Outsource Your Data (FIS, FISV, CSC)

By Dean Lundell | June 06, 2007 AAA

The data-processing business sounds about as exciting as box-making or widget distribution, but let's give the devil its due. Over the past few years the S&P 500 returned roughly 20%, but Fidelity National Information Services (NYSE: FIS) returned about 40% and Fiserv (Nasdaq: FISV) returned around 30%. It wasn't all great news in Data processing however, as Computer Sciences (NYSE: CSC) was flat at zero. Each of these companies provides a very necessary service. So, what has been the difference?

Divorced and Remarried
Fidelity National Information Service's spinoff from Fidelity National Financial (NYSE: FNF) and subsequent merger with Certegy created a company with a market capitalization of $10 billion that generates over $4.1 billion in revenue. The company's main business is mortgage processing, and it enjoys a dominate market position, having established relationships with 35 of the worlds top-50 banks. The scope of this operation is such that the company handles more than half of all the mortgages in the United States, and because of its merger with Certegy, it has a 7% market share in the banking core-processing business.

Just like any divorce and remarriage, this one came with some baggage. In FIS's case it was $3 billion worth of debt.

The flip-side of its big-bank relationship is that it is possible for these banks to switch to an internal, proprietary system. Trying to persuade these large banks to switch their core processing could prove problematic, as those costs to the bank would be extremely high, not to mention possible disruptions in service.

One has to question the cozy relationship and golden parachutes senior management and the board of directors have. This suggests the firm is quite possibly more concerned with pumping-up the stock price than building true shareholder value. (To learn more, see Evaluating Executive Compensation.)

A Change in Strategy
Fiserv's main business is core processing for second- and third-tier banks. This accounts for over 70% of its revenue and earns it a 33% market share. With a market capitalization of $9.6 billion, the company generates over $4.66 billion in sales. Its earning growth has been somewhat erratic, averaging 15.8% over the last three years but seeing a negative 6.7% last year. FISV manages a net margin of 9.6% from a gross margin of 28.8% and has a return on equity of 18.6%

Fiserv has been an acquisitions zealot, having made in more than 140 of them since the firm's inception in 1984. In the past Fiserv left its acquisitions alone; however, that strategy is changing. Banks are demanding complete product suites with seamless operations, not individual products, and the firm is doing its best to meet that changing market dynamic.

Fiserv has existing relationships at 98 of the top-100 banks in the United States. For a bank, switching providers is a world class hassle, and so it doesn't happen very often. While this steady stream of business has allowed management to repurchase $1.2 billion in shares during the past two years, continuing consolidation could prove to be a problem for FISV.

Outsource the Outsource
Computer Sciences has been one of the major names in data processing for years. It enjoys a 45-year relationship with government, from federal to state to local entities, and still derives over a third of its revenue from those customers. The balance of its sales come from corporate customers. Computer Sciences can boast of a customer-retention rate of over 80%.

With a market capitalization of $9.7 billion the company generates almost $14.7 billion in sales. Its earnings growth rate has gone from averaging 6.5% for the past three years to 18.5% last year - resulting in a return on equity of 5.5%. Its net margin has gone from averaging over 25% for the last five years to 4.1% for the last three, then down to 2.4% last year. Customers have been disappearing, and it's no surprise the stock has done nothing.

The company is having difficulty competing with Indian firms who have highly qualified people. While government customers are not at risk because of national security concerns, CSC's answer is setting up shop in India, where it is having good success in recruiting talent. The company hopes to save $300 million per year and start getting corporate customers back.

Consolidation Versus Globalization
There are a great many firms in the data-processing business and we only scratched the surface here. Price competition from abroad with dirt cheap labor is a serious economic threat to these firms. Whether the answer will be an industry consolidation to garner economies of scale or more globalization to exploit cheap labor remains to be seen.

Concerned about outsourcing? Check out The Globalization Debate.

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