Developers of fintech software are cashing in as a healthy economy compels banks and other financial institutions to modernize by migrating to internet and cloud service formats.
Fintech is the broad range of online, digital, network-based tools and services used by banks, insurers, brokerages and other financial services firms. Some of those tools provide what most consumers consider to be modern banking and financial services. Others enable banks to streamline records-keeping, compliance and other critical office processes.
The combination leads to rising profit and revenue.
“We’re in an environment now, nine years after the financial crisis, where most financial services companies are doing the best that they have since 2006 or 2007,” D.A. Davidson analyst Peter Heckmann told IBD. With stronger balance sheets, bolstered by corporate tax cuts and a better economy, banks are stepping up spending on technology, he said.
Fintech Group Rises 25%
That’s lifting the top and bottom lines for companies in IBD’s Computer Software-Financial industry group. The group ranked No. 16 on Thursday out of 197 industry groups tracked by IBD, up from a No. 118 ranking in January.
As seven of the 18 companies in the group have an IBD Relative Strength score of 90 or above. That means those stocks have outperformed at least 90% of other stocks in the market over the past year. As a group, the stock have gained about 25% for the year through Thursday.
The group is fairly diverse. It includes companies that make software for banks, investment firms, tax preparers, mortgage lenders and risk management professionals.
The largest stock in the group — both by market capitalization and by revenue — is Intuit (INTU). The maker of TurboTax and QuickBooks has a market capitalization of nearly $52 billion. That’s more than twice the size of No. 2 in the group, payment processing firm Wirecard (WCAGY), which has a market cap of $21 billion.
Other big names include Jack Henry & Associates (JKHY), SS&C Technologies (SSNC) and Fair Isaac (FICO).
Companies that have gone public in the sector in recent years include Black Knight (BKI), Guidewire Software (GWRE), Issuer Direct (ISDR) and Q2 Holdings (QTWO).
The newest company in the group is CLPS Global (CLPS). The Chinese company provides information technology and consulting services to the banking and financial sectors.
CLPS launched in the U.S. in a May 24 initial public offering, at $5.25 a share. It broke out of an IPO base on June 14 at a buy point of 6.44. It hit an all-time high 17.35 on June 20 before pulling back.
Fintech: Technology Outsourcing Key Trend
The financial software industry is fragmented according to the customers served. That fragmentation is growing more pronounced as many of the industry’s largest players turn from developing their technology in-house, to grabbing quicker, more innovative solutions through outsourcing.
“The biggest dynamic here is the multiyear move on the part of financial services companies to look to outsource technology,” Heckmann said.
Banks and credit unions want to offer the latest services to attract young customers. Millennials take for granted the ability to do things like mobile transactions, such as taking a picture of a check to make a deposit, or applying for loans online, Heckmann said. To satisfy that demand, financial institutions are turning to vendors like Jack Henry and Q2.
“As you go across these financial services verticals, what you find is that most of the niches are served by two or three very large players and a couple dozen very small players,” Heckmann said.
Banks and credit unions are primarily served by Jack Henry, Fiserv (FISV) and FIS (FIS). The broker-dealer market is served by Broadridge Financial Solutions (BR), Thomson Reuters (TRI) and FIS. And hedge fund administration is covered by SS&C and Bank of New York Mellon.
“Once the vendors get to a certain amount of scale, they can really leverage the fixed costs that they have in terms of software development and data centers, and really generate some really attractive margins,” Heckmann said.
M&A Activity Is A Constant
Some of the major players amass scale and expand into new technologies through mergers and acquisitions.
“Within this space, M&A is a constant,” Heckmann said.
Windsor, Conn.-based SS&C Technologies bought Advent Software three years ago for $2.63 billion. This year, it bought DST Systems for $5.4 billion. Also, on June 1, SS&C completed the acquisition of the North American fund administration business of CACEIS for an undisclosed sum.
“Through a combination of organic and inorganic growth, we believe SS&C will continue to gain share and grow faster than the market and peers,” RBC Capital Markets analyst Daniel Perlin said in a June 15 report.
Perlin added, “As regulatory burdens on financial institutions and competition drive the demand for software-enabled services and continued outsourcing, we believe SS&C is uniquely positioned, given its breadth of products and acquisitive nature.”
Cloud Services Shift Boosts Recurring Revenue
The biggest technology trend driving sales and earnings for financial software providers has been the move from on-premise software to subscription-based cloud services.
Subscription services provide software tools that once may have been loaded into a company’s network computers, and make them available online through servers operated in remote locations. This cloud-based approach to delivering services eliminates what formerly were large upfront installation costs for clients. For vendors, it also cuts installation and maintenance costs and delays.
One important result are more predictable revenue streams. That predictability, in turn, has led to higher valuation multiples for companies in the sector, Heckmann said.
Just one example: Monett, Mo.-based Jack Henry had about 60% recurring revenue 15 years ago. It’s probably 92% today, he said.
Artificial Intelligence Buzz
Other technologies getting buzz in the sector include blockchain for security, and artificial intelligence.
While those technologies show great promise and demonstrate that companies are innovating, they will not be big business drivers for a while, Heckmann said.
Mountain View, Calif.-based Intuit says it is designing artificial intelligence and machine learning into its QuickBooks accounting software. Those technologies automate tasks that might otherwise take valuable time and money. Applications include automated invoicing and categorization of expenses, the company said.
Jacksonville, Fla.-based Black Knight, a provider of software, data and analytics systems to the mortgage and consumer loan, real estate and capital markets, made an AI-related acquisition on June 4. Black Knight bought HeavyWater, a provider of artificial intelligence and machine learning to the financial services industry. Black Knight did not disclose financial terms of the deal.
Outlook Strong, But Some Concerns
The outlook for the fintech sector appears to be solid for now. Consensus estimates project Intuit’s earnings will rebound 25% this year. SS&C’s earnings growth is estimated to hit 20%, with a 30% gain for Black Knight.
Q2 Holdings has the strongest forecast: a 267% earnings gain, with a 132% jump projected for its second quarter. The company has not yet announced a reporting date.
Despite the group’s strength, Wall Street does have some concerns. For one, valuation multiples for some names in the sector may have topped out, Heckmann said.
Second, continued consolidation of customers could crimp sales and earnings.
Twenty years ago there were 20,000 banks and credit unions. Today there are 12,000. In 10 years, there probably will be 9,000, Heckmann estimates. The mutual fund industry will consolidate as well, he said.
The wild card will be how fast and in what directions technology evolves. Blockchain and artificial intelligence are on the near horizon. Digital currencies, regulatory changes and the potential for an Amazon-like disruption in the banking sector are further out on the radar.