Fair Isaac: A monopoly with plenty of growth ahead.

Fair Isaac is best known for its FICO scores, which have become the industry standard and provide the company with a significant competitive advantage, capturing a remarkable 90% market share. In addition to this dominance, Fair Isaac’s software business is experiencing substantial growth, with a large addressable market still ahead. While there are many reasons to admire Fair Isaac, the question remains: is now the right time to invest in its shares? This analysis aims to explore that question.

This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Fair Isaac. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Fair Isaac's competitors either. Thus, I have no personal stake in Fair Isaac. If you want to purchase shares or fractional shares of Fair Isaac, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $50.

The Business

Fair Isaac Corporation, widely known as FICO, was founded in 1956 in Montana and has established itself as a leader in analytics and decision-making tools. The company operates through two primary segments: Scores and Software. The Scores segment is best known for the FICO Score, introduced in 1989, which serves as the standard measure of consumer credit risk in the United States. Nearly all major banks, credit card issuers, mortgage lenders, and auto loan providers rely on FICO Scores to assess creditworthiness. These scores are generated using proprietary algorithms applied to credit data from the three major U.S. credit bureaus - Experian, TransUnion, and Equifax. Notably, Fair Isaac does not collect or store consumer credit data, making its business model both capital-light and highly scalable. Revenue is earned through fees charged to the credit bureaus for each score generated. Additionally, the FICO Score is a mandatory component for conforming mortgages sold to Freddie Mac and Fannie Mae, further entrenching its role in the U.S. financial system. The Software segment provides advanced solutions for customer engagement, decision management, and fraud prevention. These tools are used by businesses in over 100 countries and are typically sold through multi-year subscription agreements. Payments are linked to usage metrics, such as the number of accounts or transactions, with most contracts including minimum payment commitments, ensuring predictable and recurring revenue streams. Fair Isaac’s software solutions deliver exceptional value, often yielding a return on investment exceeding 100% within the first year, underscoring their importance and creating high customer retention. Fair Isaac’s moat is anchored by its widely adopted Scores and Software solutions. The FICO Score is deeply embedded in the U.S. financial system, creating high switching costs for customers and ensuring its sustained dominance. Its capital-light business model, which leverages partnerships with credit bureaus, enhances scalability and profitability. The Software segment benefits from sticky, high-value products, long-term contracts, and wide applicability across industries, making it a cornerstone for businesses aiming to optimize decision-making and mitigate risks. Fair Isaac’s consistent investment in its legacy products ensures they remain at the forefront of innovation, while its market share in critical applications faces minimal competitive threats. The reliance of Freddie Mac and Fannie Mae on FICO Scores for conforming mortgages and the global adoption of its Software solutions further solidify Fair Isaac’s position as a market leader.

Management

Will Lansing is the CEO of Fair Isaac, a role he has held since 2012. Prior to becoming CEO, Will Lansing served on Fair Isaac’s Board of Directors starting in 2006, offering strategic guidance that laid the foundation for his leadership. Under his tenure, Fair Isaac’s stock price has increased more than 20-fold, reflecting his exceptional ability to drive substantial shareholder value. Will Lansing brings a wealth of experience across diverse industries. Before joining Fair Isaac, he served as CEO and president of InfoSpace and held CEO roles at ValueVision Media, NBC Internet, and Fingerhut. His career also includes senior leadership positions at General Electric, Prodigy, and McKinsey & Company, as well as a partnership at the global private equity firm General Atlantic Partners. This extensive background equips him with the expertise to navigate complex markets and foster sustained success. Will Lansing’s alignment with shareholder interests is evident in his ownership of 1,7% of Fair Isaac’s shares - nearly four times the contractual requirement. He has consistently championed returning value to shareholders, primarily through stock buybacks, a strategy he passionately defends. In an earnings call, Will Lansing remarked, “I’ve been doing these calls now for 13 years, and every single call, it seems like our stock is at an all-time high, and people wonder why we’re still buying back our stock. To date, it’s been a pretty good call. We expect that to continue.” Despite a high valuation, Will Lansing’s confidence in Fair Isaac’s stock remains unwavering, as he noted, “It is remarkable to say with a PE north of 100 that we still think our stock is a screaming value, but we really do believe that.” Will Lansing holds a Bachelor of Arts from Wesleyan University and a Juris Doctor from Georgetown University. Beyond Fair Isaac, he serves on the global board of advisors for Operation Hope and the board of directors of SafeGraph. His proven track record of delivering exceptional shareholder returns, coupled with his strategic vision and deep leadership experience, positions Fair Isaac for continued growth. Will Lansing’s confidence in the company’s future and disciplined focus on value creation solidify his role as an ideal leader to guide Fair Isaac forward.

The Numbers

The first metric to evaluate is the return on invested capital (ROIC). Ideally, a company should consistently achieve a ROIC above 10%. Fair Isaac has delivered impressive results in this area, with only one year falling below the 10% threshold. Notably, ROIC has reached new heights since 2019, driven by management’s strategic decisions to implement annual price increases in the Scores segment and transition their software from a license model to a cloud-based subscription model. These changes have enhanced profitability and scalability, positioning Fair Isaac to sustain high ROIC levels in the future. This outlook aligns with management’s optimism about maintaining strong returns. In fiscal year 2024, Fair Isaac achieved its second-highest ROIC ever, a testament to its operational efficiency and strategic execution. With these trends in place, it seems likely that the company will surpass its all-time ROIC high from fiscal year 2021 in the coming years.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. At first glance, the numbers may not seem particularly strong, with declines and even negative figures over the past four years. This is primarily due to management’s strategy of leveraging low-interest loans to finance share buybacks. Management has justified this approach, citing their confidence in the company's future revenue generation and overall business performance. While this strategy reflects optimism, using debt for share repurchases distorts the numbers, making them less indicative of the company’s underlying operational performance. As such, I won’t place too much emphasis on these figures.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is no surprise that Fair Isaac has consistently generated positive free cash flow every year. The company achieved its highest free cash flow ever in fiscal year 2024, with an impressive increase of more than 30% compared to the prior year. From 2015 to 2024, Fair Isaac has grown its free cash flow at a compounded annual growth rate of nearly 19%, showcasing exceptional financial performance. Management remains confident in their ability to continue growing free cash flow, driven by robust revenue prospects, operational efficiencies, and strategic capital allocation efforts. The levered free cash flow margin reached its second-highest level ever in fiscal 2024, with management projecting further improvements for the same reasons underpinning free cash flow growth. However, the free cash flow yield is currently at its lowest point in a decade, indicating that shares are trading at a premium valuation. This will be examined in greater detail later in the analysis.

Debt

Another important aspect to evaluate is the level of debt. A manageable debt level can typically be repaid within a three-year period, assessed by calculating the ratio of long-term debt to earnings. For Fair Isaac, the debt-to-earnings ratio currently stands at 4,28 years, exceeding the preferred threshold of 3 years. This elevated ratio stems from management’s strategic use of inexpensive debt to fund share repurchases, a key component of their shareholder value strategy. Management has expressed confidence in the current debt structure, indicating no immediate plans to reduce it and aiming to maintain debt at current levels. While I generally favor lower debt levels, it is reassuring that management appears comfortable with their approach, supported by the company’s consistent track record of creating shareholder value. The strong returns generated through share buybacks and operational excellence lend credibility to this strategy. That said, this remains an area worth monitoring, particularly if earnings growth fails to keep pace with debt levels over time.

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Risks

Macroeconomic factors pose significant risks to Fair Isaac due to its heavy reliance on the banking and consumer credit industries, which accounted for 92% of its revenue in fiscal 2024. This reliance makes the company particularly vulnerable to broader economic instability, including inflation, interest rate volatility, geopolitical tensions, and military conflicts. Such disruptions can adversely impact credit and financial markets, potentially leading to bankruptcies or financial distress among banks and credit issuers - Fair Isaac’s primary customers. If these institutions reduce spending or consolidate operations, Fair Isaac's revenue growth could slow or even decline. For example, a shrinking banking sector may lead to fewer clients requiring Fair Isaac's products and services. Mergers between existing clients could also reduce the number of active contracts, particularly those tied to per-transaction revenue agreements. Similarly, a decline in consumer demand for financial products, such as loans and credit cards, would lower the demand for Fair Isaac’s credit scores and decision-management tools, further pressuring revenue. Another challenge lies in the slow growth of new customer accounts within the U.S. banking sector. To counter this, Fair Isaac has focused on selling additional products and services to its existing large bank clients. However, if the banking industry contracts or reallocates budgets to other priorities, Fair Isaac may face difficulties sustaining or growing its revenue streams.

Fair Isaac’s reliance on a concentrated group of large customers, particularly the three major U.S. consumer reporting agencies - Experian, TransUnion, and Equifax - represents a significant business risk. These agencies collectively accounted for 45% of the revenue in Fair Isaac’s Scores segment in 2024, making them essential partners and its largest customers. This dependency means that any disruption in these relationships - whether through altered contract terms, reduced sales efforts, or the termination of agreements - could materially impact Fair Isaac’s revenues and operational performance. Compounding this risk is the competitive dynamic with these key partners. Experian, TransUnion, and Equifax are not only critical distributors of Fair Isaac’s products but also direct competitors through their joint venture, VantageScore. This alternative credit scoring system challenges the FICO Score, creating a complex relationship where Fair Isaac relies on these agencies to distribute its products while facing competition for market share. The agencies have both the incentive and capability to promote VantageScore over the FICO Score, potentially eroding Fair Isaac’s dominance in the credit scoring market. This dual role as partners and competitors introduces uncertainty and heightens the strategic risk for Fair Isaac, making its reliance on these relationships a key vulnerability in its business model.

Regulations present a significant risk for Fair Isaac, as they can directly affect the pricing, distribution, and usage of its flagship product, the FICO Score, along with its broader portfolio of services. Heightened regulatory scrutiny, especially in the U.S. residential mortgage market, introduces uncertainty around the company’s ability to sustain its current pricing model and revenue growth trajectory. A key area of concern is the increased attention from federal agencies, such as the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC), on the costs associated with residential mortgage closings. In 2024, the CFPB initiated a public inquiry into fees charged for credit scores and other settlement services. The inquiry aims to identify the reasons behind rising costs and explore strategies to reduce expenses for consumers and lenders. Should this inquiry result in regulations that cap fees charged by Fair Isaac, consumer reporting agencies, or their end users for credit scores, the company’s ability to increase pricing for FICO Scores used in mortgage originations could be significantly constrained. This would directly impact revenue and profitability in the Scores segment - a cornerstone of Fair Isaac’s business - and potentially disrupt its long-standing growth model.

Reasons to invest

Fair Isaac’s Scores segment is a cornerstone of the company’s success, leveraging its dominant market position, innovative solutions, and integral role in the $2 trillion U.S. mortgage market. The FICO Score is a critical tool for mortgage originations, relied upon by borrowers, lenders, and other stakeholders to assess credit risk effectively. The segment’s pricing underscores the value it delivers. In 2025, Fair Isaac will charge $4,95 per score for mortgage originations - a relatively small component of overall mortgage closing costs. This affordable price, combined with the indispensable role of the FICO Score in evaluating creditworthiness, gives Fair Isaac a strong competitive advantage. The Scores segment’s growth potential is further bolstered by innovations such as the FICO Score 10 T and the upcoming FICO Score mortgage simulator. The FICO Score 10 T, which incorporates trended credit data for more precise risk assessments, has gained traction with major lenders and is widely used in credit decisions and securitizations. The mortgage simulator, set to launch soon, enables lenders to model changes in a borrower’s credit profile, helping them provide better loan options and interest rates. This innovation enhances value for both lenders and consumers, strengthening the appeal of FICO's offerings. With steady demand, robust pricing power, and a strong pipeline of innovations, the Scores segment remains a core driver of Fair Isaac’s growth.

Fair Isaac’s Software segment is a standout reason to consider investing in the company, driven by the innovative FICO Platform, strategic partnerships, and substantial growth potential. The FICO Platform, a leader in the Decision Intelligence market, empowers organizations to automate and scale complex decision-making processes efficiently. Strategic collaborations with companies such as Tata Consulting Services and iSON Xperiences extend the platform's reach into new markets and industries, broadening its impact. Despite already serving nearly half of the top 300 global financial institutions, Fair Isaac sees ample opportunities for growth. These include expanding its client base, penetrating mid-market segments, and entering additional verticals. The platform’s cost-effectiveness and unmatched functionality make it a preferred alternative to in-house solutions, offering quicker implementation and superior value. Fair Isaac’s $1 billion investment in its software creates a significant competitive advantage that few rivals can match. The FICO Platform is viewed as a critical investment by top executives, even during economic uncertainty, due to its ability to drive operational efficiency and enhance decision-making. To further expand its reach, Fair Isaac is building an ecosystem of open APIs and a marketplace, enabling independent software vendors and resellers to integrate and utilize the platform seamlessly. As adoption of the platform grows, Fair Isaac is poised to benefit from increased operational efficiencies and economies of scale, bolstering profitability while continuing to invest in innovation and new features.

Fair Isaac’s pricing model for the FICO Score, which charges for initial use but allows many subsequent uses for free, represents a significant opportunity for future revenue growth. This approach has established the FICO Score as a trusted standard in credit risk assessment, but the company sees untapped potential in monetizing currently free downstream uses under existing contracts. Fair Isaac has indicated it is exploring pricing adjustments to better align charges with usage. For example, it could reduce fees in some areas while introducing charges for downstream uses, creating new revenue streams without compromising the widespread adoption of the FICO Score. This strategy provides flexibility to enhance profitability while maintaining its essential role in the financial system. The company’s cautious approach to pricing changes is a key strength. Fair Isaac remains mindful of its responsibility to financial stability and avoids actions that could disrupt markets. By carefully evaluating potential adjustments, the company ensures that changes align with stakeholder interests and its long-term objectives. Although no immediate changes are planned, Fair Isaac’s willingness to explore new pricing strategies underscores its adaptability and growth potential. By thoughtfully monetizing uncharged uses, the company is well-positioned to unlock additional revenue over time while reinforcing its leadership in credit risk assessment.

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Valuation

Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.

The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 20,45, which is from fiscal year 2024. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 26,8% in the next five years, but 15% is the highest number I use. Additionally, I have chosen a projected future P/E ratio of 30, which is twice the growth rate. This decision is based on the fact that Fair Isaac has historically had a higher P/E ratio. Lastly, our minimum acceptable rate of return is already set at 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $613,50. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Fair Isaac at a price of $306,75 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 571 and capital expenditures were 19. I attempted to review their annual report to determine the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 13 in our calculations. The tax provision was 129. We have 24,39 outstanding shares. Hence, the calculation will be as follows: (571 – 13 + 129) / 24,39 x 10 = $281,67 in Ten Cap price.

The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Fair Isaac's Free Cash Flow Per Share at $25,45 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $401,75.

Conclusion

I believe Fair Isaac is a fantastic company led by great management. The company essentially has a monopoly in the credit scoring market, with its FICO Score being the industry standard and even required for conforming mortgages to Freddie Mac and Fannie Mae. This creates a significant moat around its business. Fair Isaac consistently achieves a high ROIC, particularly over the past four years, with management expecting these levels to continue. The company recently delivered its highest free cash flow ever and its second-highest levered free cash flow margin, which is very encouraging. However, risks remain. Macroeconomic factors pose a threat to Fair Isaac's revenue due to its reliance on the banking and credit industries, which are vulnerable to economic instability and reduced demand for financial products. Additionally, the company depends heavily on the three major credit bureaus - Experian, TransUnion, and Equifax - which account for a significant portion of revenue while also competing through their joint venture, VantageScore. Regulatory scrutiny, particularly from the Consumer Financial Protection Bureau, could lead to fee caps or restrictions on credit scores, potentially impacting Fair Isaac’s revenue and profitability in its core Scores segment. Despite these risks, Fair Isaac’s Scores segment is a key reason to invest, given its dominant market position, affordable pricing, and critical role in the $2 trillion U.S. mortgage market. The Software segment is equally compelling, driven by the innovative FICO Platform, which automates complex decision-making and is a leader in the Decision Intelligence market. Moreover, the company’s pricing model for the FICO Score offers untapped potential to monetize downstream uses, creating significant opportunities for future growth. While the CEO believes a PE north of 100 still represents value, I am cautious about overpaying. I will consider buying Fair Isaac shares if they reach the intrinsic value of the Payback Time price of $803.

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