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When Fidelity National Information Services (NYSE:FIS) was combining its operations with Worldpay in the spring of 2019, I believed that the deal was compelling, yet feared that competition would eat margins over the long haul. Just four years later, the company has admitted that the deal was an utter disaster, having real implications on the shares which have halved in the meantime, although a lot of bad news appears to have been priced in already.
A Recap
When Fidelity National Information Services essentially merged its operations with Worldpay in 2019, it created a giant in (e-commerce) payments and finance service technologies. The $43 billion deal for Worldpay looked rich as the business was a bit smaller but was seeing quicker growth.
Both firms sought to create an overlap in services and to deliver on synergies, as the combination was set to deliver a more comprehensive set of services outside payments, including services like issuer series, loyalty programs, and fraud detection (merchant services), among others. This should drive a stronger commercial position, with combined revenue and expense synergies pegged at $700 million a year.
FIS posted $8.4 billion in revenues in 2018, posting fat EBITDA margins of $3.1 billion, as the company commanded a $44 billion enterprise valuation at $109 per share. Worldpay was acquired at a similar valuation (in dollar terms) but was much smaller with $3.9 billion in sales and $1.9 billion in EBITDA.
The pro forma implications were that the deal created a business with $12.4 billion in revenues and $4.9 billion in EBITDA, as the combined market value of $86 billion was steep. After all, this came in at 17 times EBITDA, although the EBITDA number would still see a boost to the tune of $700 million from anticipated synergies.
Adjusted earnings power of $3 billion excludes stock-based compensation, of course, as earnings likely trended around $5 per share on an adjusted basis, as accretion from synergies could be seen as high as eighty cents while Worldpay had the potential to bolster the growth profile of the business. With earnings multiples in the 20-25 times range and leverage at 3–4 times, valuations were demanding, but both firms had a solid value-creating track record for investors.
The issue which I had with the deal and both firms is that of margins, as 40-50% EBITDA margins simply look high, perhaps unsustainably high in my eyes, despite the track record.
Doing Well – Coming Down
Since voicing a cautious tone at $109 early in 2019, we saw shares perform well as shares rose to the $150 mark pre-pandemic in 2020. Like many other stocks, shares rallied in 2021, but highs around the $150 mark only approximated the pre-pandemic highs, while many other stocks set fresh new highs.
Towards the end of 2021, shares had fallen to the $100 mark again amidst the pullback in technology names, but during 2020, shares have fallen in a very steady fashion to the $50 mark here, which quite frankly is the lowest level in a decade.
Forwarding to February 2022, the company posted its 2021 results with revenues up 11% to $13.9 billion on which adjusted EBITDA of $6.1 billion was reported. The earnings numbers were highly distorted with adjusted earnings posted at $4.1 billion (or $6.55 per share) with GAAP earnings only coming in at $0.67 per share. Most of the difference stems from amortization charges on the deal and other deal costs, with stock-based compensation of $383 million only coming in at $0.62 per share on a pre-tax basis.
Net debt was posted at $18.4 billion, having increased amidst some share buybacks although the $6 billion EBITDA number makes that leverage ratios have come down on a relative basis at just over 3 times.
The outlook for 2022 looked pretty decent, with the company seeing solid single-digit growth with revenues seen between $14.8 and $14.9 billion, with the midpoint of the adjusted earnings guidance seen up to $7.31 per share, as the gap with GAAP earnings should narrow a bit.
Forwarding a year in time, we see why shares have sold off from $100 at the start of 2020 towards the sixties in February, before falling further to $50 at this point in time.
This softer share price came as the company grew full-year sales by 5% to $14.5 billion, coming in a touch light, albeit that this can in part be explained by the strong dollar. The problem is that adjusted EBITDA rose just a percent to $6.2 billion as adjusted earnings only rose ten cents to $6.65 per share, as the company kept net debt flattish at $17.9 billion. Worrisome is the outlook, indicating that the company has a margin and competitive positioning issue.
For 2023, the company sees sales down to $14.20-$14.45 billion, which is bad enough as it is, but this is accompanied by anticipated margin pressure, with adjusted earnings seen between $5.70 and $6.00 per share. This suggests that EBITDA might fall by about $600 million, increasing leverage ratios a bit. With 593 million shares now down to $50, the equity valuation has fallen to about $30 billion, for an enterprise valuation below $50 billion.
For the year, the company posted a huge GAAP loss, taking a $17.6 billion loss related to goodwill impairment charges on the merchant business.
Getting Rid Of The Problem Child
The painful conclusion is that FIS now faces huge write-downs on the merchant business, activities which it only recently obtained with the purchase of Worldpay, of course. Rather than opting for a fix, the company announced plans to separate the unit alongside the release of the 2022 results.
This is in essence a reversal of the Worldpay deal, although both firms will continue to hold commercial agreements to minimize dis-synergies from the move. Of course, few details on spinoff ratios are known at this point in time, but the move is a clear admittance that the purchase of Worldpay, at least its valuation was too steep and that margins indeed across the board are sustainable here.
And Now?
The truth is that there are many uncertainties on the business here, including an unknown exchange ratio (or valuation) for the spin-off and the fact that leverage will likely creep up, that is leverage ratios in 2023, with earnings under pressure.
On the other side, earnings multiples are dirt cheap if we can trust the adjusted earnings numbers here. Besides these concerns, FIS stock is likely hit by the pressure in the US banking system as well, as further concentration of banking deposits and uncertainty on their safety are not a driver for the business.
On the other hand, the uncertainties might attract a desire for consolidation as well, this time not with FIS in the lead but actually as a potential target by some larger and more established players, after Visa (V) was reportedly interested in the company. The disappointing share price performance means that activist involvement here at some point in time looks likely as well.
The reality is that at current levels, a lot of bad news appears to be priced in. Moreover, the leverage situation appears manageable as this should be a somewhat stable business, although slower economic growth and competitive issues will hurt sales and margins a bit, yet it should be manageable from a leverage point of view. Given this, a small speculative position seems warranted, although I have to stress the word speculative here.