By Richard Stice, CFA Following the steep decline of many technology stocks over the past two years, investors have become more cautious and skeptical when evaluating tech investments. The focus has shifted to more defensive areas of tech and to companies with consistent, if not spectacular, revenue and earnings growth, along with solid balance sheets.
One such category is data processing. These companies often go unnoticed because they perform routine or mundane tasks that are taken for granted. However, they're an integral part of the Information Age and, in many cases, offer attractive investment opportunities. Two of our favorites at Standard & Poor's are Concord EFS (CEFT) and Convergys Corp. (CVG), both rated 4 STARS (accumulate).
TRANSACTION ACTION. Concord EFS is a national provider of electronic-transaction services, focusing on supermarket chains and major retailers, financial institutions, gas stations, convenience stores, and the trucking industry. It specializes in payment-processing and generates most of its revenues from fee income related to merchant services. These include providing integrated electronic transactions for credit cards and debit cards.
Concord offers merchants a cost-effective, reliable, turnkey debit- and credit-card processing system. The company can do this on a profitable basis due to its low-cost operational structure, using efficient marketing, volume purchasing arrangements with equipment and communications vendors, and direct membership in bank-card associations.
Acquisitions are an integral part of Concord's growth strategy. In February, 2001, the company acquired Star Systems, the nation's largest personal identification number (PIN) secured debit network for 24.75 million common shares of stock, or about $540 million. With this acquisition, the Concord's network services doubled to approximately 6,500 financial institution customers and 5 billion transactions annually. The acquisition is expected to add to earnings this year.
More recently, in December, 2001, Concord acquired Logix Companies LLC, a provider of services including ATM processing, electronic check conversion, and database development and reporting. Concord expects the acquisition to be neutral to earnings in 2002 and then add to them in future years.
The shares have performed exceptionally well over the last year and are near their 52-week high of $33.72, as investors have shifted to companies offering a haven from the economic slowdown. Concord is well positioned within the transaction-processing industry, with healthy market shares in the grocery, trucking, and benefits-payment sectors. Moreover, its large book of recurring revenues provides excellent visibility, making an EPS shortfall less likely. For these reasons, S&P views Concord EFS shares as attractive, despite a premium p-e relative to its peers and the broader market of 42 times a 2002 EPS estimate of $0.75.
OUTSOURCING INCOME. By providing value-added billing and customer-management solutions and building long-term relationships with its clients, Convergys has developed a large base of recurring revenues. In fact, a major contract with AT&T (T), which accounts for about 40% of revenues, does not expire until 2006.
Its strategy includes leveraging its position as leader in billing solutions for the communications industry, pursuing international growth, increasing its sales and marketing efforts, and engaging in strategic acquisitions and alliances that expand its client base, add new capabilities, or enable it to accelerate product-development efforts or geographic expansion.
The company's operations are split into two segments: The information management group (IMG) and the customer management group (CMG). IMG is a provider of billing and information outsourcing services to all segments of the communications industry, including wireless, wireline, cable, broadband, direct satellite, and Internet services. Its software and data-center capabilities include the activation of services, capturing of usage information, calculation of billing charges, and consolidation of billing for multiple services.
CMG is the largest provider of outsourced customer-management solutions, serving leading companies in the communications, technology, financial-services, and consumer-products industries. The bulk of CMG's revenues are related to providing value-added customer service, primarily through personnel dedicated to a specific client.
Convergys shares have risen sharply in recent months as the market rebounded following the September 11 terrorist attacks and the company reported solid quarterly results. Convergys reiterated its long-term goal of increasing revenues and EPS at an annual rate of 15% and 20% to 25%, respectively. S&P forecasts revenue growth of 10% in 2002, and EPS of $1.60.
Based on this estimate, the shares trade at a discount to the company's peers and the broader market on both a p-e and p-e-to-growth basis. S&P believes the valuation, combined with an accelerating trend to outsource services and steady stream of revenues, makes Convergys attractive for capital appreciation. Stice is a technology equity analyst for Standard & Poor's