Bryan Keane, an analyst at Prudential Securities, expects financial institutions to continue to outsource technology over the next five years and create a significant opportunity for transaction processors.
The trend to outsource will continue to accelerate, especially in difficult times, Mr. Keane said in an interview Thursday. Financial institutions have less money to spend on internal staff and building internal systems to keep up with technology. Theyll outsource to some of these processors that have expertise in streamlining data, helping them save cost so they can focus on core competencies.
Even when the economy recovers, outsourcing will continue to increase, because banks will not want to spend time and money on in-house technology, he said.
Prudential expects financial services companies to spend $130 billion on information technology services next year, 35% of it on outsourced services. This external spending will grow 12% from this year, the firm projects.
Companies are always trying to make better decisions about business operations, looking at the return on investment, and we believe that larger corporations are starting to catch onto the outsourcing concept, Mr. Keane said. Transaction processors have the opportunity to save the financial industry over $500 billion of excess costs associated with distribution inefficiencies, duplication, and errors in processing.
On Nov. 30 Prudential initiated coverage of nine transaction processors First Data Corp., Concord EFS Inc., Bisys Group, Jack Henry & Associates Inc., Fiserv Inc., SunGard Data Systems, DST Systems Inc., Automated Data Processing, and Paychex Inc.
The nine companies have relatively stable recurring revenue bases, and their average earnings should grow 19% over the next five years, Mr. Keane said.
Processors use cross-selling opportunities within their customer base to increase sales, he said. Once a processor becomes a vendor for a financial institution, it is difficult for another vendor to come in, since there are high barriers [for the financial institution] to exit such a relationship, he said.
These technology vendors serve companies in five primary industries payments, banking, brokerage, payroll, and insurance and Mr. Keane said the banking and payments markets have the most promising 12-month outlooks. Banks IT budgets are pretty stable, unlike brokerages.
Banks will spend 10% more next year on outsourced IT services than this year, he said. Most financial institutions have the opportunity to be the anchor for consumers on the Internet, and its up to transaction processors such as Bisys, Jack Henry, and Fiserv to provide the back-end technology to make that possible.
Fiserv, one of the largest outsourcers of core processing systems for banks, will continue to dominate the market and gain market share over its estimated 50 competitors, Mr. Keane said.
Unlike his optimistic forecast for bank processing, he has concerns about mergers and acquisitions. Bank consolidation will continue at a 3% rate over the next five years, according to Prudential estimates.
If consolidation occurs in the industry, transaction processors can be hit by the loss of a large customer and the associated revenue earned from it, Mr. Keane said.
First Data and Concord are the best-positioned to capitalize on the electronic payment market, he said. First Data will benefit from its growing international money transfer business, and Concord from the growth in debit payments and its electronic fund transfer system the nations largest, he said.
The number of online and offline debit card transactions are growing 30% a year, Mr. Keane said. Even if a consumer spends a little less this year, the accelerating growth of electronic bill payment helps to offset that slowdown.
However, he says he is less enthusiastic about SunGard and DST Systems, processors that primarily serve the brokerage industry, which has been hit by the recession. We are cautious on this industry until we can see a rebound in budgets.
Last year was pretty good for investment banking firms, because the healthy flow of initial public offerings and M&A activity provided enough money to fund sizable IT budgets, but this years market has been different, he said.
People are more conservative this year, Mr. Keane said. With purchase decisions being delayed and budgets being cut quite drastically, we expect the revenue opportunity for the industry to be flat, down 5%.
However, in our view, the transaction processor group has been one of the best plays in technology, through both bull and bear markets, he said.
From January 2000 to November of this year the Prudential Transaction Processing Group consisting of 20 major data processors stocks rose about 46%, while the Nasdaq composite fell 53%.
