First Data Filing Points to Break-up of Chase Paymentech

Talks under way between processor First Data Corp. and banking giant JPMorgan Chase & Co. indicate Chase Paymentech Solutions LLC, the world's largest merchant acquirer, might be split between its two owners, according to documents filed this week with the Securities and Exchange Commission. Greenwood Village, Colo.-based First Data, which owns 49% of Chase Paymentech, says in its annual report that the acquisition of First Data in September by private-equity firm Kohlberg, Kravis, Roberts & Co. amounted to a change in control that gives JPMorgan Chase, 51% owner of Chase Paymentech, the right to terminate the so-called merchant alliance that governs Chase Paymentech before the current alliance contract's scheduled 2010 expiration. Although Chase hasn't exercised its option to terminate and the owners are in discussions, the two sides are apparently wrangling over how to divide up the sprawling assets of Chase Paymentech, a mammoth processor with strengths in both card-present and card-not-present commerce. Because of the complexity of such a break-up, the process is one some experts say could take months to resolve, but it appears to be a likely outcome and one that may have taken on increased urgency since KKR's $29 billion takeover of First Data. “There is substantial doubt about the continued existence of the company in its current form,” says a statement from Chase Paymentech's auditor, Grant Thornton LLP, which is included in First Data's annual report filed with the SEC. A statement from Dallas-based Chase Paymentech essentially confirms that a new arrangement is likely, though its form is unknown. “It is our understanding that the review period for the joint venture was extended by 60 days to allow all parties to determine how they will operate as new business partners,” a spokesperson tells Digital Transactions News by e-mail. “We believe that during the extension JPMC [JPMorgan Chase & Co.] and KKR are continuing to explore the best options for a new working relationship that will bring exceptional advantage to merchants, employees, and business partners.” Michael D. Capellas, First Data's new chairman and chief executive officer, briefly mentioned the change-in-control provision Friday morning during a fourth-quarter earnings conference call with analysts, but he added little light to the issue beyond what was in First Data's earnings release. “Since our conversations are ongoing, we will not be commenting further on this issue,” he said. A spokesperson for JPMorgan Chase refused to comment. If they were to part ways, First Data has the right to get 49% of Chase Paymentech's contracts by value, and 49% of the alliance's sales force. First Data says the break-up would not have a material effect on its income from continuing operations, but it could lose access to the bank's brand and the referrals it gets for new merchant accounts from Chase's 3,000-plus branches. Chase Paymentech has about 600,000 merchants in its portfolio, which includes Wal-Mart Stores Inc. and many of the nation's biggest online and catalog retailers. Chase Paymentech processed 19 billion transactions in 2007 and handled $719.1 billion in bank card charge volume. The acquirer reported net income of $582.4 million in 2007, up 22% from $476 million the prior year, on revenues of $1.29 billion, up 7% from $1.21 billion in 2006, according to the auditor report. The possible split of Chase Paymentech has precedent. JPMorgan Chase chief executive James Dimon is a professed believer in doing as many back-office functions in-house as possible. Chase had outsourced the processing of its big credit card portfolio to Total System Services Inc. (TSYS), but Dimon took it in-house last year (Digital Transactions News, Jan. 18, 2007). Chase's processing platform, however, is based on licensed TSYS software. But an observer contacted by Digital Transactions News on Friday says trying to split merchant contracts and other assets is not a workable solution. “I'm mystified as to how they're going to carve it up,” says Steve Mott, an industry consultant and principal of Stamford, Conn.-based Better Buy Design. Instead, he sees the two sides eventually deciding to flip the current ownership ratio, handing First Data operational control of Chase Paymentech and giving JPMorgan Chase a long-term acquiring agreement with ultra-low fees for authorization and settlement. A key outcome in any break-up plan, however, will be control of Chase Paymentech's huge e-commerce business, Mott says. “What has everybody scratching their heads is who gets [that],” he says. “That's the crown jewel. If First Data got that it would put a lot of wind in their sales. Capellas, meanwhile, said at the analysts' call that First Data is well along in its plan to streamline operations with the goal of saving $200 million in annualized costs, in part by consolidating its disparate processing platforms. That's only part of it, though Capellas did not give details. “We do have more levers to pull,” he said. “We are working on plans for more improvements.” First Data's domestic merchant transaction volume was up 9% to 10% in the fourth quarter over the 2006 period, while PIN debit transaction were up 5%, below historical growth rates. Chief financial officer Kim Patmore, who announced today that she will leave First Data for personal reasons after 16 years at the company, attributed the slow growth to two banks leaving First Data's Star electronic funds transfer network. The company reported some wins for its troublesome card-issuer processing unit that has suffered from low margins and heavy competition in recent years. It renewed several major contracts, including one with Wells Fargo & Co. Wells had intended to deconvert its signature debit card portfolio, some 19.6 million cards, from First Data. Instead, Wells and First Data inked a multi-year renewal in February. Edward Labry, president of First Data's U.S. operations, reported that the merchant unit added 145,000 locations in the fourth quarter, and that price compression, while still a factor, has dropped “pretty significantly in just the past couple of months.”