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Equifax: Thoughts After the Casualty

TransUnion interesting; Equifax on radar

September 18, 2017 | About:

More than half of the adult population – 143 million people – with credit profiles had their credit data stolen. That is big and unfortunate.

And the fault lies with one company, Equifax (NYSE:EFX).

The Wall Street Journal also revealed that the problem in software was found as early as March. A patch to fix the problem was sent shortly after but appeared to be not fully implemented. On July 29, the data breach was identified, but it was not disclosed until Sept. 8. In addition, media reported that the executives of Equifax sold stock worth $2 million between July 29 and Sept. 8, fueling the public fury. Equifax said those who sold stocks, including the chief financial officer, did not know about the data breach. But who would believe it? A couple of executives already resigned, including the chief information officer.

Equifax stock is in free fall, losing one-third of its value. The stocks of the other two credit bureaus are somewhat in sympathy, especially the smallest of the three, U.S.-listed TransUnion (NYSE:TRU), whose stock was down about 13%.

The situation is too fluid to make any call at the present time. But it seems that one of two scenarios would emerge.

  1. Equifax ultimately recovers from the scandal, possibly after a shake-up in management and/or a settlement with the government. A new chapter is started.
  2. Equifax becomes much smaller. Its two competitors become larger, although everybody would incur higher expenses due to stricter regulations and higher standard of data security.

It is unclear which scenario will prevail. But it appears opportunities will rise either on Equifax stock or the stocks of its peers, Experian (EXPN) and TransUnion. Scenario one is more likely, but it is not clear how much smaller Equifax would become.

All three credit bureaus have large sets of consumers’ data such as credit and employment data. With those databases, they sell data and provide analytics to businesses such as retailers, banks, insurance companies, government agencies and health care providers so that these clients could form better strategies in, for example, marketing and credit underwriting. The databases they created over many years are their key assets and are hard to replicate. As a result, the businesses enjoy high margins and high ROIC.

What is unclear is whether there is really a need for not one or two but three credit bureaus. In North America, the three companies cover more or less the same demographics. Equifax appears to have more data in income, employment and utilities. But its core credit data should be about the same as the other two. The material risk to Equifax is that its customers could go to the other two credit bureaus and stop using Equifax data. This is the key on the stock of Equifax.

The following has some comparisons between the three credit bureaus.

History

Equifax has a relatively clean history as an independent company. Experian and TransUnion both had been bought by conglomerate and/or private equity firms. This is important. When the dust settles, Equifax could be a good acquisition target with a clean M&A history, terrific stable recurring revenue, high profit margins and ROICs and 100 years of data impossible to recreate.

Equifax

Equifax was founded in 1899 as Retail Credit Co. By the 1960s, it was one of the largest credit bureaus, holding a significant amount of personal information on a large part of the population. It was criticized as holding too much, sometimes inaccurate, information and willing to sell to anybody. Congress held hearings in 1970 which led to the Fair Credit Reporting Act, giving consumers rights regarding information stored about them in corporate data banks. Subsequently Retail Credit changed its name to Equifax.

Experian

Experian has a somewhat volatile history. Experian’s U.S. division started in the conglomerate TRW, which was also in the aerospace and automotive businesses, besides credit reporting. TRW’s credit reporting business grew with acquisitions starting in 1968. By 1986, TRW Information Systems & Services (TRW IS&S) had become the first agency to cover all 50 states, with Equifax not far behind. In 1988, TRW IS&S acquired Chilton Corp., which was founded in 1897 and gave Experian its 125-year history in the credit reporting business. TRW IS&S was sold to private equity firms Bain Capital and Thomas H. Lee in 1996 and was renamed Experian. In the same year, it bought leading U.K. credit bureau CNN. In 2006, Experian was listed on the London Stock Exchange. In 2007, it bought leading Brazilian credit bureau Serasa.

TransUnion

The smallest of the three, TransUnion was originally formed in 1968 for a railroad leasing organization. In 1969, it acquired Credit Bureau of Cook County, which possessed and maintained 3.6 million credit card files. In 1981, TransUnion was acquired by a holding company, The Marmon Group. In 2010, it was acquired by Goldman Sachs Capital Partners and Advent International. Then in 2013, TransUnion had an IPO.

Business composition

Experian has significant international exposure. Experian is the most profitable in both the North American and international markets. Equifax looks to have margin expansion opportunities in international markets. TransUnion appears to have the highest growth potential of the three.

Competitive positions

Experian and Equifax are leaders in North America. TransUnion is the smallest.

Financial performance

While Equifax and TranUnion both had material revenue growth in the last several years, Experian seemed stalled in revenue growth.

Equifax and Experian show similar operating margins and ROIC, while TransUnion has significant room to move up.

All three companies have substantial debt, with TransUnion materially more relative to its size. The high debt level concerns us somewhat. But the business has stable recurring revenue and strong capability to generate free cash flow, which is typically materially higher than net income. As a result, TransUnion, a previous leveraged buyout, is paying down its debt  quickly.

Observations

Equifax used to have a premium over the two peers. Not any more.

Currently both Experian and TransUnion are priced at about 20x forward earnings. Equifax is at a discount of 14x. It was priced much higher before the breach because of better growth and better free cash flow generation. Of course the breach created uncertainty on Equifax’s future earnings and liabilities.

Among the three, at the current stage, TransUnion looks the most attractive if one feels comfortable with its high leverage. It is small, growing revenue, expanding margins and deleveraging.

Equifax could become a play when the dust settles. We do not worry too much about the fines to be paid. In previous breaches, the fines to the companies have been very bearable. Although part of the reason is management’s negligence and unsatisfactory responses to the breach, we think that the fine to the company also would be bearable, likely below $500 million. Up to now Equifax has lost almost $6 billion market cap. Therefore the fine is not a real concern to us. What is more worrisome is how big its business will be in the future. Until we are confident enough to do some guesswork, it is prudent to wait.

Disclosure: we do not own Equifax shares.

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