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Taking Stock of Tech Vendor Marketplace

November 08, 2005

Taking Stock of Tech Vendor Marketplace

Tuesday, November 8, 2005
By Bill Stoneman

The stock of substantial financial technology companies has been rising, and so have takeovers and mergers among them.

The attractions of the more prominent public companies in this sector are strong cash flow and a largely fixed cost structure that sends most incremental sales directly to the bottom line. But smaller players are still feeling repercussions from the dot-com bust. IPOs are scarce, and most tech spending by financial companies is for consolidation, not to break new ground.

FactSet Research Systems Inc. of Norwalk, Conn., has been a beneficiary of the price increases.

The company has been supplying computer-based financial and economic data to the investment community since 1978. Until about a year ago it made few acquisitions, and it always paid cash.

But lately it has been on a shopping spree. Since September 2004 it has closed four deals, partly by paying with its own stock. In August, for example, it paid $42.5 million in cash and 305,748 shares of its common stock for Derivative Solutions Inc., a provider of software for analyzing fixed-income securities and managing portfolios and risk.

FactSet's share price has more than doubled since late 2002. The company had $313 million of revenue in the fiscal year that ended Aug. 31, and its market cap is $1.7 billion. (FactSet executives did not respond to repeated requests to be interviewed.)

Ken Marlin is the managing partner and founder of Marlin & Associates New York LLC, an investment banking firm that focuses on technology companies serving the financial services industry.

He says stock performance has been a key factor in heating up mergers and acquisitions market that was tepid in 2001-03 but has gotten hot since then.

Companies as different as FactSet, Fiserv Inc., and Reuters Group PLC have been filling up their shopping carts, he said, and in each case their stock prices have rebounded from lows to which they had descended around 2001.

The rise "has provided them a currency," Mr. Marlin said, "as well as confidence, giving them a willingness to be acquirers."

Meanwhile the market's snubbing many smaller financial tech companies has encouraged some to sell. Private companies especially, which might have gone public before the March 2000 tech stock crash, are now more willing to be acquired, Mr. Marlin and others said.

STOCK PRICES RISE


By some measures, financial technology stocks have been doing well.

One index of 15 North American banking and software system companies, created by National Bank of Canada's Putnam Lovell NBF and Financial Insights, was up 27% in the 12 months through September.

A 44-company index created by Robert W. Baird & Co. was up 8.7% in the 12 months through mid-September and 41.6% in three years.

Neither index, however, shows how widely the performance of individual stocks has ranged. First Data Corp., for example, was down 0.5% in the 12 months through mid-October, while Bisys Group Inc. was down 8.1% and Global Payments Inc. surged 61.3%.

"The market is, appropriately, looking … on a case-by-case basis, as opposed to painting the group with a broad brush," said Franco Turrinelli, an analyst with William Blair & Co. in Chicago.

Still, Baird's figures suggest that financial tech stocks are fully valued or close to it. Its group was trading in mid-October at 25.2 times the average of analysts' estimates of 2005 per-share earnings.

FLEDGLINGS FALTER

Capital is not much of a problem for publicly traded financial technology companies, because they can generally fund new product development from their own cash flow, observers say.

But start-ups and fledglings have a tougher time raising capital than five years ago, generally because of investors' resistance to initial public offerings.

"Clearly," said Baird analyst Carla N. Cooper, "during what we would call the dot-com era, companies that otherwise would have been considered too small to go public went public."

That resistance is driving private companies to sell to the Fiservs, FactSets, and First Datas, analysts said. The big payday for building a company from scratch comes from selling it to a larger one, typically a public company.

Mr. Marlin said that today it's nearly impossible to go public without putting at least $200 million of stock into the public's hands. That loosely translates into $50 million in revenue plus good growth prospects and solid profitability, attributes that many companies with interesting ideas in development do not have.

PRIVATE AND PUBLIC


Many of this year's deals involve public companies buying private ones. (The four companies FactSet agreed since last fall to buy were private.) Such deals make it hard for investors to build strategies around M&A forecasts.

But public companies were on both sides of the two deals announced Sept. 15.

In one, Fidelity National Financial Inc., the big title insurer, is to merge its tech subsidiary, Fidelity National Information Services Inc., with the card and check processor Certegy Inc. in a new publicly traded company.

In the other, Open Solutions Inc., which one analyst has called a smaller Fiserv, will acquire a unit of Bisys that provides core processing services to banks.

Private equity firms, a big unknown for analysts and investors in financial technology companies, have also made their mark lately in deals for two technology companies that mostly serve securities and mutual fund companies.

In July, SS&C Technologies Inc. of Windsor, Conn., said Carlyle Group would buy it for $1 billion. In August, a consortium led by Silver Lake Partners bought SunGard Data Systems Inc. for $11.4 billion in cash.

"Those guys almost have more cash than they know what to do with," said Shane Diamant, an analyst with Stephens Inc. of Little Rock. More such deals would not be surprising, he said.

But Blair's Mr. Turrinelli pointed out that two deals don't necessarily establish a trend. At the least, though, executives with public companies will take comfort from getting private equity investors' notice, he said.

"In circumstances where management feels very strongly the market is not 'getting it,' there is an alternative, which is to take the company private," Mr. Turrinelli said.

Whether SunGard and SS&C ultimately justify the deal premiums remains to be seen - but private equity investors have a different perspective than the Street's.

"The private-market folks were clearly willing to take a longer-term view of the prospects for those businesses," Baird's Ms. Cooper said.

GROWTH SLOWDOWN?

Financial technology analysts and investors are generally enthusiastic about such big players as Fiserv, Jack Henry & Associates Inc., Fidelity National, DST Systems Inc., and SEI Investments Co.

A drag on that enthusiasm, though, is that the banks, insurers, and securities companies will not boost such spending much soon, and that the tech firms' stock is nearly as high as it is likely to get.

Prognoses on the stocks hinge largely on the forecaster's view of the spending prospects.

Peter Heckman, an analyst with Stifel, Nicolaus & Co. in Saint Louis, is rather bullish on bank spending. He says banks must pay up to keep up with new regulations, customer expectations for new functions, and competitive pressures to streamline everything possible.

"Banks have relatively high requirements for automation and efficiencies and processing," Mr. Heckman said.

Michael Maxworthy, a partner at Marlin, said much the same about the securities firms. "They're usually willing to take risks on newer technologies that might help them trade that stock a half second faster or get that information a half second earlier than the next guy," he said.

Leslie M. Muma, Fiserv's president and chief executive, said financial companies are still shifting from internal development and management of technology to using third-party providers.

Small banks and credit unions have led the way, he said, but more midsize and large banks are turning over check processing and lockbox servicing to companies like his.

The trend "has many more years to go," Mr. Muma said.

But Robert J. Coolbrith of Financial DNA LLC, a San Francisco research firm, said financial companies are resisting big changes in their technology.

For example, said Mr. Coolbrith, the firm's director of research services, banks have yet to move from batch processing to real-time processing. Doing so would change the customer experience, he said, but banks would have to demolish the silos that separate their various businesses, and they have not convinced themselves that the investment would pay off.

"It's unclear when banks are going to bite the bullet and invest in a big way," Mr. Coolbrith said.

Overall spending forecasts vary, but Financial Insights of Framingham, Mass., and Forrester Research Inc. of Cambridge, Mass., both see speed bumps ahead.

Financial Insights estimates growth this year at 4.6% and expects it to drift slightly lower in the next few, said Bill Bradway, group vice president for its banking practice.

Forrester thinks outlays will rise just 1% to 3% this year, over last year's levels, said Andrew Bartels, an analyst there. Companies in all sectors face pressures to restrain tech spending next year as well, he said.

TOP OF THE HEAP

Analysts and investors say that the most familiar names in core bank processing and payments processing are well positioned to be winners in head-to-head competition.

Fiserv and First Data, for example, have used acquisitions to build an ever-wider menu of services, said Thomas Plumb, the president of Wisconsin Capital Management LLC, a mutual fund company in Madison, Wis., that owns shares in both companies. They boost revenue in part by selling new capabilities to existing customers, Mr. Plumb said.

The strategy works, industry observers say, because financial services companies increasingly want to consolidate their technology spending with fewer companies.

But Mr. Diamant at Stephens said market share is not moving fast from specialty companies selling Internet banking, check imaging capabilities, or any of dozens of other services.

"I don't think that has materialized to the point that it's causing any of the specialized providers to struggle," he said.

Still, analysts widely expect significant consolidation as leading core processors - in banking, Fiserv, Fidelity National, Open Solutions, Jack Henry, and Metavante Corp. - acquire smaller core processors and specialty technology companies.

THE NEXT BIG THING

On the specialty side, though, Financial DNA's Mr. Coolbrith said investors might do well to look for companies working in areas with big market potential.

One such area, he said, is the money-transfer business, for which new tools will be needed. Worker remittances, especially internationally, will generate considerable increases in money transfer revenue, he said.

Companies as yet unknown may bring new money transfer technologies to market, Mr. Coolbrith said, but Western Union Financial Services Inc. and MoneyGram International Inc. will probably be the long-term beneficiaries, if only after acquiring developers of the next new ideas.

Securities firms' extra spending on compliance-related tools means an opportunity for vendors, Mr. Coolbrith said.

Mr. Stoneman is a freelance writer in Albany, N.Y.

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