Wall Street Undervalues Some Service Providers

A planned $11.3 billion buyout of SunGard Data Systems Inc. by a group of private investors shows that the stock market is undervaluing vendors of IT and business-process-outsourcing services that have steady, recurring revenue and strong cash flows, Merrill Lynch said in a report last week.

A planned $11.3 billion buyout of SunGard Data Systems Inc. by a group of private investors shows that the stock market is undervaluing vendors of IT and business-process-outsourcing services that have steady, recurring revenue and strong cash flows, Merrill Lynch said in a report last week.

Silver Lake Partners, the Blackstone Group, Bain Capital, and several other private equity firms plan to buy SunGard, a $3 billion-a-year company that provides financial-services software and backup-and-recovery services, at a 14% premium over its market capitalization at the time the deal was revealed last week. That premium should lead investors to take a second look at IT services and BPO service vendors whose balance sheets resemble SunGard's, Merrill Lynch analyst Gregory Smith says.

Affiliated Computer Services, Fiserv, and First Data are among those deserving a second look, Smith says in the report. Those stocks "are all trading at very attractive multiples, offer relatively high earnings stability and visibility, generate strong free-cash flow, and should offer good downside protection in any tough environment for technology investing," he says.

ACS has a strong presence in the fast-growing BPO market, one that was bolstered by its recent acquisition of Mellon Financial's human-resources-management outsourcing business, Smith says. He also likes Fiserv, which provides software and services to the financial industry, in part because he believes the company's outsourcing business will see modest but steady single-digit growth in 2005. And Smith expects First Data "to remain aggressive in buying back its stock at current levels given the company's very strong free-cash flow."

The SunGard deal is expected to close in the third quarter. Also, reversing a previous plan, SunGard won't spin off its Availability Services Business. The question now is whether the new private owners will keep the company intact or break it up. In addition to backup and disaster-recovery services, SunGard sells software that performs trade-order execution, risk-management, and record-keeping tasks for banks, investment managers, mutual funds, brokerage firms, and investment advisers.

Customers would probably notice little impact if the company is broken up as many already view it as a collection of discrete entities. HVB Americas, a customer of both SunGard's disaster-recovery services and its derivatives-trading financial software, plans to go live in July with a new backup data center in New Jersey using SunGard Availability Services, CIO David Dart says. And, he says, SunGard's decision not to spin off the disaster-recovery unit won't impact HVB's planning.