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Thursday, January 15, 1998
Fair, Isaac & Co.
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Phone:415-472-2211
Website: http://www.fairisaac.com
Price (1/14/98): $30
HOW DID IT FIND TROUBLE?
Best known for its credit risk scoring products for the credit card industry, Fair, Isaac Co. found its most recent trouble in December when it announced that would miss its first quarter earnings estimates. The company blamed the recent flurry of bank mergers, customer preoccupation with Year 2000 compliance, and spot staffing shortages that have caused the company to hire expensive contract labor to finish some big consulting jobs. Shares fell $8 5/16 to $32 on that one brutal day and have not gotten a respite since, trading down as low as $28 1/2 in the last few weeks.
The expensive contract labor issue also caused the company to miss earnings estimates in the fiscal 1997 third quarter and smashed investor sentiment like a china plate. Despite the company's assurances that demand for its risk analysis algorithms and its credit scoring devices remained strong and that revenue growth would be in the "mid-twenties," investors fled the shares because of decelerating earnings growth, higher-than-expected costs, and concerns about slowing growth in the credit risk management business, pushing the stock to its lowest valuation in years. The shares trade at four-year lows relative to earnings per share, cash flow, book value and sales.
BUSINESS DESCRIPTION
Fair, Isaac & Co. bills itself as the "gold standard" in decision technology. The firm provides data management software and services that allow customers to make "better decisions through data." By using database enhancement software, predictive modeling, adaptive control and systems automation, the company provides financial services, direct marketing, and personal lines insurance companies with the means to decide which potential customers present the less risk.
In fiscal 1997, 48% of revenues came from sales to credit bureaus and third-party transaction processors and 29% of revenues came from selling directly to banks and other credit industry end-users. This leaves the company generating the vast majority of its revenues from credit issuers, although 13% of the 77% of revenues that come from the credit industry come from international banks. To compensate for the heavy weighting in the credit industry, Fair, Isaac has sent out tendrils into a number of other industries that could improve returns by harnessing customer data and better assessing risk, including auto and home insurance, small business and mortgage lending, telecommunications, and healthcare.
FINANCIAL FACTS
Income Statement
12-month sales: $199 million
12-month income: $20.7 million
12-month EPS: $1.46
Profit Margin: 10.4%
Market Cap: $430.4 million
Balance Sheet
Cash & Securities: $32.6 million
Current Assets: $81.8 million
Current Liabilities: $34.1 million
Long-term Debt: None
Ratios
Price-to-earnings: 20.8
Price-to-sales: 2.2
HOW COULD YOU HAVE SEEN IT COMING?
Many investors have been negative on Fair, Isaac because of slowing account growth in the North American credit card industry. With the majority of its revenues coming from account growth, these investors reasoned that the rubber would eventually hit the Fair, Isaac road. This belief came in spite of the fact that throughout the '90s, while account growth in the U.S. credit industry was slowing, Fair, Isaac managed to grow revenues by gaining market share and developing new products that provide increased utility at various points in the credit issuance process.
A more troubling sign was the third quarter earnings disappointment that came from high-priced labor contracts. Although the difficulty in hiring quality people seems like a much less sophisticated reason to expect trouble, in the end every business depends on qualified labor. In the case of Fair, Isaac, where it markets and delivers a complex, information-rich, data service, good help is pretty critical to success. Unfortunately for Fair, Isaac, it was not exception to the rule that cost overruns normally last for much more than just one quarter.
WHERE TO FROM HERE?
Part of Fair, Isaac's problem seems to center on a basic inability of the investment community to understand the company's business. Although many like to fit it in the category of risk assessment for credit cards, the company does a lot more than just provide "rule-based" credit risk scoring technologies. Fair, Isaac describes its business as "helping clients make better decisions using data." By applying better data analysis to technically complex, data-rich problems, the company believes it can offer customers a compelling value proposition.
Through acquisition and organic growth, Fair, Isaac has been adding new products. The most promising product line comes from its Risk Management Technologies (RMT) unit acquired in July of 1997. RMT provides enterprise-wide risk management and performance measurement solutions to major financial institutions across the world. What this means in English is that the company's products can tell you what you have at risk in various scenarios -- something that, given the recent turmoil in Southeast Asia, is nothing to scoff at. Fair, Isaac plans to integrate RMT's interest and market risk analysis products with its credit products, creating a killer application in the risk assessment arena. In fiscal 1997, RMT generated 4% of the company's total revenues -- not a huge slice by any means, but significant.
With a 22% return on equity, 28% return on invested capital, 18% operating margins, and 20%-plus revenue growth, Fair, Isaac remains near the top tier of business quality and overall growth in corporate America. If these cost overruns prove to be one-time events, the current P/E of 20.8 and price-to-sales ratio of 2.2 suggest that these shares might be worth a close look. Should the shares trade much lower, even the value crowd might start to get excited.
--Randy Befumo
([email protected])
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