Davis and Henderson's planned $1.2 billion acquisition of Harland Financial Solutions marks the Canadian technology developer's biggest push into the U.S. market and its first foray into payments processing.
Harland Financial Solutions ranks fourth among providers of core banking systems to U.S. financial institutions, behind Fidelity National Information Services, Fiserv and Jack Henry. The Lake Mary, Fla.-based subsidiary of Harland Clarke Holdings also offers a slew of ancillary products and services for payment processing and merchant services, consumer and mortgage lending, as well as compliance and credit risk analytics.
"The main catalyst of this deal was acquiring a strong core banking platform and using that to sell other products and solutions to banks," says John Guzzo, a managing director at investment bank Berkery Noyes. "It's really about providing a full product suite and acquiring a business that's going to get them into different markets."
Many of those products and services will be new offerings for Davis and Henderson, including payments processing. Based on their respective full-year 2012 earnings, the combined company's revenue from U.S. operations would account for 36% of total revenue, compared to only 8% prior to the acquisition. The transaction is expected to close on August 19.
"We looked at a few smaller acquisitions and when we found out the possibility of this one, it made all the sense in the world," William Neville, president of D+H USA, says in an interview. "This acquisition clearly demonstrates our desire to be full-time and long-term players in the U.S."
In payments, Harland provides banks with credit, debit and prepaid card issuing and processing capabilities, merchant services for acquiring banks and a person-to-person payments platform that runs on the Automated Clearing House network.
D+H provides Canadian financial institutions with consumer and commercial lending origination and credit risk analytics technology. In the United States, Davis and Henderson has previously acquired two mortgage technology vendors and Compushare, a technology management and cloud computing provider.
Davis and Henderson, founded in 1875, and Harland Clarke, created from a pair of companies founded 1874 and 1923, both trace their origins back to the check-printing business. But both companies have evolved, primarily through acquisitions and other types of financial technology and services.
While D+H doesn't have core banking systems or payment processing technologies in its current portfolio, Guzzo says the similar histories of the two companies, combined with D+H's previous experience in the U.S., will help smooth the acquisition process.
"They're already in a lot of these midtier banks and credit unions and they already have experience selling to that audience and customer base," he says.
When a small startup gets acquired by a large technology aggregator, it's often a challenge for executives and staff to assimilate into the corporate world of its new parent company. Harland Financial Solutions accounts for only 15% of Harland Clarke Holdings' total 2012 business, but Guzzo says the two cultures will mesh well because D+H and Harland are relatively similar in size.
"Harland Financial Solutions is coming from another large business and they're very comfortable with parent companies and different hierarchal structures," he says. "So I would think that they're comfortable with that sort of corporate structure and from a culture perspective, I see the companies pretty much having a natural transition."
The biggest difference between the two companies is that D+H has historically served a highly consolidated Canadian banking industry, while Harland's bread-and-butter is the myriad community banks and credit unions throughout the U.S.
Still, 850 of Harland's 5,400 U.S. bank and credit union clients already have a relationship with D+H, Neville estimates. After the acquisition, the combined company will have more than 6,200 financial institution clients, after accounting for overlapping firms.
"The fit is great. This is not a cost-synergy play; it's a revenue-synergy play," Neville says. "We don't have a lot of overlap, so it's all about being able to bring new products and services to D+H's clients and also to the HFS clients."
But there are some reasons for financial institutions to be worried about the acquisition, says Brad Smith, CEO of bank advisory firm Abound Resources.
"In five years, D+H will have grown from 100 customers to nearly 6,000. That's impressive if you're a shareholder and frightening if you're a customer," Smith wrote on July 24. "I hope their management team consists of superstars."
Davis and Henderson had approximately $780,000 in cash and equivalents at the end of the first quarter, down from about $5.6 million at the end of 2012, according to regulatory filings, and it's funding the Harland acquisition through a combination of convertible debentures, equity and debt.
"D+H's leverage is already sky high and its liquidity is very low We've seen several highly leveraged core processing acquisitions before and none of them survived," Smith says.
The enormity of adding so many new customers and D+H's financial footing may limit new features being added to Harland's core banking technology, Smith adds.
"I wouldn't expect major development dollars for a while," he says. "History has taught us that vendors will typically focus on integrating their legacy products with their newly acquired ones before they start to tackle new developments in the acquired products."
D+H CFO Brian Kyle said on an analyst conference call that the company will reduce its debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio from 3.4 at the close of the acquisition to less than 2.5 by 2016.
"We believe that strong cash flows from the combined business will support reduced leverage in a relatively short timeframe," he says.