Business Overview: Fidelity National Information Services (FIS) is a leading provider of financial technology solutions for merchants, banks, and capital markets firms. The company was initially founded in 1968 as Systematics before eventually being acquired by title insurance giant Fidelity National Financial in 2003 and spun-off in a 2006 reverse IPO. Since then, FIS has grown both organically and by acquisition, most notably acquiring Worldpay for $48B in July 2019. The Worldpay acquisition fundamentally transformed the business from an IT outsourcing provider for financial institutions and asset managers to an end-to-end financial technology player with a best-in-class merchant acquiring business. FIS is based in Jacksonville, FL and has ~60K employees.

Thesis: FIS is a high-quality business with long-term compounding potential given an achievable HSD top-line growth profile, material operating leverage, and proven ability to conduct accretive M&A. FIS is well-positioned to capitalize on long-term secular tailwinds such as the electronification of payments, rise of digital banking, and synchronization of capital markets technology sets.

FIS has durable competitive advantages across its businesses which are evidenced by stable/non-cyclical cash flows, high margins, and high returns on incremental capital. FIS’s Banking and Capital Markets segments benefit from high switching costs driving strong customer retention, while differentiated scale in the Merchant segment drives low processing cost per transaction and an improved merchant service offering. Furthermore, FIS competes in oligopolistic merchant acquiring and core processing markets with rational competitive pricing.

Despite these quality characteristics, FIS trades at a reasonable valuation (~13x NTM P/E) as the market has become overly pessimistic on legacy FinTech players because of new disruptor competition (and red herrings like BNPL/crypto disruption risk). However, payments and core processing are hardly winner-take-all as there are many attractive swim lanes in which legacy players like FIS will remain differentiated. 

Merchant Solutions (~30% revenue): Provides merchant acquiring & processing solutions, integrated payment solutions, and global eCommerce solutions to 1M+ merchants in 140+ countries. Merchant Solutions is primarily composed of the former Worldpay and offers payment processing services including authorization & settlement, chargeback processing, and network/interchange fee management. FIS processes over $1.2T in annual payment volumes serving merchants all sizes with a focus on large multi-national enterprises.

Revenue Model: Generally FIS offers two pricing schemes: a flat fee per transaction where FIS earns the residual after interchange and network fees, and an interchange-plus model in which only the merchant acquirer fee is fixed (preferred by larger enterprises). In addition to merchant acquiring, FIS provides high margin value-added services in data & analytics including customer data which are increasingly valuable in CRM applications. Merchant revenue is largely volumetric / reoccurring vs. recurring but FIS’s core customer base of large merchants is naturally lower churn than the industry at large with an estimated 1-2% annual logo churn.

Growth Drivers: FIS is well-positioned for future growth with 50%+ of Merchant revenue exposed to fast-growing eCommerce and integrated payment verticals. Overall, Merchant Solutions revenue is directly correlated with V/MA LDD go-forward growth.

eCommerce/Omni-Channel: FIS benefits from the shift to online purchases, either by eCommerce or mobile channels. Global eCommerce purchase volumes have consistently grown in the MDD for several years with COVID accelerating eCommerce penetration by ~3 years. As merchants add eCommerce capabilities, having omni-channel payment solutions has become critical, particularly in emerging markets where only ~35% of eCommerce volume is traditional credit/debit with the rest in mobile wallets, bank networks etc.

Cross-Border eCommerce: FIS is the leading player in cross-border eCommerce which is expected to grow ~25% annually vs. MDD growth in domestic U.S. eCommerce. Given differences in local payment methods and regulations, large global merchants have historically managed up to 50 merchant acquirer relationships. However in recent years these merchants have worked to consolidate to fewer partners to take advantage of volume discounts from scaled acquirers and simplify back-end data/reporting processes. As one of the few scaled global acquirers with both online/offline capabilities, FIS should capture greater wallet share from its existing eComm merchant base by displacing local in-country acquirers (usually local bank acquirers).

Integrated Payments: Merchants are increasingly purchasing bundled solutions from integrated software vendors (ISVs) which combine specialized vertical software with payments processing. An integrated payments solution links valuable payments data with data from payroll processing, invoicing etc. which provides improved business analytics to the merchant. These integrated payments revenues are highly recurring with estimated ~5% logo churn vs. ~15% in traditional merchant acquiring.

Cross-Sell Upside: In addition to these secular growth areas, FIS has idiosyncratic growth upside resulting from the merger of merchant & banking capabilities at legacy Worldpay & FIS. Given its large int’l and domestic base of core processing banking relationships, FIS is able to cross-sell merchant acquiring through FIS’s existing bank referral channels (estimated 75%+ of distribution in int’l acquiring). In particular, Brazil and India are large payments markets in which FIS has large core processing market share (e.g. FIS has ~70% core processing market share in Brazil). These cross-sell initiatives should not only drive growth but also reduce attrition by deepening client relationships.

Moat / Competition: As payment processing has become more commoditized, scale has emerged as the most important differentiator driving lower costs and an improved merchant experience. Payment processing is inherently a scale game as high fixed costs are spread over billions of transactions resulting in material operating leverage (80%+ incremental margins). The industrial logic of scale has driven material consolidation in the merchant acquiring industry with ~80% of U.S. payments volume flowing through the top 10 merchants (FIS 2^nd largest by volume). Scale provides additional value by reducing the variable costs of processing as processors can earn volume discounts from card networks.

Due to its global scale and large data advantages, FIS has a structural advantage in driving differentiated authorization rates for merchants, particularly in eCommerce (FIS aims for rates 200-500bps higher than ~85% industry average). Since a 1pt increase in auth rates far outweighs the ~30bps large merchant yield, merchants are hardly price sensitive and far more motivated by top-of-funnel authorization improvements. By combining processing capabilities with legacy FIS issuer processing knowledge and data sets (~340M cards), informational synergies can improve already high authorization rates. Large merchants typically diversify and maintain a least two acquirers but rely on the acquirer with higher authorization rates to handle the majority of payments volumes, so even marginal improvements in authorization rates can significantly increase FIS processing volumes at existing merchants. In addition to higher auth rates, informational synergies from acquiring + issuing capabilities may help reduce fraud which is of growing importance to online merchants who bear ~2/3 of the chargeback liability.

FIS’s combination of acquirer and issuer processing capabilities also has the potential to be transformative by creating an alternative closed loop network in which certain transactional activity can be validated without the card networks, allowing FIS to pass on cost savings to merchants. However, ChaseNet attempted this strategy with even greater overlapping merchant/issuing volume and it hasn’t appeared to gain much traction outside of large volume retailers who are willing to adjust payment systems to capture these savings.

As large merchants look to consolidate global merchant acquiring relationships, FIS’s differentiated cross-border capabilities should help it improve share. FIS has continually expanded its cross-border eCommerce capabilities which now includes 300+ types of payments, ~150 countries, and 125+ currencies. FIS’s large global footprint includes ~60 countries with on-the-ground local acquiring presence, a key differentiator that allows merchants to avoid high cross-border network fees. Building a local presence in a new market is non-trivial as it involves serving all local payment types, connecting to local banks, and obtaining licensing to do processing business (usually a fixed number available). FIS is able to extract pricing power with these advantages with FIS cross-border eCommerce net revenue yields ~1.5x domestic yields.

In addition to these scale moats, FIS benefits from unique access to valuable distribution channels. Unlike payment peers FISV and GPN which have in-house merchant software offerings (FISV’s Clover, GPN’s vertical software portfolio), FIS’s integrated payments strategy depends on being a neutral payments vendor to vertical software players. This avoids any potential channel conflicts with ISVs and could feasibly lead to market share gains. FIS also maintains exclusive merchant acquiring relationships with certain regional banks and can leverage these bank referrals to sell acquiring solutions into the large base of merchants served by these regional banks (45% of U.S. distribution). This is especially important in international merchant acquiring where banks are often the most important distribution channel (75%+ of distribution).

Key Risks / Possible Mitigants

FIS competes with tech-forward Adyen in cross-border eCommerce with a single full-stack architecture vs. FIS’s multiple acquiring platforms. With a simplified tech stack, Adyen may be able to offer lower processing costs per transaction (reflected in ~60% EBITDA margins). While FIS says they plan to consolidate platforms, migrating merchants to new platform is disruptive and can lead to churn.

• Low pricing and high auth rates often matter more than slick tech/APIs for many large enterprises. Anecdotally, FIS discloses their auth rates while Adyen often contends that they often compete on factors other than price and auth rates.
• Adyen is somewhat constrained by its single architecture in offering customer-specific customization (e.g. Adyen typically won’t work with existing merchant tokenization scheme, requiring a rebuild of payments tech stack).
• Adyen is more of a pure-play eCommerce offering and doesn’t yet have the same omni-channel capabilities.

Online payment gateways (Stripe, Braintree etc.) have further distanced the merchant acquirer from the POS and risk turning FIS into a commoditized processing “dumb pipe” or will eventually disintermediate FIS entirely.

• While Gateways are likely to gain share with SMBs/mid-market, large enterprises are more likely to contract FIS directly for lower pricing and greater integration customization. Because third-party gateways add another point of integration on-top of underlying processors, they are often more expensive and add another layer of processing friction which could lower auth rates.
• Gateways are unlikely to disintermediate merchant processing entirely given large incumbent benefits of scale. For example, Amazon accounts for ~3% of global card volumes but still relies on Chase for merchant processing.

ISVs are increasingly interested in converting to Payment Facilitators (PayFacs) which then fully-integrate payments into merchant software offerings. PayFacs take a share of the merchant acquiring fee (~40-80%) but outsource back-end merchant processing. For example, Mindbody built vertical software for the fitness industry before converting into a PayFac (payments now ~50% of revenue). Fast-growing white-label platforms and consultancies have further reduced the friction in PayFac conversion (e.g. Finix).

• Though PayFac conversion negatively impacts FIS revenue, the impact on contribution margin is more muted as standalone processing is higher-margin than full-service acquiring (customer acquisition & service costs).
• Taking on the merchant of record relationship involves material capital (chargeback & fraud liabilities if merchant is insolvent) and compliance (PCI/DSS) risks.
• PayFacs must have significant payment volume ($300M+) to justify the upfront investment of setting up master merchant infrastructure ($1.5M+) and ongoing annual expenses ($500K+).
• ISVs must convince the merchant to terminate its existing merchant acquiring relationship before taking on PayFac responsibilities.

Payments are highly-regulated and some jurisdictions may consider capping merchant acquiring fees.

Banking Solutions (~50% revenue): Provides mission-critical financial technology infrastructure such as core processing & ancillary services, digital solutions (mobile banking), fraud/risk/compliance management, funds transfer and network services solutions, and issuer processing solutions to ~1.5K financial institutions (FIs) in 130+ countries. Clients use core processors to maintain primary customer records and will often purchase ancillary services that interact directly with the core processor. Core processing applications include daily transaction processing, general ledger accounting, loan and deposit processing, and account origination (nearly every type of transaction running through a bank), while ancillary applications include customer-facing services like digital banking and back-office support in account management and risk & compliance management. Clients include global financial institutions (FIs), regional and community banks, credit unions and commercial lenders, and other commercial institutions with a focus on large FIs (>$10B assets).

The core processor serves as the central nervous system of a bank’s IT system with 20-40 ancillary systems that provide specific functionality. On average, banks are estimated to concentrate 75% of processing spend with their core provider while the core processing product itself earns ~30% of total processing spend. While this is true on average, small banks are more likely to stick with the core processor and use a single vendor approach for ancillary solutions while larger banks generally prefer best-in-class solutions.

Growth Drivers: Banking Solutions benefits from highly recurring revenues as multi-year contracts (5 year avg.) and high termination fees result in minimal logo churn of ~1-2% annually. Given the consistency of the base business, growth is largely dependent on cross/up-sell of high margin ancillary services and new client growth. Outsourcing has been a predictable source of historical growth as in-house bank core solutions are expensive to operate and are frequently ill-equipped to integrate with third-party digital ancillary offerings. Consumer expectations for digital banking services continue to rise as the big four money center banks make massive tech investments (~$10B each on annual IT spend) and sleek neo-bank offerings gain share. In recent years, outsourcing to third-party core processors has largely occurred at smaller banks (benefitting FISV & JKHY) while larger banks (>$10B assets) are only ~30% outsourced and largely rely on in-house or hybrid systems.  

FIS should be well-positioned to capture the large bank outsourcing opportunity given its 80%+ existing market share of outsourced large banking cores and strong product offering in the cloud-native Modern Banking Platform (MBP) which supports more open APIs for ancillary services. Legacy in-house cores typically run on a COBOL architecture using a 60+ year-old programming language with a shrinking developer base that is increasingly unable to deliver digital banking solutions. MBP is both cloud & code (even C++/Java) agnostic unlike FISV’s offering which only runs on the Oracle cloud and still requires COBOL. The transition from on-premise to cloud-native infrastructure could prove to be enough of a step-function improvement to encourage hold-out banks to outsource core processing. FIS has early proof points demonstrating the strength of its MBP product offering with 8 wins of top 30 banks—a segment that was largely non-outsourced until recently.

Moat / Competition: FIS’s Banking operations benefit from very high client switching costs particularly in core processing. Core replacement is generally viewed as the most time-intensive, expensive, and disruptive IT project a bank can undertake. For example, bank executives overwhelmingly describe core replacement as high / very high risk with one executive likening the process to “open heart surgery” or “replacing a car engine while traveling 60 mph”. Should a bank wish to switch cores, options are very limited with an oligopolistic industry structure in which 70%+ of market share is captured by FIS, FISV, and JKHY with each operating in clearly defined segments of the market based on bank operating complexity. Additionally, the incumbent core processor is often the client’s first choice for high incremental margin ancillary services given existing relationships and ease of integration with core (avg. FIS bank client uses ~35 products). Ancillary and core contract expirations are often offset by design, further increasing switching costs.

Key Risks / Possible Mitigants

Ongoing trend toward M&A consolidation in banking industry (# of FIs decreasing ~4% CAGR) could lead to client attrition and reduced pricing power as scaled bank clients have more bargaining power.

o    FIS is somewhat insulated from this risk as the larger bank is more likely to be an existing FIS customer and will usually choose to migrate the smaller bank over to the FIS core.

Next-gen cloud-based core processors are starting to compete with the legacy players from the low-end.

o    Given the mission criticality of core processing, larger banks are unlikely to trust new players without client references and financial stability ensuring long-term operations and continued product development.

As the banking industry moves toward cloud-based cores, core conversion may become less painful thereby reducing switching costs. Additionally, more flexible API integrations in cloud-based cores may reduce the incumbency advantage of core processors when cross-selling ancillary services.

o    A growing number of vendor management FDIC regulatory requirements (like FFIEC audits) have forced banks to purchase from fewer vendors.

o    FIS has built the Code Connect platform which charges third-party ancillary solutions for API integration with the MBP core (e.g. ancillary app marketplace).

Capital Markets Solutions (~20% revenue): Provides mission-critical capital markets services such as securities processing, trade settlement, data and analytics, regulatory / risk compliance, and corporate liquidity solutions to clients including buy- and sell-side securities firms, insurers, and corporations. Historically, Capital Markets was largely dependent on non-recurring licensing revenues but has largely shifted to a SaaS model with ~75% recurring revenues.

Growth Drivers: Like core processing, FIS benefits from outsourcing trends as banks and other financial services firms look to modernize their back-end infrastructure. For example, FIS’s securities processing clients are increasingly interested in consolidating legacy asset class-specific platforms. FIS also benefits from the global trend toward electronification of trade settlement with some asset classes largely relying on manual settlement (high-yield bonds only ~25% electronic vs. futures at ~90%). Finally, growing complexity in compliance and risk management increases demand for greater automation of audit reporting (i.e. RegTech and FFIEC audits).

Moat / Competition: Capital Markets has highly recurring revenue and significant switching costs due to heavy regulations, mission criticality of product, and networks of co-dependencies across front and back-office users. The competitive landscape is largely fragmented with many in-house solutions and various bank IT players.

Key Risks / Possible Mitigants:Given its exposure to asset managers, FIS is negatively impacted by the shift from active to passive management. As fund investors increasingly focus on fee reduction, tech spend at end-clients will be increasingly scrutinized.

Valuation: At the current price of ~$95/share, I estimate FIS trades at 11x 2022E Adj. EBITDA, 13x 2022E Adj. Net Income, and at a ~8% 2022E FCF yield. With strong competitive positioning and exposure to attractive growth areas, FIS should be able to achieve mgmt’s guided 7-9% top-line growth profile with high incremental margins driving LDD Adj. EBITDA growth. With a ~8% going-in FCF yield, 10%+ EBITDA growth, and minimal share dilution, I estimate that FIS shareholders can expect a mid-teens IRR without any multiple expansion. However, given FIS’s durable moats and long-term growth runway, FIS should continue to trade at a premium multiple at exit. Should FIS trade closer to pure-play peers like JKHY (and GPN / SSNC to a lesser extent) or re-rate to the historical average ~20x NTM earnings, multiple expansion would provide further upside.