Shift to Discount Stores Hurts First Data, But New Products Await

Merchant transaction volume increased by a healthy 11% at processor First Data Corp. in the second quarter, but a marked shift by consumers toward debit cards and spending at big discounters lowered margins at the card industry's biggest processor. Debit's growth has been outpacing credit's for years, but in a conference call with analysts on Thursday, chairman and chief executive Michael D. Capellas gave a partial demonstration of what that means for First Data. He noted that credit card transactions processed by the company's Merchant Services unit grew 8% but PIN-based debit card transactions rose 21%. Total domestic merchant transactions totaled 7.02 billion, a 673 million increase from 6.35 billion in 2007's second quarter. More of those transactions originated from national discount retail chains, a merchant category that generally pays less for card processing than smaller retailers. “As a result, in the second quarter we experienced lower average revenue per transaction, which created some pressure on margins,” Capellas said. The merchant unit's segment revenues of $1.03 billion nominally were up 8% from a year earlier, but flat when reimbursable expenses and costs associated with private-equity firm Kohlberg Kravis Roberts & Co.'s $29 billion buyout of First Data last September are backed out. Operating profits of $109 million were down 2%. Still, the merchant segment hummed along in other respects. Greenwood Village, Colo.-based First Data added 175,000 domestic merchant locations, 25 independent sales organizations, and 11 referral partners in the second quarter. Capellas said the company is well along in consolidating its merchant platforms, but is doing so at a deliberate pace so as not to disrupt customers. Edward Labry, head of First Data's U.S. unit, said the effort would take First Data from seven merchant platforms down to two, with two of the smaller ones already closed. Capellas said little, however, about the impending breakup of Chase Paymentech Solutions LLC, the world's largest merchant acquirer, other than that the split between its two owners is under way with apparently few problems and should be done by year's end. Banking giant JPMorgan Chase & Co. owns just over half of Chase Paymentech and First Data the rest. “The wind-down of that venture continues to go smoothly,” he said. “We've made significant progress in allocating the merchant contracts and sales force on the basis of First Data receiving 49% of the assets and JPMorgan receiving 51%. We have also agreed to jointly provide processing and related services to each other's clients in order to execute the most orderly wind-down of the joint venture.” The biggest problem so far could be a tax bill of $200 million or more, but First Data executives said that issue is far from resolved. Under previously announced plans, First Data will get a copy of one of Chase Paymentech's most valuable assets?the software that forms the basis of the acquirer's so-called Salem platform, which processes transactions from online and other card-not-present merchants (Digital Transactions News, May 27). Chase Paymentech has about 600,000 merchants and claims to serve 70% of the top 500 Internet retailers. Meanwhile, First Data's Financial Services unit, which processes for credit, debit, and retail card issuers and oversees debit operations, eked out a 1% increase in second-quarter operating profits, to $111.7 million, on segment revenues of $703.5 million, off 2% from a year earlier and 4% when reimbursable expenses are excluded. Debit card transactions from Financial Services' clients increased 3% from 2007's second quarter to 3.08 billion, while total credit, retail, and debit card accounts on file increased 8% to 648.6 million. The unit, which has struggled in recent years, scored a big win this week when it announced a seven-year contract with Nordstrom Inc. to process the upscale department store's 4.5 million Visa credit and debit, private-label, and commercial card accounts. Capellas said he was cautious about the near term, but noted that the current transaction mix likely would change toward higher margins when the economy improves. And he also touted upcoming new products, including closed-loop, open-loop, and payroll cards in the prepaid sector. “With or without acquisitions, this is a really exciting space for us,” he said. Capellas also said new loyalty and analytic services are coming, and without giving details he mentioned mobile commerce several times. “Mobile commerce continues to be an area of key interest for us,” he said in prepared remarks. “Our pipeline of new products is full and we've signed letters of intent with major strategic customers. Shortly we will be announcing a major trial of our proprietary [contactless] solution in the United States.” Later, in response to an analyst's question, he said, “We think mobility will be really big.”