[EFX – Equifax] Investment Implications of Breach Fiasco

Considering what’s at stake, we can’t dismiss the torrents of negative headlines, venemous tweets, pending AG investigations, and congressional rebukes that have justifiably buffeted Equifax on all sides, as hyperbolic grandstanding even if that’s exactly what much of it is.  In a very direct and non-hokey sense, trust – that the data lenders and employers contribute to Equifax is secure and used as intended – is what greases the feedback loop between data contribution and consumption.  To the degree that trust has been impaired, so has the company’s long-term earnings potential.  But even impaired earnings have a price.

As you’ve probably gathered from previous posts, I like data businesses with self-reinforcing competitive advantages.  I wrote in my VRSK post:

“When evaluating the competitive advantage of a data-based analytics business, three important questions come to mind: 1) Is the data proprietary? 2) Are the insights from the data critical? and 3) Does the data fuel a product feedback loop? […]The company sits at the center of a network that procures data from a wide variety of sources (claims settlements, remote imagery, auto OEMs), analyzes it, and delivers predictive insights to clients (insurers, advertisers, property managers).  The agreements through which a customer licenses VRSK’s data also allows the company to make use of that customer’s data….so essentially the customer pays Verisk for a solution that costs almost nothing for the company to deliver and Verisk gets to use that customer’s data to enhance its own solutions, which improved solutions reduce churn and attract even more customers (and their data) in a subsidized feedback loop.

 This flywheel, built on top of Verisk’s historical advantage as the repository of industry data, has generated world’s largest claims database (VRSK aggregates claims data from 95% of the P&C industry), containing granular information on 1.1bn claims (up from 700mn claims in 2011), with the insurance ecosystem submitting ~200k new claims a day across all P&C coverage lines.  It would be effectively impossible for a competitor to replicate this ever-burgeoning flurry of data.”

Like Verisk, Equifax owes much of its current success to the frightening scope and potency of its burgeoning database, which itself is, to a large extent, the product of historical momentum.  Founded in 1899, and as outlined in this Wired article from 1995, Retail Credit (as Equifax was known until 1975, when it changed its name to purportedly wash the taint of suspected consumer rights violations) grew to become one of the largest consumer credit bureaus by the 1960s after accumulating sensitive data on millions of Americans.  Equifax’s database was so encompassing that its move to computerized files in 1975, which coincided with congressional hearings re: privacy concerns that year, led to the passage of the Fair Credit Reporting Act that we all know today.

By paying for Verisk’s data and having full purview of the industry’s historical claims experience, an insurer can better underwrite risk than it could by simply relying on its own parochial experience.  Similarly, a lender or merchant is better positioned to assess credit risk if it has insight into the borrower’s historical propensity to meet other obligations.  Back when people lived their entire lives in their town of birth, a banker or store owner might have determined creditworthiness by your personal reputation or the strength of your handshake.  But as freeways increasingly criss-crossed the national landscape, folks shuttled off to pursue opportunities in faraway cities, and we all became strangers to one another, lenders needed a reliably updated and accurate centralized repository of payment histories and obligations to gauge how likely you were to pay your loan.

Since no single lender has proprietary understanding of a customers’ complete payment history, all lenders collectively benefit from voluntarily sharing this information with one another. Moreover, centralizing consumer data acts as a stick since if a consumer knows that his behavior will be captured no matter which bank he borrows from, he will be more motivated to stay current on his payments. This results in a feedback loop wherein only the most widely referenced databases are fed borrower data, which in turn compels lenders to access those database in a process that trends toward oligopoly.