The gravitational pull toward M&A is claiming some of the industry’s biggest merchant processors. Are more mega-deals inevitable?
There’s nothing new about mergers and acquisitions in the merchant-processing business. These combinations have been going on for years, after all, as acquirers seek to penetrate new markets or bulk up for economies of scale. But nowadays that urge is commanding bigger numbers than ever. And lately it has been mashing up processing giants with big-name buyers that come from outside the industry.
Just since January, the payments industry has witnessed the announcements of deals in which Fiserv Inc. proposes to buy First Data Corp. for $22 billion (“Fiserv’s Big Bite,” March) and Fidelity National Information Services Inc. (FIS) looks to snap up Worldpay Inc. for nearly twice that sum (“The Payments M&A Party Just Got Wilder,” April).
These aren’t, to say the least, penny-ante propositions. And most experts say the big-time dealmaking is far from over. “This is a trend,” says Jared Drieling, senior director of business intelligence at The Strawhecker Group, an Omaha, Neb.-based payments consultancy. “There will be more mega-deals.”
In With Innovation
The big questions are: What’s driving the trend, who will be buying, and who will be selling? The big driver is the insatiable appetite for growth—or “scale,” as the chiefs in charge of these companies put it. Scale, as they see it, cures many ills, unlocks geysers of new profit, and makes possible the crucial innovation that the payments business has come to depend on.
“Worldpay brings large-scale capability. It accelerates our organic growth trajectory on day one,” said Gary Norcross, FIS’s chief executive, on the day his company announced its agreement to lay out $43 billion to buy Cincinnati-based Worldpay, the country’s second-biggest merchant processor. “We want to make sure we have scale to compete not only now but in the future.”
But this is not a push for bigness for the sake of bigness. There is method to the mad money. One of the biggest imperatives behind these combinations can be summed up in one word: innovation. And much of that these days is coming from relative newcomers.
Square Inc., for example, emerged 10 years ago with a simple card-reading dongle that flea-market sellers and food-truck managers could attach to a smart phone. Since then, it has added sleek new devices and funding options whose appeal has attracted more than 2 million merchants and launched the company to the threshold of the 10 largest processors in the country.
Meanwhile, other so-called fintechs like Adyen, Stripe, and Shopify emerged with technologies that won loyalty from merchants and plumbed new depths in e-commerce.
While companies like these aren’t yet threatening to break into the top 10, their fast growth has demonstrated the value of innovation, both in technology and in strategy, by focusing on markets neglected by the big providers. “First Data is a very large acquiring entity, but it opened the doors to the Squares of the world,” says former First Data executive Drieling.
But not for long. When strategists saw how merchants were responding to Square, First Data in 2012 bought a Square rival called Clover. By last September, the company had shipped 1 million Clover devices, doubling the cumulative number in only two years. Now that fast-growing technology is on the cusp of belonging to Fiserv, which until this year operated chiefly in a business—core processing for banks—that couldn’t be more removed from merchant acquiring.
‘The Second Inning’
Closely related to the imperative for innovation is the push into another rapidly growing market, that for integrated payments. Here, the major player is not so much the independent sales organization selling merchant services as the software developer offering to tie payments into business systems that might also track time and attendance or sales volumes.
These integrators, called independent software vendors or ISVs, have grown into a major component in the payments chain. And they’ve touched off a scramble to control payments integration via acquisition.
Both First Data and Worldpay, formerly known as Vantiv, have hoovered up ISVs over the past few years, and now, assuming the deals go through, Fiserv and FIS will be the beneficiaries.
“Payments is being integrated, and it’s not going to stop. It’s probably only in the second inning,” notes Robert Carr, chief executive of payments provider Go Beyond and formerly the CEO of Heartland Payment Systems Inc., a processor acquired by Global Payments Inc. in 2016 for approximately $4.3 billion.
Again, the imperative is for growth. ISVs, says Carr, “are going to be attractive to these big companies that have trouble growing.” ISVs also bring value to payments that businesses are willing to pay for, fattening transaction margins, says Carr.
Other factors could play a role in further M&A activity, and not just among the biggest firms. Besides top-down acquisitions, smaller players may be ready to post for-sale signs, hoping to attract larger would-be buyers.
“We’re seeing a lot of interest from small ISOs seeking out a larger home,” notes O.B. Rawls, president of Payment Processing North America for Paysafe Group, a top 15 processor and the largest privately held one.
Companies like Paysafe can provide sales technology and feed leads to ISO operations once they’re in-house. And the benefit to the buyer? Again, that “S” word surfaces. “Scale is more important than ever before,” says Rawls. “And it’s important for us at Paysafe to capture more scale.”
The company knows firsthand the value of the kind of instant growth mergers can bring. It is itself the result of acquisitions, including that of Merchants’ Choice in 2017 and iPayment Inc., Rawls’s former company, last year.
Factors external to the industry may also help fuel more M&A, observers point out. Take the Federal Reserve’s decision earlier this year to refrain from further interest-rate hikes. That decision brings some certainty to the cost of funds, and could be “very favorable for deals,” says Raymond Pucci, director of merchant services at the Mercator Advisory Group, Maynard, Mass.
But while instant—and big-time—growth is a major factor behind at least some deals, observers differ on what purpose that growth serves. For companies like Fiserv and FIS, the mega-deals they’ve wrought bring them immediate credibility in an industry in which they have had little or no presence.
Bigger scale brings benefits in operating and cost efficiencies. And those efficiencies arrive fast. When the Worldpay acquisition is consummated, Jacksonville, Fla.-based FIS will see its revenue grow by 46% to $12.4 billion virtually overnight.
The ‘Fourth Leg’
Still, observers differ on whether scale will help combat what some perceive as downward forces on revenue as savvier merchants negotiate harder for deals. The reason is that they differ on whether such pressure exists in the first place, at least for the larger firms. “Overall, there’s pressure on fees,” says Pucci. “Scale and volume is a way to mitigate when revenue comes under pressure.”
To be sure, in theory, the incremental transaction should cost less to process than the preceding one, and that should help margins, not hurt them. But whether most big firms are at that point or not, they’re simply charging plenty for their services, argues Carr.
“The idea that there’s a race to zero is laughable,” he says. “Margins per merchant account are higher than they’ve ever been. Merchants accept the increases in a surprisingly docile way.”
Whether margin pressure is reality or myth, not all big processors are ready to be steamrollered into a merger. Many observers point to Total System Services Inc. (TSYS), a Columbus, Ga.-based processor of both merchant and consumer card accounts, as a strong candidate for the next deal, either as buyer or seller. The logic is that the deal, if nothing else, would be a defensive move in the wake of the year’s two mega-mergers.
But the man who runs the company isn’t buying that idea. “Our model has proven quite successful. We don’t see a need for a fourth leg to our stool, and we don’t see anything changing here,” said M. Troy Woods, chairman, president, and CEO, during the Columbus, Ga.-based company’s January earnings call, which came in the wake of the Fiserv-First Data announcement.
But that was before the other shoe dropped with the FIS-Worldpay deal. The industry will soon find out whether that fourth leg is forthcoming for TSYS—or for rivals now contemplating a significantly changed processing landscape.