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Fair, Isaac & Co. (FIC
) is hardly a household name, but its proprietary "FICO score" is practically the standard for determining an individual's creditworthiness, with respect to everything from credit-card applications to car and home purchases. The San Rafael (Calif.) company is much more than just FICO scores, though. It's a leading global provider of business analytics. Standard & Poor's recently upgraded Fair Isaac's stock to 5-STARS (buy) from 4-STARS (accumulate), and we expect it to outperform the S&P 500-stock index over the next six to 12 months.
It has significantly outperformed its peers and the broader market over the past few years. Year-to-date through Nov. 5, the shares were down 2.2%, vs. a decline of 21.2% for the S&P 500.
Fair Isaac develops and sells scores, software, and services used primarily by the financial and marketing industries to assess credit risk for customer-acquisition and business-management purposes. The basis of many of these offerings is mathematical equations created and revised by the company's more than 100 PhD scientists.
WEBWORKS. Fair Isaac packages and sells its equations in a variety of ways. Offerings are sold to customers as stand-alone products (called Strategy Machines), custom solutions (through its professional-services organization), or as components (the equations and rules by themselves, called tools).
One of its most successful Strategy Machines is myFICO.com, a direct-to-consumer scoring offering. Among the Web site's features are ScorePower, which is a report consisting of an individual's FICO score and a relevant explanation; Equifax Credit Profile Reports; and the FICO Score Simulator, which explains the impact of certain actions on one's FICO score. The site also offers Credit Advantage, a service that provides six ScorePower reports and quarterly e-mail updates. ScorePower costs $12.95 per report, and Credit Advantage costs $59.95 per year. We expect myFICO.com to generate over $20 million in revenues for fiscal year 2003 (ending September).
In August, 2002, Fair Isaac acquired HNC Software in an all-stock transaction valued at $810 million. HNC is a leading provider of fraud-detection and prevention software, with a long list of clients in the insurance industry and an emerging health-care business.
LEADING POSITIONS. We believe the combination of Fair Isaac and HNC will result in notable cross-selling opportunities (across geographic regions, industries, and companies) and significant cost savings that will benefit it for some time. In fact, the combined company has already achieved its goal of removing an annualized $35 million in operating expenses from its income statement less than three months after the transaction was completed.
The new Fair Isaac is truly an analytics powerhouse. Its Strategy Machines have leading positions in a wide variety of areas, including credit scoring, customer acquisition (due to its MarketSmart product), account management (TRIAD), fraud (Falcon), insurance-bill review (ClickPremium), and loan origination (Liquid Credit).
The company influenced over 25 billion transactions in fiscal 2003. From September, 2001, to August, 2002, if you had a credit card, used an ATM, had a cell phone, received a marketing call, got injured in a car accident or on the job, or bought a car or house, chances are Fair Isaac was involved and got paid accordingly.
Through cross-selling, expanding into new industries and international markets, and increased emphasis on partner relationships, we believe Fair Isaac can increase its revenues 13% to 15% annually over the long-term. New product offerings could also boost its growth rate above this level.
GOOD PROSPECTS. Fair Isaac also has a superb operating model. Recurring revenues account for 75% of the total and provide significant visibility. We expect operating margins of 27.7% for fiscal 2003, reflecting great scalability and leverage in the business.
Once Fair Isaac develops an algorithm or application, it can reconstitute and sell it with little additional investment. We expect earnings per share (EPS) to grow 16% to 18% annually, reflecting expanding margins and an active share-buyback program. The company is currently authorized to repurchase some 9% of its outstanding shares.
As of Nov. 14, the shares closed at $38.35, or 19 times our fiscal year 2003 EPS estimate of $2. We project calendar year 2003 EPS of $2.08. With a price-earnings multiple of 18 (based on our 2003 estimate) and p-e-to-growth ratio of 1.1, the shares trade at a notable discount to the S&P Software Industry. In addition, using
discounted cash-flow analysis, we calculate the stock's intrinsic value is around $47, about 23% above its recent price.
Given Fair Isaac's solid and improving fundamentals, notable growth prospects, earnings visibility, and attractive valuation, we believe it would be a good addition to an investment portfolio.
Analyst Kessler follows Internet software and services stocks for Standard & Poor's
Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
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