Equifax: Your Score & More - [Business Breakdowns, EP.130]

30:26That would also imply that 95 million of aquifax is 120 million records are exclusive to itself. So the reason that the direct corporate contributors will share with aquifax exclusively, I think is basically threefold. Number one, it's sensitive employee information, and so they don't want to share the data with more parties than they have to. I know it's sort of ironic saying that in context of Equifax being the lucky party to have it after its breach. Wasn't going to go there? Yeah, not yet. But so I think also Equifax is considered the standard in the verification space. It's the only one that's really been doing it for a meaningful period of time.

31:07It has is quite an appreciable head start and lead. And so it's just kind of accepted practice that it would be okay to share with Equifax. That's number one. Number two is Equifax and we'll get into this, I think in more detail, but Equifax has by far the largest verify or footprint, meaning that if an enterprise shared it's record with experience, for example, it likely wouldn't be offloading any incremental verification requests. And then thirdly, Equifax with its HR paperwork, which it calls its employer services makes the relationship stickier. When we think about the processors, it really relates to the fact that this is a network business in the sense that aquifax because it has the largest verifier footprint, it can offer the greatest revenue share to the payroll processors.

31:54And so the way that the contracts work with the processors is that aquifax will pay a revenue share. My understanding is it's probably in the ballpark of about 20 % of the verification fee. And so to kind of bring this to life, for example, let's say Moe works at fund ABC fund ABC uses ADP as its payroll processor. If Moe goes to try to get a mortgage from Wells Fargo and Wells Fargo uses the work number and Wells Fargo pings the twin database on most bullen and then the ADP record will be pulled. Equifax will send over the information that might cost about 50 bucks to the originator and then Equifax would pass 10 bucks back to ADP and because Equifax has such a larger breadth of verifiers in its network it just offers much more revenue share to the processors and that's why they're willing to share exclusively.

32:51And I understand that the work number is kind of a one -stop shop, but ADP is not small as the payroll processor and they do represent a large percentage of employees who would need to be verified for whatever reason. Is this a service that ADP has ever considered offering in any way themselves? It seems like if you could just collect 100 % rather than 20 % it's an interesting option. Yeah, so I think a couple different forks to go off of that. I would say from ADP and all the processors standpoint, I think the way they think about it is just 100 % margin revenue stream. They don't have to stand up any infrastructure.

33:33They don't have to create any verifier relationships. I think about it almost as like their data set being more extensible in the way that they just find one more way to monetize it at 100 % margin. I think this also feeds into the competitive situation in the verification of income and employment space. So, experience also I estimate has about 10 million exclusive records and then there's a third private company called TrueWork, which has a partnership with an investment from TransUnion and that company might have about 5 million records exclusive to itself. So, the way I segment the market is, Equifax has 95 million exclusive, 80 P shares with all vendors.

34:14That's another 25. Experian has 10 and true work has five. And so you would think about maybe about 135 million records. I've been aggregated. The Delta between 135 and the 220 million Americans who make money is kind of the record growth runway. Similarly to the Bureau business, verifiers will kind of stack rank the different vendors because even if experience only has 10 million records, which is just my estimate to be clear. Those are still 10 million records that you don't need to go calling that person's former employers. And so the way that it would work in originator would, or a verify of any sort, would basically probably first ping the twin database then perhaps experience, then perhaps true work.

35:00And the vendor with the most exclusive records is generally going to be placed at the top of the waterfall Because even though ADP is shared with all the vendors, because Equifax has all of those direct corporate contributors and for now all these exclusive payroll contracts, it will be pinged first. And when most bull and walks into a mortgage branch to take out a loan, the lender doesn't know whether he works at a company that uses ADP or one of the processors that's exclusive or a large enterprise that's a direct contributor, et cetera. So they just transmit my social security number in essence to the work number database.

35:41And then the work number returns a record. And even if it is from ADP, then the work number still captures that because it's at the top of the waterfall. I think so long as Equifax and the work number continue to have by far the most exclusive records that remain at the top of the waterfall. That makes sense. And I assume the pricing is no different for Equifax or experience because I am someone that's doing a lot of verification and I noticed that there's different pricing and both ADPs in both databases, I might switch the waterfall around in order to hit that. Is there any pricing competition there that takes place?

36:21For most of its history, the work number hasn't really had to contend with much or any competition at all, but with experience coming into the market, what the work number has is done is offer a discount to be placed at the top of the waterfall, which I think more strategically is viewed would be viewed as the fact that the work number charges a much higher price if it's relegated behind experience. And so it just becomes kind of a weighted average math calculation as the, okay, experience might have a little bit of a discount to Equifax just because it's the new entrant has to to convince the lender there's a reason for it to switch.

37:00But the more often that you're relegating the work number and then therefore the more often you're paying the higher price because you're still going to the work number because it's the one that has the exclusive record, a significant percentage of the time. Then even if you get a small discount because you hit ADP with experience, you're all in cost as the verifyer ends up being higher because you're paying a higher price to the work number from the second position. So I'm curious about this. How do they audit that they are the second position on the waterfalls? There's some type of system that's tracking this?

37:34Yeah, I will say my experience with the Equifax team is that they're super analytically driven. So I wouldn't be surprised. They are in the information services business after all. So I wouldn't be surprised if they've come up with certain ways to track that share change. And I think it might even be just a threat. Like, hey, if we notice that our shares falling off in a way that doesn't correspond to just our estimate of and market volumes You're going to start seeing higher prices when you do come to us on the exclusive stuff. Yeah, so What is protecting them is the Breath of data and the percentage of the industry that they have a control on but the actual switching costs for someone who's looking for verification isn't necessarily high in terms of pinging out.

38:22Yeah, I wouldn't think about, I would probably more than trivial, but I wouldn't say the switching cost is the primary consideration. I think particularly in the mortgage space where Equifax and the work number is most established, I think there is an appetite for additional verification providers. the problem the verifiers have is that no one else has the data in size and so it even generally gets to the extent where if a company is contributing its data to the work number directly say Amazon or if you're see ADP will go to market and say use our solution you don't have to answer calls from verifiers anymore that's like bundled in to being an ADP payroll customer and so if a bank says you know, I'm sick and tired of paying this monopoly supplier, IE the work number.

39:16I'm going to try to call these companies and just have them send the data manually like the old fashioned way. A lot of times the employer will just say, we don't do that. If you want the information to go to the work number, not to mention that I think it's sort of a situation where there's more resentment than logic in it. And that even if the work number is taking price in a way that reflects its competitive standing. I think Equifax is very rigorous about quantifying the value that they're providing. They'll always say they priced a value, value -based pricing. I think they have ways of thinking about, okay, well, how much faster is your conversion rate on your mortgage loans, how much cost you take out by not having to call around, employers, et cetera, and essentially just price to capture that surplus.

40:04lesson, so it would probably not be rational for verifiers to really go back to manual processes unless aquifax doesn't have the record. Yeah, yeah. The manual process, I think, is probably lost the experience move into the market. They have a long way to go to capture all of that data that aquifax has. I'll just add one more thing. I think both experience and true work understand that it's going to be nearly impossible to replicate the record database that Equifax has. It's been in the business so much longer and as such a large lead at this point. But if you think about the fact that Equifax, the work number has 120 million records out of 220 million Americans who make money, that's only about a 55 % hit rate.

40:49And so there is still a substantial percentage of the verification request that can't be fulfilled by twin. And I think that's where true work and also experience can carve out a business. I think both from the customer standpoint and the business model economics of it, the instant database, i .e. what Twin has where the verify or just pings the database and instantly gets an answer. That's the best business model and best for the customer. But there's still a lot of records out there. And so I think Equifax and probably now experience are really racing to try to aggregate the rest of those records and sign them up exclusively.

41:25But I think my view is for true work, I mean, their unit tam is sort of shrinking every quarter as Equifax adds more records. And I would imagine, I think, in the end state of the industry, I think experience is a legitimate competitor. They have kind of the capital structure to compete with Equifax. And I think they'll probably get a fair share of the incremental records that are out there that haven't been signed up. Now, aquifax, the contract partnerships are three to five years. As those come up for renewal, it's possible that experience could win some of those. I think the issue for experience, again, they're just can't offer the same revenue share, but it wouldn't surprise me if experience makes a little dent too.

42:08I think as long as the records remain exclusive to each verification provider, then it's almost like each vendor will have a mini monopoly. There won't really be sort of a regional local monopoly, I should say, kind of like the cable business in a way, is that there wouldn't be any really record overlap, so there wouldn't be any direct competition introduced. I think when you think about the incentives today, the processors are also incentivized to keep the market highly concentrated or monopolized because that provides pricing power to the work number. And if the processors are participating in a revenue share, they don't want the price of the verification request to get competed down.

42:54So they really have no interest in opening up the market to multiple players. But I think what could end up happening would be that the processor's partition, the exclusive rights more finally. So a processor might say, okay, well, Equifax, you get mortgage talent and government exclusively, but we're gonna give tenant screening or auto screening exclusively to experience. And still, I think in that way, that would allow the processors to kind of have their cake and eat it too. That way they could get kind of full, realize the revenue from full volumes and not introduce price competition into the market.

43:31I think that would be at least the most rational and state for the industry. And today, what does the margin profile look like for this business and how is that trended over time? So when Equifax acquired talks, the mix in the business, it was actually more than 50 % the HR paperwork, BPO operation, and that's wardly a commodity service -based business that I would estimate probably operates a 10 % operating margins if not less. Whereas the work numbers is very high, build at once, sell many times, information distribution business with very well marginal costs. And so the verification work number database has much higher margins.

44:18And so as the work number database revenue line technically termed verification services within EWS has outgrown the HR paperwork business, then the margins of the total segment have mixed up quite significantly. So actually, when talks was originally acquired by aquifax, the business had actually high teens, even though margins, that's mixed all the way up to North of 50 % today. And again, the paperwork, HR paperwork business is really just there strategically as a way to source and retained records. Got it. Okay. So putting it all together in the business, a lot of this it sounds like from both sides of things, it's just tied to general macro.

45:06You're going to have more things pulled in good economies, more borrowing. I guess there's some tie to job changes and different things related to employment. But when you put it all together as a business, How do you frame the forward outlook for something like this? Top line at some level of GDP, margin profile, how does that change? How do you look at it as an investor? You're exactly right on the bureau side that it is basically a GDP, GDP plus grower. I think that the work number business has a significant amount of light space ahead just from an idiosyncratic structural business model perspective to grow.

45:43And the reason for that is again, if we think back about hit rate and penetration, the work humbers still only has 120 million records. I made an estimate, maybe 135 million are aggregated in some. The growth between that 135 and 220, every time Equifax adds a record that's instantly monetized because it's already getting the pings from the verifiers. So Equifax is still growing records, high single digits, low double digits. I think that will decelerate as the number of available records naturally just declines, but for perspective since talks was acquired 16 years ago, its growth records 6 to 7 % annually.

46:22So I still think there's a pretty long runway to grow records mid single digit plus. And what's unique about the businesses is that it basically has two vectors to grow units, records and penetration. So we just covered records. If we move our penetration on the penetration side and mortgage the work number is most highly penetrated at about 60 to 65%. It was mandated by the GSEs following the great financial crisis when it was the whole no income, no jobs, application, craze, but it's still not at 100%. I think the work number will still keep chugging along in mortgage coming closer to 100 over time.

46:59They've increased that penetration by about 10 points from 55 -ish to 65 -ish over the last three or four years. So just keep kind of chugging that along. And then I think the key kind of growth bet for the business is on the talent and the government Penetration and uptake so in those verticals the penetration rate is really only 20 25 % just kind of quickly on each of those in talent right now Twins gets almost all of its distribution through the three public background screeners which are first advantage higher right and Sterling, those three altogether have about 30 to 35 % share of background screens in the US.

47:42And they're taking share in a very fragmented industry. They're the most technologically enabled. They're competing with regional mom and pops, et cetera. And so they take a few points of share every year. That flows through directly to twin penetration. And then also, whereas the twin penetration talent is 20, 25%, but the market share of the three screeners is 30, 35%. That Delta is because, twin historically, that's only been used for white collar screens, just because of its price point and the robustness of the data. So recently, Equifax has come out with a couple of products to try to increase penetration in the more blue collar workforce, verification's there.

48:24And so really, the motions within talent are to one, start servicing all the blue collar screens commissioned by those public background screeners, because right now, first advantage, et cetera, they are commissioning or conducting background screens for blue collar jobs or just having to do that manually because Twinn hasn't had a blue collar kind of portfolio of skews until more recently. And then also partnering with all the other background screeners out there in the country that have more have the remaining 65, 70 % share that the public players don't have. And then on government, it's a very fragmented industry.

49:03There's thousands of agencies at the state and federal levels, which disperse benefits. And so it's really just kind of, I think, a blocking and tackling sales motion. On the government side, just having folks at all the different state capitals, selling the agencies on the value proposition of doing things instantly rather than manually. And so I think when you add up records and penetration across the three end markets, I do think there's a pretty credible case for growing units 10 % plus and then on price the work number as historically been considered pretty aggressive and it's pricing as discussed.

49:39I think the company will continue to take some pure price really up until the point it makes sense to use an alternative if an alternative is really even feasible and then also So increasingly, the work number is selling more SKUs with historical records that come at a higher price point and also education and incarceration data. So via acquisition and partnership, aquifax has also built out 90 plus percent coverage of incarceration records and then 99 percent plus coverage of secondary degree data. And so those data sets are particularly useful in talent and government. And so as those data sets are monetized more of the time, that's also an ASP uplift.

50:27So there's more sort of like a structural driver to price as well. And so I think when you put it all together, the work number business does have a strong case to grow. So all the double digits for quite a long time. And that would be consistent with the way the company frames it to the market. But all things together when you add in the Bureau business, I think about the US Bureau business probably growing mid single digits, the international business growing a little more quickly as there's greater uptake of the Bureau services overseas. And then the all in EWS business, including the BPO operation probably growing mid teens, the whole business should be probably low double digit grower.

51:08and then as the work number mixes up, that's a margin tell, and because it's the most profitable segment in the company. We've foreshadowed this for a while, but transitioning into the risk category and not talking about upcoming risks necessarily, but something that happened in the past, the breach, it was huge. It felt like at the time, it could have been a business killer. They've obviously rebounded and been fine with the aftermath. But can you just walk us through exactly what happened with the breach in terms of what actually got breached and leaked and then what the consequences were after the fact?

51:47Yeah, so in 2017 over a course of several months aquifax was breached data on 140 million Americans was X -Filtrated Names address, Social Security numbers, etc but critically not credit card information. At this point, the now accepted hypothesis is that the hack was actually perpetrated by Chinese state sponsored cyber thieves, whose intention was to compile personal private information on US government employees for espionage and blackmail purposes. And so because the credit card data was not taken and because large scale commercial identity fraud was never committed in the aftermath. In some ways, Equifax kind of didn't dodge a blow, you know, an atomic bomb because they could have been liable for a massive amount of identity fraud that really never materialized.

52:44Now with that said, Equifax's data governance practices, I think were very, very poor, leaving data unsegmented, unencrypted so that a bad actor could come in and navigate throughout the IT residency and stack really unencumbered Equifax went as far as to not renew a particular security tool that allowed them to monitor the state of their security protocols and because they did not renew this encryption key, they couldn't detect the breach. So it was really basically a total shit show on Equifax's part to add insult to injury. There were reports that certain level of the certain members of the executive team were familiar with what was going on, well before it was publicized to the market and to the general public and some of those folks sold stock.

53:38Ultimately, there's a few relevant outcomes of what happened with the breach. Number one, the former CEO, Richard Smith, was ousted. There was only one insider was actually charged with insider trading. So it wasn't an entire turnover of the executive staff, but there was a new CEO in place. Out of facts ended up having to pay about 800 million in legal fines and to finance a consumer restitution fund. So those are kind of the direct consequences, but then downstream from that number one, when the new CEO Mark Beagor took over, I think he understood the promise in the workforce solutions business and EWS largely skirted by the breach and was not impacted.

54:28And so with the US credit bureau really hurting with the new leadership, Aquifax really leaned into the work number business, which kind of from all dimensions is just objectively a much more attractive business than the Bureau right now. But I think Aquifax had always identified itself as being a BRL first and foremost. And so it precipitated kind of the resource allocation internally to focus on the work number. Secondly, BeGore also led this total IG stack rewrite. So Equipax will eventually hopefully kind of in the next year -ish, be fully cloud -native, have no on -premises data center footprint at all, and be fully in the cloud.

55:11and the company will talk a lot about how that should help them with new product, velocity, and the more ways that Equifax can, the more like kind of permutations of useful ways that Equifax can deliver its data to customers, particularly on the work number side, that will be very important for growing penetration and talent and government and mortgage and so forth. The investment in the cloud has totaled a billion and a half over the last five years. And so aquifax expects, once that concludes, that margins will come up, capital intensity will decline. And so it should definitely start to show up in the cost structure of the business at the time that it concludes.

55:57And I think we've talked a lot about the various risks that could be associated with this business and whether you would consider them big or small or overstated or understated. Do you think there's anything that we haven't touched on that would be a risk for this business? Of course, the one that's unpredictable would be another breach, I think, on the competitive positioning when you're placed very well. Things can't get much better. So competitive intensity definitely is increasing in the work number side. I still believe Equifax is well positioned to continue to compete, but directionally competitive intensity is increasing.

56:40I think another risk is just that Equifax has been quite aggressive with its pricing, and so I wondered to what extent that alienates customers. I think Equifax is pretty well known. It's not a popular company, especially on the work number side. So I think there is an appetite for alternatives. I just think the entry barriers are so strong that customers haven't really gotten one, but I wonder if, for example, if background screeners and government agencies and the incremental mortgage originators who haven't adopted, there hasn't it to adopt because they know that aquifax will really exercise its position as a sole supplier.

57:17That would just be a headwind basically to the growth algorithm. A couple more. I think the cloud rewrite has taken longer than unexpected and been over budget and it's not a make or break thing for the business, but the USIS and international margins are down clearly over the last five years, CAPX is up. And so I do think there's a bull bear debate about when, if to what extent there's going to be an inflection in the cost structure. and we should start to see that later this year into 24, especially 25, 26, 27, the business should be at a more normalized, what it considers its steady state cost structure, which would be kind of high 30s plus margins than leveraging off of that with the work number mixing up.

58:11And then the last one I think we haven't talked about is just could the work number come under regulatory focus in particular, these exclusive contracts because the work number just says such a strong position right now, I think Matt, you alluded to it at the top of the episode, it kind of flies under the radar that this extensive database of most of our income and employment histories even exist. And the way it's facilitated is through these contracts that are exclusive. I do wonder to what extent that could be regulated. I'm not an anti -trust expert, So I don't have very well informed opinion on that from what I've read and I understand I think the technicalities surrounding it.

58:55I think the arguments that Equifax would put forth is that it's a free market Anybody can bid on the contracts and the reason that Equifax wins them is because they have the verifier side of the network Anybody is free to try to replicate that verifier side of the network of course to build that network You need the records which is why it's such a defensive business model. I also think Because the contracts are not perpetual they come up for renewal and then when you think about the fact that The exclusive direct corporate records. There's no contract there They're just kind of practically but not contractually exclusive So aquifax has I'm estimating 40 million exclusive payroll records out of 220 million Americans who make money in certain ways you can frame it such that it doesn't look As monopolistic as it feels I think to a lot of customers That makes sense.

59:48All right, we close out these conversations with lessons that you could apply elsewhere. What would you say? I think there's a lot of really interesting themes going on here with this business, but what would be your main lesson that you think you learned from studying Equifix? For me, what I felt was very useful was digging into all the revenue drivers breaking down on price times quantity. One of the wraps on Equifax is that there's just too many moving pieces in the work number side of the business. And I think it almost has like, I don't know if a complexity discount, but like a complexity barrier to investor interest because you can go look at the investor decks they put out and they'll probably the most extensive, you know, investor decks you've ever looked at.

1:00:35And there's just, it's kind of a very complicated ecosystem between the processors, the verifiers, the consumer, eco -fac sitting in the middle, the different end markets. So I think there's a lot going on. And I think for me to get more clarity on how the business can grow for a long period of time at a healthy rate, it was very useful to think about price and quantity separately and how those differed by each of the end markets. And then I think the other thing, just to think through the incentives of everybody in the ecosystem, why would processors want to share exclusively what would happen if records shared with all vendors, would the work number still have a credible case to stay at the top of the waterfall, someone and so forth and just trying to think through additional consequences.

1:01:20And I think that's kind of consistent with there being a number of different participants in the ecosystem. The last thing that kind of interests me, I think Cliff Sosin, he said this either on business breakdowns or maybe your other podcast he was on, but he talked about how businesses kind of stumble along until they find a position. And I think in some ways, Equifax, the talks business model, it almost came to be how it is right now on accident. That it wasn't some grand plan. It was really very incremental listening to customers saying, why don't you do this for us? Now that we're doing it, why don't we flip our business model around?

1:01:58It wasn't some kind of stuff launch and grand plan. It just fell into where it is almost accidentally. I mean, there's a chance for all of us. I love that. Well, this has been awesome. I appreciate all your insights here. It is a super interesting business from the outside, but even more so when you get on the inside. Thank you very much for your time. Yep, thank you, Matt. Really happy to be here. To find more episodes of breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary, check out Join Colossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com.