Credit scoring giant Fair Isaac (FIC) shocked Wall Street on Apr. 28 with weaker than expected quarterly results, and its stock sank 12% the next day on the news. But things could get even worse for the company, analysts warn. With banks pulling back on lending and consumers buying fewer cars and homes, demand for Fair Isaac's ubiquitous FICO score—the three-digit number that signals a customer's credit worthiness—is dropping.
At the same time, increasing criticism of FICO (BusinessWeek, 2/7/08) is helping upstart credit scoring firm VantageScore grab more business and put pressure on FICO pricing. Still, some of the savviest value investors have bought shares on the weakness as a longer-term opportunity.
A Fixer-Upper
The short-term turbulence is complicating the reorganization plans of CEO Mark Greene, a 12-year IBM (IBM) veteran who took the top job at Fair Isaac in February, 2007. Greene's initial moves to accelerate credit scoring improvements, cut costs, and restructure his sales force haven't paid off for investors. He announced a further plan on Apr. 1 to sell off or shutter six money-losing lines of business.
"Their core business is deteriorating faster than people anticipated," says analyst Mark Bacurin at Robert W. Baird & Co. "It's made his job much more challenging than it would be in better economic times."
There was plenty that needed fixing when Greene arrived. The Minneapolis company's shares had slumped from a peak of almost $50 in early 2006 to under $35 by November when then-CEO Thomas Grudnowski stepped down. Now they're less than $25.
In Grudnowski's final years, revenue growth ground to a halt as a hodgepodge of acquisitions failed to mesh and distracted management from growing complaints about FICO. Fair Isaac periodically tweaked the automated scoring system, first rolled out in 1989, but failed to overhaul the score as subprime lending and other trends in consumer borrowing dramatically altered the landscape. That created an opening for VantageScore, a private scoring competitor created by the three major credit bureaus, Experian, Equifax (EFX), and TransUnion.
From Bad to Troubling News
As recently as last fall, Greene was expressing optimism that the widening credit crunch wouldn't hurt demand for credit scores. And he had suggested a renewed focus on risk management at banks would create more demand for Fair Isaac's analytic products. But the company missed analysts' estimates for its fiscal first quarter ended Dec. 31, 2007, as revenue from the high-margin FICO unit dropped 4%.
The news was even worse for the most recent quarter. Fair Isaac said profit for its fiscal second quarter, ended Mar. 31, fell 37%, to $13.5 million, or 28¢ a share, thanks in part to a $4 million restructuring charge. And while total revenue increased 1%, to $193.2 million, revenue at the high-margin scoring unit declined 7%. Analysts had been expecting profits of 43¢ a share and revenue of more than $200 million.
"They used to have a pretty strong competitive advantage in scoring," says Michael Nemeroff, an analyst who follows the company for Wedbush Morgan Securities in New York. "Now, VantageScore is nipping at their heels."
The most troubling news was what Fair Isaac had to say about the next six months. Greene's Apr. 1 plan sparked hopes of an immediate boost to earnings. Instead, just one month later, the company slashed its projected revenue and profits through the end of the fiscal year. "The current markets are unlike things that many of us have ever seen before, so we are being conservative," Greene said on a call with analysts on Apr. 28 after the results were announced.
Still a Valued Investment
VantageScore's biggest impact so far has been in the pre-approval market where lenders purchase credit scores to search for consumers to whom the lenders can mail out "pre-approved" credit offers, analysts say. The upstart hasn't made deep inroads into the larger and more profitable segment of using scores for making actual loan transactions. Fair Isaac is rolling out a dramatically improved version of FICO known as FICO 08 to combat the competition and address complaints about the existing system.
Although analysts don't foresee a turnaround for at least six months, some of the very best value investors have been buying Fair Isaac shares. Longleaf Partners Small-Cap Fund (LLSCX), run by investing ace Mason Hawkins, bought up almost 11% of Fair Isaac's shares last year, according to SEC flings. Analysts say Hawkins has a long-term outlook, and his fund has outperformed 90% of similar funds over the past 10 years. Hawkins' firm, Southeastern Asset Management, didn't return a call for comment about Fair Isaac.
Two other star managers, Chuck Royce of Royce Premier Fund (RYPRX) and Joel Tillinghast of Fidelity Low-Priced Stock Fund (FLPSX), have also been major buyers, according to Morningstar (MORN) data. Both managers declined to comment.