Fidelity Information Services: Business Simplification Supports Further Upside (NYSE:FIS)

Shares of Fidelity National Information Services (NYSE:FIS) have been a strong performer over the past year, rising about 36%. In November, I upgraded FIS from “sell” to “buy” as much of the bad news appeared priced in while simplification of the business created potential upside. Since that recommendation, shares have returned nearly 40%, significantly outperforming the market’s 17% gain. In the process, shares have rallied past my initial low-$60’s price target, making now a natural time to revisit FIS.

On February 26^th, Fidelity reported Q4 results that generally missed estimates with non-GAAP EPS of $0.94 being $0.15 light while revenue fell 1% to $2.5 billion. For the full year, it earned $3.37. Q4 EPS was $1.67 including the contribution from discontinued operations. The total company grew revenue by 2% in 2023 to $14.68 billion, above the high-end of initial guidance.

There are a lot of moving parts in results with a large contribution from discontinued operations. This is because FIS has been undoing misguided acquisitions and simplifying its business, as I wrote about previously. This culminated in the sale of a 55% stake in Worldpay that closed on January 31, 2024. FIS retains a 45% stake in Worldpay, but these results will now be accounted for on an equity method basis as FIS no longer controls Worldpay. For its 55% stake, it received $12 billion in proceeds, and Worldpay was valued at 9.8x EBITDA, including debt the new Worldpay will carry. With these proceeds, FIS will be allocating $9 billion to debt reduction and $3 billion to buybacks.

It is important to remember that its most recent financials include Worldpay as the transaction was not yet complete. FIS was carrying $19.1 billion of debt at year end alongside $440 million of cash, but with these proceeds, this debt balance will come down meaningfully on 3/31. Indeed, it has completed a $2.53 billion tender of senior notes, mostly below par, given they were issued when interest rates were lower. This is likely to cause some noise in GAAP financials during Q1 when FIS will book on a gain on the extinguishment of debt. Aside from this debt paydown, FIS can reduce its commercial paper borrowings, which total about $4.8 billion. It also has a 500 million euro note due in July that I expect it to pay down with cash on hand. As such, it will take several quarters for FIS to fully achieve its debt reduction. One benefit of rates staying higher is that it lowers bond prices, making these tenders cheaper than they otherwise would be. As a result of this debt paydown, debt to EBITDA leverage should end 2024 at ~2.8x, in the middle of its 2.5-3x target and safely guarding investment grade ratings.

With Worldpay off to the side, it is now critical to focus on the remaining business, or continuing operations, which provides technology, security, and processing support to banks and capital market participants. Alongside a loss of focus from managing large acquisitions, FIS lost some cost discipline, and we are seeing this improve. FIS generated a 42.1% EBITDA margin from continuing operations, up 70bp from last year. It has achieved a run rate $370 million in cost-savings with a further $160 million targeted this year, which should support modest incremental margin expansion.

Alongside costs, FIS is trying to reaccelerate the top-line, and I see positive signs here, with revenue mix shift also improving. About 2/3 of its business supports banks and 1/3 capital markets. In Q4, adjusted banking revenue was flat while capital markets rose 1%. Both saw 7% growth in recurring revenue and declines in non-recurring revenue. For banking, FIS was enjoying incremental revenue from helping to service pandemic-related programs like PPP. These programs were temporary and hence are allocated to non-recurring revenue. With each quarter, more of these loans are forgiven or paid off, and I noted there was a decline in Q3, which I expected to continue. We should lap this one-time revenue benefit over the next 2-3 quarters and the headwind will continue to fade.

Capital markets was hurt by extremely strong license sales in Q4 2022, which created a very difficult comparison. These mix shifts also impacted margins. License fees are quite high margin while pandemic servicing activity is relatively low. As such, banking margins expanded 20bp to 44.2% while capital markets contracted 250bp to 53.2%. Importantly, this shift to recurring revenue and long-term support contracts increases revenue visibility. FIS has about a $23.5 billion backlog, equivalent to over two years of revenue. This helps to support management’s long-term planning. Additionally, strong capital markets activity, including elevated debt issuance and a reopening of the IPO market, should support non-recurring revenue in capital markets. In other words, some of the headwinds that faced the business in Q4 are unlikely to persist in my view.

Accordingly, the company gave guidance I view positively. It expects 2024 revenue growth of 4% from its continuing operations, which should lead to $4.66-$4.76 in EPS, given 20-40bps of margin expansion. This is a slowing pace of margin expansion, given the majority of cost cuts have been realized. I would note this includes about $0.70 of equity method earnings from the Worldpay transaction, so FIS will earn about $4.00.

In Q1, it sees revenue rising by about 3% led by 6-7% growth in capital markets with an adjusted EBITDA margin of 39.3-39.5%. It should earn $0.94-$0.97. Given its reliance on recurring revenue, guidance should be relatively accurate, particularly one quarter out. With economies continuing to expand, which supports ongoing growth in transaction volumes to process and buoyant capital markets, volumes should be at least as strong as FIS is assuming for the full year. Previously, I expected FIS to have about $3.85 in standalone earnings power. I am revising that to $4.00-$4.05 this year, in part aided by lower interest expense as debt reduction is somewhat less costly than previously assumed.

Free cash flow conversion continues to improve, toward 90% in 2023. It expects 85-90% this year and then around 90% in 2025 and 2026. This is particularly important because capital returns are a key part of the investment thesis. FIS previously aimed to buy back $3.5 billion of stock from Q4 2023 through Q4 2024. This included $3 billion from the Worldpay sale and $500 from its own free cash flow. It has revised this up to repurchased $4 billion of stock by the end of the year, using $1 billion of its own free cash flow. I would note this total includes $510 million repurchased in Q4, for about $3.5 billion of buybacks in calendar 2024. This should reduce the share count by about 8%, which will provide a further tailwind to EPS growth through 2025 as the lower share count fully feeds through calculations.

This doubling of its stand-alone buyback is a sign of confidence in the business, consistent with rising recurring revenues and improved cash flow conversion. Beyond buybacks, FIS offers a 2% dividend yield. It targets a 35% dividend payout ex Worldpay equity method earnings. At my estimates, it has a 35-36% dividend payout, in-line with targets. As such, dividend growth is likely to mirror earnings growth over time.

At 85-90% free cash flow conversion, FIS can repurchase $1-$1.2 billion of stock per year, for about 3% share count reduction. Any dividends received from Worldpay could be added on top of this. I continue to believe FIS should be valued on a sum of the parts basis. Based on the sale price for Worldpay, its remaining stake is worth about $10/share. With $4-$4.05 of standalone earnings, FIS is trading about 15.7x earnings. Given faster growth in recurring revenue streams, a supportive buyback, and improved cash flow, this is inexpensive. In addition, while I do not expect further strategic actions imminently, a complete divestiture of Worldpay would allow for an additional one-time large buyback. Such a sale would further simplify the business and make it a more attractive M&A target. Indeed, its focus on recurring revenue could even increase its attractiveness to private equity.

To be clear, I do not view an M&A event as likely in 2024, but over the medium term, if it exits Worldpay, it’s cash flow generative, recurring revenue business could garner interest and provide some upside optionality. With 3-5% long-term growth and a balance sheet that has been restored to strength, I would value FIS at a 5% free cash flow yield, to create an 8-10% long-term return. With about $3.50 in free cash flow capacity, shares are worth $70, plus $10 for Worldpay, for $80 total. With about 10% further upside and longer-term M&A potential, I would stay long FIS.