TSYS Builds Warchest for Deals, Could Shift Strategy

Total System Services Inc. has accumulated a substantial pool of money earmarked for acquisitions, and with its core transaction processing business in decline, observers speculate that it may want to expand its merchant acquiring operation.

The Columbus, Ga., processor told analysts Tuesday that it is "aggressively" pursuing acquisition opportunities and had $420.1 million in cash and cash equivalents as of the third quarter.

"We're certainly anxious to put together a plan … that makes sense both strategically and financially," Philip Tomlinson, TSYS' chairman and chief executive, said during a conference call to discuss its third-quarter results.

TSYS has considered and taken a pass on multiple agreements, he said, and it bid on some opportunities, but he would not discuss any specific deals that may be in the works. "We're looking for targets that will provide long-term growth," he said.

Darrin Peller, an information technology and computer services analyst at Barclays Capital, the investment banking division of London's Barclays PLC, said that TSYS has "more than enough to make a nice-sized deal. The challenge is finding the right candidate."

He said that most of TSYS' current business is working with issuers but speculated that it may be interested in buying a merchant acquirer to expand its TSYS Acquiring Solutions division.

Processing transactions for issuers "only generates one to two cents per transaction," Peller said. But with a larger acquiring operation, TSYS potentially could earn 30 cents to 40 cents on some transactions, if they did the processing for both the merchant and issuer.

However, he noted that TSYS has talked about dealmaking for some time. "If you look at conference call transcripts for the past two years, they have been saying they want to make an acquisition," he said.

Mike McCormack, the president of Palma Advisors LLC, a Fort Lauderdale, Fla., consultancy, said that TSYS might want "to change strategies, from pure processing on the acquiring side, where they make a couple of cents per transaction, to get" bigger in acquiring, though the company has not explicitly discussed such a shift.

Analysts said that TSYS' main processing business is shrinking after several large client losses.

The number of accounts on file shrank by 3.8%, to 342.1 million, in the third quarter compared to the year earlier. TSYS added 29.6 million accounts from internal growth and 25.7 million from new clients but lost 31.3 million as clients purged their customer rolls and issuer-clients were bought, as well as 37.4 million in deconverted portfolios.

TSYS "is focused on dealing with overcoming the large loss of several large clients … primarily to financial difficulties and credit issues with the banks," Tomlinson said. The losses include Washington Mutual Inc., which sold its banking operations to JPMorgan Chase & Co.; Wachovia Corp., which was bought by Wells Fargo & Co., and Charming Shoppes Inc., which sold its portfolio to Alliance Data Systems Corp. A prospective loss at Bank of America Corp., which plans to shift some of its portfolio to a joint venture it formed this year with TSYS' processing rival First Data Corp., "does create a big hole," he said.

Peller said the number of accounts on file is the "most important underlying driver of the business, and [the decrease] shows the market is still challenging."

TSYS has signed 21 letters of intent for new business and believes the associated accounts could potentially offset the company's recent losses, said Tomlinson.

However, "the uncertainty in the market is inhibiting them from signing contracts," Peller said, and it is "challenging their revenue growth."

Overall, TSYS reported a 14.2% drop in third-quarter net income, to $55 million, from the year earlier. Revenue fell 1.6%, to $432.3 million.

North American cardholder transactions shrank 8.1% in the quarter, to 1.6 billion. International cardholder transactions dropped 10.1%, to 299.7 million.

The North America services segment reported $253 million in revenue, down 8.8%. Revenue from the international services segment fell 2.2%, to $85.9 million. Merchant services revenue grew 25.7%, to $93.4 million.

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