Equifax, Inc. (EFX, Financial) is one of the three national credit bureaus, alongside competitors Experian (LSE:EXPN, Financial) and TransUnion (TRU, Financial). In addition to its bureau services, Equifax is also the preeminent provider of automated verification of income and employment via its Equifax Workforce Solutions (EWS) segment. EWS is Equifax's largest, fastest-growing, and highest-margin business unit. Although Equifax is best known as a credit bureau, EWS is the focal point of the investment case.

Equifax has three segments: EWS, which accounts for ~45% of revenue and ~60% of profits; U.S. Information Solutions (USIS), the U.S. credit bureau which accounts for ~33% of sales and ~30% of earnings; and International, the business unit which holds a portfolio of credit bureaus in countries across the globe, including in Canada, Australia, and numerous nations within Latin America. Together, the domestic and international bureaus amount to ~55% of sales and ~40% of profitability.

CREDIT BUREAU

The credit bureaus are aggregators of individuals' financial information. Banks — as well as other creditors such as utilities, telecom providers, and property landlords — contribute their customers' borrowing and repayment histories to the bureaus. In return, the creditors may “pull the credit file” of any given consumer, provided the data is used for approved purposes. A credit file represents an individual's complete borrowing and repayment history across all creditors. Creditors pull the file each time they make a credit decision; for example, whether to grant a consumer a mortgage and on what terms. Without access to the credit file, lenders would not have full visibility into the credit history of prospective borrowers. Lenders pay the credit bureau a small fee each time they pull the credit file.

Fair Isaac Corporation (FICO, Financial), better known as FICO, is not a credit bureau. Rather, FICO licenses a mathematical algorithm to the bureaus, which the bureaus apply to the data in the credit file and calculate a FICO Score. In other words, FICO is a supplier (of an algorithm) to the bureaus.

Equifax and the other credit bureaus are all highly regulated, primarily by the Fair Credit Reporting Act (FCRA), which governs the methods by which the bureaus may collect and share consumer information. This regulatory environment serves as a large barrier to entry, thereby mitigating the risk of potential new competition. Furthermore, the credit bureaus benefit from a network effect, since they operate on a “give-to-get” framework; that is, a lender cannot pull the credit file from a bureau unless it is also contributing data from its own customers. This poses a conundrum to a potential competitor gunning to start a new credit bureau. The hopeful entrant would go to creditors and ask for data to begin building their repositories. The lenders would ask in return, “What data will you share back with me?” Of course, the upstart bureau would confess, “We have none to share.”

While there is unlikely to be a fourth credit bureau any time soon, the competitive intensity between the three incumbents is high. Most lenders contribute their data to all three bureaus such that the data at Equifax, Experian, and TransUnion is largely uniform. With that said, once a lender selects a preferred bureau, the lender rarely switches, as the selected provider becomes integrated into workflows.

Credit bureau services are highly adopted across modern economies. A credit file is pulled in nearly every credit decision in the U.S., and more than 90% of Americans have a populated credit file. As a result, the bureaus are likely to grow at a rate in line with consumer credit activity, which is likely to generally mirror that of GDP over time.

We think of the credit bureaus as above-average businesses — durable assets that have been around for over 100 years, are highly entrenched within financial services processes, face minimal threat of entry, and generate recurring and modestly growing cash flow streams.

THE WORK NUMBER

What makes Equifax stand out is its crown jewel asset: The Work Number (TWN). TWN is housed within the EWS segment and serves as a database holding income and employment records on over 125 million Americans. TWN receives records directly from the largest employers as well as payroll processors. In the case of processors, Equifax shares a percentage of its verification revenue with its contributing partners. Income and employment are verified in three primary use cases: mortgage origination, employment background screening, and government benefits disbursement.

Verifiers — that is, lenders, background screeners, and government agencies — request an individual's information in the appropriate contexts, and Equifax instantly returns the information to the verifier for a fee. The alternative to TWN is inefficient, antiquated manual processes. For instance, verifiers may request proof-of-income documentation from the consumer or contact the individual's employer to validate their work history. These incumbent verification methods generate friction for the verifier, who has to pause their workflow to authenticate the individual's income, as well as the consumer and employer who must manually provide the information to the verifier.

We believe TWN is structurally superior to the credit bureau business in two ways. First, most of the records within TWN are exclusive to Equifax, which results in a much more attractive competitive landscape. Experian and TransUnion are the largest competitors in the verification space, but their databases are a fraction of TWN's size.

Record contributors share exclusively with Equifax for a few reasons. First, Equifax provides large employers with HR administrative services, such as completion of W-2s and I-9s, which make the relationships very sticky. With respect to payroll processors, Equifax can pay a greater revenue share to partners because it has the largest customer base of verifiers. Lastly, both employers and payroll companies are loathe to share employee data with more parties than is absolutely necessary, for fear of liability in the case of a cyber incident.

Similar to the credit bureau segment, there is a network effect present in verification services. Verifiers want to use the database with the most records. Consequently, the more records TWN compiles, the more verifier customers Equifax wins, which helps TWN retain and partner with record contributors.

Second, automated verification is still relatively early in its adoption curve. For perspective, there are about 220 million income-generating Americans, meaning Equifax still has runway to add tens of millions of records to TWN. Since Equifax only charges customers for verifications when it has the record, each incremental record drives new revenue. At the same time, TWN is used in only about two-thirds of mortgage originations and about a quarter of hiring screens and government benefit applications. As the TWN database grows and its record count is increasingly used in lieu of outdated manual verification methods, EWS is positioned to grow volumes at a strong clip for several years. TWN's unique competitive positioning also affords it pricing power, further augmenting the growth outlook.

MORTGAGE MARKET

Equifax may experience a more accommodative operating environment in the coming years. The company's largest industry by revenues is the mortgage industry, which accounts for ~20-25% of sales under normal market conditions. Over the last three years, U.S. mortgage origination volumes have declined significantly as interest rates have risen. In fact, Equifax estimates that mortgage origination activity is now about half of what it averaged in the five years prior to 2020. Needless to say, this has served as a headwind to Equifax's results. A total recovery to pre-Covid activity levels may not materialize for years and origination volumes are likely to be volatile in response to interest rate movements, but Equifax stands to benefit meaningfully as the U.S. mortgage market comes into better balance over time.

CLOUD MIGRATION

In response to the infamous 2017 breach, Equifax pursued a total technology systems rewrite, migrating all of its infrastructure to the cloud. This provides for a much-improved security posture. The project has been long and onerous and is set to conclude over the next year. Upon completion, Equifax will see a sizable reduction in its cost structure.

CONCLUSION

Equifax serves a critical role as an information services provider, enabling vital economic processes such as credit origination, hiring, and government benefits disbursement. Equifax possesses several high-quality business characteristics, including a cash-generative business model, mission-critical positioning in growing markets, and durable competitive advantages. Furthermore, Equifax stands to benefit from a recovery in the U.S. mortgage market and the completion of its cloud migration, which should accelerate revenue growth and increase margins. We believe Equifax is well-positioned to grow business value over the coming years.

As of 03/31/2024, the following portfolio company constituted a portion of the net assets of Conservative Allocation Fund, Large Cap Equity Fund, Multi Cap Equity Fund, and Partners III Opportunity Fund as follows:

• Equifax, Inc. 0.0%, 2.8%, 2.6%, and 0.0%.
• Experian PLC.: 0.0%, 0.0%, 0.0%, and 0.0%.
• Fair Isaac Corp.; 0.0%, 0.0%, 0.0%, and 0.0%.
• TransUnion LLC: 0.0%, 0.0%, 0.0%, and 0.0%.

Holdings are subject to change and may not be representative of the Fund's current or future investments.

The opinions expressed are those of Weitz Investment Management and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through 6/6/2024, they are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor's specific objectives, financial needs, risk tolerance and time horizon.