One of the most important personal financial planning tools for consumers is maintaining a high credit score. A decent credit score has the potential to save borrowers thousands of dollars in interest expense as lenders recognize the value of a good credit history and typically offer lower interest rates. The leader in this field with a near monopoly position is Fair Isaac Corp (FICO, Financial) with its ubiquitous FICO score.
FICO's Business Segments
The company has two segments, Scores and Software. The Software segment provides pre-configured analytic and decision management solutions such as account origination, customer management, customer engagement, fraud detection, financial crimes compliance and marketing. This segment also includes the FICO Platform, a modular software offering designed to support advanced analytic and decision use cases for various industries.
The Scores segment covers the well-known FICO score and provides business-to-business scoring solutions as well as consumer services, primarily from myFICO.com platform. Founded in 1956, the company currently has a market capitalization of $21.5 billion.
Business Review and Growth Drivers
Approximately 250 million consumers in the U.S. can be scored using a FICO score, which are used in over 90% of credit lending decisions. Roughly 40% of FICO’s business comes from the three major credit bureaus, Equifax Inc (EFX, Financial), Experian PLC (EXPGY, Financial) and TransUnion (TRU, Financial). These organizations essentially act as distributors of the FICO scores.
The core business model is very capital expenditure-light as the product is basically just a computerized number and does not require factories or major capital expenditures. After decades of not raising prices on their scores, the company began taking higher price action in the 2016 to 2018 time frame, which is one of the drivers for its high growth rates.
Financial Performance Review
Fair Isaac Corp (FICO, Financial) recently reported third-quarter results for the period ending June 30, which showed continued strong growth in revenue and profits. Revenue increased 14.3% to $398.7 million and net income increased 37.7% to $128.8 million.
Revenue in the Scores segment, which is the company’s business-to-business scoring solutions and business-to-consumer scoring solutions, were $201.8 million in the third quarter, compared to $179.4 million in the prior-year period. Business-to-business revenue increased 24%, driven by price increases and was partially offset by mortgage originations declines. Business-to-consumer revenue decreased 11% from the prior-year period due to lower volumes at the consumer oriented myFICO.com business.
Software Segment Performance
Revenue in the Software segment, which included the company’s analytics and digital decisioning technology, were $196.9 million in the third quarter, compared to $169.6 million in the year-ago period. Software annual recurring revenue was up 20% year over year, comprised of 53% platform ARR growth and 11% non-platform growth. The net retention rate was 117% in the third quarter, with platform software at 142% and non-platform software at 109%.
Free Cash Flow and Share Buybacks
The company produces substantial levels of free cash flow, which came in at $301.7 million for the nine-month period as of June. The primary use of free cash flow is share buybacks, which totaled $285.2 million for the same period.
CEO's Statement and Future Outlook
In a statement, Fair Isaac Corp (FICO, Financial) CEO William Lansing said, “We had first-hand confirmation of the critical nature of FICO Platform at our recent FICO World Conference. This is a three-day event, and it attracted customers for more than 60 countries where they shared best practices, learned about the latest in AI and advanced analytic innovations and learned new approaches for digital transformation. We talked about how FICO Platform can design, build and deliver AI-powered hyper-personalized customer journeys across every touch point and with every interaction.”
Valuation and Analysts' Estimates
The company provided fiscal 2023 guidance of $1.48 billion in revenue, $489 million in non-GAAP net income and $19.45 in non-GAAP earnings per share. Analyst consensus earnings estimates are approximately $19.93 for the year. That puts the stock selling at a current price-earnings ratio of 43. The enterprise value-to-Ebitda ratio is highly elevated at approximately 29.
The GuruFocus discounted cash flow calculator creates a value of approximately $705 per share when using a generous 20% 10-year growth rate and a starting point of $20 in earnings per share. There are six Wall Street analysts that have current ratings on the company with an average price target of $963, a high target of $1,100 and a low target of $875.
Guru Trades and Investment Decisions
Gurus who have purchased Fair Isaac Corp (FICO, Financial) stock recently include Ken Fisher (Trades, Portfolio) and Ray Dalio (Trades, Portfolio)'s Bridgewater Associates. Investors who have reduced or sold out of their positions include Chuck Royce (Trades, Portfolio) and John Rogers (Trades, Portfolio).
Summary and Final Thoughts
Fair Isaac Corp (FICO, Financial) has high pricing power and a near-monopoly position in credit scoring, which creates a runway for rapid growth going forward. However, at 29 times Ebitda, this level of growth optimism seems to be well priced into the stock. The company’s price-sales ratio has increased from approximately 2 10 years ago to over 14 today.
The company has also been buying back stock at these elevated valuation levels, which may not be the best use of free cash flow and could be destroying shareholder value. It may be better for investors to wait for a significant pullback before purchasing shares as upside is likely limited from these levels.
