Digital Insight Shares Fall as Retention of Clients Declines
By SHELLY GARCIA
San Fernando Valley Business Journal
Shares of Digital Insight Corp. have been pummeled by warnings of a lower-than-expected fourth quarter as a result of budding price wars in the Internet banking industry and fears that competition will continue to take a toll on customer retention.
Stock in the Calabasas-based company lost more than 30 percent of its value since Oct. 25, when company executives disclosed that competitors were picking off clients.
“We remain concerned over top line growth given the competitive landscape that will likely pressure pricing and customer retention in the near term,” wrote Jeffery B. Baker, senior research analyst with US Bancorp Piper Jaffray in a report reducing the rating from an outperform to a market perform.
Digital Insight develops and sells software applications and related services that allow banks, credit unions and other financial institutions to offer their customers Internet banking services. The company is considered a leader in an extremely segmented and competitive field.
Ironically, the third quarter announcement that sparked Wall Street’s concern included news that Digital Insight beat earnings estimates for the period.
For the three months ended Sept. 30, Digital Insight reported net income of $1.7 million, compared with a loss of $9.9 million for the like period a year ago. Sales were $33.9 million, up from $24.5 million.
But along with the good news, Digital Insight disclosed the defection of clients whose contracts had come up for renewal. “In hindsight, we took these customers a little more for granted,” said Chairman and Chief Executive John Dorman.
The announcement led to a trading free-for-all. On the day after the company released its third-quarter earnings report, shares fell to $9.03, with 5.6 million shares traded. The day before, the stock closed at $13.57 with 250,000 shares traded. Last week, the stock was trading around $10.10.
Roughly 8,000 financial institutions signed up for Internet banking services between 1997 and 1999, when the business was just taking off, and this year those contracts, which typically run three or four years, began coming up for renewal.
The cycle created a feeding frenzy among suppliers of Internet banking services, with each trying to nab competitors’ accounts. While Digital Insight put its resources behind pursuing new accounts, its existing clients were being courted by the competition.
About 23 clients switched sides in the third quarter. “What’s significant is the average size (of those clients) was up significantly,” Dorman said.
Because of the increasing popularity of Internet banking services, the average number of potential end users lost with each client has grown to 30,000, up from about 10,000 last year. Digital Insight’s fees for service are based on the number of end-users each client serves.
Looking to shore up the losses, Digital Insight recently hired a former executive of Electronic Data Systems to head up a newly created post to develop customer satisfaction and retention programs. It also is adding sales and support personnel and tweaking its compensation programs to offer stronger incentives to its workers.
Last week, the company announced that Dale Walker had resigned as president and chief operating officer.
In the past, the company typically retained about 90 percent of its client contracts, but in the third quarter, and through the fourth quarter, Dorman said the retention rate was expected to be in the low 80 percent range. “We’re confident we can turn it around quickly,” Dorman said.
But with so many contracts coming up for renewal and so many smaller competitors anxious to gain a foothold, some believe it is only a matter of time before a price war drives down margins.
Stephen A. Laws, an analyst with WR Hambrecht + Co., cited the recent loss of two accounts to Corillian, a Digital Insight competitor, as a reflection of what may come.
Not only is Digital Insight likely to have a tough time with pricing, it faces more competition. Besides the many competitors currently in the market, some see a push by other types of banking companies to add Internet solutions to their offerings, a development that could put Digital Insight, which only offers Internet services, at a disadvantage.
“There are simply too many ‘Internet-only’ banking vendors in the market,” said Baker.