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Fiserv: A Finger in Many Pies

By Scott Kessler Fiserv (FISV

; recent price: $34), which carries Standard & Poor's Equity Research Services' highest investment opinion of 5 STARS, or buy, provides data-processing and information-management systems to more than 15,000 financial-services companies located almost entirely in the U.S. Over the last few years, the company has also built a significant health-plan management business. Fiserv has grown by developing specialized services and product enhancements, winning new clients, and acquiring complementary firms.

We believe Fiserv is poised to benefit as companies, particularly in the financial-services industry, introduce new offerings and reduce operating costs. The market for products and services offered by financial institutions changes regularly, particularly as the financial industry develops and introduces new alternative lending and investment offerings.

Moreover, we believe distinctions among financial services provided by banking and thrift organizations and securities and insurance companies are narrowing. As financial institutions diversify and consolidate, they're trying to stay competitive by offering transaction-oriented and fee-based products. The growing volume and types of financial-services transactions and accounts have increased the data-processing requirements of these institutions. We believe Fiserv stands to benefit, as the financial-services industry requires more specialized systems and development, maintenance, and enhancements.

AGGRESSIVE GROWTH STRATEGY. To capitalize on these industry trends, Fiserv's strategy consists of developing new products and services, improving the cost-effectiveness of its offerings, aggressively soliciting new business, and making both opportunistic and strategic acquisitions.

In fact, technology-research firm International Data Corp. has estimated that spending by U.S. companies on outsourced services such those offered by Fiserv is expected to increase from $32.7 billion in 2003 to $42.3 billion in 2008. The banking, financial services, and insurance industries are expected to account for more than a quarter of these expenditures. Healthcare companies spent $1.3 billion on these services in 2004.

Fiserv's Financial Institution Outsourcing, Systems, & Services serves more than 9,400 financial institutions, including banks, credit unions, leasing companies, mortgage lenders, and savings institutions. Offerings include account- and transaction-processing services, item processing, loan servicing, and lending systems. It also provides insurance-processing services and products. In addition, Fiserv's products enable financial institutions to provide services to their clients including home banking, automated-teller-machine (ATM) access, asset-liability modeling, and cash management.

WIDE-RANGING OFFERINGS. The company also provides integrated securities clearing, execution, margin and stock lending, mutual fund, and customer-account processing, and facilitation of traditional and Internet brokerage services through its Securities Processing and Trust Services businesses. Through TradeStar Investments, Fiserv offers retail brokerage services at discount commission rates. In addition, it offers self-directed retirement-plan-administration services and mutual-fund custody-trading services. First Trust Corp., Fiserv's principal trust company subsidiary, is the country's largest independent trust firm based on revenues.

The Health Plan Management Services segment provides claim adjudication and payment and customer services. These offerings are provided to employers that self-fund their health plans, insurance companies, and HMOs. Fiserv also provides complementary services, ranging from traditional services such as utilization management and case management, to newer disease-management, population-health, and prevention programs. In addition, the company offers health-plan prescription benefit-management services, including worker-compensation prescriptions.

Acquisitions are a major component of the company's growth strategy, enabling Fiserv to broaden its product portfolio, pursue new markets and customers, and cross-sell its services. In fact, the company's fastest-growing segment, Health Plan Management Services, was built through six acquisitions starting in January, 2001.

NET ACQUISITIONS. Fiserv purchased 12 businesses in 2001, five businesses in 2002, and 12 businesses in 2003. The company has completed three acquisitions this year. In September, 2004, Fiserv acquired Results International Systems, a provider of services for the property and casualty insurance industry. In August, 2004, the company purchased Pharmacy Fulfillment, a provider of pharmacy services. In January, 2004, the company bought RegEd, a provider of Internet-based compliance management systems and distance-learning programs for the insurance and securities industries.

We project that Fiserv's revenues will increase about 30% in 2004, from about $3 billion in 2003, and 16% in 2005. These anticipated increases reflect internal growth and completed acquisitions.

Among the company's various businesses, we believe the Financial Institution Outsourcing, Systems, and Services segment, which accounted for 64% of second-quarter revenues, will continue to benefit as financial-services providers use Fiserv's products to deploy new offerings and reduce costs. We also expect the segment to benefit from the Check 21 law (formally known as the Check Clearing for the 21st Century Act) set to go into effect on Oct. 28 that will promote the electronic presentation, exchange, and processing of checks. We project segment revenue growth of 16% in 2004 and 13% in 2005.

REAPING HIGHER RATES. The Securities Processing & Trust Services business, which generated 7% of second-quarter revenues, has struggled somewhat lately in light of relatively low securities-trading volumes and margin-account balances. However, we expect this unit to benefit from the higher interest rates we forecast for 2005. And we believe the securities and trust offerings will be aided by improved sales efforts. We estimate an 8% increase in unit revenues in 2004 and 14% in 2005. We would note that Fiserv has been de-emphasizing this segment, in our view.

The Health Plan Management Services business, which contributed 26% of second-quarter revenues, has benefited from efforts to reduce costs associated with maintaining healthcare plans. In particular, the pharmacy-services business, an area the company entered last year, has done quite well. We project segment revenues will more than double in 2004 and increase 25% in 2005. Unit revenues have been aided by three acquisitions made in 2003, but internal growth was still 50% in the second quarter.

The success of the health-management segment, which garners lower margins than the financial business, has had a somewhat negative impact on profitability in 2003 in 2004. However, we expect operating and net margins to increase in 2005.

PROFIT POP. For the company as a whole, we forecast earnings per share of $1.95 for 2004 and $2.20 in 2005. We project annual EPS can grow at an average annual rate of 16% over the next five years. Our estimates of Standard & Poor's Core Earnings are $1.86 for 2004 and $2.11 for 2005. These forecasts reflect estimated stock-option expense under SFAS 123 of $18.7 million in 2004 and $20.6 million in 2005. We expect the impact of stock options as a percentage of net income to continue to decline from already relatively low levels. The company doesn't have any pension-related expenses because it doesn't maintain a defined-benefit plan. We believe the 4% to 5% discrepancy between our projections for Fiserv's operating earnings and S&P Core Earnings is quite low, and indicates earnings quality.

We believe Fiserv shares are attractively priced, given our blended valuation model. Based upon relative and intrinsic analyses, our 12-month target price is $42.

Fiserv's price-earnings ratio based on our 2004 estimate was 18 and its p-e-to-growth ratio (PEG) was 1.1. The stock -- a constituent of the S&P 500 Data Processing & Outsourced Services Index, which recently had a 2004 p-e of 21 and a PEG of 1.5 -- is trading at a discount to its peer group. The stock's p-e was 14% below the index and its PEG was 27% lower. Fiserv's price would be $44 if it traded in line with its sub-industry index, based on a combination of p-e ($41) and PEG ($47). In years past, Fiserv traded at a premium to its peers, which we believe stems from the company's notable growth prospects, consistent financial execution, and above-average earnings quality.

"ATTRACTIVELY PRICED." Our discounted cash-flow (DCF) analysis indicates that Fiserv's intrinsic value is $41. Our assumptions include a weighted average cost of capital of 12.3%, projected growth in annual free cash flow averaging 17% from 2004 to 2008, and a perpetuity growth rate of 3%. We believe our discount rate and out-years growth projections could prove conservative.

Blending our relative p-e and PEG and DCF analyses yields our fair value estimate for the shares of $42, which is also our 12-month target price.

Potential risks to our recommendation and target price include consolidation in the financial-services industry contributing to pricing pressures, a backlash against outsourcing associated with political sentiments, companies following the lead of JP Morgan Chase by canceling outsourcing contracts or bringing or keeping operations in-house, securities-market and internet-rate conditions continuing to be a modest drag on the company's securities businesses, and negatives associated with the company being linked to improper securities transactions.

We believe Fiserv is poised to benefit as companies, particularly in the financial-services industry, aim to deploy new offerings to increase revenues, or wish to reduce costs by outsourcing certain data-oriented operations. In our view, Fiserv is well diversified, effectively managed, and attractively priced.

Given our target price of $42 a share, the stock recently had an appreciation potential of 23%. We foresee Fiserv outperforming the S&P 500 over the next 12 months. Analyst Kessler follows data processing stocks for Standard & Poor's Equity Research

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