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

Good morning, everyone.

My name is John Davis. I'm the payments and fintech analyst here at Ray J. We're excited to have Fiserv CFO, Bob Hau with us this morning. This will be a fireside chat. I will definitely leave some time for questions at the end. So first off, Bob, thanks for joining.

Sure. Absolutely. Thanks for having us.

So gave me an easy start here this morning with a press release. So just maybe touch on some of the executive changes you talked about put out this morning.

Yes. So what John is referring to is earlier this morning, we issued a press release announcing 2 changes in our leadership team. One, we hired Rick Singh to be our Enterprise Growth Officer. Rick joins us actually after, I think, 10 years or so from JPMorgan as one of their portfolio managers and will be part of our management committee leading strategy, ventures and M&A. It's a new role for us. We had it a few years back, and the organization has evolved. And so we thought it was appropriate to recreate the role and excited to have Rick rejoin us. Not only did he spend almost a decade or so at JPMorgan, but a number of other funds that he was part of as well as started out in M&A as an investment banker with Sullivan Smith Barney. So a great add to the organization. The other thing we announced is Suzan Kereere, who is the Head of our merchant business, announced her intent to resign from the company at the end of this year. Her new spot hasn't yet been announced. We expect that to be announced very shortly, definitely disappointed to see Suzan go. But as a testament to the strength and the depth of our organization, we immediately announced the movement of Jen LaClair, who is our Chief Revenue Officer, over to lead that Merchant Services business. So that will take place January 1. Jen joined us about 6 months ago, the former CFO at Ally Bank and spent a number of years at PNC, both in finance and business roles actually ran the business banking organization at PNC, which included the joint venture that PNC has with Fiserv. In fact, faced off with Frank at his first day to day when that joint venture was first created. So excited to see Jen move over, been working with her for some period of time. She's a great person to take over that responsibility and keep running what's been a terrific business for us.

All right. Great. So I want to ask the obligatory quarter-to-date question. Obviously, on certain macro environment out there. I talked about, I think, October being similar to the third quarter. We had Black Friday. So just maybe update thoughts on macro.

Yes. Yes. So I think one of the most overused words of 2023 has been uncertain. Maybe the second most overused word is resilient, and it's exactly what we're seeing. As you're seeing others talk, we're obviously given our position in the marketplace, we're seeing the same sort of a thing. October started out in the quarter similar to September. November actually improved slightly, but in line with what you're hearing from others. The practicality is Black Friday, Cyber Monday, aren't quite as important as they used to be, is still big days, particularly if you're a retailer, but not quite as important. The holiday season has stretched quite a bit. In fact, there's the maximum number of days from Thanksgiving to Christmas this year. And so we continue to see a resilient consumer and good business for our merchant. Importantly, December is the biggest month of the quarter. So we're still a bit ahead of us.

Good stuff. So a couple of weeks ago, you guys hosted an Analyst Day in about '24 and longer-term outlook. So maybe let's double-click on 2024, talking about elevated kind of 11% to 13% top line driven by high teens merchant growth. But if you peel it back, you're still kind of mid-teens, even excluding the Argentina and Latin American inflation. So I really want to understand the drivers and how you're able to grow that business so far above the market.

Yes. So you've seen some great growth across the company, certainly led by our merchant business over the last couple of years. We expect 2023 to close out as the third consecutive year of 11% organic growth for the company, high teens growth for our Merchant Solutions business. And we did provide an outlook for 2024 and '25 and '26 for the total company and then our 2 segments that we'll be reporting starting January 1. For our merchant business, as you point out, high teens growth. We did disclose or did provide some additional information that says we anticipate 2024 growth to be benefited by about 6 points of growth from high inflation and high interest in Latin America, in particular in Argentina. We've seen that benefit this year in 2023. We anticipate that to continue in '24 and then ease into '25 and '26. So we provided that additional color. But as you say, even if you would adjust that out. And by the way, that is performance, so that is in our numbers. We're still at the mid-teens growth. And it's a great business for us. We've been investing heavily. That merchant business is really led by our 2 operating systems: Clover for small business and Carat for our enterprise clients. Those 2 businesses -- excuse me, those 2 operating systems, Clover and Carat account for just under 40%, call it, 35% of the revenue and are growing very nicely. And back in March of 2022, we provided an outlook for 2025 for that merchant business. where we expected that to grow to $10 billion of revenue by 2025. A couple of weeks ago, we reaffirmed that number. We're nicely down that path right on track to deliver that $10 billion. And then we also provided guidance for '26. For 2024, in particular, we'll continue to see growth in Clover. The "secret sauce" to our merchant business is actually very simple, 3 things: number one, sign up more merchants; number two, grow with those merchants; and number three, provide value-added services, get more wallet, provide more capability, and that's the beauty of the operating system. There are merchants sign up for Clover and typically some number of software solutions and then over time add more software solutions as either they grow and, therefore, want more capability or that we add more solutions or of course, the combination of the both. And so it's something we continue to be focused on. We've been focused on that for the last couple of years. The value-added service penetration continues to move north. We've guided that by 2025, we expect that to be 25% penetration in our Clover business for value-added services. By 2026, we expect that to be 27%. And in 2024, we'll get growth from all 3 of those areas, signing up more merchants, selling more Clover solutions, continuing to penetrate with more value-added services as we continue down that path towards 25%. We're in the mid- to high teens right now, 17% third quarter. And so good growth there. On the Carat side, again, our operating system for our enterprise clients, growing very nicely, continue to build out our Commerce Hub solution, which enables enterprises to connect into our operating system in whatever form they want and absorb or take a variety of different solutions. Large enterprise clients have their own capability and want best-of-breed, best-of-class capability. And so they may sign up and connect into our payments capability and then add certain elements of that. And over time, again, continue to add to that capability. We provide a significant number of services to those enterprise clients. Each enterprise client has their own requirements, their own needs and their own capabilities, and we think we've got a great solution that helps serve that.

Okay. Let's maybe double click on Clover for a second, given all the attention there. You laid out the $3.5 billion revenue target and then you want to step further a couple of weeks ago, $4.5 billion 2026 implies about a 30% CAGR from 2021. So just maybe help us understand and underpin the growth drivers there and how you're so confident about 30% growth for the next couple of years.

Yes. So we're in the high 20s now. And back in March, when we gave that $3.5 billion for March of '22, when we gave that $3.5 billion for 2025. We talked about the ability to grow to that. It wasn't going to be an even growth rate every year. We would accelerate into that. And that's really as we continue to develop our vertical capabilities, focusing on restaurants, retail and services, as we add more horizontal value-added services that serve a variety of different verticals. As we grow in our capability, providing Clover for our ISV clients, so getting the long tail of other verticals beyond those 3 priority verticals for us right now, gives us that continued growth rate to it allows us to achieve that $3.5 billion. Additionally, we talked about growing internationally. We're in a number of countries, Ireland, U.K., Germany, Brazil today works in Argentina. We're expanding that next year into Brazil and Mexico, and we have further growth rates in '25 and '26. So moving beyond our existing footprint allows us to add geographically. And important to note, these are not new countries for Fiserv. In fact, they're not typically new countries even for merchant acquiring, they're new for Clover. So we have leadership. We have a brand. We have knowledge of those areas, and we're just bringing additional capability Clover in this case to those countries. So it gives us confidence that we can bring the new solution into that base because we've already got experience in those countries. We also talked about the back book, which really is part of the impetus to give the $4.5 billion for 2026 when we talked about $3.5 billion back about 18 months ago, we talked about 90% of the Clover revenue growth is from new clients, about 10% back book. And back book is an opportunity for us that we are looking at, and we do see opportunity next year and into 2026 and beyond. And so that will help give additional capability for growth into '26 and of course, beyond. We're not planning to stop there. We just gave a 3-year guidance this time around. So very excited about what we've been able to achieve. If you recall, Fiserv First Data bought that company back in, I think 2017, when it was essentially 7 patents and a handful of software developers and has really grown it to be the leading operating system for small businesses today.

And I think this is related. There's been a lot of attention this year on the volume versus revenue growth gap in the merchant business. And you guys have talked a lot about the sustainability of that. Maybe it's not going to be 1,000, 1,500 basis points where it's been at times this year. But maybe just talk about the drivers and why you're so confident in that ability to continue to grow revenue well ahead of volume.

Yes. And it's actually something we've been talking about for a few years now. This focus around the spread between volume and revenue. We actually anticipated expanding. It's the value-added services capability for Clover. You're going to see a difference delta between volume and revenue growth. It's expanded pretty meaningfully this year. We don't necessarily anticipate that some of that is the growth we're seeing down in Latin America. Some of it is the increased value-added services penetration. The other thing that we talked about quite extensively in our third quarter earnings call to try to give some additional color on it is the difference between volume in our processing-only business and volume in our nonprocessing or our SMB and enterprise client base, very different dynamic. The enterprise and SMBs, and we do plan to start disclosing more capability or more detail around this. That processing volume accounts for about 40% of our volume, but only about 12% of our revenue. And so as you see processing movement, you don't see the revenue movement and that causes some of that variation between volume and revenue. We don't anticipate that to be as wide as it was this year going into the future, but we continue to expect to expand value-added services, and so we'll continue to grow faster than volume.

Great. That's super helpful. Maybe switching gears to the Financial Solutions segment. Maybe talk a little bit about why it kind of collapsed what was historically fintech and payments and networks into one. And then talk a little bit about the 5% to 7% growth next year being half a point below what you're talking about longer term? Like what some of the drivers are there? And anything else that we just think on '24.

Yes. So what you're referring to is a couple of weeks ago, we announced a slight reorganization restructuring on a realignment of our segments. Today, through the end of this year, we're reporting on 3 different segments: merchant, financial technology and payments and network. Starting in first quarter of 2024, we'll report our Merchant Solutions business, which is slightly reconstituted and then our financial solutions business, which, in large part, is a combination of our Payments and Network business and our financial technology business. And what we've seen over the last couple of years, the structure that we are reporting on today is the one that we started with post-merger in actually January 1 of 2020, right after we completed the merger, we started reporting under the existing structure. And over the last several years, we've seen our financial institution clients, banks and credit unions continue to evolve in their buying behavior. It used to be many years ago, our financial institution relationship started with core account processing. We sell the core account processing capability, and then we cross-sell or sell surround solutions beyond that. Today, we actually will lead with our financial institution clients with a number of different solutions. It might be debit, it might be credit. It might be Zelle, it might be core account processing. It's a variety of other solutions. It might be digital banking. And so our clients are more looking at the entire suite of capabilities that we're bringing to them, not just that core account processing. And oh, by the way, what else can you sell me, what other solutions do you guys have? And so we've seen that evolution take place. We've also evolved as a company. We're no longer leading with just core account processing and then trying to sell others. We're happy to sell best-of-breed solutions and then expand our relationship, much like we do in our enterprise business and merchant with Carat will sell best-of-breed capability and provide whatever services that's allowed us to expand our relationships in terms of the number of banks we're doing business with. It's also allowed us to move higher up in the asset class. 5, 6 years ago, we talked about the sweet spot of Fiserv being kind of the $1 billion to $10 billion asset base. We're well beyond that at this point in time. Part of that is the capabilities that we're bringing to the market and that ability to bring a variety of different solutions. And then in terms of your 5% to 7%, that's our outlook for 2024, right in line with essentially if you combine the payments network and fintech solution businesses today, we're about that 5% to 7%. So we expect that to occur again in 2024, and then in '25 and '26, we guided to a 6% to 8% growth. And that's really driven by a number of different things. One, Finxact continues to mature. Our new cloud-native solution for core account processing. We build out our cash flow Central, which we announced during the Investor Day, our new cash solution that we're selling through our financial institutions for their small business clients, things like building out DNA, which has been a terrific product for us that we continue to sell quite well. Andrew Gelb, who leads our issuer business, talked about another $125 million worth of revenue that he's booked in the last 12 months. On top of the $120 million that he announced back in December of 2020 at our last Investor Day prior to the most recent one. We now have another $125 million. That will begin to implement next year and really ramp into '25 and '26 to give us that next level of growth opportunity. And we continue to build out new capabilities. So we're excited about the combination of those 2 segments, essentially reporting financial solutions business, which is more than just combining those and continue to serve our client base there.

Okay. Maybe one last question on kind of '24 outlook, what kind of macro assumptions are kind of embedded behind that 11% to 13% growth overall.

Yes. I would say, again, given the position in our market, how the macro goes, we go, and I don't have a different perspective than what you read in the papers and hear from all the economists. We expect moderate growth next year. I do not anticipate in that guidance recession, certainly not a hard recession. And I think that word is coming out of favor finally. I think people are starting to believe the opportunity for soft landing and potential Fed cuts next year. I think the fact is this company has proved to be incredibly resilient. 2023 will be our 38th consecutive year of double-digit growth. So we'll perform in any macro environment. And we expect '24 to be a good year for us and a reasonable macro environment here in the U.S. We talked a little bit about the tailwind that we're going to get from Latin America. We expect that to ease the second part or the latter part of '24 into '25 and '26.

Okay. Great. And then maybe just touch on margins. We spend a lot of time talking about the kind of impressive double-digit top line growth, but you get pretty good flow through, talking about 300 basis points of margin expansion. How should we think about -- is it ratable kind of 100 basis points a year, should be more next year? Just talk about the drivers and the ability despite really healthy margins today to continue to drive that higher?

Yes. So one of the things I talked about at that investor conference a couple of weeks is what I referred to as the virtuous cycle of growth at Fiserv. And incremental dollar of revenue falls through to the bottom line at a very good margin. We take that strong margin and reinvest it back into the company for more organic growth, first and foremost. And that allows us to reinvest in the company organically as well as continue to improve operating margins. The last 3 years, we've seen operating margins improve 550 basis points, give or take. Some of that is certainly enhanced or benefited by the integration and the synergies that we drove. Over the next 3 years, we expect 100 basis points, I would say, roughly ratable. We did call for 100 basis points in '24 and then 100 basis points per year in '25 and '26. I think that's the appropriate way to look at it. And we continue to see very good fall through. That allows us to invest organic growth that gives us more top line growth that falls through at better than company averages. And so when we expand that 100 basis points a year for the next 3 years, we expect to hit 40% operating margin in 2026. Yes, very good margins and still opportunity to grow from where we are today for the next 3 years.

That's great. And then moving on to free cash flow. We've gone from something north of 100% conversion to the mid-80s. You've guided to high 80s, 90s going forward. Maybe talk a little bit about the improvement from this year to next year and beyond, but also kind of that change? I mean, obviously, you're investing in the top line growth that we're seeing results. But just talk about that change in free cash flow conversion and that 90% how it improves next year?

Yes. So we were north of 100%. If you look back 2019 and prior -- actually, in 2020, we were also north of 100%. And I think that's actually perhaps a good data point to look at. We grow free cash flow conversion very strongly in 2020 when 2020 was 0% organic growth. Obviously, a tough year with COVID. And as we looked into 2021, 2022 and now our outlook for '23 is 11% growth each of those 3 years. That's roughly twice the rate of growth the prior 3 or 4 years, even excluding 2020. And that required investment in CapEx, software development, and it requires investment in operating working capital. When you're growing, you're going to use more receivables, you're going to have some more inventory. And so working capital tends to go up. And we thought that was a good investment. Obviously, we've been able to return that in a big way in terms of top line growth and significant earnings per share growth. In 2020, we spent about $900 million in CapEx. In 2021, we increased that 30% to $1.2 billion. And in 2022 and '23, we increased it again 30% to $1.5 billion. So the last 3 years, we've actually invested an incremental $1.5 billion above the 2020 run rate to deliver that much accelerated growth in the last 3 years. And as you saw in our outlook for '24, '25, and '26, we anticipate that strong growth to continue. Going forward, we do think that, that investment level is about the right level to sustain that growth rate, particularly given what we've got in the pipeline, what we've already developed, what we see in the macro environment, what we see with our clients around both of our new segments in both merchant and in financial solutions. And so we'll anticipate spending about that level of CapEx, which as a percent of revenue from a free cash flow conversion standpoint, will drop from roughly 9% of revenue this year to about 7% of revenue in 2026 that helps with the conversion rate. You've now elevated to that, so you're not adding working capital, you're more sustaining the working capital level. So the guidance that we provided for next year is $4.5 billion of free cash flow for '25 and '26 was $5 billion to $5.5 billion each year. That's a roughly 90% free cash flow conversion on net income.

No, that's great. And with lots of cash, you got things to do with it. So you guys historically bought back a pretty significant amount of stocks on to M&A. Maybe talk a little bit about your capital allocation priorities, what you're seeing from an M&A perspective? We're starting to see valuations rationalize maybe with public market valuations and just how we think about it. You done a couple of deals, but it's been heavy on the buyback. Just how do you think about that going in 2024?

Yes. So for the last, what, 2 years or so, we've spent about $2 billion in acquisitions. And that's for a number of different businesses. I think Finxact was the largest acquisition that we did at just under $750 million, many of them quite a bit smaller than that. We see opportunity out there. I wake up this morning not worrying about my portfolio instead of products. We've got a tremendous capability in-house. We have a tremendous set of products. We've got a great distribution system. So I don't wake up thinking, geez, if I could only buy x capability or y solution. And so I don't need to do an acquisition. We see value opportunities out there, which is why we did spend $2 billion out there. We certainly have capacity. As you said, we generate good strong free cash flow to be $4 billion anticipated this year, growing nicely. We also have a very strong balance sheet. We delevered post merger back to our "historic levels" of 2.5 to 3x mid last year. And as EBITDA grows, we have more capacity on the balance sheet. So the opportunity is there if we find the right solution. Valuations have come down. Valuation expectations haven't come down quite as much yet. And because I don't wake up needing to do a deal, we can be patient and we can be very focused on making sure that there's a return for that investment. And we're happy to return our shareholders' cash back to them through share repurchase. We'll repurchase about $4.5 billion this year alone. Over the last 3 years, we've repurchased $11 billion, well spending that $2 billion on acquisition while delevering the balance sheet back to our historic levels. So we've got a great, strong balance sheet. We've got a long history of a disciplined capital allocation, and you should expect to see that continue into the future.

Okay. Great. And then I just want to touch on the competitive landscape for a minute. Maybe we'll zoom in on the merchant business. It seems that seems to be the biggest focus that you've had concerns with adding, talking about pricing pressure. If you go back to the first day of days business was not growing, what it is today. Just curious how that competitive landscape has evolved? And how do you guys see that today, both the U.S. and internationally?

Yes. Look, the merchant business has been incredibly competitive for a lot of years. And if you go back to the First Data days, which is now 4 years ago, 6, 7 years ago, it was probably a shared owner. That's changed in a big way. We've got a great set of solutions. Again, whether it's SMB or enterprise clients, we can run the gamut. We've got a great world's leading point-of-sale solution. We also have a great e-commerce or omni-commerce capability. And so we compete across the globe every day with everyone. And is there more pricing pressure today than there was yesterday? I don't think so. It's a competitive market. We tend to try to compete by bringing value solutions to our client base and being able to win on capability, not only on price. Yes, it's a competitive dynamic, but we continue to grow quite nicely well ahead of the market, and we anticipate doing that going forward.

Okay. And then maybe just quickly on the Fintech side. I know your loss in the segment is down, but just kind of that core processing business. Obviously, there's a lot of concerns as for SVB. I think that's most of those concerns subside. But just curious, you've had a lot of consolidation in that business in that industry, what are you seeing? There's only a few players typically. But just curious you an update there.

Yes, it's interesting. So I've been with Fiserv for almost 8 years now. Every year since I joined, it seems to be a conversation about the pace of mergers is going to accelerate. And the fact is there's mergers every year. And the number of financial institutions in the U.S. has compressed every year for the last certainly 8 years since I've been a part of the business, but prior to that. And I think it's a natural outcome. There's ebbs and flows to the volume of that but the reality is today, there are fewer banks than there were last year than the year before that, but there's actually more accounts. And we get paid by account for all practical purposes. And because we are able to sell a wide variety of solutions when 2 banks merge, it is possible we're on the losing end of the core account processing decision. We are more the winner than we are the loser. It used to be big bank by small bank, big bank core wins, and we were the small bank core provider. And so we would tend to be on the losing end. That was the narrative. I don't think that was fact back then. And today, as I said earlier in my comments, we've moved up quite a bit, well north of $100 billion asset banks on our solutions, and we are selling many, many more point capabilities. And so mergers happen. We help a number of our banks. We've got a couple of examples this year 2023, where "Big bank bought small bank and small bank core won, and it was our core". And we add additional capability. Usually, that's a time for banks to really evaluate what they do in-house and what they do with partners. We think we're the partner of choice for financial institutions, and we'll continue to weather that dynamic. We've done that for a number of years, and we anticipate doing that going forward.

All right. Great. Well, I think we're out of time. So off the round it there. Thanks, Bob.

Thank you very much, John. I appreciate it.