Business Breakdowns Podcast: Jack Henry – VMS King (EP.206)

Episode Date: February 5, 2025
Host: Matt Russell
Guest: Bob Desmond, Portfolio Manager and Head of Claremont Global

Overview

This episode provides an in-depth breakdown of Jack Henry, a standout fintech company focused on providing essential technology to small and midsize banks and credit unions in the U.S. Matt Russell is joined by Bob Desmond to explore Jack Henry's origins, business model, growth strategy, culture, financials, competitive landscape, and the unique traits that have allowed it to compound shareholder value for decades. The discussion also touches on contemporary shifts such as cloud migration and the impact of broader banking industry trends.

Main Discussion Points & Insights

1. Jack Henry’s Role in the U.S. Banking Ecosystem

• What They Do: Jack Henry offers critical operating system software as a “plug-and-play” outsourced technology partner for small/mid-sized financial institutions (~$1B in assets) who cannot afford custom IT (05:19).
• Customer Base: Their average client is a community bank or credit union. Only the nation’s 50 largest banks have the scale to build or fully customize their tech in-house.
• Scope: They run core processing (deposits, loans, general ledger), payment systems (cards, bill pay, etc.), and over 300 complementary software solutions (06:51, 07:04).

2. Company History & Culture

• Origins: Founded in the mid-70s by Jack Henry & Jerry Hall in Monett, Missouri (pop. ~10,000)—unusual for a major U.S. technology business (07:54).
• Midwest Ethos: A strong, “do the right thing, go the extra mile and have fun” culture persists, reflected in high Glassdoor (employee) and customer satisfaction scores. “If we look after the employees, they will look after the clients and that'll be good for shareholders.” (09:35).
• Public Accountability: Publishes employee & customer engagement scores, six-month public roadmaps: “They really want to be held accountable to their customers.” (11:06, 12:15).

3. Business Model and Structure

• Three Segments (approx. equal in size):
  • Core Processing: The “heart and lungs” tech. Contracts are sticky, rarely switched out (“open heart surgery”). (14:30, 15:50)
  • Payments: Debit/credit card processing, bill pay, network integrations; paid by transaction volume. (14:30)
  • Complementary Solutions: ~50 add-on products per client (fraud, digital, treasury, etc.)—often built via acquisition. (14:30, 13:05)
• Recurring Revenue & Retention: About 90% of revenue is recurring, backed by ~99% annual client retention and multi-year (up to 7–10 year) contracts with CPI escalators (15:50, 30:18).
• Growth: Add ~50 new core customers (wins) per year, with secular tailwinds from IT spend and rising transaction volumes (23:23, 26:06).

4. Organic Growth vs. M&A

• Deliberate Focus: Jack Henry’s core is largely organically built; M&A mainly used to add complementary/payments products (13:05).
• Strategic M&A: “The core is almost like the hook…everything else you’re going to struggle with if you haven't got a good core and service.” (13:26).

5. Technology Evolution & Cloud Migration

• Technology Focus: Only two core systems (one for banks, one for credit unions), enabling focused R&D (~14–15% of revenue) and rapid updates (18:00).
• Migration:
  • Private Cloud: 73% of customers now hosted here; easier than expected—can migrate over a weekend (07:04, 32:07, 32:20).
  • Public Cloud: Next frontier, but slow due to regulation and trust hurdles (33:57).
  • Benefits: Two-times revenue uplift, margin improvement, and greater customer peace of mind regarding cybersecurity and compliance (33:16).
• Open Architecture: Hundreds of fintech partnerships; “They have very open APIs...invite competitors to customer days.” (18:00, 21:10)

6. Market Trends and Competitive Landscape

• Market Share:
  • ~50% share among credit unions, ~25% among small/mid-size banks (<$50B assets) (28:37).
  • Room to grow, especially by taking share from a long tail of smaller providers/legacy systems (29:12).
• Competition: Main competitors are Fiserv/FIS (more acquisitive and less focused core offerings). Many fintechs considered “frenemies”—both partners and indirect threats (11:06, 46:28).
• Fintech as Opportunity: Jack Henry partners with fintechs to extend offerings to clients vs. competing directly against them (21:22, 46:28).

7. Revenue, Margins, and Financial Dynamics

• Contract Terms: Evolving to longer-term contracts with cloud migration; CapEx becomes OpEx for customer (30:18).
• Margins: Operating margins ~22–24%, gross ~40%—slightly lower than some peers due to higher customer service and R&D spend (37:12).
• Cash Conversion: Free cash flow conversion of 80–90% (38:27).
• Dividend: Payout ratio ~40%. Dividend has grown for 20 consecutive years (38:27).
• Growth Profile: Historically 15% EPS CAGR, now more like “low double-digit grower” (38:27, 39:35).
• Resilience: No material downturn even in the financial crisis; flat organic growth and 4% EPS growth in 2008–09 (40:01).

8. Risks & Challenges

• Bank Consolidation:
  • Main concern is if big banks buy smaller ones, but most consolidation occurs among small banks; Jack Henry often retains or wins business via tech/service advantage (24:55, 25:17).
  • End-customer asset growth offsets customer count declines (41:22).
• Cybersecurity: Most significant risk—“All of these businesses run on reputation” (54:16, 56:14).
• Culture: Loss of their employee/customer-first culture could erode competitive edge (54:16).
• Adjacencies: Straying too far from core (e.g., competing directly with merchant acquirers) could undermine business model (54:16).

9. Valuation and Market Perception

• Valuation: Historically trades at a premium, with P/E multiples in the low 30s; current multiple somewhat below long-term average (~28x) due to slower recent growth but quality remains high (57:54).
• Stock Performance: Despite impressive long-term results (480x since IPO), recent share price has been flat (02:43).
• Safe Haven: Not always “exciting,” but tends to attract attention in volatile markets due to predictability and resilience (57:54).

10. Lessons from Jack Henry

“Sometimes that means taking a short-term profit hit to build the brand and the customer trust…In the long run, shareholders don’t benefit from putting them first.”
— Bob Desmond (60:23)

• Culture + Long-Run Orientation: Jack Henry’s focus on employees and customers first, not Wall Street, is cited as a key driver of its durable value creation.
• Transparency and Accountability: Publicly tracking performance, high client/employee engagement, and “doing the right thing” over quick wins.
• Modernization via Listening: Consistent R&D investment and genuine feedback loops ensure systems stay current versus competitors burdened by legacy (18:00).

Notable Quotes & Moments

• On Customer Retention:

  "Of their credit union customers, they had only lost 15 in 32 years…over 99% client retention."
  (15:50 – Bob Desmond)

• On Cloud Migration:

  “The move to private cloud is actually pretty easy to do. They tend to do it over a weekend…people come in on a Monday, it's business as usual.”
  (32:07 – Bob Desmond)

• On Culture as a Moat:

  "If we look after the employees, they will look after the clients and that'll be good for shareholders."
  (09:35 – Bob Desmond)

• On Technology Focus:

  “They have a great saying where they say our customers are not in business to make us profitable, we're in business to make them profitable.”
  (18:00 – Bob Desmond)

• On Resilience:

  “Look at the financial crisis…for their customers, they had flat organic growth that year and actually had EPS growth of 4%.”
  (40:01 – Bob Desmond)

• On Valuation:

  “We can see Jack Henry getting our clients to double digit returns plus over the next five years without taking a huge amount of risk.”
  (57:54 – Bob Desmond)

Timestamps for Key Segments

• 05:19 — How Jack Henry fits into the banking ecosystem
• 07:54 — Founding story and culture
• 13:05 — History of M&A vs. organic growth
• 14:30 — Business segment breakdown and revenue model
• 15:50 — Revenue visibility, retention rates, contract structures
• 18:00 — Technology focus and keeping systems current
• 21:10 — Open architecture, fintech partnerships
• 26:06 — Sources of growth: new logos, secular trends
• 28:37 — Market share vs. major competitors
• 30:18 — Contract lengths, pricing, and move to cloud
• 32:07 — Private cloud migration process
• 33:57 — Private vs. public cloud and regulatory barriers
• 37:12 — Margin structure and trends
• 39:35 — Free cash flow and dividend policy
• 40:01 — Resilience during the financial crisis
• 46:28 — Fintech ecosystem: threat and opportunity
• 54:16 — Key risks: cybersecurity, culture, drift from core business
• 57:54 — Valuation and approach to modeling returns
• 60:23 — Key lessons from Jack Henry’s longevity

Conclusion

Jack Henry’s story sits at the intersection of durable business excellence, culture-as-a-moat, and the unique needs of America's fragmented banking landscape. The company’s relentless customer and employee focus—anchored in Midwestern values, high transparency, and deep technical investment—has created a rare compounding engine in vertical market software. As banking technology modernizes and cloud adoption continues, Jack Henry appears well-positioned for continued relevance, but faces challenges from cybersecurity, shifting culture, and potential missteps into adjacencies. Above all, the lesson from Jack Henry is the enduring power of putting employees and customers first, letting shareholder value be the result rather than the objective.