First Data Reduces Loss Despite Merchant-Acquiring and Debit Card Headwinds

Leading payment card processor First Data Corp. on Wednesday reported it lost less money in the first quarter than it did a year earlier despite price compression in its merchant-acquiring business and slow debit card transaction growth.

Atlanta-based First Data typically posts an operating profit but a net loss after paying interest on the massive debt it incurred from its $29 billion leveraged buyout by Kohlberg Kravis Roberts & Co. in 2007. For 2014’s first quarter, the net loss was $200.5 million, a 41% improvement from $337.4 million a year earlier, outgoing chief financial officer Ray Winborne told analysts in a conference call. Earnings before interest, taxes, depreciation, and amortization (EBITDA) came in at $613.5 million, up 18% from $520.4 million in 2013’s first quarter. Offsetting most of that in the recently ended quarter were interest payments totaling $467.1 million.

The improved operating profit resulted from a 2% increase in total revenues to $2.64 billion as well as a $65 million reduction in expenses. First Data’s biggest business, its  merchant-processing segment that it recently renamed Merchant Solutions from Retail and Alliance Services, generated adjusted revenues of $856.4 million, down 1% from $861.4 million in 2013’s first quarter. Transactions grew 5% but, reflecting price competition in the acquiring industry, revenue per transaction slipped 4%. Still, partly aided by reduced expenses, the segment’s EBITDA margin improved to 43% from 41% last year.

Much of the price compression reflects the continuing shift by acquirers to more transparent interchange-plus pricing for merchants, in which the processor spells out its interchange expenses from the payment card networks and then adds its profit margin. Such pricing plans are supplanting higher-margin pricing for small merchants in which the acquirer rolls interchange and its margin into a package where interchange is harder to discern. Roughly 86% of First Data’s volume is now priced on the interchange-plus model, Winborne said.

First Data chief executive Frank Bisignano said much of Merchant Solutions’ future growth will come from new services developed by companies it recently acquired, including the Clover Station point-of-sale product that includes a tablet and business-management software, and the Perka mobile-marketing and loyalty platform. On the flip side, Wal-Mart Stores Inc., the world’s largest retailer, will be shifting some of its U.S. card volume from First Data to Vantiv Inc. as part of a strategy to diversify processors.  When asked about Wal-Mart, Winborne said the retailer’s switch will affect transaction volumes but it will not have a material effect on First Data’s financials because no customer accounts for more than 1% of revenues. “We are incredibly well diversified,” he said.

Meanwhile, the card-issuer processing unit called Financial Services, long plagued by lackluster growth, turned in a solid performance with segment revenues up 5% to $348.7 million while operating profits jumped 40% to $173 million. The improving results were produced in part from more active accounts on file, up 15% to 160 million because of new business wins and organic growth, and reduced expenses.

But parts of the segment, which includes the Star electronic funds transfer network, had their struggles. Debit card issuer transactions grew only 1% to 2.7 billion. Star, like many other PIN-debit networks, is still adapting to market conditions radically changed by the Durbin Amendment in 2010’s Dodd-Frank Act, which gave merchants more debit card transaction routing choices. Visa Inc.’s industry-leading point-of-sale PIN-debit business suffered a big hit when the Durbin Amendment took effect in 2011, but is now in growth mode as a result of Visa’s multifaceted post-Durbin debit strategy. Observers believe MasterCard Inc. also has picked up debit card market share. That’s forcing competitors such as Star to respond.

“Growth from the secular shift from cash and check to debit was offset by attrition in the debit-processing business and lower network volumes on merchant-driven routing decisions,” Winborne said. “To enhance competitiveness, we began rolling out a new PINless debit product in first quarter. We’re excited about the prospects based on the early returns.” Winborne said First Data also introduced a transaction-routing incentive program, but he did not provide details.