The Mega-Merger Nobody Expected

In a stunning announcement that surprised many observers last month, Fiserv Inc. struck a deal to acquire First Data Corp. with what the parties say will be the biggest ever such transaction in the payments and financial-technology businesses.

The all-stock deal, expected to close in the third quarter, values First Data at $22 billion and will bring to Brookfield, Wis.-based Fiserv major assets in merchant acquiring, including the fast-growing Clover smart-terminal unit.

It will also bolster both companies’ connections with financial institutions and expand Fiserv’s PIN-debit business by adding First Data’s Star network.

With the combination, the expanded Fiserv will boast annual revenue of some $15 billion but will also inherit a significant albatross—approximately $17 billion in debt Atlanta-based First Data has struggled pay down over a number of years.

Fiserv’s plan is to refinance the debt load as soon as the deal closes and then begin paying it off with free cash flow from the combined operations, said Fiserv chief executive and president Jeffery Yabuki in a conference call held jointly with First Data CEO and chairman Frank Bisignano on the morning the merger was announced.

Yabuki cautioned that the investment community has allowed First Data’s debt load to overshadow the importance of its payments assets. “We’ll still have that $17 billion in debt for a little while but it’ll be at a lower cost,” he said. “What we saw [in First Data] was a lot of debt but also major investments in the [payments] market. When we saw that, we said, ‘Wow.’ This is a misunderstood investment. It’s a lot of debt, but it’s a lot more EBITDA.” EBITDA is an accounting term referring to earnings before interest, taxes, depreciation, and amortization.

With the merger, Fiserv will generate some $4 billion annually in free cash flow by the third year of the merger, Yabuki estimated.

Yabuki will serve as chief executive and chairman of the united entity, while Bisignano will fill the role of president and chief operating officer and will be a member of the board of directors.

For his part, Bisignano cited two overarching benefits of the merger. “For years, we have had aspirations to deliver a compelling core processing platform,” and the combination with Fiserv fulfills that ambition, he said. The second benefit involves what Bisignano referred to as an immediate process of “deleveraging” First Data’s balance sheet.

With Fiserv’s assets in payments businesses like electronic billing, the merger will also allow First Data to market what Bisignano called “the largest and broadest merchant-services platform in the world,” which will now extend to some 20,000 bank branches served by Fiserv.

To spur new businesses, Yabuki said the combined company will commit $500 million over the next five years “to enable new sources of growth,” without being specific.

The announcement has stunned most observers, leaving some optimistic while stirring skepticism in others. “This combination creates an intriguing new entity in payments with the capacity to change the game for any and all banks and merchants other than the great big guys,” says Steve Mott, principal at Stamford, Conn.-based consultancy BetterBuyDesign, by email.

“It substantially changes the balance of power in the industry and will have huge implications, if the deal is approved, for several of the key product futures including PIN debit, faster payments, and digital commerce, among others,” Mott adds.

“The trick will be making this a strategic-marketing thrust and not just a cost-cutting exercise,” he says. “If it’s the former it could really energize the industry in a productive way.”

Others are less sanguine. “Surprise is the first word that comes out. Skepticism is probably the second word. It’s a big deal between two companies I never thought would come together,” says Lawrence Berlin, senior vice president at First Analysis Securities Corp., Chicago, where he covers Fiserv and monitors First Data.

Berlin cautions that managing First Data’s big debt load will be a more significant encumbrance than the two companies are saying publicly. “It’s a lot,” he says, adding that “Fiserv has a little over $5 billion [of debt] on their own. Bottom line, it’s going to be a ton of work to make this thing work.”

Still, Berlin sees “synergies” for the combination in person-to-person payments and in PIN debit, particularly with the combination of Star with Fiserv’s Accel network. “You can see there’s synergy, there’s overlap,” he says.

The terms of the deal call for First Data shareholders to receive a fixed exchange ratio of 0.303 Fiserv shares for each share of First Data common stock, representing a share price of $22.74 based on the Jan. 15 closing price. This is a premium of 29% to the five-day volume weighted average as of that day, the companies said. This formula will result in Fiserv shareholders owning 57.5% of the new company, leaving First Data shareholders with 42.5%.

The transaction is subject to customary regulatory approvals and the approval of shareholders.