Fidelity National Information Services Inc. (FIS) recently dodged a downgrade threat from rating agency Fitch, after the company abandoned its plans of acquiring British financial software company Misys Plc.
Earlier, in late June, Florida-based Fidelity made a preliminary offer to buy Misys for approximately $2.27 billion. This prompted Fitch to put Fidelity’s rating under review, with the possibility of a downgrade looming large.
Misys, whose clientele comprises all of the world’s top 50 banks, received a revised non-binding offer from Fidelity on July 20, 2011. However, the London-based firm rejected the offer, citing undervaluation.
Fidelity backed out from its acquisition bid, but did not give any reason for the decision. Instead, Fidelity announced its intention of repurchasing shares under its existing share repurchase authorization. Fidelity has approximately 13.6 million shares remaining under the existing authorization that was approved by the company’s Board of Directors on February 4, 2010.
Following the announcement of the company’s decision, Fitch reaffirmed Fidelity’s BB+ issuer default rating. Fidelity also has its senior secured term loans at BB+ and two series of senior unsecured notes at BB with a stable outlook. All of the ratings are below investment grade, or “junk” status.
Fitch said that the key considerations for the ratings are the company’s free cash flow conversion rate and the amount of debt it carries.
As of June 30, 2011, Fidelity’s total debt (including the current portion) was $4.88 billion; the net cash position (cash less debt) was negative $14.33 per share and the debt-capital ratio was 41.5%. Fidelity’s high interest expenses (interest expense soared 241.0% year over year in the second quarter) will negatively impact its profitability going forward.
The rating agency also reported that if Fidelity’s debt level increases due to further acquisitions and share repurchase, its current rating will come under threat in the near future.
We believe that the Misys acquisition would have expanded Fidelity’s business in the European market, thereby reducing its dependence on the US market. On the flip side, we also note that Fidelity possesses significantly high debt levels, and an acquisition of this magnitude would have hurt the company’s risk profile going forward.
Moreover, Fidelity continues to face integration risks. Fidelity’s recent growth was primarily driven by acquisitions including as those of GIFTS Software, Inc., consulting firm Capco, ValueCentric Marketing Group, Inc., Compliance Coach, Inc., and Metavante Technologies.
Although we believe that the acquisition of these companies will drive both top-line growth and cost synergies with increased operating leverage; we expect this to come at the expense of lower cash flows due to increased working capital requirements.
Recommendation
We believe Fidelity’s expansion into emerging markets such as Brazil, India and China will drive organic revenue growth over the long term. We also believe that Fidelity’s commanding position in the financial services market, increasing international exposure, recurring revenue model, diversified product portfolio, cost synergies from acquisitions and a loyal customer base will drive growth over the long term.
However, increasing consolidation in the banking sector, a challenging environment for the Payments Solutions business and an uncertain regulatory environment are primary headwinds, in our view.
We maintain our Neutral rating on a long-term basis (for the next 6 to 12 months), primarily due to increasing debt and intense competition from Fiserv Inc. (FISV), and privately held SunGard Data Systems Inc.
Currently, Fidelity has a Zacks #3 Rank, which implies a short-term Hold rating (for the next 1-3 months).
