from cash and cheques to cards and electronic payments, processors
have become increasingly powerful players – and are ever more
attractive assets to would-be buyers, as investors look to capture
unrealised value. Charles Davis reports.
There has been significant merger and acquisition activity in
the cards processing industry recently. In the past month alone,
Kohlberg Kravis Roberts & Company (KKR) agreed to buy First
Data, a major processor and owner of the Star ATM network, for $29
billion. Wisconsin bank Marshall & Ilsley announced that it
would spin off its payment-processing unit, Metavante. Metavante,
which purchased the ATM network NYCE for $610 million from First
Data in 2004, has emerged as a powerful force in the processing
business.
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Comdata, another processor, may also be on the block. Its
corporate parent, Ceridian, is being pushed by a hedge fund manager
with a major stake in the company for a spin-off of the
fast-growing processor. And Synovus Financial has been under
pressure to spin off its credit-processing arm, TSYS.
These deals are largely financial transactions rather than
strategic plays: private equity firms are unlikely to be the kind
of buyers that would facilitate broad strategic changes in place of
efficiency-orientated ones.
Strategic implications
In contrast, several recent back-office deals were driven
largely by strategic implications, such as CheckFree’s agreements
to acquire both Carreker, a provider of cheque processing software
and consulting services, and the online banking software maker
Corillian. Software maker Intuit’s purchase of Digital Insight had
a similar rationale.
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By GlobalDataWhether for merchant acquiring, payments processing or online
banking automation, the back office is getting a lot of attention
these days. Its stable cash flow and steady growth in an era of
consumer migration toward electronic payments has investors looking
at the processing business with an eye toward capturing unrealised
value.
What effect, if any, the deals will have on the broader
processing market is unknown, but most analysts view the moves as
evidence of the vitality and potential of the sector, despite the
fact that decades’ worth of consolidation in the cards industry has
tightened competition for processing work.
The merchant acquiring industry has changed substantially in the
past ten years. In the mid-1990s, most card issuers maintained
their own merchant acquirers, but most of them have either been
sold off to larger players or converted to joint ventures such as
Citicorp Establishment Services. First Data, the US and global
leader in merchant acquiring, grew even bigger with joint ventures
between JPMorgan Chase’s Paymentech and Citicorp. Bank of America
(BofA) left TSYS, taking its processing in-house following the
acquisition of National Processing. NaBanco grew through a series
of acquisitions into Global Payments, a top-five processor with
revenues nearing $1 billion in 2006.
Nova, a subsidiary of US Bank, moved into the ranks of top
acquirers with several large acquisitions, including deals for
First Horizon and Schneider Payments. Fifth Third maintained its
top-tier status through a joint venture with the Armed Forces
Financial Network and the acquisition of Card Management Group.
Sharing over 90 percent of US transaction volume, TowerGroup
estimates that the volume driven by these five merchant acquirers –
First Data, BofA, Nova, Fifth Third and Global Payments –
approached 46 billion transactions in 2006. (See figure 1.) In
terms of total transaction volume, the rankings shift a bit, with
Chase Paymentech topping the list, followed by BofA, First Data,
Fifth Third and Nova.
Citibank, once a top-tier acquirer, has faded a bit due to the
divestiture of its US business to First Data and its European
processing operation to euroConex during 2005. The gap between the
largest acquirers and the competition is immense. Chase Paymentech
is ranked by US research consultancy First Annapolis as the largest
global acquirer in terms of transaction volume, with over $400
billion processed in 2005, whereas, for example, Société Générale
handles less than one-tenth of that volume. The industry is likely
to continue to shrink, as a few very large, resource-rich
organisations extend their scale-related advantages over the rest
of the competition.
Many of the big banks that dominate card issuing do their own
processing, and the number of small issuers that depend on
third-party processors such as First Data and TSYS is declining.
The US credit card processing industry includes fewer than 500
companies with combined annual revenue under $10 billion.
Processors provide transaction services to banks that issue
credit cards and to merchants that accept credit card payments.
Merchant products include authorising, capturing and settling
merchant credit and debit card transactions, and handling
chargebacks. Processors also sell or lease POS terminals. Card
issuer products include transaction authorisation and posting,
statement generation and printing, and card embossing.
Large processors such as First Data and TSYS provide services to
both sides of the transaction. Small processors typically offer
either merchant or card issuing services, and may specialise in
particular vertical markets such as credit unions or retail cards.
For every merchant transaction, there is a card issuing
transaction.
First Data focuses on processing
For First Data, the KKR deal is the culmination of a series of
moves the company has made to focus on its core competencies in
processing. In October, the company spun off its prize subsidiary,
fast-growing money transfer provider Western Union, in an effort to
generate greater return for shareholders. The performance of the
card-issuing unit over the last few years – it has grown, but not
as spectacularly as Western Union and other subsidiaries – raised
the possibility that it would be sold. Instead, First Data
executives decided in January to spin off the high-flying Western
Union money-transfer business by the end of the year and focus on
the processing unit.
The core company, the US’s largest electronic payments
processor, generated income of $1.51 billion on revenues of $7.08
billion last year. It generates rich cash flows – $204 million in
the fourth quarter of 2006 – although First Data has lost ground to
its more streamlined rival, TSYS, which snagged JPMorgan and other
clients.
Business drivers
Max Narro, senior vice-president, product, marketing and
industry for First Data Resources, the US bank card processing unit
of First Data, told CI that combating fraud, extending payments
products into new sectors and increasing activation and loyalty are
increasingly driving the processing business.
Disaster recovery and business continuity is another big issue
for card issuers, Narro said, as access to critical data when and
where the user needs it has become the market standard.
“It’s a 24/7, 365-day-a-year business, and there is really no
downtime in the processing market,” he said. “And now that
processing has become more of a one-to-one driver for talking to
the customer, it’s even more imperative that we reach across the
institution and manage that relationship at the high end and at the
individual end.”
First Data serves 4.9 million businesses and 1,900 card issuers.
It has acquired several companies across the globe, including GZS
in Germany, Austrian Payment System Services, EuroProcessing
International and Korea Mobile Payment Services. First Data
recently announced plans to acquire Polcard, Poland’s leading
independent merchant acquirer and card issuer processor, in an
all-cash transaction for $325 million.
A leaner, meaner First Data can begin to pursue ways to expand
its processing strengths in new areas, such as the deal announced
in April to buy a New Zealand company that makes billing software
for utilities.
Usage of mobile commerce and analytics will increase
significantly, according to Narro, who added that the emerging
links between customer data management and fraud prevention have
issuers discovering the power of sophisticated data analysis.
“Prepaid continues to expand, and we want to be in the right
spot at the right time, and so you be as agnostic as you can, while
moving strategically to make sure we are ready as the platform
shifts,” he said. “Issuers see the potential for expanding
relationships in new ways here, using the card relationship as an
aggregated customer experience.”
It’s that change – from the macro-level processing that built
the business to the micromanagement made possible by today’s
technology – that is creating tremendous change in the payments
business, he said.
Handling payments in the health care industry is another way
First Data has started diversifying. The most recent addition in
that field was a deal with PayFlex Systems USA. PayFlex maintains
workers’ flexible-spending accounts and other health care financial
services for a number of companies. Just as it does for credit card
issuers, First Data will print and emboss cards and electronically
process the transactions of PayFlex participants. About 1 million
electronic transactions are made annually on cards issued by
Omaha-based PayFlex.
Indeed, the core processing business, while profitable, may not
be the apple of KKR’s eye. Some industry watchers say the company’s
other divisions, First Data Commercial Services and First Data
International, are the growth areas that attracted buyers.
First Data Financial Institution Services may not be the star of
the First Data holdings, but it is a consistent money-earner and
its financials are stable. The unit’s operating margin held steady
at 20 percent between 2005 and 2006, down only a little from 22
percent in 2004. Some painful client losses, such as JPMorgan Chase
and FleetBoston Financial, have been offset by the purchase of
Citigroup’s private-label portfolio from Sears, Roebuck &
Co.
Narro said that the processing business is one of
“self-renewal”.
“We have to always be rewriting the business to keep pace with a
changing business environment,” Narro explained to CI. “How fast we
bring products to market, and process in ways that reduce
redundancies and complexities so our clients can extend their
payments business.”
International competition heats up
All processors face a shrinking pool of issuers, which has given
the remaining giants more leverage to squeeze card-processing
margins. At the same time, the largest banks, such as Citigroup,
BofA and JPMorgan Chase, have large enough scale to keep processing
in-house. Citi handles its general-purpose card processing;
JPMorgan Chase switched from First Data to TSYS last year, but
after this year will go in-house under a novel licensing agreement
with TSYS. BofA is set to end outsourcing relationships with TSYS
and use the newly acquired MBNA platform to process in-house.
In most markets in the world, acquiring is at core a local
business, but, as First Annapolis said in a recent report, “it is
clear the industry is in the very early stages of an evolution
where multinational acquirers in various forms are beginning to
emerge”.
In an interview with CI, Vinnie Calo, global director of
business processing outsourcing administrative services for EDS,
said that as the North American processing market nears saturation,
international competition is heating up.
“We moved into international markets several years ago, because
we saw greater opportunities for growth,” Calo told CI. “Now, as
the US market continues to consolidate, we see many of our US
competitors looking abroad for opportunities as well.”
TSYS expands global presence
TSYS, for example, lost some major US clients in the past couple
of years, but created a joint venture with Merchants, a UK unit of
Dimension Data of Johannesburg, to focus on Europe. TSYS, which
owns 55 percent of the venture, said its stake has given it a base
from which to win more customers in the region.
In September 2006, TSYS raised to 44.5 percent its ownership
stake in China UnionPay Data, the credit card processing unit of
China’s only card network, China UnionPay. TSYS bought its initial
35 percent stake in December 2005. China UnionPay Data has
processing contracts with 21 Chinese banks, among the 172 banks
that participated in the national network as of autumn 2006. All
bankcards issued in China can be used at the 80,000 UnionPay ATMs
and 560,000 POS terminals at 370,000 merchant locations.
TSYS also broke into the Japanese market with a deal to process
transactions for a co-branded Visa debit card from Tokyo Finance
and Nikko Cordial Securities. In Mexico, the company extended a
contract with Visa card issuer Spira de Mexico, which specialises
in the unbanked segment, to continue processing its consumer credit
portfolio and providing risk management and portfolio management
tools. The processor’s international revenues increased by 47
percent in 2006, and TSYS expects similar growth in 2007.
Bob Evans, senior director of business development at TSYS
Europe, said: “Our growth strategy combines organic sales, select
acquisitions and partnerships. Our focus is to build our presence
in Western Europe, particularly in the main markets of UK, Italy,
Germany, France and Spain. Our long-term approach is to build
relationships to prepare for the structural changes taking place in
Europe’s payment market. Last year we opened an office in Spain and
in May we’re opening offices in Munich and Milan. In the third
quarter of 2007 we will be opening an office in Paris.
“Our aim is on cross-border issuers with international
requirements – multinational banks looking for international
exposure, and European card issuers who are going through bank
consolidation. TSYS is on a journey. We have strong foundations in
the Anglo-Saxon world but we are determined to be successful in
central Europe too. That is the next step in our evolution.”
EDS’s role as an integrator
Calo told CI that EDS and its competitors have found issuers
across the world in need of help.
“If you look at the issuer side, they are faced with saturation,
pressure on fees and wallet share issues, and these huge Cobalt
mainframe processing systems that require an army of programmers to
make the slightest change to the card offering,” Calo said.
“Security and data protection, hardening the data centres,
encryption – it all distracts from the mission, and an integrator
can take a whole lot of that activity off their plates.”
On the acquiring side, EDS finds in all 18 of its international
processing markets that merchants are all struggling with
transaction costs – most of it interchange.
“The biggest defence that the retailers have is having
procedures and training to qualify transactions for the best rates
available,” Calo said.
“For example, if you swipe a card and it doesn’t work, we train
the merchants to swipe it again, rather than hand-entering that
transaction, because once you hand-enter the transaction, you’ve
entered a whole higher interchange tier. These things are simple,
but if you are maintaining the merchant acquiring relationship, you
should be providing that sort of hands-on touch.”
Calo said that EDS’s position as an integrator, involved in a
myriad of business relationships rather than siloed processing
agreements, allows the company to remain nimble in a changing
payments landscape.
“It’s increasingly likely that we’ll see a third association – a
large issuer, a processor and potentially a large merchant or group
of merchants will just take their show on the road,” he said. “Or
we look at the telcos – they do more billing than all these guys
put together, and they have the pipeline already built. If
teenagers really hop on mobile, and they go to the retailers and
give them a low rate for small payments, then we potentially could
see a dramatic shift in the processing base.”
New growth markets
EDS has used its international processing business to become a
leader in offshoring acquiring services, particularly
reconciliation and authorisation, drawing on its wide choice of
best-of-breed servicers from Brazil to Canada and across Western
Europe. Calo said that EDS has a major investment in a large Indian
processing operation, MphasiS BFL, and added that the next
processing hotspots will be in China and Dubai.
Underscoring the untapped potential of Middle Eastern markets,
credit card issuer JCB and financial services group Orix, both of
Japan, and Middle East property developer Majid Al Futtaim Group
have entered into a joint venture to establish a credit card
business in the Middle East and North Africa. It will be
headquartered in Dubai and the United Arab Emirates. The venture,
MAF JCB Card PJSC, expects to begin issuing JCB cards in July 2007
to existing and potential Majid Al Futtaim Group customers in the
UAE, and plans to develop licence partners for JCB’s card issuing
and merchant acquiring businesses.
The new establishment will also conduct marketing activities to
develop partnerships with financial companies for JCB card issuing
and merchant acquiring businesses.
EDS plans to open at least two outsourcing centres in China,
hiring 2,000 staff over the next two years. These facilities,
called global delivery centres, will offer a range of outsourced
services, including IT outsourcing and hosting, for multinational
and Chinese clients. The other three EDS global service centres are
located in India, South America and East Europe.
Outsourcing boom
EDS, First Data and other international processors are all
angling for a share of the rapidly growing Asian market, where
emerging businesses will soon look to turn over their IT and
processing systems to third parties in what global consultancy IDC
sees as a coming outsourcing boom.
The size of the outsourcing market in Asia, excluding Japan, is
expected to top $10 billion in 2006 and could reach $16 billion by
2010, according to IDC.
