Flyover Stock: Jack Henry (JKHY)
This financial software company checks off all the boxes for what makes a Flyover Stock
Executive summary
Being headquartered in a small Missouri town and serving small banks and credit unions, Jack Henry flew under investors’ radars for decades.
In his 2015 letter to shareholders, Constellation Software founder and president Mark Leonard profiled Jack Henry as a “high performance conglomerate,” and noted that, “[Jack Henry’s] values are those to which we aspire and their multi-decade performance is remarkable.”
Despite high-single digit revenue growth targets and room for margin expansion, the stock is trading at or near ten-year average EV/S, EV/EBITDA, P/E, and FCF yield.
If you were going to create a Flyover Stock from scratch, you might follow the Jack Henry playbook:
Headquartered well outside a major city
Have an ambiguous corporate name
Operate in a relatively dull industry with few competitors
Fly under the radar while compounding value at a high rate
Disclosure: At the time of publication, KNA Capital Management owned shares of Jack Henry. Please see disclaimers.
Background
Headquartered in Monett, Missouri (population 10,000), Jack Henry’s main office is 200 miles from the closest major international airport.
As the below Google Maps image shows, corporate headquarters is nestled among farmland - not the typical location of a $13 billion company.
Jack Henry & Associates was launched in June 1976 when two business partners, Jack Henry and Jerry Hall, saw an opportunity in data processing for small banks. At the time, only the largest banks could afford expensive data processing software. Small banks and credit unions would send their processing to large banks, which added time and cost and put them at a disadvantage. While the large software companies didn’t want to serve smaller banks, it was the perfect problem for a startup to solve.
A classic American business story, Jack and Jerry started the company out of an engine repair shop with a few community bank customers. One of those banks, First State Bank of Purdy (Missouri), was the second customer to implement Jack Henry’s software and remains a customer today.
The US banking system is different from most countries in that it has so many banks and credit unions (over 8,000 combined). The reasons for this are many and beyond the scope of this post.
As the below chart shows, however, the number of U.S. banks used to be much higher. Indeed, the number of US banks has declined by about 3% per year for the last 40 years since interstate banking restrictions eased in the 1980s and ended in 1994 with the Riegle-Neal Act. Increased regulation following the financial crisis only encouraged further consolidation and discouraged new bank formation.
Despite this consolidation of potential customers, Jack Henry thrived over this period. One reason for Jack Henry’s success might be that potential competitors shied away from this consolidating industry, giving JKHY an opportunity to dig and widen its moat.
Credit unions are similar to banks in terms of the services offered, but they are organized as non-profits, owned by their members, limited to a specific type of customer (e.g. teachers, employees of a company, military), regulated and insured by different bodies, and reinvest profits into lowering rates on loans or raising rates on savings. Their number has similarly declined over the last 40 years.
Jack Henry’s bread and butter has long been core processing software for small- and mid-sized banks and credit unions. Core processing is the lifeblood of any bank as it processes everyday transactions like deposits and withdrawals, customer account management, and reporting.
Once a financial institution (FI) deploys one type of core processing software, the costs of switching in both time and money are considerable. Given the competition for deposits and loans today, banks can’t afford to risk bad software transitions.
Indeed, Jack Henry’s customer retention ratio is 99% (excluding bank consolidation) and 91% of its revenue is recurring in nature. Compared to its larger competitors Fiserv and Fidelity National Information Systems (FIS), which dedicate more time to large banks, Jack Henry’s focus on small banks has allowed it to offer better customer service and attention to the needs of those customers.
Jack Henry has also been less acquisitive relative to its peers and has sidestepped some of the integration problems Fiserv (First Data) and FIS (Worldpay) faced in recent years.
While FI consolidation continues, the average assets per FI has increased, providing remaining FIs with larger budgets for tech spending.
JKHY’s business is divided between three major segments: Core, Payments, and Complementary.
Core: The legacy business, which provides software to process everyday banking transactions like deposits, loans, and customer information. Historically, FIs ran off of on-premise servers. Over the last decade or so, most have migrated to private cloud arrangements. Today, about 73% of JKHY’s customers use private cloud core solutions. In 2022, JKHY announced a partnership with Google to migrate some clients to a secure public cloud, which is typically cheaper for the client (and cheaper for Jack Henry since they manage the cloud), but can be a tough sell due to security, compliance, and legacy system integration concerns. Its major core processing systems are SilverLake (banks) and Symitar (credit unions).
Payments: JKHY’s payments business accelerated in 2010 with the iPay acquisition and it is now the largest segment by revenue. Payments includes ACH, bill pay, mobile deposits, and business-to-business and business-to-vendor payments. Mobile banking and modern online functionality have become table stakes in the banking world and are critical in retaining and attracting clients.
Complementary: These are specialty products including Financial Crimes Defender, online account opening, and anti-money laundering. Management noted that FIs that do not use JKHY for core processing have on average three JKHY complementary products. Most US based FIs have at least one JKHY product.
Let’s dig into the company’s moat, managemement, rankings, and valuation.