Description

Equifax (EFX) is a high-quality global information services company that provides credit reporting, income & employment verification and other risk assessment services to financial institutions, corporations, government agencies, and individuals. The company has an extensive set of data assets with information on individuals and businesses including their credit history, financial assets, telecommunications & utility payments, employment, income, educational history, criminal justice data, healthcare professional licensure and sanctions, demographic, and marketing. It leverages these assets and its analytical capabilities to help their customers make informed decisions in areas such as the extension of credit and the verification of employment and income in background checks and eligibility checks for government services.

Historically Equifax’s core business was its credit bureau operations where it competes primarily against Experian and Transunion. This is a wonderful business characterized by rational competitors and steady GDP+ growth supported by increased consumer credit over time. However in the last few years Equifax has become more known for its proprietary database of current and historical income and employment records, ‘The Work Number’ (TWN). TWN is used by mortgage lenders, hiring screeners, and government agencies looking to instantly verify income and employment status of prospective customers/employees/beneficiaries. This database was acquired in 2007, but it wasn’t until TWN’s record count covered over 50% of nonfarm payrolls before adoption began to accelerate. This increase in penetration, coupled with healthy pricing has taken its Workforce Solutions segment (TWN = 80% of segment revenues) from ~21% of segment profits in 2008 to ~56% today, yet we continue to see ample room for continued penetration and pricing.

At the same time, EFX is in the final stages of a multi-year $1.5bn+ investment cycle to modernize its IT systems and security, bringing all its unique data assets into the cloud. The company ended 2023 with 70% of revenues fully in the cloud and expects to be 90% complete exiting 2024. The transition is already bearing fruit in terms of improving security, accelerating new product innovation, and reducing maintenance tech spending, while free cash flows are set to ramp up as capital expenditures return to more normalized levels. On our estimates, we see free cash flows doubling in 2024 and increasing ~20% a year through 2029.

The only fly in the ointment to what should have been a very strong last few years has been Equifax’s exposure to the mortgage market. Historically mortgage accounted for ~20% of revenues but the surge in home buying / refinancing activity in 2020/2021 took mortgage revenues up to a peak of 32% of sales – just in time for Fed rate hikes to tank the market. Since then mortgage inquiries have fallen >80% from peak and mortgage revenue is just 18% of sales. This has been a painful process, but the go forward setup is much more attractive as further downside is limited and EFX would be a major beneficiary from a normalization of the mortgage market. According to management, a return to 2015-2019 activity levels would add $1.1bn in revenues, $700mn in EBITDA and ~$4 in EPS, though this is conservative as it fails to incorporate future pricing activities.

Currently Equifax screens expensively, trading at a mid-30s multiple of depressed forward earnings, though we expect forward earnings growth well above its long-term target of mid-teens growth supported by continued TWN penetration, pricing, and a mortgage market recovery. On our estimates, EFX could deliver ~$23 of earnings in 2029, implying a low-to-mid teens IRR from here (including dividends).

Company Description

Equifax is a global data, analytics, and technology company that provides credit reporting and employment & income verification solutions for businesses, governments, and consumers. It services are based on comprehensive databases of consumer and business information derived from numerous sources including credit, financial assets, telecommunications and utility payments, employment, income, educational history, criminal history, healthcare professional licensure and sanctions, demographic, and marketing data. The company has operations across the globe but generates most of its revenue (~77%) in the US. It has three operating segments: (1) Workforce Solutions (44% of sales); (2) U.S. Information Solutions (USIS, 33% of sales); and International (23% of sales).

Background on credit bureaus and company history: In the early 1900s individual merchants and local businesses started forming informal credit bureaus to share information about customers’ creditworthiness within their communities. These local bureaus were small and operated independently. At the behest of financial institutions looking for a more comprehensive picture of an individual’s credit history, national credit bureaus began to form. These national credit bureaus entered into affiliate or partnership agreements with local and regional credit bureaus across the country which gave the national players access to their information in exchange for giving the local affiliate broader reach and resources.

Over the next several decades, the national credit bureaus began acquiring local affiliates as the synergies of outright ownership (e.g. standardizing the collection and reporting of data to deliver faster and more accurate results) outweighed the cost of the purchase. Industry consolidation picked up after the enactment of the Fair Credit Reporting Act in 1970 which brought about regulatory changes (and resulting additional compliance costs) and introduced guidelines for the fair and accurate reporting of consumer credit information, and further gained steam as technological advances in the 1980s-2000s coupled with widespread usage of standardized credit scores provided further benefits to scale. Today credit reporting in the US is dominated by three players; Equifax, Experian, and Transunion.

Equifax – originally named Retail Credit Company – dates back to 1899 when the business was founded to evaluate applications for insurers. In its early days it was also a local credit bureau, providing credit reports to merchants and businesses in the Atlanta region. In the 1920s it began to expand by acquiring and affiliating with local credit bureaus. By the 1930s it had developed a nationwide network of affiliates, and in 1975 it changed its name to Equifax to better reflects its national presence. The company acquired its last affiliate in 2012 – CSC – for $1bn.

Over time the company began to layer in additional data sets and analytic capabilities with the idea of improving lending outcomes. In addition to its credit bureau data, Equifax has (1) a proprietary database of telephone and utility payment information with 220mn active records, (2) wealth data contributed by brokerage firms that covers ~50% of the wealth in the US used in marketing as they cannot sell this data on an individual basis, (3) rental payment data, (4) property data, (5) commercial data on (primarily) small businesses, and (6) its most valuable dataset, The Work Number, which it acquired in 2007 with the acquisition of TALX Corporation for $1.4bn.

Equifax branched out internationally in the 1990s, entering both Europe and South America through acquisitions. In 2016, Equifax entered the Australia/Asia Pacific region through the $1.9bn acquisition of Veda. Most recently the company bolstered its presence in South America with the acquisition of Boa Vista Servicos, Brazil’s second largest credit bureau. Today, international credit bureaus account for ~23% of sales and ~16% of profits, with sales split relatively evenly between Asia Pacific, Europe, Canada, and Latin America.

Segment Overview:

 U.S. Information Solutions (USIS): The USIS segment includes Equifax’s legacy online credit reporting business where information is derived from multiple large and comprehensive databases of consumer and commercial information (credit history, current credit status, address, and payment history, of telephone and utilities). Clients use their credit reports to improve their underwriting and risk management decisions, authenticate identities, reduce fraud, monitor risk, and proactively manage their portfolios. The USIS segment also includes its consumer credit monitoring business and a marketing business that utilizes consumer and commercial financial information to help clients better target their marketing efforts. Its largest end markets, Mortgage (24% of segment revenue), Financial (i.e. credit cards, 17%), and auto (12%) account for just over half of segment revenues with the remainder diversified across a host of end markets.

Including the US portion of global consumer solutions segment, which was reclassified into USIS in 2021, segment revenues and adjusted EBITDA have increased at 5% and 4% CAGR, respectively. Adjusted EBITDA margins peaked around 42-43% in 2015/2016 prior to Equifax’s well-publicized data breach in 2017 which resulted in increased spending on security and a massive multi-year capital investment to modernize the company’s IT architecture to become 100% in the cloud. More recently, margins have been negatively impacted by a slowdown in mortgage activity, somewhat offset by the company passing along FICO price increases with an embedded margin neutral to the segment.

At its 2021 Investor Day, the company outlined a plan to grow the USIS segment 6-8% organically, leveraging AI and its single, cloud-native data fabric to accelerate new product development and ultimately take market share.  Results have been mixed since, with mortgage activity a drag on results up until the last quarter.  

Equifax security hack overview: Equifax was initially hacked in March of 2017 when attackers exploited a vulnerability in the open-sourced code on Equifax’s website just days after the company’s IT department was supposed to patch the flaw (but didn’t). This error was compounded by the company failing to renew a software license that would have allowed the company to identify the encrypted data being transferred out of the company and thus catch the hackers attempt to exfiltrate the data. The license was ultimately renewed at the end of July, which is when the company first knew about the breach. After another month of investigation, the company disclosed the data breach to the public. In total, the names, addresses, dates of birth, social security numbers, and drivers’ licenses numbers of as many as 143mn people were exposed.

The breach resulted in a wave of lawsuits, regulatory scrutiny, and the resignation of then CEO Richard Smith, and directly contributed to Equifax spending ~$1.5bn in a multi-year capital investment to upgrade its security systems and move to a 100% cloud-native architecture. It also negatively impacted the company’s reputation and led to meaningful share loss in both its marketing and consumer credit monitoring businesses. In 2019, the company announced a settlement with the affected parties whereby it would pay up to $700mn to settle with the Fair Trade Commission, Consumer Financial Protection Bureau, and the 50 US states/territories.

Workforce Solutions: The Workforce Solutions segment provides services enabling customers to verify income, employment, educational history, criminal justice data, healthcare professional licensure and sanctions of people in the US, as well as providing employer customers with services including unemployment claims management, I-9 and onboarding services, ACA compliance management, tax credits and incentives, and other complementary employment-based transaction services. It operates through two business units; Verification Services (mostly employment & income verification using it’s The Work Number database) and Employer Services (mostly HR BPO services).

The Workforce Solutions segment was created when EFX acquired TALX Corp in 2007 for $1.4bn. TALX started out as a business process outsourcing operation where it would do HR paperwork on behalf of large enterprises across the country, things like I-9s, unemployment claims, tax credits. To do this work, enterprise customers would have to share their payroll data with TALX. In the early 1990s one of its customers asked TALX to handle the task of answering calls from verifiers and they would pay TALX for this because this didn’t want the administrative burden of handling all the verification requests from mortgage originators, background screeners, creditors, etc… TALX went and set up call centers and took over this task for their customers. Ultimately, TALX digitized and automated the data into a database that verifiers could ping instantly to get income & employment data, offering to take the job of handling verification calls in exchange for contributing their data. By the time TALX was acquired by EFX, it had 95% of the Fortune 500 companies contributing payroll records.

Today, almost all the large U.S. enterprises contributes records directly to The Work Number, and TWN has augmented its records with largely exclusive partnership agreements with payroll companies whereby EFX pays the payroll company a revenue share in exchange for their employee records. In effect it is a multi-sided platform where employers and payroll providers provide income and employment data electronically to EFX directly from their payroll systems (in exchange for EFX handling their inbound verification requests) and verifiers (e.g. lenders, employers/background screeners/government agencies) receive frictionless and automated information about individuals upon whom they are running checks.  At year-end, TWN had 166mn active records (vs. ~160-170mn non-farm payrolls and ~220mn Americans that make money in some way shape or form) and ~125mn of these records are exclusive to TWN, and the company has grown records at 12% CAGR since Covid. And with the acquisition of Apriss Insights in 2021, the company added 770mn incarceration and court records (~92% real-time coverage) to further augment its capabilities in background checks.

Since 2011, Workforce Solutions revenues and adjusted EBITDA have increased at a 16% and 18% CAGR, respectively, while EBITDA margins have increased ~1,200bps to 51%.

At its 2021 Investor Day, management guided for this segment to increase revenues 13-15% annually. There are multiple ways in which the EWS segment can grow which support this outlook. First, the company only recognizes revenue from successful queries of its database. As its record count grows, its ‘hit rate’ should increase. Second, penetration of their TWN database remains very low outside housing. If a client is not using TWN, they are most likely relying on paper paystubs and manual processes. As more and more companies contribute records to the TWN database, they are increasingly likely to send inquirers to EFX, thereby driving higher penetration. And third, pricing has been a major lever of growth in this segment, particularly in mortgage (8-10% annually) and background screening (pricing +>500% in the last 5 years per a December 2022 Stifel Research note).

International Segment: The International Segment consists of its credit bureau operations in Canada, Asia Pacific (Australia, New Zealand, and India), Europe (UK, Spain, and Portugal), and Latin America (Argentina, Brazil, Chile, Costa Rica, Ecuador, El Salvador, Honduras, Mexico, Paraguay, Peru, and Uruguay).

Since 2011, segment revenues and adjusted EBITDA have increased at a 6% and 5% CAGR, respectively. Foreign currency has generally been a headwind over this time period, and the acquisition of Veda (Australia Credit Bureau) in 2016 added ~$250mn to revenues.

Looking ahead, management expects revenue growth in the 7-9% range, driven by market growth, new product innovation, price, and further credit penetration.

Investment Highlights:

(1)     The Work Number will continue to drive strong growth. While Equifax is more often thought of as a credit bureau – a fine business in its own right – its best business is its Verification Services business which accounts for ~80% of Workforce Solutions revenues. Verification Services growth has been underpinned by 3 primary drivers: (1) TWN record growth; (2) client penetration growth; and (3) pricing.

a.       Despite covering ~75% of the BLS non-farm payroll records, Equifax has continued to enjoy success growing records. Growth should slow from the 13% record growth averaged since 2019 but continued efforts to tackle the long tail of smaller payroll providers and adding other types of records such as pension and gig economy is expected to deliver solid MSD plus record growth going forward.

b.       Outside of mortgages, verification penetration is relatively low within talent and government. Within talent, the largest users are the big 3 background screeners (~25% market share) who use TWN for employment and income verification. The background screener end market remains highly fragmented, suggesting TWN can gain share by both recruiting smaller companies and by continued consolidation by the big 3. In government, contracting is done on an agency by agency basis at both the Federal and State levels, suggesting the company can slowly increase penetration over time.

c.       We see no reason EFX cannot continue pricing in the mid-to-high single digit range over the medium term as this represents a meaningful step down from 2019-2021 when TWN first achieved scale. All else equal, EFX has more pricing power in verticals where the cost is passed through to the end customer (i.e. mortgages and talent) than in verticals that don’t (i.e. government).

All-in, we think management’s growth outlook of 13-15% looks reasonable/potentially conservative. With the segment now 44% of revenues and 56% of profits, outsized growth in this business unit (at 65-70% incremental margins) should pull organic growth and margins higher for the overall business.

Potential competitive threats are worth monitoring but don’t appear to be a major concern. Notably, we are not worried about competition for records even as Experian is looking to expand its database beyond the 43mn records currently (~35mn of which come from ADP who provides records data to EFX, too) because it is not in payroll providers’ best interests. Employers and payroll companies want to limit the number of vendors they share personal data with for security reasons, and payroll companies specifically would not benefit from increased competition because they benefit from higher pricing via their revenue share agreements. One potential threat worth monitoring comes from competitors using consumer permissioned data (CPD) which can bypass TWN’s contractually and practically exclusive contract with payroll providers and employers. Mitigating this risk is that there is a lot more friction in this process because it requires either the applicant to enter in their username and password of whichever payroll system their company uses. Either that or competitors are seeking permission from employers to scrape payroll data of their employees, which strikes us as a tough ask because it introduces privacy risks with no additional benefits because they are already sharing this information with TWN.

(2)    Equifax is dramatically under-earning because of a depressed mortgage market. From 2021 to 2023, EFX’s U.S. mortgage revenue declined by 36% as mortgage activity (as measured by the MBA mortgage index) fell ~80% from the highs in 1Q21 to 3Q23 due to the rapid increase in mortgage rates from historically low levels. Equifax tracks mortgage inquiries and the company disclosed that activity is currently >50% below normalized (2015-2019 average) levels, and on its 4Q23 conference call the company noted that a return to normalized would add $1.1bn in revenues and ~$4 in EPS (vs. consensus 2024 EPS of $7.56). From our perspective this is likely understated as it fails to incorporate additional pricing actions by in both Workforce Solutions (historically 8-10% annually in mortgage verification services) and in USIS (where EFX passes along FICO price increases along with their own margin).

Another notable benefit to mortgage revenue will come in 4Q25 when the FHFA is expected to begin implementing new credit score requirements for loans sold to Fannie and Freddie. Upon implementation, mortgage lenders will switch from requiring credit reports from all three credit bureaus (the tri-merge) to just two credit bureaus (bi-merge) but it will require lenders to also use VantageScore (VS) in addition to FICO score. FICO is on record stating that it does not expect any revenue impact from this move, implying it will price to at least offset the reduction in FICO scores pulled for a mortgage (and credit bureaus will pass this price increase on to end customers with their own margin baked in). And we would expect VS to price at or near FICO for its own score, which would also be passed on by the bureaus. Thus, while Equifax could potentially lose 1/3 of its volumes (we would take the under as EFX has the most share in mortgage, has the ability to bundle their score with income and employment verification, and a lot of lenders are expected to continue using the tri-merge for risk management purposes), average selling price increases to reflect both FICO price increases and the addition of the VS should more than offset this headwind.

(3)    EFX is at the tail end of a major investment cycle that will improve growth, margins, and cash flows. In the wake of the 2017 data breach, Equifax made the decision to completely overhaul its IT architecture to improve security, increase uptime of its databases, and improve the speed of transmission. The company has spent >$1.5bn in the last 5 years to complete this transition, ~50% of which was spent re-writing applications from on-premise to Google Cloud and ~50% moving its disparate data sets to a single data fabric. The company ended the year with ~70% of revenues fully in the cloud and expects to end 2024 with over 90% transitioned. Upon completion, we expect this transition to benefit revenues, costs, and cash flows.

a.       Revenue benefit – With a single, cloud-based data fabric containing all its data sets in one place, EFX believes it can accelerate the speed and effectiveness of new product innovation. Pre-Cloud, EFX was a laggard in innovation. Its innovation index, which measures % of revenues generated from products introduced in the last 3 years, was 5-7% annually whereas it is ~14% today. The Workforce Solutions business was the first business to fully transition to the cloud, and its vitality index is ~20% (it is currently benefiting from a couple of one-off ne w products that dramatically outperformed). Its long-term goal is 10%+ currently and we would expect this to rise steadily over time.

b.       Cost benefit – Moving to the cloud will reduce its technology costs by ~15% as the company goes from operating 40 disparate data centers to 0. The company has also been incurring duplicative costs as it maintains both its legacy and updated architecture, which has contributed to lower adjusted EBITA margins in both USIS and International segments (both segments showed peak EBITDA margins in 2017 and steady declines thereafter) plus higher corporate expenses as a % of sales (from 5.1% in 2017 to a high of 9.3% in 2021 and 7.7% in 2023).

All-in the company reduced spending by ~$210mn in 2023 (~400bps margin benefit) and spending is expected to decline an incremental $65mn in 2024 (~100bps benefit) with further follow-through in 2025. Not all of this will fall to the bottom-line as the company is reinvesting savings, but all else equal, spend reductions from moving to the cloud should be accretive to incremental margins.

c.       Cash flow benefit – Prior to the data breach, capital expenditures amounted to just over 4% of revenues on average. Since the company has undertaken its huge investment program, capex has averaged 10.7% of revenues. Once the implementation has been completed, management expects capex as a % of revenue to reach a steady-state of ~7.5%. The combination of accelerating growth, rising margins, and declining capital intensity will have a powerful impact on free cash flows. On our estimates, FCF doubles in 2024 (to just over $1bn and increases at >20% a year after that, and we see the company reaching its historical pre-breach FCF conversion levels (58% of adj EBITDA) by 2025 with further upside.

(4)    Capital returns expected to improve. EFX currently has net leverage of 3.2x trailing EBITDA and expects to exit 2024 at ~2.5x (we are more bullish, estimating a year-end leverage of 2.2x), a level which the company believes is appropriate to maintain its current BBB credit ratings. Assuming no large-scale M&A, we would expect capital returns to step up meaningfully in 2025. On our estimates, we assume the dividend (0.6% current yield) grows with earnings (~20% payout ratio) and EFX is in a position to repurchase over $1bn in stock annually (~3% of outstanding shares) while still having >$2bn in excess capital to deploy into bolt-on acquisitionsover the next 3 years without taking leverage over 2.5x.

(5)     VantageScore ownership is a potential hidden asset. We think the recent ruling by the FHFA to mandate VS’s credit score into the mortgage origination process for loans sold to Fannie and Freddie is a major positive VS and its owners, the 3 US credit bureaus. The FHFA effectively moves VS into the ‘big leagues’ with it being mandated for use in high dollar value originations whereas previously it was mostly used in lower value marketing scores. Moreover, the government effectively just granted FICO and VantageScore a monopoly position in mortgage so we would expect the company to price accordingly. FICO took this opportunity to raise pricing dramatically during an epic mortgage slowdown (our estimates have FICO mortgage revenue increasing from ~$85mn in CY22 to >$420mn in FY24 despite a 80% decline in mortgage activity from peak) and has showed no inclination to take its foot off the gas going forward.

Assuming VS adopts a similar strategy when the industry begins complying in 4Q25, EFX’s 33% ownership of the business could be worth a lot. Currently, VantageScore is structured such that expenses are shared by the bureaus but revenues related to credit reports with a VS are only recognized by the bureau that sells the report. Thus, it is difficult to ascribe direct value to VS separate from the bureaus as presently constituted. But, assuming the company could restructure its ownership agreement such that VS has costs and revenues on its own P&L, this would unlock real value in their ownership stake. Assuming VS is worth 25% to 50% of FICO would imply a valuation in the range of $9-18bn equating to $3-6bn of value for EFX (~$25-50/share).

Estimates: Our estimates assume continued strong growth in non-mortgage verification services, a gradual recovery to normalized mortgage activity levels, and improving profitability. All-in, we see revenues increasing 11% annually through 2019, adjusted EBITDA increasing 17% (implying 60% incremental margins), and EPS increasing 23% annually to $23.

Valuation and IRR: At $262, EFX is trading at 32x/25x our FY24/25 estimates which compares to its 5/10/and since 2000 average of 27.5x/24x/19.5x. Notably we think the company should trade at a premium to historical levels given (a) the emergence of The Work Number and the business’s subsequent transformation and (b) the fact that the business is dramatically under-earning due to a depressed mortgage market.

A valuation of 20-25x our FY29 EPS estimate of $23 implies a year end 2028 value in the range of $460-575 and an IRR of 13-18% annually (inclusive of dividends).

Risk Factors:

(1)     Continued mortgage weakness – The surge in mortgage refinancing in 2020/2021 and subsequent dramatic increase in mortgage rates has stalled out the mortgage market. It appears activity has bottomed out though it could take longer than we are modeling for activity to rebound.

(2)    Competition in verification – As we discussed, this is worth monitoring but we do not believe competing credit bureaus or competitors trying to gain access via consumer permissioned data represent a credible threat at this time.

(3)    Regulatory risk – Equifax has aggressively priced its products and could be subject to regulatory scrutiny. We do not believe the pricing they are taking in mortgage is impacting the end consumer and/or their ability to access credit, so we think this risk is low currently.

(4)    Capital allocation – Equifax has made a number of large acquisitions of international credit bureaus over its history and we are not convinced this is the best use of investor capital given how attractive the workforce solutions business is. Should the company continue to plow money into dubious acquisitions as opposed to returning capital to shareholders, we would be concerned.

Key Executives: Equifax’s CEO Mark Begor joined the company in 2018, leaving his role at Warburg Pincus where he was focused on operational improvements across portfolio companies in their industrial and business services group. Prior to Warburg Pincus, Mr. Begor spent 35 years at GE, serving as CEO of GE’s Energy Management, Real Estate, and Retail Finance units during his tenure there. Mr. Begor also served on FICO’s board of directors. Mr. Begor owns ~$175mn of EFX stock.

The president of Workforce Solutions Rudy Ploder took over Workforce Solutions in November 2015 having previously served as head of EFX’s US credit bureau business. By all accounts Mr. Ploder was the person who initially realized the value within the Workforce Solutions business and the one who pushed the business to continue growing records by partnering with payroll companies and reaching out directly to employers. Our checks indicate that he was essentially the CEO-in-waiting but the timing of a stock sale around the time of the data breach (he was subsequently absolved of any wrong-doing) left him in limbo when the Board was looking for a new CEO post the data breach. Mr. Ploder owns ~$38mn in EFX stock.

Executive compensation: Annual incentive compensation for the CEO is 100% based on financial performance metrics, namely organic growth and organic earnings per share growth. Long-term incentive compensation is balanced between market-based and operational performance. Approximately 30% of the CEO’s compensation is based on the 3-year cumulative total shareholder return vs. the S&P 500, 30% related to adjusted EBITDA growth over a 3-year period, 20% in time-based RSUs, and 20% in premium-priced options.

Catalyst

-Inflection in cash flows starting in 2024 with the scaling down of capital investments

-A recovery in mortgage inquiry volumes

-Continued penetration of TWN