From the Bargain Bin

(This article originally appeared in the The Motley Fool's Evening News on Monday, March 03, 1997)

FOOL ON THE HILL
An Investment Opinion by TMF Templr

From the Bargain Bin

Shareholders of BHC FINANCIAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BHCF)") else Response.Write("(Nasdaq: BHCF)") end if %> had reason to rejoice this morning. Financial processing behemoth FISERV <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FISV)") else Response.Write("(Nasdaq: FISV)") end if %> announced today it was acquiring all of the outstanding shares of BHC in a stock-for-stock transaction valued at $212 million. Shares of BHC Financial rocketed $11 7/8 to $31 7/8 for a snappy 59% gain after FIserv informed shareholders that it would profer $33.50 of worth of its own stock for each share of BHC. This merger represents only the latest in a wave of ongoing consolidation in the financial processing business, a fast-growing industry feeding off of the ongoing conversion of paper dollars to electronic dollars in the digital economy.

FIserv is the second-largest financial processing company in the United States, behind only outsourcing giant ELECTRONIC DATA SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EDS)") else Response.Write("(NYSE: EDS)") end if %>. FIserve provides financial data processing systems and related information management services to more then 5,000 banks, credit unions, mortgage firms and savings institutions worldwide. The company's services include check clearing, funds transfer, credit card administration and data processing. With the acquisition of BHC Financial, FIserv now adds securities processing to its oeuvre, managing the transactions related to stock and bond accounts for the securities brokerage affiliates of banks and other financial institutions. Even the most cursory examination of the two companies highlights the outstanding fit between the two businesses, the principle reason that FIserv climbed $3 7/8 to $36 5/8 today.

Today's gain in FIserv is paltry compared to the returns shareholders have reaped in the stock over the last decade. Since March 3, 1987, the average annual return has been 20.2%, almost twice the S&P 500's 10.8% annual gain over the same period. How has FIserv managed to lap the S&P over the past decade? Largly through the ability of its top management to find solid, well-run acquisition candidates with strong management. The company has eagerly played into the trend of financial services providers to outsource functions, adding services to its line up incrementally over the past ten years. Co-founders George Dalton and Leslie Muma still manage the company, applying the same criteria to acquisitions today as they did when they started the business back in 1984.

With FIserv priced at $36 5/8, it will need to issue 5.8 million shares to pay for Philadelphia-based BHC Financial. For those 5.8 million shares of stock, FIserv gets a company with $81.2 million in trailing revenues and $18.0 million in trailing earnings, boasting 22% net profit margins. Until the merger today, BHC traded at only 1.35 times sales, subtracting from the market capitalization the current cash the company has on the balance sheet. With $2.69 per share in trailing earnings, BHC was trading at less than 7.4 times earnings. Why was the stock so cheap? Only one lone analyst is currently covering BHC Financial, according to both First Call and Zacks, with very low profit estimates for both 1997 and 1998 -- $2.75 per share and $2.90 per share respectively. This analyst was forecasting flat growth over the next two years in spite of the company's share buyback program, leaving the crucial earnings growth factor out of the investor interest equation.

Was BHC's only potential value its earnings? With an infrastructure dedicated to one specific line of securities transaction processing, it is painfully obvious in retrospect that the answer was no. Even paying $33.50 a share for BHC gives FIserv an incredible acquisition that will add to earnings (or be accretive, as the Wall Streeters like to say) from day one. FIServ currently has 45.36 million shares outstanding. By adding 5.8 million more shares (at the current price) to get BHC Financial, it will now have 51.16 million shares outstanding. It is also adding 18.0 million in trailing earnings, meaning that instead of the $60.8 million in trailing earnings over 45.36 million shares FIserv had before it did this deal, it now has $78.8 million to spread over 51.16 million shares. Trailing earnings goes from $1.34 per share to $1.54 per share overnight, meaning that should this deal go through, FIserv's price/earnings ratio will drop from 27.2 to 23.7, assuming a share price of $36 5/8.

Why would FIserv want to acquire a business that one analyst forecasts will show little growth over the next two years? With $798.3 million in trailing revenues, FIserv has an extremely large established base of customers that are buying a significant amount of product. Many of these customers are banks that are starting to get into the brokerage business because of the recent banking reform (detailed in the November 8, 1996 issue of the Evening News). It is entirely possible that FIserv can generate more out of BHC if BHC becomes a subsidiary of the company than BHC could generate alone. Certainly FIserv's management believes so, or else it would not be interested in closing the transaction. So FIserv purchases a company in a complementary business at a price that does not dilute earnings for current shareholders, an investor's dream.

Certainly, it is easy to say a merger was obvious after it happened. This is the stuff of which punditry is made. An important lesson that investors can take away from this is to look at the market share a company has in its current line of business and factor that into the overall valuation for the company. Did BHC Financial have a very large market share? The only other company in this line of business that I am familiar with was purchased by CONCORD EFS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CEFT)") else Response.Write("(Nasdaq: CEFT)") end if %>, a smaller competitor of FIserv, late last year. Because BHC was so tiny and poorly covered by analysts, institutional investors had missed it. If there are any other companies like this left, odds are they will be attractive to transaction processors like Electronic Data Systems, FIRST DATA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDC)") else Response.Write("(NYSE: FDC)") end if %>, NATIONAL DATA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NDC)") else Response.Write("(NYSE: NDC)") end if %>, BA MERCHANT SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BPI)") else Response.Write("(NYSE: BPI)") end if %>, FIRST USA PAYMENTECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PTI)") else Response.Write("(NYSE: PTI)") end if %> and SPS TRANSACTION <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAY)") else Response.Write("(NYSE: PAY)") end if %>, to name a few.

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.

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