By Olga Kharif
Back in April, investors cheered the proposed merger of First Data and Concord EFS, the two leaders in processing electronic payments. After all, it seemed like a union made in cyber-heaven, one that would create a $10 billion behemoth that could trample rivals. But the Justice Dept. raised a red flag in October, suing to stop the deal on antitrust grounds, and soon after investors raised a white flag, punishing both stocks.
Even though the two companies and Justice reached a compromise on Dec. 15 that will let the deal proceed, First Data (FDC ) and Concord (CE ) continue to trade about 10% below the 52-week highs they reached soon after the deal was first announced. Analysts worry that Concord's business has weakened since April because some of its customer banks chose not to renew their contracts after the merger announcement.
And as part of the agreement with Justice, First Data will have to sell its majority stake in electronic-funds transfer network NYCE, which would have been a key unit in the merged company. Along with Concord's similar network, called STAR, NYCE would have given the new company a 50%-plus market share in certain debit-based electronic transactions. Some analysts worry that without NYCE, the deal isn't worth the $6.9 billion in stock First Data agreed to pay on Dec. 15 -- even though that's 9% below the original figure.
"CREAM OF THE CROP."
The skeptics could always be right, but it's more likely that Wall Street is being too cautious. Both the sale of NYCE and the loss of some business at Concord were widely anticipated back in April and were factored into the original price, says David Robertson, publisher of consumer payments newsletter Nilson Report in Oxnard, Calif. While "NYCE was going to be a cherry on the top, its [divestiture] won't take away from First Data's success," he contends. Long-term, say many analysts, the stock of the combined company, which will likely be named First Data, could still hit a home run.
For one thing, First Data's shares are trading at a multiple of 17.5 times projected 2004 earnings of $2.17 a share -- historically a good entry point for investors, according to US Bancorp Piper Jaffray. Moreover, the stock could easily benefit in 2004 from an anticipated migration of investors to big-cap stocks from small-caps, says Scott Kessler, an analyst at Standard & Poor's. "And this stock is among the cream of the crop when it comes to quality," says Kessler, who has an accumulate rating on it and believes the merged company will be stronger (see BW, 1/12/04, "First Data: The Power Behind the Plastic").
Certainly, many mutual-fund managers are holding onto First Data, which is profitable and has $1 billion in cash and equivalents. It's a top-five holding at Transamerica Investment Management, where Jeff Van Harte, head of equity investments, manages a $4 billion portfolio. Van Harte says he even owns First Data shares personally. Like many others, he's betting that approval of the revised merger by Concord's shareholders will be a formality. "We don't have any reason to believe that there will be problems," says a Concord spokesperson.
One reason for optimism over the merged company's prospects is that Concord hasn't lost as much business as some analysts had feared. Because of the uncertainties surrounding the merger, Concord's STAR network has shed about 20% of its volume since April, estimates Robert Dodd, an analyst with Morgan Keegan & Co. in Memphis. But back in April, Dodd, who doesn't own First Data shares, expected STAR's volume to fall 30%.
Another plus is that First Data, which owns funds-transfer service Western Union, is viewed by its customer banks as a fellow bank and, consequently, these clients see it as trustworthy, says Robertson. And they'll now view Concord in the same light.
What's more, the NYCE divestiture might not prove as detrimental to First Data as some analysts fear. Even with NYCE gone, First Data's market share in certain electronic payments -- such as PIN-based (personal identification number) debit-card transactions -- should increase from 10% to about 45%, thanks to the addition of STAR. And this market share could grow: Nothing in the Justice settlement would prevent First Data from wooing away NYCE customers after the sale, say both analysts and First Data executives. By Olga Kharif
Plus, NYCE could fetch First Data a nice sum -- perhaps as much as $650 million, estimates the Nilson Report's Robertson. He figures the network would be a valuable addition for such First Data rivals as credit-card associations MasterCard International and Visa or payments processor Fiserv (FISV ). First Data could use the proceeds for more acquisitions -- which have contributed about one-sixth of its 14% annual growth rate over the years, estimates John Kraft, an analyst with brokerage D.A. Davidson in Lake Oswego, Ore.
The addition of STAR will speed up First Data's growth. It'll gain about $300 million a year in revenue from that segment of the Concord acquisition, estimates Wayne Johnson, an analyst with SunTrust Robinson Humphrey. And those operations will grow faster than its core business: PIN-based debit transactions processed through the STAR network are growing at 20% a year, vs. 10% for signature-based debit cards and 3% for credit cards.
That's partly because PIN-based debit cards are cheaper for merchants to accept than credit cards -- and the world's largest retailer, Wal-Mart (WMT ), is pushing them. On Feb. 1, it'll stop accepting certain MasterCard debit cards that require signatures instead of a PIN.
What's more, STAR is more efficient and will deliver higher operating margins than NYCE: 55% vs. 20%, Johnson estimates. Consequently, it'll bolster First Data's growth in both revenues and earnings.
Thanks to the muscle the combined company will exert in attracting clients, Kraft expects First Data's revenues to grow 21% next year compared with 12% this year. And once cost efficiencies are gained, its operating margins could increase by nearly three points vs. this year, to 19% in 2005, he estimates.
Without the merger, First Data's growth would have moderated, since revenues are heavily tied to credit-based payments, says Keith Eadie, an equity analyst for HSBC Asset Management, which owns First Data shares. About 30% of revenues today come from credit and debit payments processing, with the remainder coming from businesses like Western Union.
Of course, First Data's near-term future isn't as rosy as it would have been had Justice not intervened. The delay in the merger -- which was slated for last October but is now scheduled for next April -- has caused First Data to hold off on other acquisitions. That accounts for most of the moderation in its 2003 revenue growth below its 14% to 17% target, says Kraft.
Still, First Data will start buying again once the Concord deal goes through, says David Banks, First Data's senior vice-president for investor relations. Indeed, on Dec. 22, it announced its intention to purchase electronic-payments processor Cashcard Australia Ltd.
First Data concedes that divesting NYCE also means the combined company won't achieve as many efficiencies as it might have. That could hurt its 2004 per-share earnings. Kraft recently dialed back his estimate to $2.17 from $2.23. Still, First Data could surprise the Street. After all, the STAR network -- the largest ATM system in the country -- could allow it to offer additional services, such as Western Union transfers via STAR ATMs, Kraft says -- and thus generate extra revenue.
Integrating the $2 billion Concord will be a huge undertaking that, as with any merger, could stumble over numerous glitches. And whoever acquires NYCE, which will likely be sold within the next few months, could become a stronger rival.
Competitors are already readying for a battle: In November, MasterCard began testing a new kind of debit card that requires neither a signature nor a PIN. A scanner simply recognizes the chip inside the card from a distance. However, it remains to be seen how secure this payment method is. MasterCard is also starting to offer more electronic-payment services, in hopes of developing as complete an offering as First Data's.
Still, rivals will face an uphill battle -- largely thanks to the merger, which "is an unquestionably good decision for First Data," says Robertson. Going with the stock now might prove to be a good decision, as well.
Kharif writes for BusinessWeek Online from Portland, Ore.