Strategies: First Data After the LBO

Jim Daly

Five years after its momentous leveraged buyout, has First Data transformed itself into a toned-up competitor while confined to what some might say is debtor’s prison?

On Sept. 24, 2007, Wall Street’s legendary Kohlberg Kravis Roberts & Co. took leading payment processor First Data Corp. private in a $29 billion transaction that proved to be the last big leveraged buyout before the gathering financial crisis slammed the door on such deals.

Another processor, Ceridian Corp., managed to go private as that turbulent year closed, but Alliance Data Systems Corp.’s plans to be bought out by private-equity firm The Blackstone Group fizzled.

The KKR buy-out may have enriched First Data’s former shareholders and investment bankers, but it saddled the company with more than $22 billion in debt—almost nine times the amount on its balance sheet before the LBO.

Since then, First Data has managed to kick the principal-repayment can down the road through refinancing. But the company is paying nearly $2 billion a year in interest on its high-yield debt securities that in layman’s terms get “junk” ratings from the ratings companies.

The LBO’s five-year anniversary raises some interesting questions, most notably whether the huge debt has hurt First Data’s ability to compete in a fast-changing payments market. Or, did going private give First Data the time and resources needed to rationalize its sprawling empire of semi-autonomous subsidiaries built over the decades by chief executives Henry C. “Ric” Duques, Charles Fote, and then Duques again? Will the company go public again?

‘Poland Was Poland’

Payments veterans have mixed assessments of the KKR-owned First Data, but they agree it’s still a strong competitor. Bob Philbin, an independent consultant and a former senior vice president in merchant processing at First Data archrival Total System Services Inc. (TSYS), notes that, technology aside, the payments business is all about relationships between banks, merchants, processors, and independent sales organizations. First Data, sometimes accused by ISOs of sporting an imperial attitude, has gotten better at that, according to Philbin.

“They’ve done a great job in analyzing what it takes to be successful in this industry,” he says. “What they’ve done extremely well is develop relationships that sustain business and create growth opportunities. Everyone in the industry thought they were going to lose focus. They didn’t lose focus.”

But perhaps First Data is not as strong a competitor as it would be if some of the money it spends on interest went into more research and development, marketing, and other channels that drive business growth.

“They haven’t stopped product development, but I think there is still an opportunity cost if you’re paying over $1 billion in interest,” says consultant and former Visa executive Eric Grover, principal of Minden, Nev.-based Intrepid Ventures. “There’s stuff you haven’t done.”

Philbin, while assessing that “five years later they’re a better company than they were,” agrees “they’d be further along if they had more cash.”

The before-and-after difference is subtle, but Philbin points out as an example First Data’s role as trusted service manager for Google Wallet, the mobile-payments venture of Google Inc. Perhaps a less-leveraged First Data would have developed a soup-to-nuts wallet itself rather than strike up a partnership with another provider.

“By them being this burdened with debt, they’ve had to bring in players that they wouldn’t have needed, like a Google,” says Philbin. “They don’t have the same level of R&D that they used to. They’ve identified partners that can serve the ever-changing market.”

Grover also notes that the formerly acquisitive First Data isn’t shopping as much as it once did. Over about 20 years, First Data in the U.S. alone gobbled up such payments giants as Card Establishment Services, First Financial Management (which brought Western Union under its wing from 1995 to 2006), Concord EFS, and Cardservice International, among others.

For more than 11 years it co-owned Chase Paymentech, the world’s largest acquirer, with JPMorgan Chase & Co. In 2008, Chase, as 51% owner, exercised its option to separate from First Data.

First Data also bought its way into many foreign markets. “They have been noticeably less aggressive in expanding their footprint overseas since 2007,” says Grover.

KKR maintained before the LBO that First Data, with its Amazonian stream of revenues, would have more than enough cash flow to service the new debt. And First Data’s chief executive, Jonathan J. Judge, is emphatic today that the LBO did not shackle the company with an undue burden.

“The debt has not had an effect on us in any noticeable way,” he says. Judge concedes “it is a lot of debt, no question about it.” But he quickly adds: “We clearly have the ability to handle the debt.”

Regarding the relative quiet on the acquisition front, the company’s top brass readily concedes that point—and for good reason. In the U.S., the process of fully integrating all the acquired companies into one efficient processor was never completed. Abroad, the operations in each of the 37 countries in which First Data operated in 2007 functioned independently of one other.

“Poland was Poland,” says Judge. “There really was not a lot of integration. That’s dramatically different today.”

‘A Good Era To Be Private’

After the buyout, KKR was much more interested in unifying the company and spurring organic growth than in making new acquisitions, according to Judge and Ed Labry, Concord’s former president who is now president of First Data-North America, the unit that brings in 85% of the company’s revenue, and who oversees the company’s huge merchant-processing business.

“I think it would be fair to say the organization was marbled with redundancies,” says Grover.

Not surprisingly, rationalizing First Data’s operations became the top priority of the KKR-installed management team that took over in 2007. That team was led by Michael D. Capellas, who earlier had headed telecommunications company MCI Inc. and PC maker Compaq Computer Corp. Capellas left in 2010, with Accenture veteran Joe W. Forehand taking over for a few months on an interim basis. Judge, the former chief executive of payroll and human-resources services company Paychex Inc., became chief executive in September 2010; Forehand remains as chairman.

The operational integration is far along, although First Data still has 28 end-to-end processing systems globally. In 2007, First Data had 34 data-processing centers and 16 so-called “command centers,” which provide transaction monitoring and management, around the world.

Today, the 13 U.S. data centers have been consolidated into three—two in Omaha, Neb., and a back-up facility in Chandler, Ariz. And what the company calls a “handful” of satellite command centers in various countries now support a global command center in Omaha.

Similarly, the many front-end platforms in the U.S. for authorizations and related functions that First Data operated as a result of acquisitions is down to four, with esoteric names that would be good candidates for a merchant-acquirer version of the TV game show Jeopardy: North, South, Buypass, and Omaha.

Although the recession poured cold water on the payments industry, especially the credit card side, Labry says the years after the LBO proved to be just the right time to take on the consolidation job since the company no longer had to worry about earnings and revenue growth every quarter.

“It was probably a good era to be private, you were able to concentrate on the business,” he says.

Another job was shoring up profitability in First Data’s Financial Services division, which includes the Star debit network and card-processing services for issuers of bank debit and credit cards, and store cards (First Data issues about 75% of U.S. retail cards, according to Labry).

Issuer processing has long been plagued by thin margins and heavy competition. Things got especially tough in 2008-09, according to Labry, when financially stressed credit card issuers closed accounts or reduced the credit lines of many customers.

The mild economic recovery has helped the rehab effort; in fact, credit card usage has been on a roll of late, according to figures from Visa Inc. and MasterCard Inc. That’s helping out issuer processors such as First Data and TSYS that live or die based on the volume of transactions going through their massive computer systems.

“I think you’ve seen just a dramatic shift, really, in the last 18 months,” says Labry.

Issuer processing, however, remains a tit-for-tat game often driven by price concessions to clients. First Data got a big win recently when retailer Kohl’s Corp. switched its business to the company. But Chase deconverted the former Washington Mutual card file, a $100 million piece of business for First Data, and Wells Fargo & Co. is deconverting its big debit card portfolio.

In its 2011 annual report, First Data said that, as of Dec. 31, it had 58 million new accounts in its pipeline, most of them retail cards, which will help offset deconversions.

Ready To Play

First Data is more toned up today than it was in 2007, and seemingly better able to recover from such blows. Besides the operational consolidation, head count is down 11%, and the number of countries the company operates in is down by three—goodbye Pakistan, Turkey, and France. But other key measures, including merchant locations served and revenues, are up. Profits, as measured by earnings before interest, taxes, depreciation, and amortization (EBITDA), got whacked in the recession but are on the comeback trail.

And despite all the interest payments, First Data spends a not inconsiderable $400 million a year developing new products and services. One of the newer ones is OfferWise, a service that delivers electronic coupons and promotions via mobile devices and payment cards.

The company continues to emphasize its security services, with demand spurred in no small measure by the years-long but still incomplete adoption by merchants of the Payment Card Industry data-security standard (PCI). Several hundred thousand merchants use First Data’s data-encryption and tokenization products, according to Labry.

“Definitely security is on the minds of customers,” he says.

First Data also is adding to its FD line of proprietary terminals and related point-of-sale hardware (“The Allure of Private-Label Terminals,” July). It recently introduced a PIN pad called the FD35.

In fact, First Data is ready to play in any mobile or new payments segment where it sees an opportunity, according to Judge.

“We’re about as excited as one could get,” he says. “We’re the biggest company by far … we think we have the ability to play a fairly significant role.”

Nor is First Data passing on new international opportunities. It formed a merchant-acquiring alliance with ICIC, India’s largest private-sector bank, in 2010, and last year it formed its first acquiring venture in the United Kingdom. This spring it bought out the remaining stake that it didn’t own in Irish processor OmniPay.

‘They Set the Pace’

Now, back to all that debt. Two years ago, the company’s repayment schedule called for a whopping $15-billion-plus to mature in 2014 and 2015. Thanks to amendments to its lending agreements, most of that has been postponed until much later, with $3.39 billion now due in 2014 and $1.5 billion in 2015. Some $5.24 billion in debt matures in 2016.

Somewhere along the line, a whole lot of the debt likely will be converted into equity.

“We do need to have a de-levering event at some point,” says Judge. “Clearly, we’re on a path to an IPO. We have a very detailed plan.”

The particulars of such an IPO, including when it will happen, remain a secret known only to First Data and KKR. Profit growth is the surest path to a de-leveraging event, but the weak economic recovery undercut growth in adjusted EBITDA, which First Data hopes to get up to $3 billion a year. Adjusted EBITDA amounted to $2.25 billion in 2011, up 11% from $2.03 billion in 2010.

And when an IPO or related event happens that frees First Data from much of its debt, competitors better watch out. Says consultant Philbin:

“I’m not sure what the final chapter on the investment is, but they are the lead player in this industry, they set the pace and they set the standard.”