Three Strong Legs for First Data
By Scott Kessler
Standard & Poor's is bullish on the prospects for First Data (FDC ), the name behind Western Union and a leading provider of data-processing services. We recently upgraded its shares to 5 STARS (buy), S&P's highest investment ranking.
Our stance is based in great part on three favorable trends. The first is the rising volume and average size of money-transfer and credit-card transactions. First Data also stands to benefit as businesses increasingly outsource transaction processing, its area of expertise. We believe as well that the global economy will rebound somewhat in the second half of 2002 and in 2003, which should give an additional lift to its results.
First Data has three major business segments. The Payment Services unit (which accounted for 42% of second-quarter 2002 revenues) allows customers to securely transfer money around the world and consists primarily of the well-known Western Union business. Through its Merchant Services segment (35%), First Data enables more than 2.8 million locations to accept electronic (noncash or check) payments. And the Card Issuing Services business (25%) enables credit- and debit-card issuers to better serve their customers.
Payment Services is the world's leading provider of nonbank money transfer and payment services to consumers and commercial entities through money transfer, official checks, and money orders. Western Union's expansive network of over 50,900 agent locations in North America and 68,800 international agent locations provides money-transfer services to consumers in 186 countries and territories. They're located in both freestanding units and within retail establishments such as 7-Eleven convenience stores, Rite Aid pharmacies, and Publix supermarkets.
The primary market for these services consists of people who periodically need to send or receive cash quickly to meet emergency situations, to send funds to far-away family members, or to use nonbank financial services to pay bills or meet other obligations.
Money-transfer transactions totaled 108.8 million in 2001, compared with 88.9 million in 2000 and 73.5 million in 1999, for an average annual growth rate of 22%. Payment Services revenues are derived from both transaction-processing fees and the investment of funds received from the sale of payment instruments (primarily official checks and money orders).
First Data's Merchant Services arm provides vendors with card-transaction processing services. This segment also provides processing services to debit-card issuers and operates the NYCE automated teller network.
A key element of Merchant Services involves joint-venture alliances with bank partners that provide check-clearing and settlement functions, while First Data provides transaction processing and certain back-office operations. Eight banks were in the program as of December, 2001, including Bank One, J.P. Morgan Chase, and Wells Fargo. Revenues are generated from fees charged based on dollar-volume processed or on a per-transaction basis. Merchant transactions processed totaled 8.8 billion in 2001, compared with 8.0 billion in 2000 and 6.4 billion in 1999.
Card-Issuing Services provides domestic and international card-processing services to financial institutions that issue credit and debit cards, as well as issuers of gasoline and private-label credit cards. First Data also offers fraud-detection, billing, database analysis, cardholder-behavior scoring, and customer-communications services. Among its big-name customers are Citibank, GE, and Wal-Mart. Revenues for card-issuing services are derived based on the number of accounts or transactions processed.
S&P believes that First Data is poised to experience increases in the number -- and size -- of transactions, reflecting an anticipated recovery in the U.S. economy. S&P has projected that real U.S. gross domestic product will rise 2.8% in the third quarter and 5.0% in the fourth quarter. We also expect First Data to continue to benefit as consumers make increasing use of credit and debit cards and electronic payments (as compared with cash and checks) to make purchases and pay bills.
Also, technological capabilities required for the creation, processing, handling, storage, and retrieval of information are becoming increasingly complex. They require significant development and capital expenditures and processing expertise, and have contributed toward a trend of outsourcing of processing services that we believe will continue to favor First Data.
We also expect Western Union to continue its strong performance, fueled by an increase in the number of international locations and a growing worldwide immigrant population (immigrant workers sending funds back to their countries of origin are a key customer segment). In the second quarter of 2002, the agent network expanded 20% with key signings including the Australia Post, Pakistan Post, Industrial Bank of Korea, United Arab Emirates Post, Bank Rakyat Indonesia, and Post of Tajikistan.
The ramp-up in China and India (markets First Data entered in 2001) is on schedule with more than 7,800 locations installed. The company's goal is for more than 20,000 locations in these two countries alone by yearend 2003.
Given the favorable trends for payments and outsourcing, coupled with the solid growth prospects of Western Union (which delivered 18% revenue growth in the second quarter of 2002), we believe that First Data can boost revenues and EPS 15% annually over the next several years. We expect it to record EPS of $1.69 in 2002 and $1.92 in 2003.
With a recent p-e of 20, based on the 2002 estimate, and a p-e-to-growth ratio of 1.4, its valuation was on par with the average of its peer group, the S&P 500 Data-Processing Sub-Industry. However, First Data has historically traded at a premium to its peers. Since 1992, its average p-e has been 26, which if applied to our 2002 earnings estimate, yields a value of about $44 per share.
We believe that First Data deserves a premium valuation based on its diverse business, market dominance, competitive advantages, strong cash flow, high return on equity relative to its peer group, and talented management team.
Using another yardstick, discounted cash-flow analysis, our estimate of the intrinsic value of First Data stock is about $42 per share. Averaging the two valuation measures, we have set a price target of $43, which implies over 33% upside from the stock's July 19, 2002, closing price of $32.26.
Analyst Kessler follows data processing stocks for Standard & Poor's