Fidelity National Info (FIS)

Fidelity National Information Services, Inc. (FIS) is a provider of core financial institution processing, card issuer and transaction processing services, mortgage loan processing and related information products, and outsourcing services to financial institutions, retailers, mortgage lenders, and real estate professionals. FIS is a member of Standard and Poor's (S&P) 500 Index. Headquartered in Jacksonville, Florida, FIS maintains a strong global presence, serving more than 7,800 financial institutions in more than 80 countries worldwide. FIS has processing and technology relationships with 35 of the top 50 global banks, including nine of the top. Nearly 50% of all U.S. residential mortgages are processed using FIS software. On February 1, 2006, FIS merged with Certegy Inc. (CEY), a provider of credit card, debit card, other transaction processing and check risk management services to financial institutions.

FIS currently has main two reporting segments, Transaction Processing Services (TPS) and Lender Processing Services (LPS), comprising approximately 62.3% and 37.4% of 2007 revenue, respectively, while the remaining 1% came from its Corporate and Other segment. TPS includes enterprise solutions (including large banks, international, retail, and gaming) and integrated financial solutions (including smaller financial institutions, North American card processing, e-banking, and bill pay). LPS includes original FIS businesses of mortgage processing, mortgage origination, default management, and information services.

Transaction Processing Services include Certegy's former Card and Check Services segments as well as the financial institution processing component of the Financial Institution Software and Services segment of the original FIS. Included in this segment is the Integrated Financial Solutions business, which serves over 8,000 customers in commercial banks, savings institutions, and credit union markets. This business generates revenue by charging recurring fees for outsourced services on a per account basis as well as up front license fees with annual maintenance charges. Services provided by Integrated Financial Solutions include: Core processing - serving customers that tend to be smaller community-based institutions where FIS processes deposits, loans, mortgages, general ledger, CRM, origination, and back-office support. Credit Processing - customers include financial institutions and associations where FIS provides cardholder services and loyalty programs, collections and risk management, and merchant processing for financial institutions and associations. The Item processing business which provides image capture of deposited items, Check 21 image clearing and settlement, branch and merchant capture, check image archival, and related image services. ATM/ETF Processing - provides ATM and debit processing and fraud detection and prevention. Finally, the eBanking business - provides Internet banking, bill payment, and voice response solutions to domestic financial institutions. Also included in Transaction Processing is the Enterprise Solutions Business. This business provides deposit solutions and lending platforms to large bank customers, loan processing to auto lenders, lending solutions to commercial lenders, and check risk management. Customers of the Enterprise Solutions business include major banks and financial institutions, such as Bank of America, Citibank, J.P. Morgan Chase, Wells Fargo, and other well known institutions.

Lender Processing Services includes Mortgage Processing Services and Lender Information and Outsourcing Solutions businesses. Mortgage Processing provides specialized software and portfolio processing services to mortgage companies affiliated with retail banks and thrifts, traditional mortgage servicing companies, mortgage sub-services and sub-prime lenders. The division provides professional services, including training, consulting and conversions services and FIS' InterChange platform provides for the exchange and delivery of data between different service providers. The Lender Information and Outsourcing Solutions business includes both Lender Outsourcing Services and Information Services. Included in these services are Fidelity's default solutions, which provide services to lenders foreclosing on properties, settlement solution services that help automate the real estate closing process, and mortgage information services that provides mortgage market participants with data that assist in making decisions and managing risk. In October 2007, the Board of Directors approved a plan to spin-off the LPS division into a separate publicly traded company. The proposed separation, expected to occur in mid-2008, will provide more company flexibility and dedicated management focus to ultimately improve shareholder value for Fidelity.

Although we like the synergies created by the merger of FIS and Certegy, both have businesses that are currently facing either secular or cyclical headwinds, which are likely to be a drag on results over the near and long term. In fact, this may have partially driven the motivation for the merger. On a secular basis, Certegy has historically generated a significant portion of revenue from check services. FIS recorded check guarantee losses, net of anticipated recoveries excluding service fees, of $113.8 million in 2007 compared to $102.9 million in 2006. During 2005, the company acknowledged that check processing declined 4% to 7% and we believe that this trend continued into 2007 as paper continues to be replaced by electronic transactions and credit/debit cards take share from checks and cash. In 2007, electronic transactions processing rose to 35% from 7% in 2006. As such, management is currently evaluating strategic alternatives for its U.S. and Australian check services businesses. The remaining merchant processing business of the original Certegy may also come under pressure as consumer spending appears to be slowing, although over the longer-term this is a growing business. The company sold the Certegy Gaming Services during the first quarter of 2008 and plans to sell other parts of the check services business during the second quarter. On a cyclical basis, Fidelity has benefited from a robust housing market with 22% of the original company's revenue coming from real estate trends. Although growth in the default business should help offset lost revenue from mortgage originations, there is a lag period of approximately twelve months before defaults pick-up. While revenue in Default Solutions has been growing, it is a small part of overall revenue.

FIS has exposure to new home sales and refinancing activity with its mortgage origination services. While this is offset by the counter-cyclical nature of its Fidelity National Default Solutions business, given a weakening market for home sales combined with rising monthly payments for many borrowers with hybrid mortgages, defaults have been on the rise. Moreover, increasing government scrutiny into the mortgage business will have adverse consequences that could affect FIS' business. The sharp rise in home foreclosures that started in the United States during the fall of 2006 has accelerated in 2007 and 2008, and has begun to result in investigations and lawsuits against various parties commenced by various governmental authorities and third parties. The company is already facing multiple lawsuits nationwide resulting from new scrutiny by the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) into the mortgage business. The company also expects mortgage processing revenues to decline modestly in 2008, primarily due to the deconversion of ABN's portfolio in the fourth quarter of 2007.

FIS has also gone through significant changes over the past year as it digests Certegy and integrates Fidelity National Financial (FNF). This is a big shift for FIS as it goes from being a subsidiary of FNF to a public company while trying to integrate a company with a revenue run-rate only slightly below its own. Moreover, the surviving management came from Certegy while the majority of employees came from FIS. The company also has a fairly aggressive target for cost synergies of $65.0 million annually, which is likely to cause disruptions in the business. Moreover, GAAP earnings are well below pro forma earnings, making it difficult to gauge the true extent of cost savings versus what is being charged and excluded from pro forma numbers. Forward comparisons are likely to be more difficult with the sale of Property Insight business, which contributed approximately $0.09 to FIS' EPS during 2006 and $0.21 during 2007.

Moreover, there are always risks when dealing with sensitive information. An employee of Certegy stole consumer information and sold it to brokers who in turn sold it to direct marketers, which resulted in customers receiving unwanted solicitations from marketers. To date, after elimination of duplicates and invalid data, approximately 7.4 million consumer records were stolen and further investigation is still undergoing. In August 2007, the law firm of Girard Gibbs LLP filed a class action complaint on behalf of these consumers. In addition, FIS's public disclosure of the theft prompted an inquiry by the Federal Trade Commission (FTC). In January 2008, homeowners sued the company, accusing it of raising the price that consumers must pay to avoid foreclosure of their homes. The lawsuit, filed on January 16th, in the U.S. Bankruptcy Court in Houston, contends that Fidelity has conspired with mortgage-servicing companies and law firms to add to the indebtedness of homeowners by taking secret fees that remain undisclosed for years.

On a positive note, Fidelity is planning to spin off its Lender Processing Services (LPS) into a separate publicly traded company, the completion of which is expected to occur in mid-2008. Recently, FIS completed the sale of two non-strategic businesses, including FIS Credit Services and Certegy Gaming Services' quasi-credit card cash advance, debit and casino ATM operations. During the first quarter of 2008, FIS also announced plans to exit HFN, a small operation that provides services to the residential homebuilding market. We believe, the sale of company's assets will improve margins, free up capital, and will enable the company to focus on core operations. This follows the sale of its Property Insight division in August 2007.

Recently, FIS announced a stock repurchase program to repurchase up to $250 million of its common stock. This authorization replaces the company's previous share repurchase authorization, of which approximately $117 million was outstanding. During the third quarter of 2007, the company repurchased 1.6 million shares for $80.3 million. To support return value to shareholders and pay debt, FIS parted with its 29.0% investments in Covansys, which was acquired by CSC in July 2007. Meanwhile, FIS has been expanding its offshore presence through multiple acquisitions in recent years. Currently, the company is solidifying its presence in Brazil with its back-office outsourcing and item processing operation, named Fidelity BPO Brazil. The company has also won a few contracts in the area to support its growth strategy. Moreover, FIS announced a new five-year consumer loan outsourcing agreement with a top three-tier bank headquartered in the U.K. with operations in more than 50 countries. Though average loan count declined in the fourth quarter of 2007, driven by the acquisition of ABN's mortgage loan portfolio of $1.5 million by Citibank, the company believes that this sale of ABN will not impact the conversion of the bank's card portfolio to its Brazilian card processing platform. Any losses will be offset by new business wins from Wachovia and Chase, which will come online throughout 2008, adding more than $6.0 million in loans to FIS's mortgage servicing platform and driving growth in the number of average loans processed in 2009 and beyond. During 2007, FIS processed more than 38.5 million loans for 84 clients, while also maintaining normal system access. Also, in 2007, nine new lenders signed contracts with FIS to implement Mortgage Servicing Package (MSP), and 17 lenders renewed their MSP contracts. Moreover, Bradesco will convert its in-source 10 million account card portfolio in late 2008.

Finally, with all the acquisitions FIS has been through, the company's balance sheet has a high level of goodwill and intangible assets, totaling $6.3 billion, or 64.3% of total assets as of March 2008. As a result, the company has been recording depreciation and amortization of over $180.0 million per quarter, which has decreased net cash provided by operating activities to $168.2 million during the first quarter of 2008, from $207.1 million recorded in the previous quarter. For the full year 2007, cash flow from operations decreased to $463.6 million from $494.7 million in 2006. The company's net cash position (cash less debt) has also weakened with the acquisition of EFD/eFunds as FIS has funded the $1.8 billion purchase with a combination of cash on hand and long-term debt in the form of a new $1.6 billion tranche of term loans (the Term Loan B). As of March 2008, the company reported a net cash position of ($3,851.4) million versus December 2007 net cash position of ($3,920.1) million. Although we believe the acquisition of eFunds will offer both top-line and cost synergies with increased operating leverage, this will come at the expense of cash flow in 2008 due to increased working capital requirements. In addition, the company has recently amended its credit facility and increased uncommitted incremental loans from $600 million to $2.1 billion. Although we do not believe FIS will face liquidity problems, it should be noted that much of the growth has come through financial engineering rather than solid fundamental growth.

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