Fair Isaac Corporation: Very Strong Business Model, but We Suggest Waiting for a Better Entry Point

In initiating coverage on Fair Isaac Corporation FICO, we peg its fair value estimate at $660 per share. Fair Isaac is best known for its FICO scores, and over three quarters of the firm’s profit is from its scoring segment as this segment has very high operating margins. Fair Isaac’s positive business attributes, including strong pricing power, are well appreciated by the market, in our view, and with shares currently trading at approximately $780 per share, we regard shares as moderately overvalued.

While FICO scores are used to underwrite loans, they are also used as a benchmark within the industry, and it is this benchmark usage that we believe is the source of Fair Isaac’s wide moat. Banks and financial institutions use FICO scores as a means of communicating credit quality in the securitization market and to investors. Even lenders that do not use FICO scores as criteria for lending will still purchase FICO scores to communicate attributes of a loan portfolio for investors. Credit Bureau data from the three major U.S. credit bureaus (Equifax, Experian, and TransUnion) are the inputs to FICO scores, and as such the relationship between the credit bureaus and Fair Isaac has fluctuated from time to time. In 2006, the credit bureaus launched VantageScore to try to displace Fair Isaac, but this effort failed to meaningfully dent Fair Isaac’s moat. About half of the firm’s revenue but one quarter of the firm’s profits are from its software segment. Fair Isaac provides a variety of workflow tools to financial institutions, such as account origination, customer management, fraud detection, risk, and marketing. Competitors are varied in this space and include the credit bureau and specialized software providers. We view this segment as having a narrow moat based on switching costs. Financial institutions are often slow to change software given the operational and logistical complexity of changing workflows.