Earnings Preview: Total System - Analyst Blog

Global electronic payment processor and merchant acquirer Total System Services Inc. (TSS) is scheduled to release its fourth quarter earnings results after the market opens on January 25, 2011. The Zacks Consensus Estimate for the fourth quarter is 24 cents per share, representing a loss of about 22.0% over the year-ago quarter.

Following the third quarter trends, higher operating expenses, sluggish internal client growth and persistent weakness in revenue growth could continue to mar the growth from the bottom line recovery. However, improving transaction volume and the growing presence in high potential markets could bring some buoyancy.

The continuous expansion in the merchant acquiring services, including the recent 100% acquisition of FNMS, along with the subsequent market stability is expected to strengthen its revenue stream.

Previous Quarter Performance

Total System reported third quarter operating net income of $52.2 million or 25 cents per share as opposed to $58.6 million or 30 cents per share in the year-ago quarter. However, earnings were a couple ahead of the Zacks Consensus Estimate of 23 cents per share. Growth from merchant services and transaction volume was partially offset by higher operating expenses.

Total revenue for the reported quarter was $433.2 million, up 1.0% as against $428.9 million in the year-ago quarter. This was almost flat with the Zacks Consensus Estimate of $434.0 million. Total number of accounts on file as of September 30, 2010 was 339.2 million, down 0.8% from 342.1 million in the year-ago quarter. New client growth was offset by a slow growth of internal existing clients.

As per segments, quarterly revenues from North America declined 11.5% to $231.5 million from $261.6 million in the year-ago quarter, while revenues from international services witnessed a 1.0% year-over-year decline to $85.3 million.

Intersegment revenues decreased 5.1% year over year to a negative of $8.8 million. However, revenue from merchant acquiring services climbed 38.4% year over year to $125.2 million.

Total System reported a 12.2% year over year surge in SG&A expenses, which came in at $51.6 million. In addition, cost of services increased 2.7% year over year to $302.7 million.

As a result, operating income plummeted 10.6% year over year to $78.9 million in the reported quarter. As of September 30, 2010, cash flow from operating activities was $284.5 million, compared with $333.1 million as of September 30, 2009.

Agreement with Analysts

Ahead of the earnings release, we do not see much variation in analyst estimates over the past 30 days. A similar trend has been noticed over the past 7 days. Hence, the estimate revision trends and the magnitude of such revisions justify no major changes in the sentiment.

In the last 30 days, none of the analysts have revised their estimates for the fourth quarter and for 2010, although one of the 20 analysts revised its estimate for 2011, overall providing no directional movement. This implies that the analysts have provided a neutral outlook and do not foresee any significant upward or downward pressure on the results.

However, the neutral approach towards Total System also gives scope for some positive surprises in the first half of 2011, particularly, when there shall be increased clarity on the potential effects of the ongoing Durbin Amendment regulation.

Moreover, the company is focused on keeping its balance sheet at low risk, a positive that could increase operational efficiencies by deploying capital through share repurchases and dividend payments. On the other hand, it could also point out the absence of any other major catalyst for growth.

Magnitude of Estimate Revisions

In the last 90 days, there have not been any significant revisions in the earnings estimate following the third quarter results. However, earnings per share dropped by a penny to the current level of 24 cents for the fourth quarter. A similar trend is further seen for fiscal 2010, wherein estimates remained constant at $1.00 and only moved by a penny over the past 90 days.

Meanwhile, for fiscal 2011, estimated earnings per share rose by a penny to the current $1.07, over the same period. This trend reveals lack of clarity in the analysts' opinion about Total System.

Surprise

Going by past trends, we have a slightly mixed opinion about Total System exceeding estimates, given the company's negative earnings guidance for 2010. The company's reported earnings per share exceeded its expectations for all of the last four quarters and has a positive four-quarter average surprise of 8.44%.

Our Take

Total System aims to expand internationally with announcement of deals in the merchant acquiring space. The company has recently acquired the remaining 49% of FNMS for approximately $169.6 million, the cost of total acquisition now being $270.1 million. The deal culminated on January 1, 2011. Following the completion of the acquisition, Total System has renamed FNMS as TSYS Merchant Solutions.

With the complete acquisition of FNMS, Total System aims to diversify its portfolio into merchant acquiring and be among the top five merchant acquirers on a global basis in 2-3 years. With a bank card portfolio of 3 million accounts on file, the company's joint venture with the FNMS is expected to be accretive to earnings in 2011 and beyond.

Moreover, through share repurchase and dividend payments, Total System continues to return value to shareholders, thereby inculcating confidence for future growth. However, despite the capital deployment, risk-free balance sheet and the marginal raise in the earnings outlook, management still expects a negative earnings growth for 2010 due to the absence of any major catalyst, limiting near-term growth.

The company is also vulnerable to increased competition from dominant players such as Global Payments Inc. (GPN) and Alliance Data Systems Corp. (ADS). Currency and interest rates fluctuations pose additional risks.

Total System is also exposed to sufficient risk from the regulatory measures enacted in the U.S. in July 2010. These are expected to take effect in the upcoming months of 2011, which could contract credit offerings from financial institutions. Any unfavorable impact of regulations could hamper the company's inorganic growth strategy.

Finally, we believe that the overall market stability and healthy impact of the regulations in the credit card industry will help recover the number of client accounts and long term contracts in the long run.

Hence, we currently provide Neutral recommendation on Total System, given the equal measure of caution in the intermediate term. This also corresponds to the Zacks #3 Rank (short-term Hold).

 
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