This Fintech has just solved a big problem. Is it a purchase?

The payment and fintech company Fiserv (NASDAQ:FISV) recently announced plans to acquire Finxact, a maker of cloud-native core processors for banks, for $650 million. The deal pales in comparison to Fiserv’s latest acquisition, First Data, for $22 billion. But don’t let the smaller number fool you: the acquisition could be bigger than some realize, and it could solve a key problem that Fiserv has struggled with for several years. Here’s why.

The problem with basic processing companies

Fiserv is a company that provides banks, credit unions and other financially oriented companies with the technology needed to carry out many of their day-to-day functions. It has three main divisions:

  • Its acceptance division enables businesses to authorize and settle payments and obtain data on those transactions. It largely provides these services for acquiring point-of-sale merchants and other digital businesses.
  • The Payments business helps banks and other businesses process digital payments from debit, credit and prepaid cards, as well as non-card transactions, such as bill payments, account transfers, P2P transfers and electronic invoicing.
  • Fiserv’s fintech division provides the core processing technology that helps banks and credit unions run day-to-day functions so they can process day-to-day lending and deposit transactions.

Image source: Getty Images.

Fiserv is one of the leading core processors in the US, with 40% market share in 2020. The problem with traditional core processors is that they have been using legacy technology for a long time. Financial institutions have long complained about the difficulty of implementing more modern systems and the time it takes to deploy some of the new digital banking products that banks now need to compete with more nimble fintech companies.

James Mahan III, CEO of Live Oak Bancsharesa well-known banking industry disruptor, described what it was like to work with major core processors in a 2019 article in Bank director:

It just seemed like every time we wanted to do something, it was impossible. It’s “Stand in line and write a big check”. And it’s really, basically, putting lipstick on a pig.

Fiserv’s fintech division has struggled to grow revenue in recent years. Segment revenue was essentially flat between 2018 and 2020, while revenue from the company’s acceptance and payment business grew very well. Fiserv appears to be on track to increase fintech division revenue this year, but not by much.

Where Finxact comes in

Finxact has been considered one of the biggest disruptors (if not the biggest) of the major core processing companies. The startup has created a cloud banking central processor based on application programming interfaces (APIs), which banks can use to digitize all their operations and leverage machine learning and artificial intelligence.

APIs allow banks to better partner with fintechs because integrating their systems is easier. Additionally, Finxact’s central processor operates in real time, so transactions are always balanced and manual processes are eliminated. Ultimately, Finxact’s core enables banks to deploy new digital banking products much faster than older processors, and enables banks to truly leverage their data, whether that’s gaining insight or accessing quickly to past transactions.

Announcing the acquisition, Fiserv CEO Frank Bisignano said, “Through this combination, Fiserv will create a streamlined path for customers to deliver digital solutions to their customers. Finxact is also enhancing our ability to support a growing number of financial institution and corporate clients.

For many years now, it seems that some financial institutions have been frustrated with large core processors because they sign long contracts with them, and it can take a while to roll out innovative new products. Fiserv knows this because it actually invested in Finxact a few years ago. Not only has Finxact been seen as the top disruptor in the core processing space for financial institutions, but some banks like Live Oak and first horizon moved to cloud-based architecture.

The acquisition of Finxact helps Fiserv eliminate a potential competitor down the line, better positions the business for the future and allows management to show customers that it has heard their calls for change and can now respond more adequately.

Is Fiserv a buy?

With Finxact, investors can feel better that one of Fiserv’s core business areas is now on a much better growth trajectory, especially considering that the industry is moving towards API-based processors like Finxact. Its other acceptance business is also showing strong growth with its point-of-sale technology.

Fiserv is trading at around 16 times projected earnings this year and around 4 times projected revenue. Considering that each of its business sectors now has good growth potential, I would rate the stock as a buy.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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