SPECIAL REPORT

A Brownstone Research Publication

My #1 Fintech Play for the Great Reset

By Jeff Brown

How To Triple Your Money As Cash Goes Digital

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My No. 1 Fintech Play for the Great Reset: How to Triple Your Money as Cash Goes DigitalBy Jeff Brown, Editor, The Near Future Report

It was a $1.5 billion admission of defeat.

That’s the amount eBay paid to acquire the peer-to-peer payment platform PayPal in October 2002. At the time, this was a surprising acquisition – eBay is an online auction company. Spending over $1 billion on what seemed to be an auxiliary business appeared irrational… especially considering eBay had its own payments company at the time called Billpoint.

But eBay knew that improving the ease of paying sellers was critical for its future success. eBay is a marketplace, after all. But before PayPal and Billpoint, buyers on eBay would send a check or money order through the U.S. postal service to the seller, who then had to go cash the check before sending the product. This increased the amount of time for buyers to receive their products… and created a hassle for the sellers.

A digital transfer of money solved the delay in payments. That’s why eBay bought Billpoint and then partnered with Wells Fargo. But Billpoint was difficult to use anywhere other than eBay. And even though fees were cheaper, sellers and buyers preferred PayPal’s flexibility.

Seeing PayPal’s popularity, eBay decided to buy the company. In essence, eBay admitted that Billpoint had failed. But the acquisition changed eBay’s trajectory. And it was one of the most

transformative acquisitions in the history of the technology sector.

eBay went from having a stagnant online auction platform to being a fast-growing, digital payments company.

At the time of eBay’s acquisition, digital payments were a nascent industry. Remember, PayPal – which is a goliath in the digital payments space today – had only been founded four years earlier. And the company had only gone public in 2002.

Digital payments were brand new, but PayPal’s growth phase was about to kick in. This acquisition energized eBay’s stock, propelling it nearly 300% higher in the two years following the merger.

That rise was fueled by PayPal. In 13 years under the eBay corporate umbrella, PayPal grew from a $1.4 billion company to an enterprise value of $40 billion when it was spun out and started trading as a separate entity in July 2015.

And now history is about to repeat…

I’ll show you in a minute how the pandemic sped up the growth of digital payments across the world. And I’ll also tell you about a company that wants to get deeper into the digital payments space and recently made a transformative acquisition to make itself a digital payments powerhouse…

Special Report 2021

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Welcome to The Near Future Report

Welcome to The Near Future Report. I’m Jeff Brown, your editor.

For nearly 30 years, I worked as a technology executive for firms like Qualcomm, NXP Semiconductors, and Juniper Networks. I’ve earned degrees from Purdue University and the London Business School.

I’ve also received professional certificates from MIT, Stanford, and most recently the University of California, Berkeley, School of Law. And I am also an alumnus of Yale University’s School of Management.

I’m also an active angel investor in early stage technology companies. I’ve invested in dozens of private deals. I don’t tell you all this to brag. But with so many so-called technology experts out there, it’s important that readers know I’m truly committed to the world of bleeding-edge technology.

With this research service, we look for stable, mid- to large-cap companies with products enabling the newest technological trends. We can think of these as “sleep well at night” stocks with great growth potential.

In the past years, we’ve covered technology trends like 5G, artificial intelligence, and cloud-based software services.

And in this report, we’re focusing on a trend that has exploded over the past year: financial technology (fintech).

Fintech: A Big Trend in 2021

Fintech has been a key area of research since I began this business in 2015. In fact, the very first recommendation I made as an analyst was in bitcoin back in the summer of 2015. Bitcoin was trading around $230 at the time. At the start

of this year, it peaked around $41,000. That’s a 178x return, and that’s not a typo.

More broadly, fintech isn’t just about blockchain technology; it is used to describe new technology that seeks to improve the speed, delivery, and cost of financial services.

Some examples of fintech are the following:

• Contactless payments

• Peer-to-peer (P2P) payments

• Mobile-only stock trading apps like Robinhood

• Robo-advisors – sites like Betterment that help streamline retirement savings

• Cryptocurrencies

• Blockchain technology

• Smart contracts

The list could go on for pages…

Because of all the ways technology can make financial services better, fintech is growing quickly. According to research firm IndustryARC, demand for fintech services will grow as much as 30% a year from 2019 to 2025. In 2018, the fintech market was around $150 billion. At that growth rate, demand for fintech services will be $950 billion annually by 2025.

But that’s peanuts compared to what Goldman Sachs believes will happen to the fintech market. It forecast that fintech could disrupt $4.7 trillion of revenue at traditional financial services companies.

Fintech services are just hitting the inflection point of mass adoption as well. In 2019, 64% of consumers worldwide have used one or more fintech platforms… That’s up from 33% in 2017. But that 64% is still well below the 96% of consumers who are aware of at least one fintech service.

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And adoption has increased even more this past year… The pandemic hastened the use of technology in the financial realm. Fidelity National Information Services saw a 200% increase in new mobile banking registrations. And reportedly, many older Americans have become more comfortable with these apps and even paying bills online over the past six months.

Worldwide, the University of Zurich estimated that an additional 5.2–6.3 million fintech smartphone applications have been downloaded every day this past year.

The End of Dirty Paper Bills

It’s easy to understand why fintech had a banner year in 2020. During the pandemic, most people didn’t want to deal with dirty money or even checks. These physical objects are just one more possible way to spread the virus.

And not surprisingly, one of the main reasons people downloaded fintech smartphone applications in such record numbers was to make payments – either to pay bills or send money to someone else (P2P transactions).

A survey of 1,000 Americans found 50% had decreased their use of cash last year “significantly.” Americans aren’t alone, as fintech firm Link found that 75% of British people were using less physical cash, while 54% were trying to avoid cash altogether.

And a 2,000-person survey done by fintech disrupter Plaid found 59% of Americans are using more fintech apps to manage money than before COVID-19. And 73% of Americans say fintech is the “new normal.”

The digital payments segment is the largest within fintech, and it is the segment we’re going to focus on in this report.

This won’t be unfamiliar to Near Future Report subscribers. After all, one of the most popular

fintech firms in the U.S. is our portfolio holding Square (SQ). Square’s payment platform uses technology to make it easier for small businesses (like bars and restaurants) to collect payments from customers. And from there, Square makes it easy for businesses to pay their employees and track expenses.

Square’s Cash App makes it easy for employees to get paid and spend money instantly. Cash App also allows P2P payments and even enables users to make investments in stocks and bitcoin.

Cash App usage is increasing and is catching up to PayPal’s Venmo – another popular P2P payment platform in terms of gross payment volume.

Get this. In Q4 2019, Cash App saw $361 million in gross revenue. By Q2 2020, that figure was $1.2 billion. In 2019, Cash App had 60 million downloads. In 2020, that figure was 90 million.

I show this to first congratulate readers who followed my April 2019 recommendation to buy Square. But this also demonstrates the speed at which this technology is being adopted.

While this report’s company is a competitor to Square in some areas, I want to make it clear that there is room in the digital payments space for both companies to succeed. There is no need for us to pick sides. And I’m still very excited about Square’s future growth prospects.

Generally speaking, these two companies go after different business segments. Square started by catering to small businesses, and this report’s company caters to large enterprises. And both are now working their way into mid-sized businesses.

The company I’m recommending to subscribers in this report is the financial services firm-turned-fintech giant Fiserv (FISV).

Not the Typical Recommendation

Fiserv started in 1984 after a merger between

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Sunshine State Systems and First Data Processing. It was the core provider for financial institutions. Fiserv made sure its clients had the best technology to process transactions, manage accounts, and integrate third-party applications into their services.

Through internal growth and strategic acquisitions, it grew to have the largest market share among financial institutions.

This isn’t a typical Near Future Report recommendation. Fiserv historically has been an incumbent that has failed to innovate.

One bank president told us, “Every bank hates their core provider. But they keep a high percentage of clients because it is such a pain to switch core providers.” In other words, it benefits from its dominant position simply by collecting “rent.”

That’s hardly a ringing endorsement. But the friction to change providers is a competitive moat for Fiserv… one that it will be able to leverage in the future. And just to be clear, Fiserv is consistently ranked as best in class, and its business will continue to grow.

It is easy for a company like Fiserv to get comfortable when business is going so well. This typically results in falling behind or completely missing new industry trends. In the case of Fiserv, that was digital payments. A perfect example is the point of sale (POS) payment processing markets.

So Fiserv mimicked eBay’s move when it had trouble breaking into the digital payments space. It made a strategic acquisition – and its move was much bigger than eBay’s. On July 29, 2019, Fiserv agreed to acquire First Data (unrelated to First Data Processing) for $22 billion.

This was an absolutely transformative deal for Fiserv. First Data enabled Fiserv to bring digital payment technology in-house and make up for lost time. Not only did it get the technology it needed, but Fiserv also got First Data’s net income, which was twice as much as Fiserv. This was no small acquisition… And it was fraught with risk.

The Story Behind the Story

First Data started as a nonprofit bank card processing cooperative in 1969… but it didn’t stay a nonprofit for long. And it eventually became the first processor of Visa and MasterCard bank-issued credit cards. Then in 1980, American Express saw the value First Data provided credit card issuers and bought it.

The company remained inside American Express for 12 years, until it spun out in 1992… The company remained public for 15 years until private equity firm Kohlberg Kravis Roberts (KKR) entered an agreement to acquire First Data in 2007. KKR paid $29 billion for First Data, which made it the second-largest leveraged buyout in history at the time.

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This may have been the worst-timed acquisition in private equity history, as the U.S. financial collapse happened less than a year later.

Despite the poor timing, KKR didn’t deviate from its plan with First Data. And that plan was the typical private equity playbook… to shove as much debt under the First Data corporate umbrella as it could and tighten the screws. KKR saddled First Data with $17 billion in debt.

In 2015, as part of KKR’s exit plan, it released First Data onto the public markets. But KKR held on to its shares for a couple of years before beginning to unload a portion in a secondary offering in 2017. But it still held 39% of shares when Fiserv made a $22 billion offer to acquire First Data in January 2019.

After the merger, KKR still owned about 16% of the combined company… which it has been slowly selling off. This selling pressure has put a ceiling on the price of Fiserv and is one reason we can get it at a good valuation today (more on that below).

But the First Data deal made Fiserv a powerhouse in payment processing and digital payments. This market has three main pillars:

• Point of sales (POS) terminals

• Peer-to-peer (P2P) payments

• E-commerce solutions

Being a leader in any one of these categories should make Fiserv a $100 billion company. Its enterprise value is around $95 billion. But Fiserv is now the largest POS provider and P2P payment processor… And the company is going to use its expansive network to quickly build out its new omnichannel e-commerce solution.

A leader in all three of these categories has the potential to be well over a $300 billion company.

Fiserv has a lot of room to grow. Now let’s talk about each of these sectors and see how Fiserv is performing in each.

First Data’s Hidden Jewel

Despite KKR’s poorly timed acquisition and debt financing, First Data’s management still made great acquisitions to ensure that it stayed at the forefront of financial technology.

In December 2012, First Data pulled off its best acquisition. After looking into more than 60 startups, it acquired POS payment processor Clover.

And in the past seven years, Clover has quietly become the largest POS payment processor in the world, processing $133 billion in payments annually. Only Square’s POS solution is close.

As I mentioned above, Clover is bigger than Square, and the two go after different markets. Clover (generally) works with bigger businesses. More than 90% of Clover customers process over $125,000 in payments annually. Only 65% of Square’s customers transact that much.

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Analysts track gross payment volume (GPV) because that’s how Clover makes most of its revenues. For users that use Clover/Fiserv to process payments, fees start around 2.3% + 10¢ per transaction.

Clover also makes money by selling/renting physical terminals and through software subscriptions for additional services. But the bread and butter for Clover is the processing fees.

Clover is also bringing Fiserv a lot of new customers. Over 90% of new customers to Clover are also new to Fiserv. This brings new businesses into Fiserv’s platform… and enables the potential for cross-sales.

When management walked Wall Street analysts through the benefits of the merger, it noted the potential for revenue synergies. And this number was just raised to $600 million annually, in part because of these new customers brought in by Clover.

P2P Payments

Another reason we like Fiserv is because of its partnership with Zelle. Zelle is a P2P payment service like PayPal’s Venmo or Square’s Cash App.

The difference between Zelle and those companies is that Zelle is backed by multiple large institutions like JPMorgan Chase, Wells Fargo, U.S. Bank, and Capital One. The traditional financial institutions basically joined together to build a network so they wouldn’t be outdone by the likes of Venmo or Cash App.

The advantage is that all of the financial institutions involved in Zelle are marketing the P2P service to their customers. If you’re a customer of any of these banks, you’ve likely seen

Zelle featured prominently in the bank apps. “Send money with Zelle,” the message will read.

That’s how Zelle became the most widely used P2P payment platform. As we can see above, it processes nearly twice as much payment volume as Venmo and it’s growing just as fast.

The interesting part is that Fiserv doesn’t own Zelle; it processes Zelle transactions. We can think of Fiserv as the glue that connects the bank accounts at the financial institutions to the Zelle application on our phones. Fiserv charges financial institutions a monthly fee and a small amount per transaction for that service.

So Fiserv doesn’t make as much per volume transacted as PayPal, but this part of the business remains undervalued by investors. And it is a strategic foothold that Fiserv has with its most important customers… financial institutions.

The E-commerce Wildcard

The other major initiative at Fiserv worth mentioning is the strategic plan for its technology to enable its e-commerce business… In just three years, this e-commerce business has grown to over $1 billion in annual sales.

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At its Investor Day in December, Fiserv announced its new global enterprise platform, Carat. Carat will house the e-commerce platform and create a seamless “omnichannel” presence for businesses. It will allow services like the following:

• Buying something online and picking it up in-store or curbside

• Scanning a QR code at a restaurant to load the menu, placing the order, and paying – all through a phone

• Scan-and-go services in grocery stores so customers can avoid checkout lines

This kind of technology is similar to what Shopify does, which drove a $133 billion valuation on just $2.8 billion in sales.

Fiserv’s size and connections with financial institutions (95 of the top 100 financial institutions are Fiserv clients) will allow it to quickly roll out new payment systems to thousands of locations at once. This is a huge advantage for Fiserv over its smaller competitors.

Fiserv has already signed some big names with Carat. Exxon Mobil uses the service at 11,500 of its gas stations and allows customers to pay for gas using Google Pay or through voice commands with Amazon’s Alexa. Other companies like Walmart, Disney, Microsoft, Shell, Starbucks, and Albertsons also use this service.

Signing these clients has demonstrated the potential success of this new initiative. The growth in Carat has the potential to surge… And that could give Fiserv an extra boost. This is where Fiserv’s size really comes into play. It can leverage its scale to win large enterprise deals with thousands of locations.

These are the three legs of Fiserv’s growth. POS transaction processing, P2P payments, and the omnichannel solution give Fiserv a lot of room to grow.

Uncertainty Gives Us Opportunity

Fiserv’s stock has stagnated over the past year and a half because of uncertainty around the First Data integration.

One point of contention was if Fiserv would be able to integrate First Data into its current business. Many analysts were skeptical of the deal because there was little overlap between the two companies. They didn’t believe management would be able to get the $900 million of synergies it predicted.

Large acquisitions are tough to integrate. There are almost always setbacks. Many don’t work out. But in this case, the merger has been smooth… And management has already achieved $1.2 billion worth of cost savings.

This merger is clearly beneficial.

The other bit of uncertainty around the merger had to do with the debt KKR saddled First Data with. $17 billion of debt, to be exact. And that’s on top of the $5 billion debt Fiserv had before the merger.

Normally, for a company of this size, $22 billion in debt would concern me. But this combined business gushes cash. It generated about $3.4 billion in free cash flow last year and will generate more than $4 billion this year. Management will easily be able to pay down debt, refinance to take advantage of the historically low interest rates, or even sell equity in the company to reduce debt. As a result, there is little risk with current debt levels.

These two things – the perceived risk of the integration and the debt – allow us to get into Fiserv at a great price.

And I would mention that we have used this investing strategy before. In May 2020, we invested in Infineon (IFNNY), which was shrouded in uncertainty with its merger

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with Cypress Semiconductor. But we saw the synergies were just beginning to be realized. We invested, the uncertainty passed, and we are now enjoying incredible returns.

With Fiserv, we have a similar picture. Any temporary uncertainty will be remedied by Fiserv’s strong performance this year.

There are simply too many overvalued technology companies in the market right now, which is why I want to make sure we have a solid company like Fiserv in our portfolio.

Fiserv’s well-established business will also provide us with some downside protection in the event of a market pullback. Grossly overvalued companies always get hit the hardest, so Fiserv, which is arguably undervalued, is a smart play.

What’s exciting is that in a healthy market environment, there is greater potential. Clover is growing faster than Square’s POS offering. And Zelle is growing faster than PayPal’s Venmo. Both PayPal and Square are trading at valuations more than double that of Fiserv. And Fiserv will have higher gross margins than both these companies.

And if Carat takes off, we could see much higher sales numbers.

I encourage readers to establish a position in this fintech transformation before Wall Street figures out that the integration is in the bag, the gross margins are going to rapidly expand, and there is a lot more upside to the story.

Action to Take: Please refer to our model portfolio for the most current recommended buy-up-to price for Fiserv (FISV). Be sure to use a limit order when placing trades. For the time being, we will hold FISV with no stop loss. Always remember to use rational position sizing.

Risk Management: Because we will be holding this stock without a stop loss, I encourage all readers to use rational position sizing. We should remember to never go “all in” on any one investment. Our mission is to build a portfolio of our companies. That’s how we’ll optimize our success.

Regards,

Jeff Brown Editor, The Near Future Report