Fidelity National: Benefits Of Its Business Transformation Priced In (Rating Downgrade)

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Fidelity National Information Services shares have gained 66% over the past year due to business simplification, but are now trading at fair value.Q3 earnings beat expectations with $1.40 EPS and $2.6...

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Jeremy Edwards/E+ via Getty Images  Shares of Fidelity National Information Services (NYSE:FIS) have been a strong performer over the past year, gaining 66% as its business simplification has paid off for investors. However, shares have pulled back a bit from their 52-week high even after reporting solid Q3 earnings, as shares may be pricing in most of the good news. I last covered shares of FIS in August, reiterating them as a “buy,” and since then, the stock has added another 15.5%, modestly outperforming the S&P 500. With the stock above my $84 price target, now is a good time to revisit FIS.   Seeking Alpha In the company’s third quarter, Fidelity earned $1.40, which beat consensus by $0.11, as revenue rose by 4% from last year to $2.6 billion. The company continues to benefit from rising recurring revenue as well as cost controls as it has focused on its core business, after selling a stake in Worldpay. This has helped to expand margins, though much of this expansion has likely already occurred. In the quarter, FIS generated a 41.3% EBITDA margin. So far this year, margins have expanded by 50bps. On top of this, recurring revenue grew by 6%. This growth helps to provide stable, forecastable cash flow, helping to support multiple expansion over the past year. If there was one blemish, the company’s cap-ex spending is now running at 9% of revenue. This is above its 7-8% long-term target. I suspect its prior M&A activity led it to underinvest in its core business, requiring some catch-up spending, which should normalize over time. Still, even with somewhat higher cap-ex, FIS generated $530 million of free cash flow, up from $390 million last year. This represented a solid 85% conversion rate relative to net income. With this free cash flow, FIS continues to return capital to shareholders. It did $700 million of capital returns, including $500 million of Q3 buybacks, and it is committed to its $4 billion target, having returned $3 billion this year. Thanks to buybacks, its share count is down about 7.5% over the past year. FIS has been able to return more capital to shareholders than free cash flow because it also has been returning proceeds from its Worldpay divestiture. This sale also improved its balance sheet. The company has $10.9 billion of debt, down from nearly $18 billion at the start of the year. It has moderate 2.6x debt/EBITDA leverage. FIS is also still carrying $1.3 billion of cash and equivalents, a reason I expect $1 billion of Q4 repurchases. Drilling into segment results, in banking solutions, revenue grew by 3% and margins expanded by 10bps to 45.2%. Recurring revenue rose by 6% while one-time revenue fell by 24%. This is due to the decline in pandemic-era programs. FIS helped to process PPP transactions, and as the COVID pandemic fades further away, this line of business is essentially in run-off. This headwind should continue to moderate. Encouragingly, it is now partnering with Apple Pay on rewards programs and seeing more traction with community banks. These deals should facilitate ongoing topline growth. Capital markets has been the standout as revenue rose by 7%, with 6% growth in recurring revenue and a 20% jump in one-time sales. Margins jumped 90bps to 49.9%. One-time licensing revenue is higher margin, so this growth in one-time revenue was the primary driver of the margin expansion. I would expect some moderation here. Still, capital markets have been consistently running at the high end of targets. With buoyant financial markets, solid results should persist. Further assisting growth, cross-selling is up 20% across the company from last year as it continues to find ways to sell more products to its existing customer base and increase the value of these relationships. I would also note that alongside Q3 results, FIS made non-cash adjustments to past financials, reducing 2022 EPS by $0.06, 2023 by $0.03, and H1 2024 EPS by $0.02. Accounting adjustments are never good to see, but it was comforting to see that there was no change to cash flow, which would suggest a more material controls problem. It believes the accounting adjustment is behind it and not a run-rate issue going forward. Given there were still adjustments in H1 of this year, I assume we will see a modest ongoing headwind of about a penny a share, though this may prove conservative. As you can see below, FIS also updated full-year guidance after the Q3 beat. It raised the low-end of its revenue and EBITDA outlook. It did substantially increase its EPS range. It has done less M&A than anticipated, reducing forecasted interest expense. This is driving the higher EPS estimate. Its equity income in Worldpay has also exceeded expectations. It expects $480-495 million from Worldpay, up by $35 million as Worldpay has deferred some planned expenses until 2025.   Fidelity National This guidance implies about $1.35 in Q4 EPS, down about 3% sequentially even as revenue will rise by about 3%. This decline is mostly due to the timing of below-EBITDA expenses, as well as increased Worldpay expenses. Worldpay is taking a bit longer to build its own stand-alone operations, relying on FIS infrastructure for longer. This has boosted this year’s earnings, but it is really a temporary saving. Worldpay still targets 7.5-9.5% growth over time. In 2025, I see some downside risk as there will be a difficult comparison with Worldpay benefitting from lower operating expenses for longer. Fidelity also closed a small tech acquisition, Dragonfly, which will contribute less than $10 million of revenue. Banks are spending more on technology, so FIS is expanding its tech portfolio to enable more cross-selling and deeper relationships with its customers. This deal will be margin dilutive for a “year or two,” as FIS scales it. Given its small size, I do not view it as material. Notably, FIS has done just $300 million of M&A vs $1 billion targeted. FIS is focused more on small bolt-on deals to expand its product portfolio, rather than large purchases. Management did say that any shortfall in this target can be returned via 2025 repurchases. FIS carries over $1 billion in cash, as it expected to commit several hundred million more to M&A. They will not keep this extra cash on the balance sheet, and as such, I expect FIS to return more capital than free cash flow next year, enabling at least 5% share count reduction. This is on top of its 1.6% dividend yield.  Back in August, I saw $4.20 in core business earnings power while its Worldpay stake is worth about $11 for my $84 fair value, based on a ~17x core business multiple. At this time, I am not adjusting my Worldpay valuation for better 2024 equity income, as much of that benefit is likely one-time expense timing. However, with ongoing recurring revenue growth and more repurchase capacity, I see forward 12-month core earnings of closer to $4.40. I still view 17-17.5x as appropriate given its recurring revenue growth, which results in a fair value of $86-89. With shares trading at fair value, I am moving FIS back to a hold and see it as a market performer. After its rally this year, the benefits of its business simplification are now largely priced in.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2482255016"}