The company does operate in the UK, but is nowhere as ubiquitous as in North America. FICO clients include more than half of the top 100 banks in the world, more than 600 personal and commercial line insurers in North America and Europe including the top 10 US personal lines insurers, 400+ retailers and general merchandisers, including one-third of the top 100 U.S. retailers, 95 of the 100 largest financial institutions in the U.S., and all the 100 largest U.S. credit card issuers.

At the core of the business are Fico ratings. The FICO score in 1956 and since then, the company has issued more than 100 billion scores. They are based on information collected by TransUnion, Experian and Equifax. These make it possible to qualify borrowers and evaluate them - and therefore to lend to them at personalized rates - according to the credit risk they represent - or even to eliminate them from the system for the most "subprime" segments. Fair Isaacs sell FICO scores to lenders.

This rating activity is a real standard and every US citizen knows his FICO score by heart. It has become a reliable standard recognized by all credit institutions. In this respect, Fair Isaac's service activity is based on an undeniable "moat", which the company has been developing for a few years in two segments: a traditional rating activity, called "B2B", which roughly grows with the GDP, and a software activity on the SaaS model, which is currently recording a modest but continuous growth dynamic (+5% in 2022) with an excellent retention rate (107%).

Source: MarketScreener

The business seems exceptionally established and resilient. However, for the record, two years ago Fair Isaac was in the sights of the US competition authority for the quasi-monopolistic nature of its business. There are competitors including Intuit, Pegasystems, Equifax, Experian and Salesforce, but FICO is in a dominant position. This investigation was eventually quashed, and Fair Isaac escaped unscathed.

In reality, the real risk is a big drop in credit activities in the US, especially in the real estate market. Let's not forget that the previous fifteen years of low interest rates stimulated demand, resulting in crazy price increases, and boosted service providers such as FICO in many markets (real estate, automotive, etc.) However, with the rise in interest rates, this bubble is starting to deflate. In fact, we are seeing spectacular drops in prices and transaction volumes in the most speculative US real estate markets. As the rise in interest rates is set to last, it is likely that the volume of transactions will stagnate or decrease following the euphoria of the last decade... This could of course impact Fair Isaac.

A tortoise rather than a hare

Financially speaking, Fair Isaac is a "High Quality Wide Moat Linear Compounder". Revenue growth is real but slow, like a tortoise rather than a hare, slowly but surely... The turnover doubled over the period 2012-2022, from $676M to $1377M. The net result on the other hand grows more pronounced, from $92M to $374M over the period, thanks to an appreciable expansion of margins. This is proof that FICO has a bit of pricing power including Moat, because it has raised prices several times over the period, albeit in limited proportions. This is of course confirmed by outstanding ROEs.

The business is remarkably non-capital intensive and the R&D expenses, which are certainly growing to support the development of the SaaS business, have been written off to P&L and not capitalized. As a result, cash generation follows the accounting results and here there is no need to distinguish FCF from accounting profit = the two are similar and easily reconcilable.

The resilient, profitable and completely asset-light business allows Fair Isaac to run at negative equity (i.e. no need for shareholder capital) which is again the sign of a solid business.

In terms of profits, FICO is making roughly $1.9 in cumulative profits over 2012-2022. There were very few acquisitions for a total amount of $240M. This leaves $1.66B of profits that were returned to shareholders, all in share buybacks since there are no dividends... The number of shares outstanding thus decreases from 36M to 26M.

As over the cycle there were $4.2B of share buybacks - which more than compensate the $300M of new shares issued via stock options - we see that there is a gap of $2.24B between the use and the generation of resources (4.2 in buybacks - 0.3M in shares issued by stock options = $3.9B net buybacks - $1.66B of profits after acquisitions). The gap is filled of course by an increase of the debt... However, debt remains perfectly under control with interest expenses covered more than x8 by EBITDA, but net debt now represents more than 4 years of profits... So, it looks like it is not going to be possible to continue these frenetic buybacks. the group cannot live beyond its means, even with such a good business model.

It's fair to say that FICO is at a bit of a crossroads: there has been a lot of financial engineering to boost the return of capital to the shareholders and in itself this is not too much of a problem given the underlying business, but it won't be able to continue forever. As there are no real reference shareholders, there are reasons to fear that the beast has been emptied of its substance, maximizing the very fashionable buybacks to please the capital institutes, if necessary by devoting more than it earns. That's fine in the short term but in the long term it's like everything else, it's not sustainable...


Quality that comes with risks

Fair Isaacs' stock  trades at a PE >30, which is typical of very good quality business. This is not a value deal for sure... But even though it has plenty going for it, this is not a sure bet. The company has an unsustainable pace of share buybacks, and there is the risk of emergence of a new competitor in fintechs and others. Let's not forget that a decline in transactions on real estate and credit markets is to be feared with the upcoming recession ... So all in all, while it is a quality business, I believe that the future is too uncertain and that there is too much risk at this level of value.