Metavante’s Big Bet on Payments
The technology subsidiary of Milwaukee’s venerable Marshall & Ilsley Bank has shelled out $1 billion to be a major player in EFT and check imaging and exchange. Its potential to control the direction of electronic payments is huge, but its strategy carries substantial risks.
When Metavante Corp. laid out $305 million this spring to buy Kirchman Corp. and Advanced Financial Solutions Inc., the two deals raised eyebrows throughout the transaction-processing world. Here was a middling player in core bank processing, ATM driving, and credit card acquiring snapping up a provider of off-the-shelf bank-processing software and the builder of the country’s only operating national network for the exchange of check images. But no sooner had analysts and observers digested these deals than Metavante announced it had won the bidding war for NYCE, the nation’s second-largest electronic funds network, taking the property off the hands of First Data Corp. and its bank owners for a cool $610 million. Suddenly, it was apparent that executives at the Milwaukee-based technology subsidiary of that city’s venerable Marshall & Ilsley Corp. had hatched an audacious strategy to stitch together disparate transaction networks, and were willing to wager $1 billion they can make it work. “That’s a sizable bet,” says a skeptical Leslie M. Muma, president and chief executive of competitor Fiserv Inc., which, with headquarters in Brookfield, Wis., is practically cheek-by-jowl with Metavante’s nerve center on Brown Deer Road. “If all three of those acquisitions work, they made a great bet.”
The men responsible for plotting and executing the strategy have no doubt they can make it work. By acquiring Kirchman, they filled a yawning gap in Metavante’s offering. The company long has provided core processing—the various back-office accounting, general ledger, and cash-management functions related to bank transactions—on a third-party basis but lacked off-the-shelf software. Similarly, with the AFS deal, the company picks up an array of some 40 software products that support the processing and imaging of checks, including fraud management. And they get CheckClear LLC, which the owners of AFS started a few years ago to operate Endpoint Exchange, a network in which some 2,900 credit unions and community banks are trading check images daily, with another 1,100 or so committed to join. More important, it’s the only such exchange with national scope now up and running, with the Check Clearing for the 21st Century Act (Check 21) taking effect Oct. 28. Check 21 is expected to touch off an ever-growing flow of check images and so-called image
replacement documents through these exchanges. “Endpoint is what put it over the top for us,” says Paul T. Danola, an executive vice president at Metavante responsible for the AFS deal. “It was up and operating. We saw we could really accelerate the growth of that business.” But by pulling off the NYCE deal, beating out a slew of eager bidders including rival Fiserv, Metavante vaulted itself into the front ranks of processing for debit cards secured by personal identification numbers at ATMs and at merchant locations. NYCE’s member banks are concentrated in the Northeast, but it links 147,000 ATMs and about 1 million retail locations throughout the country for PIN debit acceptance. By folding NYCE into its offering, Metavante becomes one of the top ATM drivers in the country. And of NYCE’s 2,150 members, only about 30% are current Metavante clients, opening an array of cross-selling opportunities for the processor.
A Payments Portal
But the biggest opportunity of all lies in the growth of the PIN debit market. The chance to buy NYCE came about in the first place because the U.S. Department of Justice, eyeing the hot market for PIN debit, forced First Data to divest its 64% stake in NYCE as a condition of dropping objections to the processor’s acquisition of Concord EFS Inc. and its Star Systems network, the largest EFT system in the country. PIN transactions at the point of sale are growing about 20% annually, easily outstripping credit cards and keeping pace with debit card transactions secured by signatures. That has a lot of transactions executives licking their chops thinking of the income possibilities. NYCE alone processes about 1.4 billion PIN transactions yearly and levies a switch fee of up to 9.5 cents on ATM transactions and up to 4 cents each to acquirer and issuer on point-of-sale transactions. “PIN debit is probably going to be the fastest-growing payment mechanism for the next three to five years,” says Frank G. D’Angelo, executive vice president in charge of EFT and cards at Metavante. “We bought [NYCE] for the switch.” No wonder: NYCE made almost $31 million last year on $143 million in revenue, a margin of nearly 22%. The strategy driving these deals has its roots in planning that began a couple of years ago, when D’Angelo and other top executives decided that Metavante’s growth prospects hinged on its ability to satisfy clients’ processing needs across the entire spectrum of consumer electronic payment channels. The idea was that banks would be hammering together so-called payment portals embracing checks, debit, and credit cards, and looking to their vendors to have capabilities across all these payment types. “A lot of these large vendors are finding a lot of banks are looking for a single vendor to provide a broad range of products and services,” says Christine Barry, an analyst at Celent Communications. “You have vendors trying to be all things to all people.” At the same time, the company saw a gradual convergence of payment channels and wanted to be ready, for example, if clients for ATM driving wanted to begin imaging checks at the machines and entering them into an image exchange. Cary M. Serif, who, as executive vice president of Metavante’s e-
Finance Group, runs the company’s electronic bill-payment service, says many institutions are interested in running these transactions across debit networks, where NYCE will fit in nicely. Also, it became obvious that paper-based transactions were rapidly going electronic, bringing along huge improvements in economies of scale. An image exchange would help reduce that last bastion of paper payments—checks— to electronic formats. And, finally, there would be undeniable cross-selling opportunities if the units Metavante acquired to fill out this payments portal did business with financial institutions that were not already Metavante clients.
And acquire Metavante did, culminating in the string of deals the company closed this spring and summer. The money—almost $1 billion laid out in a breathtakingly short time—strikes some observers as a risky bet. But with the obvious opportunities in cross-selling and economies of scale in various payments markets the acquisitions make possible for Metavante, other analysts are bullish. “It’s where you want to put your chips,” says Steve Ledford, president of Global Concepts Inc., an Atlanta-based consultancy. What matters in Milwaukee right now is that, as Danola says, “we’re building the rails so as things evolve we’re pretty well positioned. We feel that as the world moves we can move with it.” The spending binge has certainly put Metavante squarely in the cross-hairs of its competitors. Fiserv, where Danola and Frank R. Martire, Metavante chief executive since March 2003, once worked, also runs an EFT network and an image exchange. It sees Metavante as merely playing catch up. Says Muma: “They’re a Fiserv wannabe. That’s pretty obvious. Eventually we’ll eat [their] lunch.” In terms of revenue, Fiserv is four times Metavante’s size. While some experts, like Celent’s Barry, say capturing Endpoint Exchange has
vaulted the smaller company beyond Fiserv in image networking, Fiserv remains the leader in core bank processing.
Poaching Perks up
But Metavante’s larger rival isn’t its only potential competitive headache. Of all the company’s recent acquisitions, NYCE was the prize, commanding the highest price and offering as it does a nationwide system riding an ever-growing torrent of PIN debit volume. But NYCE’s future is intimately bound up with the four major banks that owned more than one-third of the network before Metavante’s acquisition and account for the bulk of its cards and volume. Many industry observers see those banks—J.P. Morgan Chase & Co., Citigroup Inc., HSBC Holdings PLC, and Bank of America Corp.—as vulnerable to the blandishments of other networks, particularly as they no longer hold any equity in NYCE. Losing even one would deal a staggering blow to Metavante’s payments plan. “Metavante has challenges,” says Del R. Tonguette, who once ran a regional EFT network and is now debit programs manager for ICBA Bancard Inc., a community-bank organization in Arlington, Va. “Keeping that network intact and then growing it are key to [Metavante’s] strategy.” Poaching big banks from rival networks has become part of the game. Interlink, Visa’s fast-growing network for point-of-sale PIN debit, lured away Wells Fargo & Co. and Wachovia Corp. from Star last year, reportedly offering higher interchange income. Now it may come after NYCE’s members. And First Data, now that it owns number-one network Star, won’t be shy about approaching the linchpin banks in NYCE. Says Fiserv’s Muma: “You can bet Mr. [Charles] Fote [chief executive of First Data] won’t leave that customer base alone.” Buyers of networks try to prevent defections by locking in members with long-term contracts. In the midst of industry observers’ doubts about the Big 4’s willingness to stick with NYCE, neither D’Angelo nor Steven A. Rathgaber, a long-time NYCE executive who took over as president of the network Sept. 1, will comment on any member commitments to the network. “Increasingly, there will be competition for the hearts of issuers,” says Rathgaber. “I’m confident we’ll continue serving the majority of these institutions over time.”
In part, he says, this is because Metavante has kept in place a 13-member oversight committee, put in place some time ago to help fend off any unwanted interference from First Data, that has veto power over rules changes. That, he says, has reassured many banks about governance of the network under a single owner. Metavante may face challenges in the check-exchange business as well. Some industry watchers argue a massive archive approach, such as that followed by a bank-owned consortium called Viewpointe Archive Services LLC, may trump image exchange. Archives serve up images only as needed, rather than replacing the transport of paper items with electronic trading of images.
And there could be problems making Endpoint Exchange talk to a big-bank system New York-based Small Value Payments Co. (SVPCo.) is putting together, but on a different standard. As SVPCo. is expected to ultimately trade a huge volume of images, interoperability between the networks will become essential to full-scale image exchange. Hank Farrar, president of SVPCo., sees hope for resolving the issue now that Metavante, a bank-owned processor, has taken over Endpoint Exchange from its non-bank creators. Marshall & Ilsley, says Farrar, understands the SVPCo model and its benefits. “We want to work to get [M&I] into the system,” says Farrar. “We’ve been talking to them for about a year.” For his part, Gary Nelson, who continues as president of AFS under Metavante, says he’s throwing some 30 in-house engineers into the effort to make interoperability happen. “Customers are going to demand the exchanges work together,” he says. For all the risks it faces, Metavante still has a lot of assets it didn’t have only six months ago, including two major networks in two key payments businesses. A third, a medical banking exchange acquired in the AFS deal, could develop rapidly as hospitals and doctor’s offices look for ways to convert paper records to electronic formats, then exchange them with insurers. That means the Milwaukee company is likely to be a player when it comes to deciding how electronic payment channels grow, and how they interact with each other, over time. That alone could justify a $1 billion bet.