Friday, November 16, 2012

FactSet Research Systems Equity Analysis

FactSet Research Systems (NYSE: FDS) gave earnings which were met with an immediate markdown. For some reason the stock seems to usually invoke great drama after it gives results, but the latest numbers and guidance were pretty much in line. I like the company and think it has some attractive defensive properties which make it a good stock to hold in a balanced portfolio.

FactSet Results

At the previous set of results FactSet had guided towards $208 million in revenues and Non-GAAP diluted EPS of $1.15-117c. In the end it recorded $207 million in revenues and $1.18c, both numbers were pretty much in line. Moreover the guidance for Q1 2013 of $210-213 million and $1.10-1.12 in EPS was in line with analyst estimates. So why the initial sell off?

Who knows? But what we do know is that these results were pretty good. Prior to them I had mentioned that the key metrics to look out for are the Annual Subscription Value (ASV) and the client count. The former represents the forward looking yearly revenue for the firm, although I would caution investors from reading too much into it. Clients can give FactSet notice and get rid of parts of the service that they don’t want anymore. In reality they are unlikely to do so in meaningful amounts as long as the financial services industry is doing okay.

A quick look at how these two key metrics have been trending.

The recovery since 2008 is clear but, interestingly, note that ASV held up quite nicely even in the turmoil. I’ll come to the reasons why in a moment.

First I want to look at the underlying trends in more detail.

Client growth improved in the last quarter even though the pace of growth in ASV appears to be slowing. Superficially this looks worrying and could be a sign that FactSet is now pushing for less lucrative customers however lets recall that new customers don’t tend to be the most profitable so when client numbers are accelerating, it’s natural to see some slowing in ASV.

Moreover the StreetAccount acquisition should create some good cross selling opportunities as well as a boost to ASV.

FactSet’s Defensive Qualities

The company did okay in 2009 for two main reasons.

 First, it has a range of product offerings which tend to offset each other across market conditions. For example if equity departments are being cut back then bonds, alternative asset classes or foreign exchange might be doing better.  It is a diversified offering which compares favorably with a company like Bankrate (NYSE: RATE) or Morningstar (NASDAQ: MORN). Bankrate offers a lot of specialist research and information to the banking and insurance industries and its products are closer tied to their prospects. Meanwhile, Morningstar is more of a play on mutual fund research. It is trying to expand its equity coverage but financial firms are notoriously particular when it comes to information.

The second reason is that FactSet’s offerings are not the most sophisticated and are often seen as a ‘trading down’ option. The company is unlikely to take this line of argument but I think many people would agree with me. Its solutions are certainly not as expensive as a Bloomberg terminal or a Reuters desktop from Thomson Reuters Corporation and as FactSet adds more information it can increasingly encroach on these companies share.

Others may disagree with me and forgive my cynicism, but I simply don’t believe that owning a Bloomberg terminal or Reuters desktop makes any equity investment professional any better. They look good though and it’s a key status symbol and the financial services industry is not short of people willing to waste other people’s money on status symbols. My point is that financial firms may well wake up to the fact that their staff are no less effective by using a cheaper FactSet solution.

Where Next For FactSet?

The results look pretty good and the StreetAccount acquisition makes sense. I would hope to see an increase in ASV going forward as the acceleration in new accounts over the last year or so should bring some added revenue opportunities.

I also like the defensive qualities of the firm. It will suffer a lot less if there is some kind of severe financial slowdown. The realist in me tells me that the story of the last few years is that no expense will be spared to save the financial services industry and I don’t think that will change anytime soon. In other words, FactSet’s customers will still be around in the future. However the risk of short term disruption caused by the EuroZone cannot be discounted.

Furthermore, it's hard to argue that the stock is cheap right now and I wouldn’t be in a hurry to pay 24x earnings for a company in this environment.  This is one for the monitor list