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Maximilian Thompson

FIC AT A GLANCE

P/E ► 14.7 AVG EV/EBITDA ► 11.9 AVG ROA ► 7.2% AVG ROE ► 12.5% AVG Debt to Equity ► 1.17 AVG Current Ratio ► 3.67 HIGH Interest Coverage Ratio ► 5.73 AVG

 

 

 

 

 

 

Fair Isaac Corporation (NYSE: FIC) sells predictive analytic and decision management systems. Its largest segment is Strategy Machine Solutions, which produces software for specific business processes such as customer management or insurance claims management. It generates 52% of revenue ($388 mm).^[1]

However, Credit Scoring (57% operating margin) generates 56% of total profits.^[2] FIC's credit evaluation FICO product is used extensively as an objective measurement of an individual consumer's risk in the form of a credit score; FICO scores are used in 10 billion credit bureau risk scores a year.^[3] 90 of the 100 largest American financial institutions and more than half of the world's largest banks use FIC systems. ^[4]

Corporate Overview

Financial Metrics

FIC's sales and profits have declined over the past three years. Net Income decreased by 21% from 2006, while sales decreased by 9.7%.^[5] Although profit increased slightly from 2006 to 2007, operating income and margins have declined since 2006 on a consecutive yearly basis.^[6] The operating margin has declined from 18.5% to 16.4%, an 11% decrease.^[7]

Source ^[8]

Although FIC has a high return on equity (ROE) and a high gross profit margin compared to its industry and the market, its revenue decreased by nearly 10% in the past year.^[9] This contrasts with growth double digit growth among its competitors. The industry is composed of credit reporting companies, as defined by SIC and NAICS codes.^[10]

Source ^[11]

Revenue Segmentation

More than half (52%) of FIC's revenue comes from its Strategy Machine Solutions group, which includes software for credit card pre-screening, fraud prevention, and insurance claims management.TRIAD, a credit account maintenance product within this segment, is used by 250 issuers worldwide to manage approximately 65% of the world’s credit card accounts.^[12] Scoring Solutions includes the FICO credit score product as well as other credit evaluation products.^[13] Professional Services represents customized software work revenue, often in conjunction with sales of other FIC products.^[14] Analytic Software Tools are used as platforms for companies to build their own Decision Management software.^[15]

Source ^[16]

Scoring Solutions is FIC's most profitable segment, both in terms of its operating margin (58%) and its contributing share to total company profit (56%).^[17] Strategy Machine Solutions is the second most profitable segment in terms of operating margin (16%).^[18] Despite the fact that it is the largest segment by revenue, it is responsible for only 38% of total net operating income.^[19] Professional services remarkably has a 0% margin, however it contributes to generating sales for Stategy Machines by enabling FIC to customize its software for customers. ^[20] Analytic Software is the smallest segment by revenue ($52 mm), and operates with a 15% margin. ^[21]

Source ^[22]

In geographic segmentation, the United States accounts for 67% of revenues, the United Kingdom for 9%, and all other countries for 24%.^[23]

Trends and Forces

VantageScore and Credit Report Agencies Challenge Market Share

In 2006, the three major credit scoring agencies (Equifax, Experian, and TransUnion) launched VantageScore, a product designed to compete directly with FICO. The agencies previous accounted for 20% of FIC's total sales.^[24] Furthermore, VantageScore threatens FIC's credit scoring related business, which accounts for 56% of operating net income. ^[25]

In response to the new product, FIC launched a lawsuit against the agencies for violations of antitrust legislation, unfair competitive practices and false advertising, trademark infringement, and breach of contract. ^[26] In June 2008, Equifax settled and is no longer a defendent. ^[27]

The trial will begin in mid 2009.

Credit Crisis Decreases Demand for Consumer Credit Information

During 2008, 71% of revenues came from sales to the consumer credit, financial services and insurance industries, most of which will have a decreased volume of credit related transactions and inquiries due to economic conditions. ^[28]Losses for 2009 are predicted to be more than $70 billion dollars; in response, lenders are tightening credit availability and new credit issuance. ^[29]

Because many of the credit evaluation and measurement products support new client acquisition, FIC's revenues and net income are particularly vulnerable. ^[30] Contraction in the number of financial institutions, even through mergers, can reduce demand for products and services charged on a "per customer" basis, as once sepreate companies combined.^[31]

Validity and Regulation Create Risk for FICO Product

Although the FICO product is highly profitable, accounting for 56% of FIC's operating net income, it is also risky.

The validity of the risk assessment made by FICO is often challenged, and hard to defend, because the exact formula is not disclosed. The possiblity of competing products gaining market share due to higher validity represents a significant risk to FIC. For example, before 2008, FICO scores assigned higher risk to those who often applied for credit, despite the trend of customers shopping extensively on the internet for the cheapest rate.^[32] Due to high consumer advocacy and government pressure, the FICO criteria and formula were changed to reduce penalties associated with frequent credit inquiries and occasional late payments.^[33] However, FICO scores do not take into account customer income or home property value, two factors that can provide substantial insight into a customer's risk profile.^[34]

Furthermore, regulation may limit the profitability and demand for FIC products dramatically, such as amendments to the Fair Credit Reporting Act (“FCRA”) or the Fair and Accurate Credit Transactions Act (“FACTA”), that would limit the applications or disclosure of consumer credit scores.^[35]

Competition

There are three major consumer credit reporting agencies that offer products to evaluate customers' credit worthiness, and recently launched VantageScore to compete with FICO. In addittion, these companies also provide systems to manage customer relationships and risks.

• Equifax (EFX) has information on more than 400 million worldwide credit holders. It sells systems software for a variety of credit related services. Equifax also provides human resources and payroll outsourcing.
• Experian PLC (EXPN-LN) maintains and utilizes a database of 215 million US consumers and 15 million US businesses. In addition to credit related products, the company provides addresses for more than 20 billion pieces of promotional mail every year.
• TransUnion LLC has credit histories of more than 500 million people in 30 countries. It sells risk management, insurance credit, and real estate information.

Compared to the credit reporting agencies, Fair Issac is small, despite the popularity of the FICO product.

Source ^[36]

References

1. ↑ FIC. Annual Report, 10-K (11/26/08), Segment Information , p. 73.
2. ↑ FIC. Annual Report, 10-K (11/26/08), Segment Information , p. 73.
3. ↑ FIC. RE: Interagency Advance Notice of Proposed Rulemaking, p. 3.
4. ↑ FIC. Annual Report, 10-K (11/26/08), MARKETS AND CUSTOMERS, p. 10.
5. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
6. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
7. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
8. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
9. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
10. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
11. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
12. ↑ FIC. Annual Report, 10-K (11/26/08), Our Solutions, p. 4.
13. ↑ FIC. Annual Report, 10-K (11/26/08), Our Solutions, p. 5.
14. ↑ FIC. Annual Report, 10-K (11/26/08), Our Solutions, p. 7.
15. ↑ FIC. Annual Report, 10-K (11/26/08), Our Solutions, p. 8.
16. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
17. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
18. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
19. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
20. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
21. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
22. ↑ Hoovers D&B Database. Financial Data, Fair Issac Corporation, Hoovers.
23. ↑ FIC. Annual Report, 10-K (11/26/08), Segment Information , p. 73.
24. ↑ Hoovers D&B Database. Overview, Fair Issac Corporation, Hoovers.
25. ↑ FIC. Annual Report, 10-K (11/26/08), Financial Statements, p. 49.
26. ↑ FIC. Annual Report, 10-K (11/26/08), Legal Proceedings, p. 23.
27. ↑ FIC. Annual Report, 10-K (11/26/08), Legal Proceedings, p. 23.
28. ↑ FIC. Annual Report, 10-K (11/26/08), Risk Factors, p. 21.
29. ↑ Reuters News Wire. Happy New Year? Not for credit card companies.
30. ↑ FIC. Annual Report, 10-K (11/26/08), Risk Factors, p. 22.
31. ↑ FIC. Annual Report, 10-K (11/26/08), Risk Factors, p. 22.
32. ↑ Hoovers D&B Database. Overview, Fair Issac Corporation, Hoovers.
33. ↑ Hoovers D&B Database. Overview, Fair Issac Corporation, Hoovers.
34. ↑ Bank Systems & Technology. As Defaults Mount, Many Question FICO Scores’ Value.
35. ↑ FIC. Annual Report, 10-K (11/26/08), Risk Factors, p. 20.
36. ↑ Hoovers D&B Database. Competitive Landscape, Fair Issac Corporation, Hoovers.