Over the past few years, the digital revolution has made things more efficient, reliable and secure all while reducing costs. Today, technology plays an important role in creating a secure and consistent payment system (Electronic Payment System) for the effective implementation of monetary policy, and for the smooth functioning of the money and capital market. Presently it is also an important channel for the settlement of other types of transactions including cross border financial cash flows.
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Today financial institutions, mostly in the emerging markets, with their complex systems are burdened with integration tasks that have higher maintenance costs, slow time-to-market and difficulty achieving differentiation. On the other hand, those financial institutions who have adopted universal payment systems not only reduce their unit costs but also increase the speed of time-to-market transactions, increase global readiness and enable data mining and cross-sell opportunities.
Promo
In this article I have analyzed the ACI Worldwide (ACIW), rising star of noncash transaction market, the company's business model, growth opportunities and historical financial performance along with the risk factors affecting its operations. In addition to that I used the company's multiples to calculate the annualized return for the next few years.
Global Scenario
Electronic payment has been a vibrant and fast-developing industry in the recent years. It has kept market participants on their toes with new product developments, technological innovations, and rapid volume growth.
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According to the report published by CEB TowerGroup, Asia-Pacific has been the fastest growing non-cash transactions market in the world since 2005, and will remain so through 2016 due to a projected CAGR of 9.5%. Latin America is the fastest growing credit card market in the world and has a projected CAGR of 9.4% from 2012 to 2016. Europe, on other hand, is a dominant player in the credit transfer market with a 52% share in the global market. Europe also accounts for over half of the global volume of direct debit transfers indicating its dominance in the Automated Clearing House (ACH) market.
Among non-cash transactions, debit cards are the most popular and fastest growing method in the world and will account for 39% of non-cash payments by 2016. Although check volumes are decreasing globally, volumes are increasing in many emerging markets as they transition away from cash.
Moreover, Universal Electronic payment volumes continue to increase around the world, taking market share from traditional cash and check transactions. In September 2013 Boston Consulting Group reported that the payments and transaction-banking businesses generated $301 billion in transaction-specific revenues and an additional $223 billion in account-related revenues in 2012. Banks handled $377 trillion in noncash transactions in 2012, more than five times the amount of the global GDP. By 2022, payments and transaction-banking revenues will reach an estimated $1.1 trillion, a CAGR of 8%. The value of noncash transactions will reach an estimated $712 trillion by 2022, a CAGR of nearly 7%.
Business Model
ACI Worldwide develops markets, installs and supports a wide variety of software products and services and delivers a wide range of solutions for payment processing, card and merchant management, online, mobile, branch and voice banking, fraud detection and trade finance. In addition to its own products, the company distributes, or acts as a sales agent for software created by third party developers.
These products and services are used principally by financial institutions, retailers and electronic payment processors, both in domestic and international markets. Most of these products are sold and supported through distribution networks covering three geographic regions including the Americas, Europe/ Middle East/Africa (EMEA) and Asia/Pacific. Its products are marketed under the ACI Worldwide and ACI Payment Systems brands.
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The company provides software products and services to customers in a range of industries worldwide, including financial institutions, retailers and e-payment processors. As of December 31, 2012, its customers included 18 of the top 20 banks worldwide, as measured by asset size, 14 of the top 20 retailers in the US, as measured by revenues, and six of the leading 25 global retailers, as measured by revenues. As of December 31, 2012, the company had 2,648 customers in 104 countries on six continents and no single customer accounted for more than 10% of its total revenues. So far, out of 2648 customers, 1,987 are in the Americas reportable segment, 502 are in the EMEA reportable segment and 159 are in the Asia/ Pacific reportable segment.
Recent Expansion
The company has shown tremendous growth in business over the years, mostly inorganic. Over the past few years the company made some serious strategic acquisitions to grow its business operations and markets. November 5, 2013 the company completed the acquisition of Official Payments Holdings (OPAY), a leading provider of electronic bill payment solutions. The acquisition strengthened the company's product portfolio and further strengthened its leadership position within the electronic bill payment market.
March of 2013 the company completed the acquisition of Online Resources Corporation, a leading provider of online banking and full-service bill payment solutions. The acquisition added Electronic Bill Presentment and Payment (EBPP) solutions as a strategic part of the company's Universal Payments portfolio. It also strengthened its online banking capabilities with complementary technology and expanded its leadership in serving community banking and credit union customers.
Growth Opportunities
The company derives a majority of its revenues from non-domestic operations and has great opportunities for growth in international markets as well as continued expansion domestically in the U.S. Refining its global infrastructure is a key component for driving its growth. The company has launched a globalization strategy which includes elements intended to streamline its supply chain and maximize its expertise in several geographic locations to support a growing international customer base and competitive needs. The company also continues to grow centers of expertise in Timisoara, Romania and Pune and Bangalore in India as well as key operational centers such as the one in Cape Town, South Africa and in multiple locations in the U.S.
Opportunity in Customer Growth
So far, the company has been able to target a small number of customers in the banking sector, approximately 800 (16%) out of more than 5,000 global banks and the retail sector, approximately 300 (10%) out of 3,000 global retailers, which means that there are still many opportunities for the company to grow its customer base.
Mobile Banking and Payments
The increasing demand of smartphones and high speed internet technology has increased the demand for mobile banking because the transactions are secure, reliable and efficient. The company has invested in mobile products through acquisitions and via partnerships that support mobile functionality in the marketplace.
Adoption of Cloud Computing
In addition, the success of cloud computing opens a great opportunity for the company to develop low-cost computing technologies for financial institutions, retailers and electronic payment processors who are seeking to modify their systems to make use of cloud technology.
Higher Demand for Electronic Payment Fraud Protection
As electronic payment transaction volumes increase, criminals continue to find ways to commit a growing volume of fraudulent transactions using a wide range of techniques. Financial institutions, retailers and electronic payment processors continue to seek ways to leverage new technologies to identify and prevent fraudulent transactions and other attacks such as denial of service. Due to concerns with international terrorism and money laundering, financial institutions in particular are being faced with increasing scrutiny and regulatory pressures. The company has an opportunity to offer its fraud detection solutions to help customers manage the growing levels of electronic payment fraud and compliance activity.
Single Euro Payments Area (SEPA)
The SEPA is a payment-integration initiative of the European Union for simplification of bank transfers denominated in Euros. The project's aim is to improve the efficiency of cross-border payments and turn the fragmented national markets for Euro payments into a single domestic one. This project will enable customers to make cashless Euro payments to anyone located anywhere in the area, using a single bank account and a single set of payment instruments. The project includes the development of common financial instruments, standards, procedures and infrastructure to enable economies of scale which in turn should reduce the overall cost to the European economy of moving capital around the region. The company's wholesale banking solutions can help financial institutions to address these mandated regulations.
Financial Performance
Backlog is the company's key operating metric as it contributes approximately 90%-95% of its sales come from its backlogs and 5%-10% sales come from direct sales.
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Included in its 60-month backlog estimates are amounts expected to be realized during the initial license term of customer contracts called "committed backlog" and amounts expected to be realized from assumed renewals of existing customer contracts called "renewal backlog". The table also reflects 60-month committed backlog and renewal backlog estimates as of December 31, 2012, September 30, 2012, June 30, 2012, March 31, 2012 and December 31, 2011 (in millions USD). Over the quarters you can see a consistent growth in revenue on a year on year basis.
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The company generated most of its revenues from its software license fees and maintenance fees. As of December 2012, the software license fees segment generated 33% of revenues, maintenance generated 30% of revenues, services segment contributed 20% of revenues and software hosting fees contributed 17% of the company's revenues.
Total revenues for the 2012 increased $201.5 million or 43.3%, compared to year prior. The increase is the result of a $32.0 million or 16.9%, increase in software license fee revenues, a $51.5 million or 34.7%, increase in maintenance fee revenues, a $51.8 million or 64.9%, increase in services revenues and a $66.2 million or 140.4%, increase in software hosting fee revenues.
The acquisition of S1 contributed $161.9 million or 34.8% of the increase in total revenues for 2012. Excluding the impact of the addition of S1, total revenues for the year ending December 31, 2012 increased $39.6 million or 8.5%. The increase in total revenues, excluding the addition of S1, is primarily due to increased sales and an increase in the number and size of projects that were completed and recognized during 2012 compared to 2011. Gross margin in 2012 decreased due to a change in product mix and a high portion of revenues from maintenance fees, service and software hosting fees.
Investing in the Future
Investment in research and development is the key source for organic growth and to staying competitive in this industry. The company's product development efforts focus on new products and improved versions of existing products. To develop new products the company works closely with its customers and industry leaders to determine product requirements. The company works with device manufacturers, such as Diebold, NCR and Wincor-Nixdorf, to ensure compatibility with the latest ATM technology. It also works with network vendors, such as MasterCard, VISA and S.W.I.F.T to ensure compliance with new regulations or processing mandates. The company works with computer hardware and software manufacturers, such as HP, IBM, Microsoft Corporation, Oracle and Stratus Technologies Inc. to ensure compatibility with new operating system releases and generations of hardware.
So far the company has invested $298 million in research and development in the last 3 years. Its total research and development expenses during 2012 was $133.8 million or 20.1% of total revenues, in 2011 it was $90.2 million or 19.4% of total revenues and in 2010 it was $74.1 million or 17.7% of total revenues.
Associated Risks and Challenges
- As markets continue to evolve in the electronic payments, risk management and smart card sectors, the company may encounter new competitors for its products and services
- The company's debt level is higher than the industry. Its high debt level may cause the company to have difficulty borrowing money in the future for working capital, capital expenditures, acquisitions or other purposes and may limit operational flexibility and its ability to pursue business opportunities and implement certain business strategies
- As electronic payment transaction volumes increase, criminals continue to find ways to commit a growing volume of fraudulent transactions. Inability to identify any loophole may result in reduction in customers
Valuation
For the valuation I used the multiples approach due to the fact that the company is undervalued compared to the industry. Certain assumptions have been made regarding revenues and margins. For my analysis I assumed that the company will see a hyper growth in the initial years and will eventually hit the industry growth rate.
As can be seen from the figure above, the company is significantly undervalued compared to the industry especially based on the P/E and P/S. The company is also undervalued based on forward P/E of 19.2 and currently trades at a 20% discount to the industry forward P/E of 23.87. For the purpose of the valuation I will use the company's forecasted EPS and forward P/E multiples. The trigger events for my valuation are the growth in the company's revenues, backed by the aforementioned growth prospects and earnings and the expansion of the company's multiple gradually reaching the industry average.
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Using the above shown forecasts of earnings I assume that the company's forward and trailing P/E will reach the respective industry averages. Using these estimates I have derived the target price of the company at the end of future periods. The annualized rate of return expected has been calculated based on the company's current stock price of $63.78, and will be realized by investors for various investment horizons. Based on the growth potential, the company's performance and above mentioned annualized returns, I believe that the company presents itself as a good opportunity for investors to invest in its stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.
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