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Valuentum is dropping coverage of the securities research industry to allocate resources elsewhere.
Structure of the Securities Research Industry
The securities research industry has become increasingly competitive, with a large number of rivals in the individual, advisor, and institutional markets. However, barriers to success for new entrants in the individual market are incredibly high, if not impossible, while the advisor market continues to be dominated by entrenched providers with deep ties. The institutional market is shielded to new rivals thanks to talent and capital costs, offering established players an attractive position. Licensed research and data can be a high-return means of generating sustainable, recurring business. We like the group’s structure.
Dun & Bradstreet (DNB)
Dun & Bradstreet has agreed to be taken private by an investor group for $6.5 billion including debt. Shareholders will receive $145 per share in cash, and our fair value estimate reflects the deal price.
Dun & Bradstreet is a source of commercial information and insight on businesses. The firm’s global commercial database contains 280+ million business records. It has coverage across more than 200 countries and records 5 million database updates daily. North America accounts for 80%+ of revenue. The company is based in New Jersey.
Dun & Bradstreet benefits from a strong brand name, which dates back to the founding of the company in 1841. Since the Financial Crisis, however, revenue performance has been somewhat stagnant, though the firm’s operating margin has held up.
Free cash flow has been ~$225+ million per annum since 2004, and we’re big fans of the company’s ability to throw off cash. The firm has been acquisitive of late, helping its stalled top line, and while deferred revenue performance has improved in the Americas region, we continue to monitor management’s progress in executing its growth strategy.
The firm enables customers to make critical business decisions (credit decisions, manage risk, acquire prospects). ‘Risk Management’ (RMS) accounts for ~60% of revenue with the balance coming from ‘Sales & Marketing’ (S&MS). Its top priority is to return the business to growth via Big Data and brand extensions in new high-growth markets.
Dun & Bradstreet is working to shift its delivery to more modern channels, which offers growth potential. Traditional delivery methods currently account for ~75% of its Americas segment with 25% coming from as-a-service delivery. This is target to flip to 30% traditional and 70% as-a-service.
Our published fair value estimate range for Dun & Bradstreet’s is $116-$174 per share, with a Valuentum Buying Index rating of 7 and an Economic Castle rating of Very Attractive.
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Dun & Bradstreet has agreed to be taken private by an investor group for $6.5 billion including debt. Shareholders will receive $145 per share in cash, and out fair value estimate reflects the deal price.
Dun & Bradstreet’s name speaks of sustainability, and its business model is efficient in generating significant amounts of free cash flow. The company speaks of enormous opportunity in the areas of commercial credit, sales and marketing info, data services, and digital marketing and supply chain analysis–cumulatively, a market size of $24 billion. We’re looking forward to improvements in organic revenue performance and its profit margins, but free cash flow fell to ~$225 million in 2017 from ~$263 in 2016. The quality and quantity of the company’s data is unparalleled, and its dividend remains on solid footing, in our view, though less than ideal trends in cash flow from operations is worth monitoring.
Dun & Bradstreet has struggled to grow at a material pace in recent years, but it’s simply difficult to find fault with the company’s free cash flow track record. Capital spending as a percentage of revenue is a meager ~5%, and while we expect the company to be acquisitive, returning excess cash to shareholders through dividends and share repurchases should be expected as annual run rate dividend obligations check in at ~$74 million. Our biggest concern is the company’s net debt position, which may weigh on the pace of dividend growth, as management seeks to use free cash flow to delever. The executive team is targeting gross debt to adjusted EBITDA below 3x and is committed to maintaining investment-grade credit status.
Our published Dividend Cushion ratio for Dun & Bradstreet is 2.4 with a Dividend Track Record of Healthy.
Factset Research (FDS)
We like Factset’s research product, but the market for providing financial information and software solutions to the investment community remains competitive.
FactSet provides financial information and analytical applications to the investment community. The firm combines content about securities from markets all over the globe into a single online platform of information and analytics. Buy-side clients account for more than 80% of ‘Annual Subscription Value’ (ASV).
The company benefits from rather high barriers to entry, which locks out new rivals. It would be incredibly difficult for a start-up, for example, to replicate in a short time the extensive databases and level of client service the firm retains.
Demand for FactSet’s products can be impacted by equity returns, as the success of more than 80% of its clients is tied to equity assets under management. In the event of a prolonged decline in equity markets, the firm may experience additional pain as the demand for services from investment managers decreases and suppresses demand for its research.
We like FactSet’s product, but the market for providing financial information and software solutions to the investment community remains competitive. Of the ~$28.5 billion market data and analytics market, Bloomberg controls ~33%, Thomson Reuters ~22.5%, and Factset 4.5%. The market appears rational, and operating margins remain robust.
FactSet’s client base is nearing an inflection point, and management believes emerging technologies (cloud computing, data science, blockchain) can fill the gaps in industry offerings. The company has a scale advantage and boasts the agility necessary to drive innovation.
Our published fair value estimate range for Factset Research’s is $138-$210 per share, with a Valuentum Buying Index rating of 6 and an Economic Castle rating of Highest Rated.
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Factset’s dividend growth prospects look excellent, but its yield is underwhelming.
There are very few business models that are better, and there are very few dividends that are stronger than FactSet’s. Fiscal 2017 was the 37th consecutive year of revenue growth at the company, but it broke its 20 year streak of consecutive annual earnings expansion. With a Dividend Cushion ratio well above 2, a whole lot would have to go wrong for the board to decide not to keep rewarding shareholders in the form of a higher dividend. If anything, our future forecasts for dividend growth at FactSet may be too conservative. The executive team could double or triple the dividend from here and not miss a beat. FactSet has all the makings of a dividend growth giant, should management desire to deliver a meaningful yield.
Though the cat is out of the bag regarding FactSet’s dividend growth potential, its yield still has a ways to go to be truly competitive with dividend growth giants. We’re not particularly fond of the company’s ties to broader equity performance, as the success of more than 80% of its clients is tied to equity assets under management. No longer a US centric software firm, this global company recently surpassed $1 billion in Annual Subscription Value, and we continue to believe its future remains bright. Competition from the likes of Bloomberg, Thomson Reuters, S&P, and Morningstar cannot be ignored, however, even as we say the company benefits from high barriers to entry.
Our published Dividend Cushion ratio for Factset Research is 2.8 with a Dividend Track Record of Healthy.
Moody’s (MCO)
Moody’s has a nice recurring revenue base across much of its portfolio, and it has some notable growth opportunities moving forward.
Moody’s provides credit ratings, research, tools and analysis to the financial markets. The firm’s ratings and analysis track debt covering more than 120 countries, 8,500 corporate issuers, 18,000 public finance issuers, and 11,000 structured finance obligations. The company was founded in 1900 and is headquartered in New York, New York.
Moody’s operates in two segments: Moody’s Analytics and Moody’s Investors Service. Moody’s Analytics has a strong presence across the globe with 10,500 institutional clients worldwide. It has customers in 155 countries, and the firm does business with 86 of the top 100 global banks.
Moody’s has a nice recurring revenue base across much of its portfolio–approximately 50% of revenue is of the recurring variety–with Moody’s Analytics accounting for the majority of this revenue stream. Recurring revenue has grown at a robust pace of late (23% growth in the fourth quarter of 2017 thanks in part to a recent acquisition), and the firm has made increasing that number a strategic priority.
Moody’s acquired Dutch credit risk measure and analytical insight provider Bureau van Dijk for ~$3.3 billion in August 2017. Moody’s expects $45 million in annual revenue and expense synergies by 2019, and $80 million by 2021. 90%+ of Dijk’s revenue is recurring, its renewal rates are typically above 90%, and the firm is a solid free cash flow generator.
Moody’s has robust opportunities for growth: 1) economic activity will drive debt market issuance, 2) disintermediation of credit markets will increase new product demand, and 3) the firm retains pricing power. Historically, rising interest rates have not significantly impacted revenue.
Our published fair value estimate range for Moody’s is $111-$179 per share, with a Valuentum Buying Index rating of 7 and an Economic Castle rating of Highest Rated.
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Moody’s is in a strong position to keep raising its dividend, but its yield leaves a lot to be desired.
Moody’s plays an indispensable role in the global financial system, providing credit ratings, research and tools to users. Very few business models have as high an operating margin as Moody’s, nor are many as capital-light and free-cash-flow rich. An adjusted operating margin north of 45% and free cash flow of ~$1 billion per annum aren’t out of the question (guidance for 2018 free cash flow is $1.6 billion), and while the company is engaged in share buybacks, dividend growth prospects perhaps have never been stronger. Generally accommodative ECB monetary policy should continue to provide a tailwind to operating performance. Moody’s Analytics could surprise to the upside, and we’re fans of the firm’s recurring revenue stream.
It’s simply hard to find much fault with a company that is as profitable and as free-cash flow rich as Moody’s. Though such an event would hardly derail the company’s dividend growth prospects, a disorderly response to the Federal Reserve’s start to the contractionary monetary cycle could hurt performance. Weaker economic growth in the Eurozone and a large correction in asset prices in China could derail the pace of issuance and increase default rates in those regions, but non-financial corporates continue to have large refunding needs, offering considerable visibility to Moody’s business. There’s not much that’s going to stop the pace of dividend expansion, in our view.
Our published Dividend Cushion ratio for Moody’s is 2.6 with a Dividend Track Record of Healthy.
Morningstar (MORN)
Opportunities in growing levels of decision support and outsourced investment management highlight the changing industry landscape Morningstar is working to capitalize on.
Morningstar provides investment research to investors and offers an extensive line of data, software, and research products for individual investors, financial advisors, and institutional clients. The company has three major platforms: Morningstar.com, Morningstar Advisor Workstation, and Morningstar Direct. Chairman Joe Mansueto owns ~57% of outstanding shares.
Morningstar benefits from a massive installed base with its Advisor Workstation product line, and the company’s construction and acquisition of new databases have augmented its data offering. It currently provides data on 500,000+ investments globally.
Morningstar Advisor Workstation, including Morningstar Office) and Morningstar Managed Portfolios are its main products for financial advisors. As of the end of the first quarter of 2018, 180 companies held licenses for Advisor Workstation, and just over 4,300 financial advisors held licenses for Morningstar Office. Morningstar Data is its largest product category at ~18% of total revenue.
Opportunities in growing levels of decision support and outsourced investment management highlight the changing industry landscape Morningstar is working to capitalize on. Digitization, declining fees, and best interest advice are a few trends impacting demand for its services. Morningstar managed portfolios have grown at a strong double-digit rate of late.
Morningstar may have lost a touch of its independence when it acquired an NRSRO (Realpoint), but it still stands head-and-shoulders above traditional sell-side research. Opportunities exist in equity and credit, but we expect the firm to become more acquisitive should organic growth slow.
Our published fair value estimate range for Morningstar’s is $63-$105 per share, with a Valuentum Buying Index rating of 2 and an Economic Castle rating of Highest Rated.
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Morningstar’s dividend growth potential is excellent, but its current yield is far from a head turner.
Morningstar can raise its dividend at will. The company’s Dividend Cushion ratio is fantastic, and its business model resilient. Significant free cash flow generating capacity coupled with a conservative, cash-rich balance sheet form the makings of a Dividend-Aristocrat-to-be, in our opinion. We’re modeling a significant pace of future expansion in the dividend that could easily be achieved should the payout become a top priority of the executive team. Majority shareholder Chairman Joe Mansueto (owns ~57% of shares) will largely determine how much he’d like to receive in dividends in any given quarter, and investors will have to accept that decision. At current levels, its yield leaves much to be desired.
There’s nothing that we see that could derail the pace of dividend growth at Morningstar, but that’s really not the biggest risk shareholders face. Fundamentally, as the firm reaches out into new lines of business, a greater dependence on asset prices and new debt issuance will make its business more and more cyclical. Currency can work against the company at times, there’s always the risk of litigation, and management may look to step up the pace of acquisitions should organic growth not live up to expectations. A debt-fueled spending spree could change our opinion of its dividend health quickly. The dividend is as strong as it gets in any case, even if its yield is not compelling.
Our published Dividend Cushion ratio for Morningstar’s is 4.3 with a Dividend Track Record of Healthy.
S&P Global (SPGI)
We’ve raised our fair value estimate for S&P Global after increasing near term expectations. Multiple secular trends should continue to provide the company with long-term growth opportunities.
S&P Global is a content and analytics provider serving the capital, commodities and commercial markets. The firm’s businesses include S&P Ratings, a provider of credit ratings, and S&P Capital IQ, a provider of digital and traditional financial research. S&P Ratings accounts for roughly half of revenue and operating profit.
McGraw Hill Financial changed its name to S&P Global after selling its Securities Evaluations and Credit Market Analysis businesses as well as its consumer data and analytics business J.D. Power. The firm continues to distance itself from publishing and move toward more recurring revenues.
Multiple secular trends should continue to provide S&P Global with long-term growth opportunities. The sophistication of investors continues to increase, requiring real-time data and analytics. Capital markets in emerging economies will continue to transform, and significant debt maturities and ongoing bank deleveraging will drive demand in its credit rating business.
Areas of focus for S&P Global in 2018 include: invest in new technology and alternative data, grow ratings beyond the core, release production version of the new Market Intelligence platform and begin phased user transition, enhance its Platts commercial model and simplify its customer facing and operating platforms, and expand index product offering.
S&P Global’s revenue mix is drastically different today than it was a decade ago. Most notably, corporate ratings accounted for 55% of 2017 revenue (was 27% in 2007), and structured finance accounted for 10% of 2017 revenue (was 44% in 2007).
Our published fair value estimate range for S&P Global’s is $124-$186 per share, with a Valuentum Buying Index rating of 4 and an Economic Castle rating of Very Attractive.
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S&P Global has paid a dividend each year since 1937 and has increased its dividend annually for the past 45 years. It paid a special dividend in 2012.
What more can we say about the strength of one of the leading credit rating agencies in the world? S&P Global’s business model is fantastic and largely recurring; it has paid a dividend each year since 1937 and has increased its dividend annually for the past 45 years. The company announced a special dividend in 2012, which may make comparisons difficult, but the outlook is bright. The company’s Economic Castle rating matches up with some of the best in our coverage universe, and its Dividend Cushion ratio is simply phenomenal. The company is dedicated to maintaining an investment grade credit rating, and it expects to return 75%+ of free cash flow to shareholders. Its dividend yield leaves a great deal to be desired, however.
For a company that has grown revenue at a 7% annual clip since 2013 and its adjusted operating margin by ~13 percentage points over the same period, S&P Global has come firing back after the miscues that arguably caused much of the pain in the housing market during the Great Recession. It’s hard to find much fault with the many secular trends powering its business, not the least of which are significant refina