Missouri-based Jack Henry & Associates (JKHY, Financial) provides technology solutions and payment processing services, mainly for the financial services industry in the U.S. The company generates highly-recurring sales from two sources: 1) services and support (62% of fiscal 2019 revenue), which covers outsourcing, cloud subscriptions, licenses, implementation services, maintenance and consulting, and 2) processing (38% of fiscal 2019 revenue), which includes remittance, card and digital transactions.
Jack Henry & Associates is another example showing that smaller size can offer consistently decent returns in the investment world. The business mainly targets small- and mid-sized banks (e.g., community and regional banks) and credit unions. Due to the limited scale of the business, it would make far more economic sense for target customers to outsource technology and some operations. As a leader in this niche, the company has delivered consistently high free cash returns on assets, outperforming its major competitors, including Fiserv (FISV, Financial) and Fidelity National Information Services (FIS, Financial), for more than a decade now (see below).
Looking forward, we have confidence in the sustainability of high returns at Jack Henry & Associates, thanks to what we see as a multi-layered economic moat.
Firstly, banking information systems process critical data with zero error-tolerance, so customers would shoot for the more reputed products in the domain. Jack Henry & Associates stands out, being well-known for its high-quality solutions and service levels that exceed customer expectations.
Secondly, outsourcing, cloud and related services provided by the company are typically subject to contract terms of five years or longer.
Lastly and most importantly, once the customer is on-board with Jack Henry & Associates in terms of core processing, it becomes quite difficult for it to switch over to another vendor. The extremely high switching cost would persist, as the customer heavily relies on the technology to manage and process accounts, day in and day out. Through a vivid analogy, Morningstar compares the core processing system to the heart and the bank to a human body to describe the “high risk” of “transplant surgery” that banks could not afford.
On the growth side, we think that a cross-selling strategy may continue to play a significant role in propelling organic top-line growth as well as widening the moat. The ongoing increase in technology adoption in the banking sector may also offer a tailwind.
Additonally, we notice that the company heavily leveraged acquisitions to deploy retained capital and fuel long-term growths. The management claims to be disciplinary with its so-called “focused diversification acquisition strategy.” The overall financial results look good so far in terms of margins and capital efficiency, but we would stay alert on this endeavor as we do with all serial acquirers.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We do not own any security mentioned in the article.
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