Jack Henry: VMS King - [Business Breakdowns, EP.206]
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This is Matt Russell, and today we are breaking down Jack Henry. Now, if you're not familiar with Jack Henry, Mark Leonard and Constellation Software once referred to this business as their gold standard.

It's a true best-in-class operator within the vertical market software space. And to break down Jack Henry, I'm joined by Bob Desmond, portfolio manager and head of Claremont Global. Jack Henry has a rich history, and there are so many things to study. On the surface, they sell a full operating system software that powers small and mid-sized banks. But this business was not born out of Silicon Valley like many great software businesses have been.

They were born in Manette, Missouri, and they continue to operate there today. And they've succeeded despite massive consolidation within that customer set, the small and mid-sized banks. We get into some of the unique dynamics. Like many great vertical market software businesses, M&A has been a piece of the puzzle. But Jack Henry puts a very deliberate focus on organic growth, and particularly in their core product.

And when Constellation referenced Jack Henry as a gold standard, it was the late 90s, and the stock had 100x in just a decade. The long-term success has certainly continued. It's appreciated 480x since their IPO in the mid-80s. But more recently, the stock has been essentially flat over the past five years. So we get into great business dynamics versus stock dynamics as well.

Consider this another name to add to the case study list. And before we move to this conversation, I just wanted to make one mention. Last year, we tested something new, Colossus Review. It's a print publication that represents our content in physical form. We only sold a limited run of the issue one, but they sold out quickly and thousands joined the waiting list. Now we're formally launching Colossus Review as a subscription platform.

As a subscriber, you'll receive a new edition each quarter. You'll get the physical magazine, full digital access, and exclusive audio content that goes deeper than we've ever gone before. So head to joincolossus.com slash subscribe or check the link in the show notes. All right, Bob. Jack Henry is a company that is intensely studied by both in

investors, business operators. So there's a lot to discuss here, but we can start at the top. Can you just share a brief overview of what Jack Henry does and how they fit into the banking ecosystem that they operate in? Sure. Thanks for having us on, Matt.

Jack Henry, they like to describe themselves as a fintech company. It's obviously quite a big company. It's bigger than your normal fintech. It's about a 12 billion market cap. The way I think about it is that they provide essential technology for banks, basically run everything that a bank needs to do, but they very much cater to the smaller end of the market. Their average financial institution, bank or credit union will be just over $1 billion in assets.

So those types of banks, they can't afford to have a big technology department, a lot of costs there. So what they're looking for is a partner who will deal with all their technology needs, plug and play solution if you like. Obviously the big 50 banks, they will have big departments and they'll have a dedicated technology officer and they will customize a lot of their solutions. So anything that a bank needs to do from a very basic level,

accept deposits, make loans, run the general ledger. That's roughly a third of their revenue would be the core processing, if you like, what they call core. And then the other solutions that a bank would have, allowing customers to make payments, debit, your credit card, bank to bank, bill pay, etc. And then there's another third of the revenue, which is anything that a bank needs. There's probably another 300 solutions there. So anything technological, think of them as an outsourced

technology provider and partner to small banks. And the US is quite unique in that you have such a fragmented banking system. When I think about their solution or what they're offering, should I picture this as just an off-the-shelf software that then can be designed for each individual's bank's liking?

Yeah, that's a good way of thinking about it. I like to think about it as the heart and lungs of a bank, just the core that runs everything that a bank has to do. 73% of their clients are hosted in Jack Henry's premises in the cloud, in a private cloud environment. So that'll give you a good example of that outsourced solution. The rest are hosted on-prem and slowly that is moving to private cloud. So yeah, I think that's a good way how you've described it.

Well, I know it didn't start out that way in terms of being so cloud-based. So we can go back into what is a very rich history. Again, I mentioned right off the top, this is a name that's studied. I know it was founded in the early 70s in Missouri, but can you walk us through a bit about Jack Henry's history and what makes it special? What happened to have it evolve into what it is today? It's one of the most unique companies I've ever looked at.

One of the things at Claremont, culture is really important. And for some reason, I'm not sure what it is, but not being American myself, but we do find a lot of really great businesses in the Midwest. Is there something in the water? Is there something in the culture? And so this is a unique combination of a Midwest company and a Midwest culture, but that is actually a technology business. So founded, as you said,

in the mid 70s by Jack Henry and Jerry Hall. And I think what is quite unique is that they're in a town of 10,000 people. So if you think of a technology company in a town that small, and then you think of their customer base,

which are obviously small banks and small credit unions in quite small parts of America. Community-based, very client-focused. So I think that has always stuck with them. And it's really interesting if you look at their business cards, they have printed on there, do the right thing, go the extra mile and have fun. I mean, those are three core attitudes, ethos that they've had since they started and

From when I first started reading their transcripts, it's just so obvious. You can look at it numerically. You can look at their employee engagement scores are very, very high. You can look at their Glassdoor rankings versus their closest peer. The Glassdoor rankings for their closest peers, 2.9, roughly around 80% of their scores as relates to employees, very, very high. Consistently ranks as one of the best places to work. To give you an example, during the

COVID fintech bubble, a lot of people left Jack Henry and went to work in Silicon Valley and were earning lots of money. And they came back because it's just a good company to work at with good values. And then they really do look after their customers. So if you look at the customer satisfaction scores, they're up around 4.7, 4.8, 5 being a max.

And so they're one of the few companies that I've seen that publicly put out their employee engagement scores, publicly put out customer satisfaction scores. They publish six-month roadmaps for their customers and then hold themselves accountable to that. And completion rates are nearly 90%. So incredibly transparent, very client-centric, very employee-centric. And their mantra is if we look after the employees, they will look after the clients, right?

And that'll be good for shareholders. Now, consistently, most companies you see shareholders come first. So one of the things I love about this company is just their real focus on customers and employees. And if you actually look at it, shareholders have done just fine since they're listing. I think their earnings have compounded nearly 15% since they're listed.

Yeah, it strikes me as unique in researching this business. I came across the customer focus and it's the type of product where I could see most feedback just being only the negative things. You have certain products in your life where it needs to either work and if it's not working, you're mad and that's when you review it. You don't usually get a lot of brownie points. So it's worth mentioning this type of product.

at least to me, does not usually stand out in terms of getting that positive customer feedback.

Well, you can compare it to their two main competitors, which would be Fiserv and Fidelity Information Services. Now, Fiserv is a company we follow as well. We think it's a very good company. Of course, only roughly 20% of the business has become more of a merchant acquiring business. But even if you compare their rankings to them, they are way better. And I think one of the reasons that they have a structural advantage, in my opinion, is

is that they were built organically, predominantly organically, apart from the complementary solutions business, which is something different. But if you actually look at the core processing, they have two main core processing systems, one for banks and one for credit unions, and they built them predominantly organically. Now, if you look at their competitors, they have over 10 each core processing systems, so built by acquisition. So you've got a lot of legacy old technology that you're just maintaining, effectively cash cows,

But ideally, you need to be sunsetted so you can focus on the ones you want to keep. Whilst Jack Henry is completely the opposite. They have two core processing, they have two smaller ones. And so they're consistently spending 14% of R&D on making those systems better. And then they back that with really awesome customer service.

To have the confidence to actually say, this is our six-month roadmap. What percent have we completed? That shows you that they really want to be held accountable to their customers. One of the things that I came across in the history was it did feel like in the

So when you compare that to what you mentioned now, just in terms of a much more organic growth focus, what do you think is the most important thing that you're going to be able to do?

Was there an inflection or a change or how would you just describe the errors to the extent that you can for this business that, again, grew from a small town in an area where you wouldn't expect the big tech leader to come out of? Were there errors that you would point to? It's important to distinguish. So when I talk about the organic growth, that's in the core processing part of the business, call it roughly a third. But the complementary solutions and the payments businesses, a lot of those were built

by acquisition. And they were very acquisitive in the early days. And again, just listening to their customers, what their customers required, they wanted a core solution, but then they needed around that, they needed a payment solution and they needed all those other complimentary solutions, be they fraud, treasury, digital, digital is more recent. And so they went out and built those two businesses predominantly by acquisition. But the core, which the way I like to think about it is the core is almost like the hook.

That's what gets the customer. And then you get all these surround solutions, roughly about 50 products per customer. But if you haven't got a good call and you haven't got good service backing that, then everything else you're going to struggle with. So that was really the acquisitions was in the complimentary solutions and the payments businesses.

That makes a lot of sense in terms of building out the vertical market offering that you can potentially have there. So I think I have some sense, you have three segments of the business. Do they split out just in terms of size and how big they each are to the business, whether it's revenue or profit or anything along those lines? They do. I mean, just simplified for your listeners, there's roughly a third, a third, a third.

So third core, as I said, I think of that as the lock or the hook that gets the customer through the door. That's probably a single digit organic growth business system.

Payments is very attractive. So that's debit, credit card processing, bank to bank, bill pay, more recently Zelle, FedNow, Bearinghouse. That is just allowing customers. And that's a high single digit, double digit growing part of the market. So very attractive. And there they get paid by the number of transactions they process. So in the core business, they get paid on asset size and the number of accounts. So that's a different business.

And then you've got the third business, which is complementary solutions. So roughly a third, a third, a third. So generally the average customer would take around 50 solutions around that core hook.

And I think you gave me some sense just in terms of having an idea of what revenue visibility looks like across the entire business, just in the sense that core is a steady dependent on some of those numbers, but you at least have some visibility into that. When you put it all together, revenue visibility, whether it's reoccurring in nature or something close to that, do you have some sense of that year to year in terms of what percentage of the business is reoccurring?

Yeah, it's one of the things we do like about the business. So one of the core value propositions we look for in all our businesses is what we call low cost to value. So if you think of the cost of their technology relative to the value provided, it's enormous. As they say, changing your core system is like open heart surgery. It doesn't happen often. There's probably around in their market 200 FPs that come up every year. Half of those are not going to move.

And of those, Jack Henry probably win half. So roughly winning one core system a week. There's a nice steady progression of growth. But if you actually look at the recurring business around 90%, so they wake up on the 1st of January, 90% recurring revenue. And their client retention is awesome. I did have a stat, might be slightly out of date. It was a couple of years ago that of their credit union customers, they had only lost 15 in 32 years.

So very rare for them to lose a customer. Over 99% client retention. So the way you lose a customer is poor technology. But one of the biggest things is poor service. That is where they really outscored. We use expert networks a lot and consistently that came through. Customers really value them. In fact, one of the calls we did, because obviously they get implemented by the likes of the consulting companies.

And they were saying often they will win a call and then the consulting company would say, you know, they were prepared to pay 30% more. So the value that they provide, if you think of a bank, the outage, the poor service, very easy to move banks. So that's how I think about it.

On the technology point, I do want to touch on this. It's a company that's 50 plus years old. A lot has changed about the banking environment over that period of time and just the general technology environment. How have they kept up to speed with the...

changes, developments, everything that's gone on in the industry. Would you point to the acquisitions being a key piece of this, the in-house talent? Where did it come from where they were able to not just become one of those old stodgy incumbents that loses share gradually?

Yeah, I think it goes back to what I was saying at the beginning is how the company was built. So having only two key core processing systems, one for small banks and one for credit unions, means they spend 14% to 15% of their revenues every year on R&D development. And they can focus that money on listening to their customers and then developing what their customers want compared to their peers.

The closest competitor would be probably Pfizer, which is only 20% of the business is actually in core processing. They have, I think, 12 or 13 systems. So a lot of their technology spend is really just maintaining what they've got. They just have to put a whole lot of other systems they have to maintain. But then where I think they've been really smart, Jack Henry,

And again, I think it goes back to, it all starts with the culture is listening to what their customers tell them they need. So they have a great saying where they say, our customers are not in business to make us profitable. We're in business to make them profitable.

And they really have that customer ethos. So they've navigated all these changes. So they've kept the core modern and up-to-date and refreshed. They've obviously moved their clients off-prem and to the private cloud, done a good job of that. Nearly 75% of those customers now have a private cloud solution. They've acquired well. Like, for example, if you look at, and you'd probably know this living in the States, Banner

is their digital solution, which was bought as a loss-making startup in 2014 and is now the number one digital app on the Apple Store. So they're really good at buying good technology, plugging it in. But one of the advantages with this type of business model, it's a one-to-many. So I can get the technology, get it right once, and then distribute it across my client base of 1,700 clients. And if you include the comp solutions, you're talking about 8,000 clients. So I think they've been

really good at just moving with the times. And now, even now, so they're looking ahead five to 10 years and they start to talk about it. What are we going to do? We want to get to private cloud. They're looking at breaking up the core and making it more modular, which means that if I'm a bank, I don't have to update the whole, I can do it piecemeal.

So I can update my deposits function or my treasury function or my fraud solutions or commercial lending, whatever. So that's where they're going. And I think that will increasingly be more attractive for potentially larger clients. So again, it just keeps going back to this thing of look after the customers, listen to what they want. One of the other things I think is very unique about the company, they have very open APIs. So they work with a lot of fintechs.

Even when they have their customer days, they will invite competitors to the customer days because they want to make sure that their customers get the best solutions. Whilst a lot of the competition have a, well, you just got to use us type mentality. I mean, this is all at the margin, but I think this is really built into their culture. Put the customer first. And even if that means we're going to make less money in the short term,

It's building the brand and the profits for the long term. And I assume that comes into play with the complementary services that they make easy to integrate with whatever core system they're providing. Is that right when it comes to the competition? Correct. 100%. So they have hundreds of fintech partners. Fintech for them is they allow them to plug into their solution to give

a better solution for their clients. Banner being a great example of that. But I think they issued something like 2 million tokens last year just to allow those fintechs to play in their sandbox and provide solutions for customers. So very open architecture. Again, that might reduce profits in the short term, but it's the best solution for the customer in the long term. It kind of goes back to what I was saying. We're in business to make our clients successful. They're not in business to make us successful.

Yeah. And with customers, do you have any sense of when you're getting somebody onboarded, how long does it take for them to hit the maturation point of having that? Let's say you mentioned, I think on average, using 50 different products provided by the company. Is that a slow, gradual build to hit that? Or are you seeing most of that come up front where they're signing up and getting most of the complimentary services?

The core is the longest one to implement. That takes probably 12 to 18 months. The other solutions are quicker to get implemented. But if you actually look at the full end-to-end process, the sales process, let's call it, obviously they're looking at these providers over many, many years. But the sales process could be 12 to 18 months.

And then to get it implemented and tested on board, you're probably looking at another 12 to 18 months. So that is quite a long drawn out process. If you're just taking the standalone complementary solutions or the payment solutions, that's going to be much shorter. That's going to be six to nine months. But most people will take the call and then another 50 solutions around that. So that makes the cycle longer.

Year to year, just thinking about the revenue equation, when you think about what goes into that, is there a general growth that you see with this business in terms of whether it's a certain percentage year over year?

Well, obviously, IT spend grows year over year. Let's call it nominal GDP growth. So you've got natural banks need to spend money. So if you actually look at, they do run surveys on their banks. And most banks are spending mid-single digit plus sort of growth rates over time. They need to modernize the customer experience. They need a better digital business.

As customers, we've all got used to the Amazon Netflix experience, and that's what we expect. They need to spend to modernize the technology. The number one concern for all of these smaller banks is deposits, raising deposits, because no deposits, low growth. So that is a big part of that, getting the deposits, running more efficiently, growing loans. So you've got just the natural, your customers are going to grow over time. Now, one of the big myths or one of the big fears is

as actually in one of your questions when we spoke earlier, was worries about bank consolidation. So people look at bank consolidation going, oh, that's bad for them. But as I said earlier, they get paid predominantly on the number of accounts and the number of transactions. So over time, the number of banks has shrunk.

But obviously, assets keep going up over time. So over the last, I think, five years, they said banking assets are up nearly 30%. And they tend to be the acquiring bank rather than the bank being acquired. So they have just this natural growth where you've got, let's call it nominal GDP growth. You've got bank IT spend behind that. You've got consolidation in the industry. And they tend to be on the side of the banks being acquired. So they get natural business that way.

Is a fair way to reframe that as long as the large top 50 banks are not acquiring the mid and smaller banks, then you're going to either have a net neutral or potentially net positive impact if it is basically consolidation happening within the small and mid-sized market amongst itself?

That's 100% correct. So most of the consolidation in their space, we're talking really small banks, well below a billion dollars. So that's banks, I say banks and credit unions, that's where most of the consolidation is taking place. Quite often what sometimes happens is one of their customers will be acquired by a bigger bank, but because of the better technology and better service, they will actually be chosen over the bigger bank's technology.

And then from year to year, is there growth happening? Would you say it's more from just existing business where it's growing year over year, whether it's the assets themselves or add-on products? How much do new logos come into play in that equation in terms of adding new customers year to year?

That's a good question, actually. Yeah. So I should have mentioned that they're normally winning one new core a week, roughly speaking. So that's 50 a year. At the moment, they've got 1,700, roughly speaking, banks and credit unions. So you've got just those coming online naturally.

And as I said, you've got asset balances go up and electronic payments are growing roughly 10% per annum. So you've got national growth there. We spend more time online. We move money around more than we used to. So you've got just these really nice, just secular growth drivers for them. For those 50 that they win, and I know you mentioned this earlier, just in terms of how much comes up for RFP or whatever it might be.

Where is that coming from? Because hearing that number almost shocks me. I wouldn't think of 50 new banks being launched in the US. Is it banks that are looking to change software providers? Exactly. Okay. So it's predominantly that. Banks are really reluctant to change their provider because it is really disruptive to employees'

and customers, but they do put their 200 RFPs a year. So I'd have call it 5,000 banks. A hundred of those is just routine. They're not going to move anyway. It's just too hard. I'm just going to stay with my existing provider. So there's a hundred that are moving. And the number one reason that they move, one is technology, but even more than that is what they describe as a broken relationship where service levels are so poor, the relationship is just broken down.

It goes to your point, what you said at the beginning, it's the type of industry where there's going to be niggles and there's going to be complaints and I'm onto my provider and this is not working and I want it fixed. I need to fix now. And if you haven't got that real ethos of service, the relationship breaks. Then I think also some of their competitors, they say they do, but I'm not sure they have it to the same degree that open API mentality. I think they're getting there.

But I think Jack Henry was there long before them. So that thing of customers are not stupid. They know that Jack Henry puts them first, both in terms of the technology needs and then allowing them to have open API architecture and then backing that with top-notch service.

And from a market share perspective today, do you have a sense of where they would rank relative to the Fiserv and other large competitors and just how much of the market the big players make up? So you have to segment the market. So obviously, you've got some really big banks in America. So let's just talk about anything less than $50 billion. So within the credit union space, they've got just under 50% market share.

And that's through their credit union solution, core solution, which is called Simitar. And then within the banking sector, about 25% market share.

So there's still room to take share there. And when they are taking share, is it coming from those large competitors or is there still a legacy of smaller players that exist in the space? It's both. There is actually quite a long tail, unlisted longer tail, maybe private equity owned, quite a long tail of software providers.

And you do, you need scale to compete. You're spending a vast 2 billion revenue company and they're spending 15% of revenue. They're just spending more. It is a one-to-many business model. So the more customers you get, the more you can spend in technology. You can monetize it. There's nice little flywheel. If you've got that long tail, you're just not spending enough on technology. It's really a cash cow.

And so they do have a structural competitive advantage. So not just against the other players like Fireserve and Fidelity, which have tried to modernize their systems over the last couple of years, but then you've got this long tail as well of other software providers.

Do you have a sense of what the average contract pricing looks like? I know because it's going to depend on all of the different products, it's going to be very difficult. But just any general sense of what they're paid, framing for a bank and how much goes to Jack Henry? So one of the things that I do like about this, now if you're off-prem, some of the cloud customers, those will tend to be seven-year contracts. So quite long contracts, seven to 10.

And so for a client, that's very attractive because CapEx has now become OpEx. You're going to take care of all the worries around cyber, regs, updates, all of that type of stuff. So that's very attractive for a customer. That's a seven to 10 year contract. The other ones are probably three to five.

They do have built-in CPI escalators, which they did use when we had the inflation over the last couple of years. They are generally reluctant to use them if they can. What tends to happen at renewal, there will be some sort of argy-bargy out of pricing. It gets a bit competitive because as you grow, it's natural that customers want to share in some of that. But they just have natural CPI escalators in there.

And then obviously over time, they're going to process more transactions in the payments business and assets grow naturally over time as well. So you can just see this nice runway. It's just such a nice way of growing off the back of GDP and economic progress, if you like. We've mentioned it a few times now. I am just thinking about the shift of going from on-premise to cloud and

And what that might entail, I think a lot of us have seen this happen from the cheap seats. For the banking system, I imagine it was much more onerous, took time. There's all types of records and compliance, things that need to be kept in mind. How long of a shift has that been just in terms of the business being focused on that? How long has it taken to play out? And where does it ultimately go? I think you referenced 75%. I mean, is that something that will eventually hit 100%? Just some context around that.

When we say cloud, it's important to stress this private cloud because obviously the long-term goal will be public cloud. So private cloud, actually the move to private cloud is actually pretty easy to do. They tend to do it over a weekend. Wow. And people come in on a Monday, it's business as usual for them.

I take back my question then. Yeah, no, it's interesting. I mean, it's a natural assumption to make. So that's actually quite a simple thing to do. Longer term, where they want the business to get to, and this is probably a five to 10 year journey, is public cloud. But then obviously banks are very cautious as are regulators. So there's a lot that needs to happen before everyone gets to public cloud. But one of the benefits of moving to private cloud, they tend to get two times the revenue on the contract, they get margin uplift.

So not only good for Jack Henry, it's also very good for the customers. If you think of being a chief technology officer of a small community bank of a billion dollars, and it just allows you to sleep better at night. I mean, you just be petrified of cyber risk and all those other things and constant updating and regulations and keeping on top of that. It's just easier to hand it over to Jack Henry and say, it's your problem. What drives the two times revenue uplift?

So basically now we've got contracts that are having to pay for the hardware, obviously. So we've got the hardware. So basically they've said to them, you're not going to pay for these costs yourself. We're going to have to actually cover some of these costs. Essentially, the hardware is obviously going to be the big one. So clients are happy to pay for that. So it does lift their capital intensity, but they're obviously charging customers for that.

And then can you give a simple overview of what the private cloud versus the public cloud entails just in terms of what that opens up if you were to shift from a private cloud and what those constraints are to a public cloud? So it's still very early days. They've touched on it, not on a huge amount of detail. In the very general sense, they feel there will be an uplift from private cloud to public cloud.

The other benefit is then now they won't have the CapEx as well. So that now gets shifted onto the hyperscaler. So private cloud, that is hosted on Jack Henry's premises. So you've just taken the information that's sitting on your premises. You've just taken all of that information and stuck it on Jack Henry's servers. Public cloud, we're going to give it to Google or Amazon directly.

So that's a totally different situation. But from Jack Henry's point of view, there's going to be better cybersecurity. There's going to be huge benefits that they're going to get from scale, better have all the capital requirements. It allows them to be more innovative on technology. There'll be faster updates. So all the benefits that companies are naturally getting are moving into the public cloud. They'll take advantage of that. But it is still early days.

And I think the big stumbling block is the regulators. Think of the data. There's a huge amount of client data here, and that's going to be sitting in the public cloud. So people need to get comfortable around that and how that's going to work. So when we speak to the company, they say, this is going to happen slowly and then very, very quickly.

Once it's social proofed up, you're looking for the social proof and then everyone will do it. I can understand the cybersecurity protection that you might be able to get from one of those larger public clouds. But I am curious just from your point of view on a shift like that, it does feel like removing some of the specialty or value out of Jack Henry. How would you think about that using an outside solution for something that

disintermediates Jack Henry to some extent. Obviously, they're still owning the relationship, but any perspective on that just in terms of to the extent that there's another side of the coin here? Yep, that is a great question. It's something we've obviously asked ourselves as well. The way the company answered that is, firstly, that's where things are going. People want to be on the public cloud

But with the new technology that they are developing now and will release over time, the core will be increasingly unbundled. So you'll pay more piecemeal solution. So once you break it down into separate solutions, you know, loans, deposits, whatever it is solution you're taking, they believe there will be a revenue uplift.

It'll also be much better for their customers in terms of just updates. Regular updates to the technology be much, much faster to do. So much better customer experience. So moving to the public cloud, modularizing, breaking it up and then charging separately, they believe there'll be a revenue uplift for that.

Certainly interesting. I can understand both sides of things and why it's an interesting point. We've talked margins a bit throughout the conversation, but can you give us a sense of what those margins actually look like from a numbers perspective? And I tend to think about this business now as it's hard to unbundle those segments as much as you do have customers that might only start with the complimentary services. But to the extent that you want to separate those and then get to the consolidated number, whatever you think is best.

So if you actually look at the margins across the business, over five years, the businesses averaged low 20 to 23, 24% margins. So very attractive margins. Is that operating? Yeah, operating margins. Gross, it's around 40%, 41%. So what's quite interesting is if you actually compare their margins to some of their listed peers, they're actually lower.

So you can look at it in one of two ways. Are the competitors spending enough money to give the right customer service or was it just a question of scale? But the thing that I like about their margins is they're consistently in the 22, 23% area and gradually scaling over time, but they don't scale too fast. So we're probably looking at about 30 or 40 basis points per annum.

So you're just getting gradual uplift over time, but that is after spending a good chunk of revenues. In total, we're spending 14%, 15% a year on R&D. So just gently scale those margins over time.

And then how much of that is converting to free cash flow in terms of what gets reinvested back into the business versus what gets distributed to shareholders? Any dynamics in terms of how that filters all the way down through earnings and free cash flow? Free cash flow conversion normally sits around 80% to 90% across the business. It's been a bit depressed from that lately just because of a couple of tax timing differences.

which will probably be reversed potentially with the new Trump administration. So normally it's around 80% to 90%. They don't have a lot of working capital. Their CapEx normally runs around 9% to 10% of revenue. So that is a good barrier to entry that if you want to be in the space, you need to be spending a good chunk on R&D and CapEx. So generally 80% to 90% cash conversion through time. If you look at the rest of the income statement, your organic growth tends to run 7% to 8%.

So you've got a little bit of margin improvement as well. They pay about 40% out in dividends and that dividend is increased for 20 successive years, which they're pretty proud of. So you're going to see that

increase over time. So the overall metrics, you're looking at a business that's growing, let's say 10 plus percent over time, you're getting 1% dividend, which is growing. It used to grow a lot faster than that. As I said, since listing, they've actually grown their earnings at 15% per annum. Now it's more like a low double digit grow, I would say.

Yeah, the history, I think they listed in 85. You have a rich history of financial performance and things to look back on. In terms of the cyclicality of the business, how much does it swing when you see soft periods? The financial crisis might be something that is hard to look at and use as the model, but to the extent that we've seen other slowdowns, how much cyclicality is there in the revenue stream? You would expect the cyclicality to be much higher.

It's interesting you look at the financial crisis, which is about as bad in my lifetime as I've seen. I mean, that was a pretty good stress test, especially in the banking sector and for their customers. They had flat organic growth that year and actually had EPS growth of 4%. There's a very, very extreme environment. So quite often what happens with Jack Henry,

is when we saw the SVB collapse and stuff like that, you'll get huge headlines in the Wall Street Journal, banking sector in crisis. But actually, when you get to speak to the customers, we don't just speak to the companies, we don't just speak to Jack Henry, we'll speak to their competitors as well. They will just say, well, it's business as usual. Just because one of our competitors has gone bust, customers don't stop spending money, they don't stop having bank accounts. But the perception is always, oh, there's a big risk. And so the shares tend to sell off.

in those types of environments. And it's normally quite a good entry point to buy the shares because they trade quite expensive. So often the reality is very, very different to the headlines and that does provide opportunities to get into the stock. And on the SVB event, and there were some other banks that had fallouts from similar situations, it sounds like the financial profile of the business did not change at all. They did not have a negative impact?

Yeah. And again, just speaking to them and also their competitors. So if you think even when SVB had an issue, the regulators go in, but there's still accounts there. Until those are resolved, they have to keep paying for that. And then let's say they shut the bank. Well, those accounts have got to go somewhere.

And if you're in a small community, there's not going to be a lot of choice. They're going to probably end up at one of the competitor banks and Jack Henry will pick it up. They don't just disappear into the ether. They've got to go somewhere and they're going to pick up their fair share of those accounts and those transactions. The banking system, a good way to think about it, has been consolidating for 30 years. There's not something new. And even if you look back over the last five years, I think the number of banks is down something like 19%.

but their assets are well up over those last five years. So people draw a false correlation between banks going down, but the more important thing to look at is what's happening with assets and transactions.

I will admit, it's even hard for me to comprehend when I think about their target market and the consolidation. What you're saying makes sense, but it's even hard for me to think about how this business and the competitors have succeeded over that period of time. It's logic, there's math behind it, but it runs counter to what you hear about going after growing markets and those dynamics. The way I think about it is you've got to look through the bank to who's the end customer. The customer is the bank, but the end customer

is an individual or a company, they haven't gone anywhere. They've just gone to another bank. And more often than not, Jack Henry's getting their fair share of them.

In terms of the margin profile of business, you mentioned there's a slow and steady approach to that expanding. Do you see cyclicality in that number? And then the second question is, do they have a target that they're looking to achieve? Do they guide to anything just in terms of where that number could be over time? In fact, there's no cyclicality, but there can be headwinds. So over the last few years, there have been some headwinds in that margin number. There have

what they call conversion revenue, which is basically where one of their banks gets acquired. So obviously they have to break the contracts. So they will get paid upfront the cost of that contract, which is a nice little bump to earnings. And that can be somewhere, you know, 30 to $50 million. But long-term, you actually don't want that to happen because you've lost the long-term contract. You've lost a customer, but that can juice your earnings. Now, when they produce their revenue,

they always strip out those numbers so it's one of the few companies that i've seen where the non-gap revenue is actually lower than the revenue so normally it's always the other way around companies like to give themselves a free kick so they've had that sort of conversion so now there's been not a lot of m&a in the banking sector over the last couple of years that's been very depressed so that number's been depressed they've also get what they call convert merge revenue

And that is where one of their banks has given them the heads up that we're going to buy another bank. And then they will then go in there and help them to merge the two banks. So that's the source of revenue. So again, because M&A has been down, that revenue line has been depressed as well. And obviously these just drop straight through. They're very high margin revenue lines.

And then they've also had headwinds. Their R&D has been a little bit elevated as they've tried to modernize the systems. And then even through COVID, IT people were costing a fortune. So they had to pay up then. The last couple of years, they've had margin headwinds. Now, if you look forward over the next three to five years, we can see those all reversing. So they've threw a big hump of technology spends. IT costs and employee costs have normalized the back end of COVID. So that's good. And then

Who knows, but it's a reasonable assumption. And potentially with the new administration in Washington, you're probably going to see a pickup in M&A activity. So those three are tailwinds. So it's one of the things I think they've done better under the new CFO who came from Microsoft. I think previously, if I were to give them, they were maybe a bit too bullish on their margin assumptions and they never really hit them. I think now they're saying 30, maybe 30, 40 basis points a year, wanting, I think, to under-promise, over-deliver.

So that's how we look at it. Slow and steady margin progression over time. But we would prefer it if they actually keep reinvesting back in the business, reinvesting back in technology, customer service, all of that, rather than taking margins up too quickly.

When I think about the competition, I think you gave a good sense on the incumbents. And I have some idea of how they operate against those in the world of fintech and the investment that you've seen in those markets. When I think about some of the bigger players like a stripe, I

almost think about it more as a business tool rather than something that the banks would think about as their customer. Obviously, there's a lot of interaction going on there. But just in general, when you think about the fintech market, the investment that's gone into those space, how do you view that as a competitive threat to Jack Henry and vice versa, to the extent that it's a complimentary and positive, you can mention that as well?

As I said, fintechs can be a bigger threat to their customers. So it's an indirect threat, if you like, to their customers. But they're also a friend as well because fintechs

those fintechs they're partnering with those fintechs to provide solutions to their customers you see this all the time in aims for enemies but to your point you take someone like stripe now stripes main target market is going to be small they're trying to move up market but small merchants so they're going directly to the merchants now it's interesting that you brought that up because one of the

things that's happened in the industry over the last few years, Fiserv merged with First Data. So First Data is obviously a legacy merchant acquirer. They've merged. And so they've gone down that route. Now, interestingly, Jack Henry, and this is one of the things I like about this company, they kind of marched to their own drum. So Fidelity after Fiserv, they also did bought a merchant acquirer as well. And Jack Henry didn't go down that route. They said, all customers are banks, not merchants. But what their banks have identified is

is what you mentioned, is that they want to get more small business customers. And one of the beauties of a small business customer is they have very nice deposits, much higher deposit bases than a retail customer.

And they obviously see all the data anyway because they're processing those payments through their payments division. So they know those customers. One of the things that they have identified is they do want to go after. But again, they don't compete with their customers. They're not going around their customers. They're going to help the banks to acquire more merchants, which brings more deposits, which they already know those customers. So it's something that often gets missed, I think, in the whole payments disruption piece.

is that you can be competing, but also friends at the same time, what they call frenemies. So on balance, fintechs have been good for them because they provide solutions to their customers, which allow them to run their businesses better. But if they are going to go down that route, they're going through the banks. They're not going to compete head to head with them.

Yeah, it's an ecosystem where, whether it's incestual in terms of how much involvement they have or whatever it might be, it's an interesting dynamic to your point in terms of friend versus foe. I mean, what's interesting, Matt, is you actually think of their competitor, Fiserv, though. So Fiserv have taken a different strategy.

So Fiserv merged with First Data and they're going head to head with Stripe with their acquiring businesses. But they have two pretty good solutions that they've developed in the last year, especially Clover in the small business space has gone pretty well against Stripe. But Jack Henry's gone a slightly different route that they're going through the banks rather than around them.

Do they ever have a preferred partner when it comes to one of these solutions? And do you ever see partnerships rather than acquisitions? It sounds like it's just very open architecture and they'll help them find the best solution. But it does feel like the type of situation where you could see partnerships evolve or something along those lines. And I'm curious if they ever explore that or work in that format.

I think it would be very unlikely. And the reason I say that, I don't have any strong evidence, but if I think of the customer-centric culture, they will go where the best solution is. And I think if they were to have a partner that could compromise them, potentially. And then this is a really interesting thing that they've done. Historically, they were in debit card processing and then they wanted to get into credit card processing. So they actually approached their number one direct competitor, which was Fiserv.

And they were actually using First Data's systems to process their credit cards, which is really interesting that they said, well, that's the best system. That's the best solution for our customers. So let's actually use that, which is our direct competitor in call. So you can be a competitor in one part of the business, but actually a friend in another part, which is really interesting that they went down that path. I'd have to check with the company, but I think it would be unlikely that they would lock themselves into a solution. Now, one of the other things that you do pick up in the transcripts and

using expert calls is that they are pretty close to MasterCard, that there's no formal relationship, but they seem to have a very good working relationship with MasterCard. And do you have any sense of why that would be the case over a visa? I don't actually.

But it just appears that they have a very good relationship with him. I mean, obviously MasterCard have the clearinghouse system, which is for fast payments in the States. That's obviously something that Jack Henry want to roll out. I might be reading too much into it, but it appears that they're pretty tight with him. No, I like that type of tea leaf reading. It's always interesting if you notice things like that. I mean, obviously you have to work with all of them. Right. And it just appears that they're pretty tight with him. Yeah.

Just thinking about the customer base over the next five to 10 years, do you think there's major shifts in terms of what that looks like? I think we talked about, we've gotten through it in terms of what consolidation means or doesn't mean and the end customer is what matters. But is there any conversation about what the customer base is going to look like in the future and whether that's different than it is today?

So you're obviously going to keep seeing consolidation because it's crazy to have 5,000 roughly financial institutions. So that's going to keep happening at the smaller end as it has for a long period of time. So that's going to be on balance, a tailwind for Jack Henry. So I think we'll just keep seeing that ongoing consolidation. One of the more interesting things that's been going on, and this is more to do with the newer technology, is it looks like the newer technology will be more applicable to larger banks and they can start moving up market now.

Remember, they have relationships with a lot of these larger banks through the complementary solutions. So they actually sell the complementary solutions to around 8,000 clients and financial institutions in the state. So the relationship is there.

So I think that's one of the interesting things that could happen over the next few years is they start moving up the size chain. So that'll be interesting to see how that develops over time. So generally, the larger banks, that's more of a sweet spot would be Fidelity. And then when you get into the really large banks, they have their own technology departments. But at a very broad sense, a lot of this bank technology is old.

on legacy systems and it needs to be modernized over time. Customers want that Netflix, Amazon experience. Plus the cost of maintaining all that old legacy architecture is wasted money effectively. That's money you could be spending on customers rather than maintaining old technology. It has been slower than I would have thought. I think just because it's just such a big thing to do, to move off that old architecture. But over time, I think if you can keep your architecture fresh and modern,

have core systems that I think there's room there for Jack Henry to move up the size curve. This is a question that I should have asked earlier, but just in terms of the asset base of customers, have you seen a shift where the larger banks are getting more of the market where their share is growing as a percentage of the total, making that requirement to go up market maybe more of a need in the future?

So you have obviously seen the consolidation of the large banks and the regional banks, but that's not really in Jack Henry's sweet spot. So Jack Henry member is in that 1.3 billion area. I just think there's potential for them to move up the scale, but into the mega banks in terms of core, I don't think that's really where they want to go at this stage.

Yep. Understood. And thinking about other risks that might exist for the business, I think we've talked through a lot, but just if you were to consolidate your thoughts and share what you see as risks for Jack Henry, what would you point to? I think it would be two risks. The number one obvious one is cybersecurity. So

A major cybersecurity incident would be huge, obviously, for their reputation. All of these businesses run on reputation. So if I'm a CTO or I'm a consultant, at the end of the day, I don't want to put my reputation at risk. So I'm going to go with the proven providing, the old adage that no one gets fired for buying IBM. So your reputation is absolutely crucial for those RFPs. So that's the thing I would worry about the most. I think the second one would probably be culture.

Because I think so much of Jack Henry's success is rooted in that culture, that culture of looking after employees and looking after customers. So if they suddenly shifted their culture, let's say to a Wall Street culture, I don't think that's going to really work in some of these smaller sort of community banks and smaller parts of America. So those two things.

Or do they branch off and don't stay focused on the core? We've seen that I think Fiserv FTC mergers in a pretty successful story. Some of the other ones have not been successful and they've been spun out again. So I think the way they've gone around the dealing with the small merchant thing is a smart way for them to do it. That fits their culture. We're not going to go around our customers. We're going to do it. We're going to do it through the banks.

So I think those are probably the three things that I worry about the most is just go into the wrong adjacencies, move away from the core. The culture gets messed up because I think that's such a key part. And then obviously cybersecurity incident would be a big one.

I'm curious on the cybersecurity risk in general. Is that something that ever comes up with the company, just in terms of being focused on stopping that? Come out maybe twice when we talk about potentially moving to the public cloud and then just as a risk. So I'm curious how often that's discussed around this business today. It's the number one worry, I think.

When you hear the stories of the FedEx and Maersk related to not Petya and what can happen in these incidents, I can understand for a business that's that in tune why they would be, but interesting to hear. I mean, the thing that's actually interesting to Novich and Mesa to think about is

Would it hold them below the waterline forever? Because I think what we've seen from cybersecurity incidents is that... No. Exactly. Because if it can happen to you, it can happen to anyone. We saw that with the credit bureaus. Obviously, Equifax had a huge cybersecurity incident and hack, but they didn't kill them. So,

So I think just because you haven't had a cyber incident doesn't mean that you're immune. Yeah, it's very interesting, especially with a name like Equifax, where if that doesn't kill you or materially impact your business, it might just be in some weird way a positive proving the strength of your actual business. Yeah, I think there's something in there. Yeah. On valuation, this is just an interesting name because you look over...

the 40-year public time horizon, and it has been an incredible compounder. Over the past five years, the performance has not been as strong. And when you look at all the financial metrics, you would say this is a business that's growing incredibly well, but the stock price hasn't necessarily performed to the same extent, which kind of leaves valuation in focus. But what is your approach to valuation on a name like this where I think we've touched about

everything culture wise, the business, what makes it so interesting. So just how do you go about it for a name like Jack Henry?

No, it has derated. I mean, it never comes cheap, this business. So over 10 years, I think the multiples averaged somewhere around 32, 33 times earnings. Currently trading around 28. So it's still not a bargain. It's trading around 28 times earnings. The way we tend to look at our valuations is we estimate what we think the business will be earning in five years' time, and then we put a multiple on those earnings. That gives us a theoretical share price in five years, and then we discount that back to today.

at 9%, 6.5% real rate, and that gives us a net present value. And then we compare Jack Henry's share price to that. Now, one of the things I think has been going on, as I said, there have been some headwinds in the business, nothing major, but they've been growing organic six instead of seven or eight. There've been some margin headwinds as well, but I think those are abating going forward. We can see it being a seven or 8% organic growth story with margin tailwinds, so called low double-digit earnings.

So another way I would think about it to reference it, say, well, let's just say the multiple holes where it is, it's 27, 28 times earnings long-term, it's been low 30s. That's roughly right, but we're going to get low double-digit earnings and a 1% dividend yield. We target eight drops in returns for clients. So we're going to be towards the top end of that range. We're not big believers in the DCF. 10 years is a hell of a long time. You can perform all sorts of gymnastics. So that's what we try and think about in five-year windows.

And we can see Jack Henry getting our clients to double-digit returns plus over the next five years without taking a huge amount of risk. One of the other things that's interesting with Jack Henry, I was speaking to the company the other day and I said, there's not a lot of analysts that have buyers on your stock at the moment. It's not very loved. And they said, well, it's quite interesting in times of excitement. We're in a bit of excitement, nice, strong bull market at the moment. You know, we're not the most exciting stock.

But in times of volatility, suddenly people really are willing to pay for that security that the stock has. I think that's happened quite a bit across the market. So let's see how they go in a tougher environment. I expect they'll do pretty well.

Yeah, I still can't believe that they grew in the financial crisis, which is just an astounding anecdote there. We close out these conversations with the key lessons that you can take away from a business. And again, I mentioned at the very top, Jack Henry is one of the most highly regarded businesses that exist. But what stands out to you in terms of key lessons that can be pulled from this name? I think the key one is really their culture.

and that customer obsession they have, that pride that they have in really looking after their customers. And sometimes that means taking a short-term profit hit to build a brand and the customer trust and everything else that will pay off in spades over the long term. So I think that thing of making sure you get the order right, customers first, then employees, or they will probably say employees first, then customers. But if you get those two bits right,

the shareholders will take care of itself. Now, too often I think we see businesses where they put the shareholders first or they're trying to make the quarter or trying to make the year

But actually in the long run, shareholders don't benefit from that, nor do customers, nor do employees. I think that's the thing that I take from them. And it's actually there. What they have on their business cards, do the right thing, do whatever it takes and have fun. And I think that is such a good way to run a business. And it's there. You can see it's demonstrated over the long term. And I actually see it in another Midwest company, Sherwood Williams, which is a completely different business. But they had that same thing and they're in business to make their customers more successful.

sharing that success. If their customers are successful, they will be. And I think that's the number one thing I take out of Jack Henry, rather than a business that's run to make the quarter or make the year, push the share price up. Because then you forget about the two things that really drive a business, which are your customers and your employees. Well, this has been a fascinating discussion. I appreciate your insights and depth of knowledge here. Bob, thank you for joining us. Thanks, Matt. It's been a pleasure.

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