Payment Processors May Pave Way to Recovery
Signal Hill says the sector could outperform coming out of the recession.
WE ARE LAUNCHING COVERAGE on the financial-technology sector with a focus on the payment-processing and core-processing groups. We believe the sector may be poised to deliver above-average returns coming out of the global recession.
The ongoing shift from paper-based to electronic transactions is a global secular trend that should lead to solid, double-digit growth for the industry, particularly for the payment processors, over the next three to five years. That coupled with the fact that cyclical pressures are starting to abate, in our opinion, and valuations are compelling, both relative to trend-growth prospects and historical levels, suggest strong performance for the sector.
We see the best opportunities in the payment-processing business where revenue can run above trend for several years and margin-expansion stories in the more mature segments of the financial-technology market such as bank processing. We prefer the stories with stronger revenue-growth prospects, such as CyberSource (ticker: CYBS) and ones with margin-expansion potential like Fiserv (NASDAQ:FISV) and Fidelity National Information Services (FIS).
The shift from paper to plastic continues unabated and global electronic transaction growth is expected at a 12% compounded annualized growth rate (CAGR) over 2008-2012, with emerging countries growing faster in the mid- to high-teens range. The secular trend has remained in place through the recent financial turmoil, and with recent macro trends stabilizing, revenue and earnings growth revisions may be biased to the upside for the first time in almost two years. Growth in e-commerce and mobile computing is leading to innovation in the payments industry and should only accelerate the shift to electronic payments.
While not as exciting as the payments sector, core processing is one of the most resilient areas across the financial-technology sector. Bank information-technology spending and new bank creation are the primary drivers of growth for the core processors, while bank failures and consolidation represent headwinds. The net impact from bank failures and consolidation has tended to be neutral for the major players. The worst appears to be behind the core processors, although investors may need to wait until late 2010 for a return to trend revenue growth of low- to mid-single-digits.
Valuations are reasonable, in our opinion, and bias to estimates is to the upside. The sector's valuation has been tracking the broader market closely but should return to trading at a premium as revenue growth visibility improves.
-- Mayank Tandon