Unboxing The Q2 2020 Fidelity National Information Services Earnings (NYSE:FIS)


I wrote an article on Fidelity National Information Services (NYSE:FIS) that can be found here. FIS has experienced strong growth and cash flow generations. However, with COVID-19 and the shelter-in-place mandate, 1Q20 financial performance was below expectations. Management came out and owned the underwhelming performance and set to fix operations to improve efficiencies and pour money into R&D to improve their products and services for their customers. What I am curious to learn from this unboxing is what is the updated run rate revenue and expense synergies, how did the Merchant Services segment perform, and see if management dropped any guidance hints, especially margin expansion. Perhaps, we will find some other tidbits along the way.

Quick Overview

Coming into 2020, management guided for organic growth of ~7% and revenues to range between $13.6Bn and $23.7Bn. As with the majority of companies, FIS was negatively impacted by COVID-19, and 1Q20 financial performance was under guidance.

In some aspects, financial performance was good, and management deserves credit for this. Other areas were not so hot, especially with the seven percent decline in organic growth. The improvement in revenue and EBITDA was largely due to Worldpay, and that is fine. Investors want the revenue and EBITDA contribution, but they also want other parts of the business to grow as well. That is why 2020 was filled with such high hopes. The money they put into technology and the reshaping of their products and services, along with the Worldpay acquisition, made 2020 the year of FIS.

Source: 2Q20 Earnings Presentation

Synergies

Management has been talking for some time about both revenue ($200MM in FY20) and cost synergies ($600MM in FY20) related to the Worldpay acquisition and has done a good job achieving those synergies. During the 1Q20 conference call, management found an additional $300MM in savings that could be delivered by the end of 2020.

Management continues to execute on their synergy plan during the second quarter.

The Company achieved annual run-rate synergies exiting the second quarter of 2020 as follows:

  • Revenue synergies of approximately $115 million, including the origination of additional new bank referral agreements, debit routing benefits, and Premium Payback product cross-selling wins during the second quarter.
  • Expense synergies in excess of $700 million, including approximately $350 million of operational expense savings, approximately $275 million of interest expense savings and approximately $90 million of depreciation and amortization savings.

Source: 2Q20 Earnings Presentation

Gary Norcross, CEO explains:

We have an additional $60 million in revenue synergies that we are in the process of implementing now, and we have a growing pipeline of cross-sell opportunities that will continue to drive additional growth. Our ability to exceed our synergy goals so early is a testament to the value our colleagues are creating by winning as one team.

It is further noted in the press release that they are ahead of schedule to meet or exceed the planned revenue and expense synergies for Worldpay. I think this will be important for investors because it shows that management has the skill to achieve what they set out to do and were able to execute their plans when the world was turned upside down.

Merchant Services

As shown early in the quick review section, Merchant Services had a strong quarter until an investor takes a closer work. All the improvement was due to the Worldplay acquisition. In fact, it was held back by poor organic performance. The following is from the 2Q20 Press Release:

Second quarter revenue increased significantly to $812 million, primarily reflecting the Worldpay acquisition. On an organic basis, revenue decreased 25% when compared to the prior year period, primarily due to reduced consumer spending trends caused by shelter-in-place, lockdown orders, travel restrictions and other impacts associated with the ongoing COVID-19 pandemic. Organic growth was also impacted by a headwind of approximately 6%, or $60 million, associated with the U.S. tax filing deadline transitioning from the second quarter to the third quarter of 2020.

I guess this was expected even though I had my fingers crossed. There has been improvement seen as the quarter progressed.

Source: 2Q20 Earnings Presentation

We are out of the depths on this one, and there is improvement. It is also noted that July has shown improvement too. As an investor, I like what I see. It makes me think that there is an opportunity to get in before more people catch on that Q3 and FY20 could be better than expected.

Margin Expansion

Right off the bat, it is explained that adjusted EBITDA margins for the second quarter expanded 150bps from 37.5% to 39% largely due to the contribution from Worldpay. It would have been higher if the Merchant Services segment was not such a drag.

Margins should continue to improve with the often-mentioned synergies. Additionally, FIS is winning long-term SaaS contracts and increasing recurring revenue streams especially in the banking segment. This product mix is favorable because it carries higher margins. Management plays a little coy in the conference call, but along with the higher margins, these business verticals should allow the company to drive 7%-9% organic revenue growth in a post-COVID-19 environment.

An analyst asked about margin expectations in the conference call, and Gary Norcross delivered great news:

Certainly have seen improving trends over that time as we tried to highlight in the prepared materials. If you think about the third quarter really and the fourth quarter, I would expect to see sequential margin expansion in both Q3 and Q4, Jason. I know the question’s coming, so I just thought I’d go ahead and just address it. We’ve also taken a look at consensus revenue for the third quarter and it’s reasonably in line with my expectations, even though we’re not a formal guide. With respect to margins, I think about margins for the third quarter. If you look back to 2019, margin was about 43%. We’ve got two tailwinds and one headwind going into the third quarter from a margin perspective. The first tailwind is about $90 million in operating expense synergies associated with the Worldpay acquisition. The second is a tailwind of about 100 million in those short-term cost actions that we’ve taken in response to the pandemic.

Balance Sheet & Liquidity

Although I was not overly concerned with the state of the balance sheet and liquidity, it is always good to check under the hood. The following table is from the Q2’20 earnings deck.

There is sufficient liquidity, the cost of debt is low, and the leverage ratio is moderate. This should improve with an increase in EBITDA and continued debt pay-downs. I am also happy to see that they still guide for leverage to decline to 2.7x in FYE21. During the 1Q20 conference call, management reiterated that leverage goal, so it is nice to see they are sticking with it and not pushing it back. If they did push it back, that would be understandable. Keeping it should give investors confidence in management’s confidence in the near-term performance.

Price Target

The chart below is the price action over the last five trading days.

ChartData by YCharts

When I look at this chart, it makes me think that investors do not know how to approach this company. Yes, there is good stuff with improvement in merchant volumes, booking new customers in favorable verticals, and strong Worldpay performance. On the other hand, Merchant Services is still a drag and organic growth is non-existent.

The 52-week high is $158 per share. I am more bullish on FIS than I was before the earnings release. Management is guiding for higher margins, they are setting up for higher organic growth in the 7-9% range, and there is improvement in Merchant Services segment. The risks are continued trouble in the Merchant Services, slowing in revenue from their higher-margin business verticals (highly competitive business) and slowing of the integration of Worldpay. When I take a look at the risks and rewards, I am definitely on the bullish side. I think $158 is a near-term target, and investors need to digest the information before it goes higher.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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