From Credit Lists to Cloud: Equifax's 125-Year Journey of Innovation and Resilience

One of the myths Fairlight covered as part of our May 2024 webinar was the notion that small and mid-cap companies are riskier than their larger counterparts, partly due to their short operating histories. Often when investors think about smaller companies, they conjure thoughts of IPOs or speculative assets that may lack the operational history required to make a long term assessment of a business’s resilience.

What is commonly misunderstood is that US mid-caps often have storied histories and are far larger than their Australian counterparts. Currently, the largest companies within the Global MSCI Small and Mid-Cap (SMID) Index are up to US$40bn in value. By way of comparison, Brambles, Woolworths and Transurban in the Australian top 50 are all valued below this hurdle.

One SMID company with a particularly long track record of earnings resilience, is US Credit Bureau, Equifax. The company’s origin dates to 1898, beginning life in a Tennessee-based grocery store. Brothers Cator and Guy Woolford compiled lists based on the creditworthiness of their customers and sold this information to surrounding businesses - unsurprisingly this list became popular, fast. From this humble beginning the company evolved into Equifax, where today it operates in a three-player oligopoly for the provision of credit reports in the US housing (and other credit) market alongside competitors TransUnion and Experian.

Credit bureaus dominate niches

Credit bureaus are competitively advantaged. Banks use credit reports to determine customer eligibility for a loan and have fine-tuned their operations to work seamlessly with the bureaus, facilitating thousands of credit decisions per hour. The use of at least two of these reports is mandated by law in the mortgage market and a third is likely to be used as not all bureaus carry the same credit histories.

Interestingly, each of the bureaus occupy interesting niches outside of their core dominant US housing franchises. TransUnion is strong in emerging markets and Experian is entrenched in consumer services such as credit score monitoring and identity theft prevention. Arguably however, the strongest niche with the largest market opportunity is Equifax’s Workforce Solutions (EWS) division.

The division stemmed from the 2007 acquisition of TALX, a HR compliance business. Whilst the core of TALX was of questionable quality, what accompanied it was underappreciated and exclusive, payroll data. A data set for which Equifax was the natural owner due to the complementary nature of its credit report business - where a credit report provides a history of a client’s timely payments of interest and principal, payroll data provides decades long employment history and salary information. In other words, a credit report provides credit history, the payroll data provides the evidence for future serviceability.

Adjacent market opportunities

Not only does this information aide in credit decisions (for banks to verify income without contacting current and past employers), but also a raft of adjacent use cases. The database can be used by Medicare/Medicaid agencies to determine if social security payments are warranted, for HR departments to verify past employment and job title accuracy, and for immigration agencies to cross check work visas with the appropriateness of employment.

An emerging network effect

EWS has a classic flywheel element. Around 50% of the data within the system is directly sourced by Equifax, the remaining 50% is sourced, often on an exclusive basis, from payroll providers. As the deals are on a revenue share basis, payroll providers are incentivised to share their information with the largest database, most used by clients, thus driving the most revenue for the payroll provider - a virtuous circle which is both difficult to dislodge by competitors and drives greater economics for all participants in the system. This has resulted in Equifax now owning 182m active payroll records, up 12% year on year with over 3.8m partner companies contributing information to the database – dwarfing all other competitors on a combined basis. Unsurprisingly, Workforce Solutions is growing faster than its legacy business (see Figure 1) and at superior margins.

Figure 1.

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The Investment Opportunity

It hasn’t always been smooth sailing for Equifax. In 2017 the company was the victim of one of the largest cybercrimes in history - compromising the personal data of 143m Americans, including social security numbers, addresses and in some cases driver’s license numbers. Equifax’s security systems were poor, and the management teams handling of the crisis worse, resulting in the replacement of the Board of Directors, and almost the entire senior executive team. Despite the epic security failure and subsequent management upheaval, remarkably Equifax experienced virtually no erosion in its competitive position.    

After carefully monitoring the situation, Fairlight purchased shares in the company during the COVID sell off in 2020 at an attractive valuation. Since then, a new board and management team has stewarded the business through a messy transition to a cloud native organisation.

This transition has improved the speed in which Equifax generates credit reports to banks or other credit providers, which in turn improves the end consumer experience. Cloud based operations have the additional benefit of higher margins, market leading security and a platform for improved innovation (the new product vitality index within Equifax is accelerating).

The Fairlight View

Not all SMID companies have short operating histories. Often Fairlight has the privilege of analysing competitive positions spanning back decades. Where short term pessimism results in the mispricing of wonderful franchises, Fairlight is prepared to purchase shares for the long term, but only where the evidence suggests the business has maintained its market position and that rational steps are being taken by management to improve operational performance. The valuation of Equifax is no longer as attractive as it was on purchase, and Fairlight has reduced its position accordingly - however, any improvement in US housing transaction activity provides optionality, as does the continued growth of the EWS division.

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