REVISED 10-19-00 eFINANCE ENABLERS: EFFICIENTLY MOVING THE BUCK Jeffery B. Baker [email protected] 415.551.8600 Stephen A. Laws [email protected] REVISED 10-19-00 eFinance Enablers: Efficiently Moving the Buck TABLE OF CONTENTS Executive Summary....................................................................................... 3 Industry Report.............................................................................................. 6 Initiating Coverage ...................................................................................... 36 CheckFree Holdings (CKFR)....................................................................................... 37 The InterCept Group (ICPT) ....................................................................................... 48 S1 Corp. (SONE)......................................................................................................... 58 Company Profiles ....................................................................................... 72 Financial Enterprise Enablers ...................................................................................... 73 Electronic Bill Presentment and Payment..................................................................... 91 Data Processors ......................................................................................................... 111 Payment Processors ................................................................................................... 118 Payment Enablers ...................................................................................................... 121 Appendix ....................................................................................................134 WR Hambrecht + Co Contact Information ............................................................... 135 Glossary of eFinance Terminology ............................................................................ 136 Legal Notices and Disclosures .................................................................139 Companies Referenced .............................................................................................. 140 Stock Rating System .................................................................................................. 141 Important Note ......................................................................................................... 141 www 1 October 2000 eFinance Enablers: Efficiently Moving the Buck TABLE OF CONTENTS Exhibits Exhibit 1: Market Segments of U.S. Financial Institutions .............................................. 11 Exhibit 2: Preferred Site for EBPP................................................................................... 12 Exhibit 3: Age Breakdown of Online Banking Users....................................................... 13 Exhibit 4: Income Breakdown of Online Banking Users ................................................. 14 Exhibit 5: Geographic Breakdown of Online Banking Users........................................... 14 Exhibit 6: Recent Transactions in the eFinance Sector.................................................... 17 Exhibit 7: Bank Online Offerings for Small Business ...................................................... 21 Exhibit 8: e-Financial Service Trends .............................................................................. 23 Exhibit 9: Web Site Plans of Community Banks by Size of Bank .................................... 24 Exhibit 10: Outsourcing Internet Banking ........................................................................ 25 Exhibit 11: Biller Direct Model......................................................................................... 29 Exhibit 12: Methods for Presenting Bills........................................................................... 30 Exhibit 13: “Thin” Third Party Consolidator Model........................................................ 31 Exhibit 14: Biller’s Web Site ............................................................................................. 31 Exhibit 15: Third Party Consolidator Model .................................................................... 33 Exhibit 16: CheckFree’s Key Historical Metrics................................................................ 45 Exhibit 17: Price Targets Based on Discounted 2005 Operating Earnings per Share Estimates ........................................................................................ 47 Exhibit 18: The InterCept Group – Products and Services ................................................ 52 Exhibit 19: Comparable Company Valuations ................................................................. 57 Exhibit 20: Applied to the Intercept Group at Various Growth Rates .............................. 57 Exhibit 21: Comparable Company Valuations ................................................................. 58 Exhibit 22: Applied to the InterCept Group’s 2001E........................................................ 58 Exhibit 23: Revenue Components as a Percentage of Total Revenue ................................ 67 Exhibit 24: S1’s Key Metrics............................................................................................. 69 Exhibit 25: Price Targets Based on Discounted 2005 Operating Earnings per Share ........ 71 www 2 October 2000 eFinance Enablers: Efficiently Moving the Buck EXECUTIVE SUMMARY 3 October 2000 eFinance Enablers: Efficiently Moving the Buck INVESTMENT THESIS We have followed B2B Internet software companies since 1998. Our focus on the infrastructure piece of the Internet versus the retail piece has given us great insight into successful industries and business models. One area where we believe the best investment opportunities are still ahead is the eFinance software and service enablers. Our thesis is spelled out based on the following points: 1) Outsource non-core technology: Within the resource equation in which financial institutions operate, there is a scarcity of talented professionals available to develop and maintain technology platforms. As the technology continuously evolves, companies become constrained by the resources needed to execute on their core competencies. For most traditional and non-traditional financial institutions, technology is not a core competency that can be effectively handled. As a result, many eFinance software and service enablers stand to benefit as these companies look to outsource their technology needs. 2) The “fear factor”: We believe the “fear factor” is what will drive traditional financial institutions to adopt new technology solutions. One thing that is clear in the financial services industry is that traditional financial institutions will either embrace new technologies or be disintermediated by non-traditional competitors like Yahoo!, America Online, Merrill Lynch, American Express, State Farm, or the hundreds of other companies looking to expand upon their customer relationship. 3) eFinance adoption to take shape over the next twelve to eighteen months: We expect increased competition among traditional and non-traditional financial institutions for commercial and consumer accounts. This competition, driven by the repeal of Glass- Steagle and the use of the Internet as a ubiquitous communication/delivery platform should drive advertising and promotional campaigns such that awareness and adoption rates for Internet-related financial services should increase. 4) Industry experts bullish on eFinance growth: • In 1998, 1,150 banks offered online banking. By 2003 this number is estimated to grow to almost 16,000 banks. (American Banker) • The number of users banking over the Internet in the U.S. is expected to increase to approximately 40 million by 2003. (IDC) • The electronic bill presentment and payment (EBPP) market is expected to grow 100% over the next four years. (IDC) • By 2004, 21 million households (33% of all wired households) will be paying their bills electronically, while two billion consumer bills, which represent 12% of all U.S. bills, will be presented and paid electronically. (Forrester Research) • By 2007, consumers will pay eight billion bills on the Internet. (Forrester Research) Clearly, this is an industry with a huge potential for growth. Although electronic banking has been around for many years in the form of PC banking, the Internet-based eFinance software and service enablers industries are very young. We believe that industry conditions are just beginning to fall into place that will make these sectors exciting for years to come. 4 October 2000 eFinance Enablers: Efficiently Moving the Buck 5) Business models do matter: It is extremely difficult for eFinance software and service companies to make money and create a respectable ROI for their investors through a pure software-licensing model. On the other hand, many companies prefer to fix the majority of their costs on software and services that are “purchased,” preferring a software-licensing model. While we understand the dilemma between the service provider and the customer, we favor those companies that have found a way to incorporate recurring revenues, other than software maintenance revenues, into their business models. These are companies that use or favor an application service provider (ASP) model in which they collect revenues by charging a transaction, usage, or subscription fee. 6) Initiating coverage on the following companies: (i) CheckFree Holdings (CKFR) Strong Buy, $50 12-month price target. We are initiating