Small-Bank Niche, Key Deals Have Been Good to Nova

Nova Information Systems Inc. chief executive officer Edward Grzedzinski fondly recalls a lesson from the early days of his company.

It was just five years ago. He and a national sales manager were pitching a merchant processing program to a community bank in Michigan.

"There were three people representing the bank, and the senior guy said, 'Well, did you bring the contract?'

"We were a little stunned," the Nova CEO said. "Most of us were used to bigger customers, where you have to make three or four calls and then you put a contract into their legal department for them to review.

"The guy who was our national sales manager said, 'No, but we can send one to you,' and the customer said, 'We could have signed it today and gotten started.'"

Mr. Grzedzinski, 41, heard this everywhere he went. Small banks had been trying for years, without success, to get the major merchant processors to pay attention to them. Atlanta-based Nova wanted to fill the breach.

"We found out there was vast opportunity at the community bank level," Mr. Grzedzinski said. "Small banks had essentially been ignored - and still are by all of the big payment processors."

Nova has become one of the big ones, jumping in the last year from 12th place to eighth with a 66% volume gain, to $12 billion in annual transaction volume. It serves more than 80,000 merchants.

Nova says technology, a commitment to customer service, and a willingness to work with banks of all sizes set it apart.

"We were able to start with nothing in place," said Steve A. Hughes, Nova's senior vice president of technology. "And that was a tremendous asset."

More commonly, he said, merchant processing companies are cobbled together from acquisitions, but "we were purposely designed as a transaction processing system for financial transactions."

A multibillion-dollar processing arrangement announced a year ago with First Union Corp. put other transaction processors on notice that Nova is a force to be reckoned with.

"There is an opportunity for someone to establish themselves as an alternative to First Data Corp.," said Richard Weingarten, principal of Montgomery Securities. "Nova with First Union was the first big alliance without First Data Corp."

As the industry leader, First Data has emphasized what it calls merchant bank alliances.

Mr. Grzedzinski, William D. Kinard, and about a dozen other former executives of a competing Atlanta-based processor, National Data Corp., founded Nova in 1991. They believed the technological basis of merchant processing was changing, and they wanted to be in step with the times.

Mr. Kinard made a deal with Jackson, Miss.-based WorldCom in 1991 to commit $3.5 million of seed money. (He left after two years and is now chief executive officer of Termnet, an Atlanta-based independent sales organization and the No. 10 nonbank processor of bank card transactions.)

WorldCom, then called Advanced Telecommunications, also provided the communications backbone that turned out to be one of Nova's important assets.

"One of their greatest strengths has been their access to low-cost communications," said Richard Robida, senior executive vice president at Speer and Associates. "That kind of gives them a leg up on some of the big guys.

"It's a transaction-processing business, and the single largest component when you get down to your per-transaction cost is the communications piece."

Mr. Grzedzinski said Nova's communications link let it get into the business while making "substantially less capital investment than someone who had to do everything from scratch."

The WorldCom deal was followed in November 1991 by $29 million of venture capital from E.M. Warburg, Pincus and Co., New York. The money was earmarked for acquisitions.

Joseph P. Landy, managing director of Warburg, Pincus Investors, said the firm became interested in Nova because it could "bring new technology to bear" on the "consolidating merchant credit card processing industry" and gain "competitive advantage."

Nova's first acquisition, made the month after the Warburg commitment, was of Interbank, an independent service organization in Knoxville, Tenn., that today is Nova's core operations center.

From 1992 to 1994, Nova acquired other ISOs - the sales agents that procure processing services for smaller merchants - and bank portfolios of increasing size.

In 1992, Nova bought MBNA Corp.'s retail merchant portfolio, $1.4 billion of sales. It later acquired Bank of Boulder's $2.5 billion portfolio and others from Regions Bank, Bank of the West, City National Bank of Beverly Hills, and several community banks.

Last year Nova acquired three ISOs: Bancard USA Inc., Seattle; American Bankcard Association, Denver; and Automated Merchant Systems, Salt Lake City.

But the company's biggest turning point was its 1995 agreement with First Union.

The Charlotte, N.C., banking company's acquisition of New Jersey-based First Fidelity Bancorp. had built a combined merchant processing base of $4.6 billion.

Mr. Grzedzinski called the First Union deal, in which the bank bought a 30% stake in Nova, "the most significant transaction that we've done. We also went into the land of the giants on that one."

Nova competed for First Union's business against several major players, including First Data, National Processing Co., and First USA Paymentech.

Mr. Grzedzinski said First Union had been looking for a "true partner" that would "allow them to maintain, and encourage them to maintain, a very active role in the business."

That contrasted, he said, with "First Data's version of an alliance" - a joint venture in which "FDC pays some money on the front end for the rights to process on their platform and then does some contract distribution among their alliance partners. But from what we can tell, the financial institution really loses control of the business."

Industry experts said First Union had not been likely to get into bed with First Data because of the latter's close relationship with archrival NationsBank Corp.

"We identified them as being a company with high technology," said Fred M. Winkler, First Union executive vice president, card products. Nova was "not bound to systems which were inflexible or outdated. Their new technology was leading the way into the future."

Mr. Winkler said First Union's equity position gives it necessary influence while reducing its cost of doing business. "We don't want to lose our customer base, the springboard of our commercial banking efforts," he said.

Nova's initial public stock offering last May caught the updraft from other successful merchant processing issues, including those of First USA Inc.'s Paymentech spinoff and PMT Services.

Mr. Grzedzinski called it "the best time that anyone could ever remember for an IPO, in an industry that the market was very pleased with."

"The consolidation of our business with First Union's and First Fidelity's," he said, "and the economic performance and momentum that those transactions gave us, really made us more than just a mildly interesting new public offering. It put some weight and momentum behind the whole thing."

Nova had planned to sell 3.5 million shares, at $12 to $14 a share. Underwriters Alex. Brown & Sons Inc. priced the shares at $19, however, and they moved as high as $29 the day of issue. Mr. Grzedzinski said Nova wound up selling four million shares and raising more than $100 million.

But experts said Nova must undertake further acquisitions and alliances to remain attractive to investors.

"People are waiting for an acquisition," said Montgomery Securities' Mr. Weingarten. "They haven't made one yet. Given their reputation and the market environment, there is an opportunity to do that."

Mr. Robida of Speer said alliances are still a weak point for Nova and should be the priority. "They still, in some circles, have a reputation of just being an ISO," he said. "I don't think many people even know of their affiliation with First Union, for example."

Mr. Kinard said he had left Nova because he felt the company's acquisition pace had slowed. Part of the problem was that Warburg had committed substantial money and "wanted us to digest the acquisitions we had made.

"I did not feel like we needed to slow down."

Warburg's Mr. Landy disagreed, saying the money was earmarked for acquisitions "on a case-by-case basis."

Nova currently has six bank alliances and 150 agent bank arrangements. It plans to get into merchant processing on the Internet and recently signed a contract to design an electronic fuel card system for the Department of Defense.

"Our goal from the beginning has been to get into the top five in our industry," Mr. Grzedzinski said. That would mean leapfrogging First Bank System Inc., National Data Corp., and First National of Omaha. But the top five, Mr. Grzedzinski said, "are going to be the survivors when this consolidation era ends."

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