KKR can't resist FD 'cash-flow machine'

Cash flow can be irresistible, particularly to takeover artists like private equity firm Kohlberg Kravis Roberts & Co. KKR, which is credited with perfecting the leveraged buyout, has agreed to pay $29 billion for First Data Corp., or $34 per share.

The acquisition makes perfect sense, noted Jefferies & Company analyst Craig Peckham. "FDC is a free cash flow machine with maturing growth prospects ™ and senior management is in the midst of transition, with CEO Ric Duques expected to 're-retire' this year."

The deal includes a 50-day "go-shop" provision allowing First Data's board to solicit other bids, Peckham stated in a note to investors. "We believe the KKR deal likely is the best possible offer for the company."

But TowerGroup analyst Theodore Iacobuzio believes two other sectors will be very interested in owning their own integrated payments processor: issuing banks and giants in online search and auction businesses.

A year ago, Bank of America Corp. Chairman Kenneth D. Lewis expressed interest in buying a processor to enable the bank to settle its own credit card transactions, Iacobuzio said. "Citi would love to clear and settle on itself." Chase, HSBC or any big issuing bank "with lots of money and liquidity" could also make an offer, he added. Iacobuzio is Managing Director and practice leader in TowerGroup's payments practice.

Software companies, some of which already own their own alternative-payments systems, may also see advantages to owning their own credit card processor. Microsoft Corp., eBay, Google and Yahoo! could be contenders for First Data, Iacobuzio said.

Several investment banks have committed to providing debt financing to KKR for the buyout.

Business as usual?

Whether First Data proceeds with its announced consolidations of platforms and data centers this year and next (for more information, see "First Data plans U.S. platform consolidation," The Green Sheet, Feb. 26, 2007, issue 07:02:02) depends on KKR, Iacobuzio said. "Once those doors close, KKR is going to do what they think is best."

"We do not expect that our private or public company status will affect the day-to-day service to our customers," Duques said on a conference call with employees April 2.

The company's consolidation of its platforms and data and command centers will proceed, possibly at a faster pace, he added. "It is the intention of KKR and First Data to ensure continuity of operations and continued excellent service to our clients."

Iacobuzio speculated KKR, a private company, would resell the processing giant quickly because regulators likely will demand access to scrutinize its financial operations. "There may be pressure on KKR to flip this, either piecemeal or as a whole," Iacobuzio said.

First Data could have launched a brand to rival Visa U.S.A. and MasterCard Worldwide had it linked all its disparate parts, Iacobuzio said. Utilizing its VisionPlus card processing system would have been key. "This is a very popular piece of software for processing all kinds of plastic," he added.

The company reported recently that several new and existing issuing clients have been moved onto VisionPlus platforms at five international locations, which in the United States includes Omaha, Neb.

Both ValueLink (now branded as First Data Gift Card) and the Star Network could have been put to use in a broader strategy, "but they've made no concerted effort to do so," Iacobuzio said.

Since the deal was announced, executives have tried to reassure clients that KKR will not drain the company of cash and then sell off its assets.

"While some cynics might scoff at this notion, KKR are very smart people with deep experience in analyzing diverse businesses," David P. Bailis, President of Financial Institution Services at First Data, wrote on his blog April 2. "This is a business that is so strong and so attractive that a group such as KKR is willing to place a large bet on its future."

"Going private makes sense for First Data," Duques said on the call. "KKR has a great reputation with companies they buy. And on average, their holding period is about seven years, which is an extraordinarily long holding period for private equity firms."

With the exception of Duques, First Data's management team will remain in place, the Chairman said.

Feeling FD's pain

Despite the rosy view of KKR's intentions, other institutions began to mirror an alternate view of KKR's strategy. Within hours, Standard & Poor's lowered First Data's corporate credit rating by several grades.

"The lowering of the corporate credit rating to BB+ reflects our view that First Data no longer possesses an investment-grade financial policy, in light of the announced debt-financed transaction," stated S&P analyst Philip Schrank.

"This agreed-upon purchase price is a premium of approximately 26% over First Data's closing share price on March 30, 2007." As more details of the acquisition emerge, First Data's rating could drop further, he added.

Upper management may have needed little incentive to welcome the acquisition: All employee stock options will vest and be cashed out at $34 per share when the deal closes, Duques told employees.

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