Pressure on core transaction processing pricing has been a fact of life for financial services technology vendors for several years and one result has been increased consolidation among participants in the business.
The past two years saw top-tier vendors become extremely active in mergers and acquisitions. More recently, that activity has shown signs of extending to midtier players who are looking to gain scale.
One acquisition-minded company, the software maker Open Solutions Inc. of Glastonbury, Conn., the No. 7 core provider, closed a financing deal last week that raised nearly $140 million of convertible debt.
Also last week, Harland Financial Solutions Inc. announced an agreement to buy Intrieve Inc., which would make Harland the No. 5 core processing vendor. Meanwhile, speculation has been building that the current No. 5, Bisys Group Inc., will leave the business by way of a unit sale.
Louis Hernandez, Open Solutions' chairman and chief executive, said debt and available cash would give his company roughly $200 million to pursue deals.
Mr. Hernandez said his company plans to expand its core business operations by buying some of his direct rivals. It also plans to diversify to compete with companies that do more than process banking transactions, he said.
"Most of our competitors live extensively on cross-selling," Mr. Hernandez said. And though much of the company's growth to date has come from deals with banks replacing their core systems, he says it is important for Open Solutions to "broaden our product suite."
Carla N. Cooper, an analyst at the brokerage firm Robert W. Baird & Co., called that a sound strategy. Buying core rivals would provide only limited growth for Open Solutions, she said, and "I would like to see them direct those funds at ancillary products, where they could get some faster growth."
Cornerstone Advisors Inc. says a big reason for core processing's lower revenue growth is banks' all-time low spending on it
The Scottsdale, Ariz., consulting firm's latest Cornerstone Report said midsize banks on average spent 7.7 basis points of their assets on core processing in 2003, versus 9 basis points in 2002 and 9.7 in 2001. Cornerstone defines core processing as accounting systems for deposits, loans, and general ledger.
"Spending on core is in a nosedive, and we expect that to continue," said Carl Faulkner, a principal at the firm. Vendors' margins are shrinking, price competition is heating up, and banks are increasingly taking core processing as a given, he said. They are choosing vendors that can best provide ancillary products and services, he said.
"The core part of these products has really become a commodity," Mr. Faulkner said. He compared it to selling razors and blades - these vendors "should take the Schick strategy and give away the core and make their money on ancillaries."
Leslie M. Muma, the president and CEO of Fiserv Inc. of Brookfield, Wis., by far the largest core provider, said landing these processing deals is crucial because they can create cross-selling opportunities.
For example, a provider of automated teller machine services might struggle to sell a customer on its Internet banking or check processing, but "if you have the core processing, you have an excellent chance to get the rest of it," Mr. Muma said. Core processing is "the key to the rest of the relationship."
Ms. Cooper at Robert W. Baird said in a research note last month that Bisys might sell its bank processing unit, which resells Open Solutions' technology to its clients. Though it is one of the New York company's most profitable units, it has limited growth potential, she wrote.
In an earnings conference call two weeks ago, Bisys president and CEO Russell P. Fradin did nothing to quell talk of a possible sale of the business.
Asked by an analyst about possible divestitures, Mr. Fradin would only say, "I'd rather just let it play out."
The only business line he mentioned was fund processing. "Investment services is clearly at the center of where we see a lot of the opportunity," Mr. Fradin said. "We want to be buyers there."
Bisys spokesman Daniel Briggs said, "We do not comment on rumors, and we do not comment on any specific businesses."
Craig Peckham, an analyst at Jefferies & Co., said Bisys has a difficult call to make on banking. Unlike fund processing, where the company is a leader, or insurance, where profit margins are growing, core processing has neither of those advantages.
Still, "it's a great cash-flow business. That makes it a tougher decision," Mr. Peckham said in an interview. On the other hand, with core competitors grabbing for market share, "it's a seller's market," which could make divesture more attractive.
