By Krishna Roy
Security First Technologies’ $1.4bn stock acquisitions of fellow financial services vendors Edify and FICs have made it the Gulliver of independent on-line financial services. With over 1,500 employees, 36 of the top 100 global financial institutions as customers and almost 1,000 financial institutions on its client list, S1 has now outgrown its Lilliputian roots as a family-owned business with a dream to start a bank on the internet.
Back then in 1993, Security First was an internet start-up conceived by James ‘Chip’ Mahan, an investment banker and his brother-in-law Michael McChesney, who ran the security software company SecureWare. The in-laws developed Security First Network Bank, the first internet bank on the web, which they formerly launched in 1995. However, internet banking was still a pioneering concept four years ago and commercial banks were unwilling to expose their financial transaction systems to the insecure protocols and untried techniques involved in internet banking. Not so surprisingly, Security First Network Bank turned out to be a loss-maker and Mahan ended up selling the business to Royal Bank of Canada for $20m in the fall of 1998.
However, the company still owned a range of web-based financial services software. CEO, Mahan, decided to shift the company’s strategic focus to the delivery of on-line banking services for the corporate, small business and retail market using software developed within the part of the business that that remained – Security First Technologies. This business seemed more assured of success company executives reasoned. After all Royal Bank of Canada had already bought the Internet bank but was still prepared to pay the company $50m to put its banking services on- line.
If one bank was willing to pay the company to host financial, brokerage and insurance services, then why wouldn’t the next? argued Mahan. His assumptions proved to be correct. Internet banking/brokerage and insurance began to enter the mainstream as both corporates and consumers alike saw the cost savings and ubiquity that could be achieved through on-line transactions.
But while many companies saw the value in off-loading the development, support and maintenance of a financial services portal to a third party such as S1, an equal number of brokerages, insurance companies and financial institutions chose to develop web-based applications internally. Consequently, S1’s competition still comes mainly from large organizations such as E-Trade, Charles Schwab and AmeriTrade in brokerage, First Union, Bank of America, Citicorp and First Union in banking and, Integrion an association of the 17 largest US banks and IBM.
Until the acquisitions of Edify and FICS, S1’s flagship product had been Virtual Financial Manager, a suite of HP-UX Java applications that integrate investment, loan, banking and credit card account data into a consolidated view. With these acquisition S1 has broadened out its financial services offering as well as expanding beyond its core market in the US. FICs was a Belgian minnow that started out as a specialist in statutory reporting software for banks but moved quickly to become one of the largest providers of internet banking software. Edify was an equally dominant web and telephone self service application vendor in the US.
FICs brings the corporate cash management component to the table. Available on Windows and as a web-based application, FICs had devoted considerable resources to making its software suite internet-enabled and as a consequence had moved from a profitable operation to one that was loosing money. Nevertheless, with fruits of the web-based application development project ripe for the market, FICs had decided to file for an IPO. S1 intervened, offering the loss making company with $55m in revenues in 1998 approximately $1.1bn in stock, when an IPO valuation would have realized half of that figure. FICs naturally accepted.
Edify was also a fast growing company but one that was also finding profitably difficul
t to attain. Having emerged from a March first quarter in which losses of $6.4m were the largest in corporate history, Edify stock had been bumping along in single digits, making the threat of takeover ever present. Furthermore, the company had just begun to rollout a small business financial product that S1 was keen to integrate into its own financial portal. It was also in the midst of divesting itself of a non- core business in web-based human resources capabilities thereby making it a more focused operation to purchase.
The Edify application will also be integrated with Intuit’s Quicken and Quick Books personal/small business software packages through a $50m equity investment Intuit made in S1. Intuit was finding it difficult to move into the financial services market because it did not have the transactional capabilities that we provide, says Rob Stockwell, CFO at S1. Intuit had also bought a payroll product that will be included in S1’s small business offering, according to Stockwell.
S1 intends to add banking brokerage and insurance services to its retail service in the next quarter through the integration of Edify offerings. Our plan is to offer a broad range of services in banking, brokerage and insurance on an outsourced basis with the primary attraction being the slight increase in incremental cost involved in adding more customers, says Stockwell.
When the deal closes, Edify shareholders will receive between $8- $9 a share for a stock that had not hit more than $10 in the last 30 days in a deal valued at $345m. Edify revenues for 1998 were $70m. However, there will be significant goodwill charges associated with both acquisitions. The company plans to write-off close to $1.4bn in the next 3-7 years.
Industry analysts argue the deal, a first in the world of on-line financial services, will sow the seeds of further market consolidation. Internet banking has been has been a land of small vendors, all of whom will now need to react to this new much larger force. Point solution providers such as Corillian, Destiny, Home Account Network, and Spherys must either combine forces or be bought, states a report by Forrester Research.
The international market for retail internet banking software was $500m last year, according to management consulting company, Dove Associates. And the market is just getting its legs. Dove expects it to grow by 40% per annum to reach $2.7bn by 2003.
Since retail banking is just one element in S1’s grand plans, the company has the potential to build an early lead and ride the tide of increasing revenues in the retail financial services market. However, this will happen only if S1 can deliver an integrated financial portal application to the market quickly. And the two-year time line the company has set to deliver the banking portal could jeopardize its ability to pick low hanging fruit, say analysts.
S1 is totally off the mark saying that it will take two years to pull this thing together. Although it has established an early lead in financial services by making these acquisitions people won’t buy this vision for very long. They need to pull it together in a year to make an impact, says Peggy Menconi at AMR Research.
The integration issues involved in this deal may make a 12-month deadline almost impossible to meet. First, S1 has the problem of assimilating two operations in different geographies from a third location on the East Coast. FICs is based in Belgium while Edify’s headquarters are in Santa Clara, California. Second, there is the not insignificant task of pulling together a plethora of software products built around different operating systems. S1 made the decision to develop its financial services offering on HP-UX after HP made an $10m equity investment in the company, while Edify’s Workplace software is entirely NT-focused. That said, S1 does have some significant development resources on which to draw. S1 has 400 developers working on financial services products. That’s only 200 less than the number of engineers Oracle has currently working on its customer relationship management software, argues Menconi.
Company executives have not yet drawn up a product integration roadmap but the sense of urgency is increasing. S1 needs to put its stake into the ground or risk being usurped by the flurry of market activity its deal making activity has created. On the same day that S1 revealed its acquisition plans, US Electronic and branch banking supplier, CFI ProServices, announced it would acquire Ultradata, primarily a credit-union-focused operation and Meca Software, a payment/presentment and personal finance software company. Although the combined entity will only play in one segment of S1’s market – the consumer banking sector – the online banking conglomerate is still a force to be reckoned with in financial terms with annualized revenues of $150m for 1999.
Furthermore, there is some suggestion that some of the enterprise software players are very soon going to make a financial services play via acquisition. S1 has identified an attractive strategy: on-line banking as a wedge into the entire enterprise. We believe that at least one large technology vendor to the financial services industry will focus on this opportunity: look for IBM, Oracle, Sun, or First Data to make selected acquisitions, says one analyst at Forrester.
