Description

We are long shares in ACI Worldwide, a software provider for the payments and billing sectors. ACI has a long-standing core product that gives the company stability, while recent investments in new products give the company strong growth potential. ACI generates strong free cash flows, has a healthy balance sheet at under 3x net leverage and is run by an excellent management team.

ACI’s core product, Base-24, is sold to large banks, processors, intermediaries like Visa and Mastercard and large merchants. Known in the industry as a payment switch, Base-24 software enables payment transactions across multiple channels. This is mission critical software, with many customers seeing thousands of transactions per minute. In 2021, ACI estimated its software processed $14T (trillion) worth of payments and securities transactions every day.

Over the decades, new payment intermediaries, partners and schemes have made switching software highly customized for each bank customer. The combination of this customization, the sheer number of transactions per day and the robustness of ACI’s software has made Base-24 an incredibly sticky product. Typically sold in 5-year license agreements, ACI rarely loses a customer and generally receives above inflation price increases. This business, reported as bank revenue, represents ~1/3rd of ACI revenue but almost 2/3rd of ACI profitability, with profits reaching over 75% of total ACI when including software sales to merchants.

Due to switching characteristics mentioned above, it is also difficult for ACI to acquire new Base-24 customers. Therefore, beginning under its previous management, ACI has been purchasing and developing ancillary and adjacent product offerings to its customer base. The most important of these is software for real-time payments (RTP).

RTP is the ability to move funds from one bank account to another instantly at any time. Many countries such as India and Singapore already have RTP schemes set up and are beginning to see large amounts of transactions through the network. Others, such as the US, are only building the rails for RTP now. For example, the Federal Reserve is planning to launch FedNow a true RTP scheme in 2023 that will allow over 10,000 US financial institutions to have instant RTP access.

ACI plays a dual role in RTP. First, they work with scheme operators (usually government entities) to provide software for the rails of a RTP scheme. ACI is a leader in this space and many times goes to market with partners such as Mastercard to offer expanded services. Second, ACI provides software to banks to process real-time payments. As more countries, banks and merchants adopt RTP, ACI will see an increase in new contracts, volumes, and revenues. Globally in 2020, cash payments declined by 6%, card payments grew by 8% and RTP grew by over 40%. We expect this trend to continue over the coming years, benefitting ACI.

ACI derives ~$100m revenue on a run rate basis from RTP, mostly in the form of long-term contacts based on volume usage. While growth will be lumpy based on new contracts and rollouts, if ACI is successful RTP revenue could be multiples of its current run rate, with 80% type margins. While hard to estimate, we believe that RTP profits at ACI could equal its current bank profits, leading to explosive free cash flow growth in the coming years.

As mentioned, ACI also has software for the billing sector. This bill pay software represents over 40% of ACI revenue but only ~20% of profits. ACI has industry leading software for bill pay, primarily focused on industries such as healthcare, utilities, consumer finance and subscription services, with much of its revenue coming from a large acquisition in 2019. While electronic bill pay adoption continues, ACI has struggled to grow its bill pay segment. However, recent investments in its salesforce and product suite are encouraging and the company expects bill pay to grow at high-single digits in the future. We view any progress here as upside not captured in our estimates. 

ACI is led by CEO Odilon Almeida who joined in March 2020 taking over the helm from long-time CEO Phil Heasley. Heasley was a visionary who understood the power of ACI’s core Base-24 product and RTP being the future of payments. Heasley did an excellent job positioning ACI to capture the full potential of the payments industry. However, Heasley was not a strong operational manager and despite a steady revenue base, ACI consistently struggled to meet analyst expectations and the stock was stagnant for many years.

Almeida joined ACI from a senior position at Western Union where he built a reputation for operational excellence. Almeida has made significant changes to the culture of ACI, brining accountability and reliability to each operational division starting with the sales team. ACI has also simplified its reporting structure and set new targets for investors. We are encouraged by Almeida’s leadership and his incentives to create shareholder value.

We see consensus estimates for 2022 EBITDA at $405m and FCF at $209m. We generally agree with the EBITDA number, however, we are largely ahead on FCF. We estimate cash outflows below the EBITDA line to be ~$125m (interest, taxes, capex and working capital) for FCF of $275m or $2.40/share and our adjusted FCF of $245 (adjusted for stock compensation) or $2.15/share. We see FCF/share moving to $3 (after stock comp) in the next 2-3 years as growth and margin expansion take hold. Additionally, we believe the company has been buying back stock and will continue to allocate capital to share repurchases so long as the stock is trading below fair value and leverage is below 3.0x (both are currently true).

ACIW has no direct public competitors and so multiple discovery is difficult. We believe ACI has strong, sustainable and growing FCF and its positioning in RTP makes the company a strategic asset. We don’t see a scenario where ACI should be worth less than 15x FCF and note that many businesses in adjacent spaces trade at FCF multiples (even today) in the 20’s. Therefore, as investors appreciate the new operational excellence, RTP opportunity and consistent results, we think ACI can trade back in the mid $30’s (15x FCF) and potential toward $50/share when a strategic (perhaps Visa?) decides its being disintermediated by RTP and needs to acquire ACI to thrive.

Catalyst

Consistent financial performance

Continued simplification of business

Aggressive asset and capital allocation

Strategic takeout