year. So we're well down the path of heading towards that magic number of $10 billion.

Inflation has benefited many payment companies this year including Fiserv. Can you help us understand how much of Fiserv's growth this year has been impacted by inflation? And what the potential headwind could be next year if inflation starts to stabilize?

Yes, inflation is a double edge sword, no doubt about it. It certainly has helped in terms of the pricing environment, in our businesses where we're able to get annual price increases largely in our Fintech segment. But also in our payments business, we also benefit from volume-based pricing, particularly in our merchant segment and particularly in our SMB part of the merchant business. And so we've seen order of magnitude probably 1.5 of growth half of inflation, that's the upside that's the good side of it from a revenue standpoint. Unfortunately, there is also the impact on cost and order of magnitude, roughly 90% of our P&L or our expensive on to the P&L are [ subject ] [indiscernible] and so we continue to work towards productivity and combat that wherever possible.

Going back to your Fintech and Payments business, can you give us an idea of any early reads you're getting on IT spending for next year? You have a competitor speaking about elongated sales cycle in their respective business. What do you think about that?

Yes. We have not seen that. We continue to have a very strong pipeline and a good progress toward signing contracts. You heard us announce in third quarter, in our Fintech space, we signed 14 new course, that's on pace with what we've seen over the last several quarters. So no slowing down of that. Our pipeline continues to be quite robust. We still see decisions being made on a very regular basis. These are long-term negotiations and particularly if a financial institution is evaluating changing out the core, those don't happen quickly, but we continue to see a good pace on that activity and feel good about that continuing. But practicality is, if you talk to a bank, some might say they anticipate slowing down IT spending, but that IT spending has a very large bucket of spending. Where we participate inside that IT spending, we have a long track-record of actually not seeing that curtailed in a big way. We -- the products and services that we sell to financial institutions are in many cases not areas that they're going to pull back in a temporary recession. We will make investments either replacing a core because of the changing dynamics of the business. But their asset base has grown and so they need more capability. They're making investments because they are trying to improve the efficiency. So if they're in a tough time, and they've got to lower their cost, we provide that capability. If they're trying to gain clients and/or deposits and accounts, we provide capability to help them do that. And so through a variety of cycles, our area of IT bank spending has proven to be quite robust and I think you'll see that in the future. Digital spending, [ asset ] acquisition, client service continues to be important aspect for banks.

Is there any data you can point us to that talk about industry spending for bank IT here?

Yes. I mean there is lots of different metrics out there, but again, those tend to be very broad IT spendings. If you talk to financial institutions and ask them, whether they are cutting back on digital spending, whether they're cutting back on decisions, mergers and acquisitions ebb and flow, and you'll see implications there and that might cause a few course to trade differently, on a rapid pace of M&A, you'll see more activity. But that's quite frankly on the fringes and we've seen -- again seen that through multiple cycles and we're seeing that right now.

How is the integration of Finxact progressing? And how does Finxact play into your longer term strategy within the segment?

Yes. So far so good. I feel very good about that acquisition. As you know, we've participated, been part of Finxact for a lot of years. First Data pre-merger was a very early first investor in the Finxact business and has been close to that company for a number of years, we have the opportunity to actually acquire the entire company at the end of last year beginning of this year, we've brought it into the family and continuing to invest in that capability. The number of conversations we're having and the wins that we're seeing, the new clients going live, we now have I think 11 clients live on the portfolio and the platform and we continue to have great conversations, whether it's with our existing clients looking to add that capability, whether it's new clients looking to switch or whether it's clients looking to add that digital capability. And it's obviously bank's [ ingredients ] but it's also not financial institutions looking to bring banking capability to enter their fold. And so great progress on integrating it into the company. I would say it's integrated, continuing to make investments and build out the capability and integrate it with our product portfolio and have lots of great conversations with a [ widespread ] of client base.

Reminder, if anyone has questions for Bob, feel free to type it into the UBS' TMT Conference app and I will read them out loud. Moving on, so on the third quarter earnings call, you mentioned some of the Fintech revenue slipped into fourth quarter. Are you getting a better line of sight on this revenue now that we're 2 months into this quarter?

Yes, definitely. And some of those -- in fact, I think we said this on the earnings call at the end of October. Some of those transactions had actually already completed. And so we expressed some confidence in delivering at least 4% to 6%, which is the medium term growth and our expectation for 2023 for that Fintech segment and continue to expect to see that happen. Those are some very short-term contract add-ons that we have with our existing clients and those in many cases have already signed and underway, revenue already booked. So we feel good about our ability over the full year.

Also on your third quarter earnings call, you spoke about supply chain issues in China impacting your free cash flow conversion. Given the recent news of further COVID restrictions in China, do you anticipate some downside risk, your 85% free cash flow conversion target for 2022?

Yes. So I think a couple of things there. First and foremost, I think the answer is no. I don't. COVID restrictions are moving rapidly there. A week ago, 10 days ago, things were looking pretty dire and going back in this restrictions. This morning, as I was getting ready, China announced relaxing a number of restrictions that they have in place. What they're announcing versus what they're actually doing is a different dynamic. But we think we've got a good spot of inventory at this point in time. And given the fact that it is December 7, we feel pretty good about where we stand. Obviously, the inventory levels and the impact of COVID restrictions is one element of our free cash flow. But given where that is, I think we're in decent shape.

Can we see improving free cash flow conversion in 2023?

Not quite ready to give guidance for 2023. But it is something we've actually obviously been talking quite a lot about. Given the growth of the company and COVID is one element, but the broad growth in the working capital that goes with that growth naturally is certainly a driver of the use of free cash flow. This is a company that for a lot of years has been 95%, 100%, 105%, 110% free cash flow conversion, but also as a company that hasn't done 11% growth top line for 2 consecutive years. And so very different growth profile that we're seeing in today's environment. Pre-merger we had one company that was mid-single-digits and you might at this point see the mid-single-digits. Yet another company that was mid-single-digits. And generally, Fiserv has a very strong free cash flow. We're now growing 11%, that requires investment. You've seen our CapEx go up quite a bit, a lot of that is software development that gets put up on the balance sheet as we drive for that accelerated growth. And you're seeing that accelerated growth, which obviously is the benefit of those investments, but also drives additional working capital accounts receivable, is one example of that. And we continue to see good opportunity, our official medium-term guidance outlook is 7% to 9%. Last year we did 11%, which granted us off of a COVID-impacted 2020, but 11% this year, a strong growth, good investment opportunities, we continue to make those investment opportunities to drive that top line growth. Just as a data point, in 2020, 0% top line growth, so flat revenue, 120% free cash flow conversion is a direct correlation.

What are your top areas of investment in 2023?

I think, continuation, more of the same. We'll continue to invest in Clover and Carat, in particular, in the merchant space, building out our e-commerce capability broadly, but also Carat which is the operating system. e-Commerce and [indiscernible] restaurant retail services continues to be a focus of ours. We have international expansion planned continuation in Clover in particular. In FinTech, building our Finxact, that's a great solution today and has continued investment. We're investing meaningfully in that business in 2022, expect to continue that in 2023. And the Payments space broadly is constantly evolving, the advancement of real-time. We'll continue to invest and stay at the forefront of innovation in the broader sense.

The number one question I've been getting on Fiserv over the last few weeks is on your '22 adjusted operating margin target. So your target implies for the fourth quarter, you will expand operating margin by 300 basis points. Can you remind us of the drivers for the strong expansion in the fourth quarter? And what gives you confidence around that forecast?

Yes. So there is a few things I would point to, and I'd actually tell everybody go back and look at our first quarter earnings call, where we talked about the margin expansion for the year and we tried to very clearly lay out that we saw that margin improving meaningfully in the second half of the year and that was largely driven, A, on basic productivity, the forefront and the heart of Fiserv on a regular basis. B, the benefit of scale as we grow the top line 11% and incremental dollar of revenue falls through nicely to the bottom line. But the third point and really the driver of that accelerating expansion is, at the end of 2022, we completed the integration -- the merger and integration activity with Fiserv and First Data merger. We have a company policy that says we will adjust out of earnings, so GAAP to adjusted earnings, merger integration-related spending, we have a policy on how long you can do that. That period expired [ August 31, 2022. ] We weren't quite done with all of that integration. So the cost that we had been dialing out in 2021, continued into 2022, but we no longer adjusted it out. But look at what we adjusted out in the fourth quarter of 2021, some of the cost finished because we did finish a large portion of the integration activity. Some of that continued into 2022 and started to roll out on our income statement. We expected that to finish in the first half, the first 9 months of the year. And so that investment that is now rolling through our P&L stops, slows down throughout the 9 months. And you get the benefit of completing those projects, i.e., productivity. And so we expected the first half of the year to be modest. We expect the third quarter to improve at 120 basis points year-over-year and we expect fourth quarter to improve even more such that we deliver at least 100 basis points this year. It's laying out -- as we had laid out, beginning of the year, we tried to re-emphasize in the end of second quarter, and said again in third quarter and feel good about our ability to deliver on those integration savings, finish those integration projects and drive productivity. Longstanding hallmark we used to call it operational effectiveness. We're working towards that and we see that happening on a day-to-day basis and expect to deliver those in the full year.

I know you're not giving 2023 guidance, but I have to ask, do you expect some of these margin benefits to continue into next year? And maybe just help us think about the puts and takes for margins next year?

Yes. Certainly, a good portion of it will continue into next year, that integration spending that's done is done. We'll continue to see growth next year. Our current expectation depending on your belief of the macro-environment and the nature of our company, I sometimes talk about the virtuous cycle that we have across the company, again that we have demonstrated year in and year out, that top line growth brings incremental dollar of operating income to the bottom line better than company average. And so if we can continue to grow the top line, you get a nice flywheel effect, it improves the operating margin. It gives us the opportunity to re-invest that benefit, that improvement back into the company to drive further growth, while also expanding operating margins. So there is a fair amount of discretionary investment that we have inside our P&L that drives that growth and those investments get you the 11% top line growth that we saw last year and then we'll see again this year. And so I expect to continue to drive productivity. I continue to expect to see the benefit of scale. I also continue to expect to reinvest a portion of that back into the company.

In October, the Federal Reserve finalized updates to its role around online debit card routing, which goes into effect July 2023. Can you talk about the opportunity to gain greater share of online debit routing and whether Fiserv needs to make additional investments to get that more openly competitive debit routing?

Yes. There is I'd say a little bit of work on our part to be able to fully deliver on that opportunity. The majority of what needs to happen in the issuer and the merchant side of the business, and we're working with both sides of that coin so to speak. It remains to be seen how that will actually play out. But more competition is a good thing for us. We have a terrific debit network capability and Star and Accel. And obviously, if we're able to get more transactions over that network that provides growth opportunity for us. So we're looking forward to -- I think broadly competition is a good thing. And so we'll see how that plays out as the rule is going to be in effect in July.

Do you think you'll be ready by July? And separately, do you think there is opportunity here to integrate Star and Accel into one debit network?

Yes. We'll be ready. We're ready now, so to speak. So it's a matter of what the issuers do and what merchants do and how broadly the market would operate under those [indiscernible].

As we get into 2023, what do you think are the priorities for capital allocation for Fiserv?

We're working through the '23 plan. And there is a lots of scenarios that we're laying out. We obviously will have a baseline plan and when we give guidance with our fourth quarter earnings call in February, we we'll talk about where we see next year playing out and the different economic environments, and obviously, as typical, we'll give a range of outcomes. Our capital allocation approach and strategy remains quite consistent. First and foremost, we will continue to invest in the business for organic growth. To deliver on that 7% to 9% medium-term top line revenue, we continue to see great opportunities to invest in new products and services for our clients and so that is always first. And lots of opportunity, again, as I've talked about, this virtuous cycle as we see revenue grow, we have good opportunity to take that growth and reinvest back into the company to provide for organic growth. We have great free cash flow, recognize that the conversion number is now what we've done historically, but we also haven't historically seen the topline growth, but we still have very strong free cash flow, and we have a very strong balance sheet. As you saw at the end of third quarter, we returned back to historic levels of leverage, so we're now sub 3 times levered on the balance sheet debt to adjusted EBITDA and we feel great about being there. You may have seen one of the rating agencies publish and declare, we had our deleverage point, they actually also talked about expanded capability on the balance sheet before they would evaluate our rating agency. So we have good flexibility to build and invest back into the company, whether it's organic or inorganic opportunities. Lots of opportunities from an M&A standpoint. The practicality is, number one, we have had and will continue to have a pretty tight filtering process. I don't wake up in the morning, planning for, If I only had X, I have this hole in my portfolio I've got to find a way to fill it with Y. But there are always opportunities to add to the portfolio. And you've seen that over the last 18 months, 24 months, I think we've spent about $2 billion of cash on acquisitions, 8 or 9 different acquisitions. Finxact obviously being one of them, and I would spend [indiscernible] a number of different capabilities that we've added to the portfolio and we'll continue to look to do that. We have the balance sheet, we have the free cash flow. One of the things that still I think needs to adjust is, valuations have come down but valuation expectations maybe haven't come down as much as I would like. And again, we have done a number of acquisitions and we continue to do acquisitions. I met yesterday afternoon with our Head of Business Development, right before I caught a plane to come out here, we evaluate our pipeline and the pipeline continues to be robust. But we'll continue to have a good filtering process and evaluate acquisitions through the lens of share repurchase and obviously through the lens of value-add accretion to our shareholders. And so after organic investment and inorganic investment M&A, we will return cash to shareholders. We have for years and years and years what we continue to do today. The free cash flow we generated is our shareholders' cash and we use share repurchase to return that to them.

Are there specific solutions you think could resolve better with [ inorganic ] rather than organic investments?

It's certainly a tradeoff that we look at quite closely. In most investment decisions, whether it's something that somebody wants to invest organically or an M&A transaction, we look at, is it faster, cheaper, better to do the opposite. So if someone wants to make an organic investment, we look at the market space to see if there is an alternative. And there is a trade-off every day, we do that, things like Finxact is an example. So we'll continue to focus on that. And the answer is it depends on the solution and it depends on the valuation and the expectations of a seller. As I've said multiple times, I'm a willing buyer at a certain price, the magic of M&A is finding a willing seller at that same price. And there are countless examples that I've got where we have had either entry conversations or in depth conversations with potential acquisition that are falling apart because of price. I think we have a long track record of, A, being a disciplined buyer, and B, executing quite well on those acquisitions. And in large part, our sweet spot has been relatively smaller investments, where we acquire a business. In many cases, we acquire the founder. And we're able to maintain that business and those founders either by growing that specific activity or expanding that. In many cases, the reach that we have whether it's geographic or it's a broad distribution channel that we have, we're able to bring solutions to a much wider set of clients. And in many cases, the founders of these companies see a tremendous opportunity to grow the company inside of our company and expand their business very rapidly and/or expand their reach and take on additional capabilities or responsibilities with inside the company.

Got it. On some of the best assets above Payments, FinTech [ acquired ]. Do you think there are several ways Fiserv can optimize its portfolio?

Every day. And you see that, a, in our productivity drive, you see that in our acquisitions, bringing additional capability, and you'll see in the divestiture. We announced a few small ones in third quarter. We haven't done a lot of those. We will pair the portfolio periodically. It's under regular review. On an annual basis, we're going to do a deep-dive strategic review both internally and with our Board. But we also are regularly evaluating the business and the assets that we have on whether perhaps it's time to move on and divest a piece of the business or whether there is an opportunity to invest more deeply on an organic basis or bring additional solutions into it. It's a large portfolio. There is a lots of different opportunities. I think we've got a great product portfolio. As I said, I don't wake up in the morning wishing if I could have X, Y, and Z, but there is always things that we're looking at that can enhance our solutions and services for our clients.

But now it's expected to be released mid-2023, do you view that as an opportunity or a risk to Fiserv's business?

It's certainly both, without a doubt. And again lots of different activities across our business and I think we've got a tremendous capability to continue to invest in our own capability and move with the market and see new opportunities and all competitive threats and expand on that. If you had talked to this company to me 6 years ago when I joined, and prior to that, we believe there was a significant market for a person-to-person payment capability within the bank channel. And so we acquired and then further developed a business called Popmoney, which was essentially a predecessor to Zelle. Now Zelle is not our solution, early warning and the owner banks developed that. We were a big believer in a Bank led P2P capability, which is why we invested in Zelle, Popmoney. Popmoney for us has been the cornerstone of our ability to now be the world's largest provider of Zelle services outside the owner bank. And so when that first came up, where we said, okay, that's going to be a big problem for Fiserv, it's the end of Popmoney and Zelle is going to really create a problem, and it's turned out to be a tremendous opportunity for us. Again, we've taken that capability and we've now sold those Zelle services to thousands of our financial institutions and that's a great business for us. We see the move to real time and Fed now we provide wide capability to all of our clients, whether it's something that we've developed ourselves or whether it's another rail or another access point, we'll continue to invest and bring those solutions to our clients in however they want to move money.

So we're at the last few minutes of our session. So my final question is, what do you think if anything investors are missing about the Fiserv story?

I'll ask you and ask the folks here in the room, maybe better able to answer that question. I think a number of things. Number one, we're a relatively new company. We merged 3 years ago and we spent 2 plus years of that in a pandemic. I think a lot of investors continue to wait and see. We believe we're delivering great topline growth. If you had talked to me 4 years ago about whether I would be describing an 11% growth rate in this company, I wouldn't have been doing that and had I been doing it, I think this room would have been quite skeptical. I actually think this room is probably skeptical when we announced 7% to 9% a couple of years ago, and here we are delivering on that. We continue to see great opportunity to invest strong free cash flow back into the company. There's lots of disruption in our industry, there's always been lots of disruption in the industry and we think we are part of that disruption, Clover is a great example of that. When legacy company invested in Clover, we talked about being larger than square, that was fantasy and here we are, larger than squaring and continuing to grow quite well. We continue to invest in that operating system in that portfolio and see great growth opportunities, $10 billion of merchant acceptance revenue by 2025, which actually Clover will be a large part of the investment we're making in Carat. So we continue to invest to manage that disruption to be part of that disruption. Yes, there are every garage in silicon always competitor of ours. But that's something that we've been dealing with for a lot of years and we'll continue to do that. 2023 lots of uncertainty on a macro environment. We have demonstrated significant resiliency, feel like we're in a great position to do that again for next year and look forward to the continuing [ journey ].

Great. Thanks for joining us today.

Great. Thank you very much.

Great, having you.

Thank you.