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[Enterprising Investor]

First Data Shares Are Too Cheap to Ignore (5/21/16)

The payment processor stock sells at about half the level of rivals though it’s growing and paying off debt

By Jack Willoughby

First Data has had more than its share of financial notoriety in recent years. In one of the largest leveraged buyouts ever, the big payment processor was taken private by Kohlberg Kravis Roberts in 2007 on the eve of the financial crisis, just after First Data had taken on $24 billion of debt. After extensive restructuring, it went public last October, in 2015’s biggest initial public offering.

Waning investor interest in tech-related stocks, especially those controlled by private-equity firms, prompted underwriters to price the offering on the low side. From there, First Data’s shares (ticker: FDC) sank another 30%, to last week’s $11. Investors have pretty much left the stock for dead.

Of course, that’s often the first sign of revival. Value investors, including Leon Cooperman of hedge fund Omega Advisors, have snapped up the discounted shares. They believe the company is making progress in cleaning up its balance sheet and rebuilding its business of processing payments for merchants and banks. One analyst expects the stock to rise 70% or more in the next year or two.

Under CEO Frank Bisignano—JPMorgan’s former co-chief operating officer—First Data has upgraded its technology, paid down some debt, and reshaped the business. Perhaps most important to shareholders, Bisignano recently bought breathing room by getting creditors to postpone to 2021 nearly $5 billion in debt payments that were to be payable in 2018. That gives First Data more flexibility to implement its strategy and improve cash flows.

“When I first joined, the company was losing customers, under a mountain of debt with $2 billion in [annual] interest expense, and so leveraged that we could have lost the keys to the building,” Bisignano tells Barron’s. “We were a ‘siloed’ company that sold individual products. Today, we bring the force of the entire enterprise to the relationship. People want to do business with us. We have a way to go, but we have momentum and are headed in the right direction.”

LESS WELL KNOWN than rivals Visa (V) and MasterCard (MA), First Data is one of the world’s largest card processors. It supplies the payment systems ubiquitous in today’s retail outlets. In 2014, it handled about 11% of global credit-and-debit purchase volume in dollars, and almost 40% of U.S. credit and debit purchases.

First Data is back on a course of steady growth. It earned an adjusted $705 million, or 74 cents a share, in 2015 on revenue of $11.45 billion. It’s expected to earn $1.2 billion, or $1.31 a share, on revenue of $11.85 billion in 2016. The following year, analysts look for $1.4 billion in earnings, or $1.52 a share, on revenue of $12.36 billion.

The biggest of First Data’s units is global business services, which include its “merchant acquiring” unit that sells credit-card terminals to retailers and then services their accounts. It represents 59% of revenue. Second comes global financial services, such as data processing for banks, which make up 21%. Just behind, at 20% of sales, are network and security services, including the Star Network of ATMs.

Bisignano, a high-energy CEO with a straightforward manner, has installed a new management team, many of whom worked with him overseeing the mortgage business at JPMorgan and, prior to that, when he was the head of global transactions at Citigroup. He and Chief Financial Officer Himanshu Patel have cut net debt from $24 billion in early 2013 to $19 billion. Free cash flow, which was negative $60 million when Bisignano arrived, has turned into a positive $211 million in the first-quarter 2016. Annual cash debt payments have been halved, to $1 billion this year.

And then there is the refinancing of $4.6 billion of term loans that pushes the due date out several years, freeing up more cash flow to meet First Data’s obligations.

The changing capital structure has provided First Data with what Bisignano calls “escape” velocity to drive its turnaround.

Improved technology and better salesmanship are expected to keep pushing revenues higher. One of the company’s bets is on a new platform called Clover, which promotes faster, more-responsive service by, for instance, letting waiters hand off customer orders via mobile devices rather than walking back to the kitchen. Clover also enables small businesses to assess customer and financial data, inventory, and employee performance more closely.
The technology is designed to address a big problem in selling to small businesses: client churn. That can result from a rival offering better terms or new hardware, or small businesses’ high failure rate. Analysts expect at least $100 million in small-business churn this year. Via better technology and bundled sales, First Data is trying to create more “stickiness” for customers, who are expensive to replace each year.

At about $11 a share, First Data’s stock doesn’t reflect the company’s progress. It trades at just eight times estimated 2016 earnings, less than half the level of some competitors, and 11 times free cash flow, a discount similar to rivals’.

“First Data’s a dominant franchise, trading at a fraction of its peers. It’s in excellent shape,” says Cooperman. “Earnings and volume are growing, and the company’s fixing problems in North America. They’ve pushed off maturities to free up cash to pay down debt,” he notes.

With a $19 price target for the stock, James Friedman, analyst for Susquehanna Financial Group, is watching closely to judge Clover’s success. “[First Data has] done an excellent job so far of saving money and coming up with ways to keep their large merchant customer base,” says Friedman. “The challenge is to manage churn rates by elevating their services to merchants,” he notes. Every 1% reduction in business loss adds $40 million in revenue for First Data, he says.

A major issue for investors is KKR’s (KKR) intentions. The firm and its co-investors own about 60% of the stock, a big overhang. The buyout firm reckons its cost to be about $14 a share, but it has no intention of unloading its biggest holding in a fire sale, says a source close to the deal. KKR historically hasn’t sold until it’s earned a multiple of its investment. The higher the share price, though, the greater the temptation to sell. The firm put another $1.2 billion into First Data via a private placement just prior to its IPO, notes Patel.

First Data posted a solid performance in the first quarter of this year, raising constant-currency revenue growth by 5%, yet pushing down costs. While cautioning that First Data is on a multiyear turnaround, Bisignano says he feels “good about the second half,” and believes “now it’s showtime.” Investors can’t wait.

http://www.barrons.com/articles/first-data-shares-are-too-cheap-to-ignore-1463803455?mod=BOL_hp_highlight_4

Pre-publication closing price: $11.41.