Tuesday, March 26, 2013

FactSet Research Looks Fair Value

The ghost of the financial crisis lingers on, and no more so than in the banking sector. It’s not only that financial services firms are reluctant to invest, having barely survived the crisis, but they are also faced with regulatory threats. In this kind of environment it is no wonder that information providers like FactSet Research Systems $FDS are not seeing the kind of pickup in demand that they might expect at this stage in the cycle. So is this a long term problem or is now the time to buy?

FactSet Gives Disappointing Numbers

The recent Q2 results were a bit disappointing. A brief summary here:

  • Q2 revenues of $213.1 million vs. guidance of $212-215 million
  • Q2 adjusted EPS of $1.14 vs. guidance of $1.11-1.13
  • Q3 revenue guidance of $213-216 million vs. analyst estimates of $217.1 million
  • Q3 EPS guidance of $1.14-1.16 vs. analyst estimates of $1.13

The revenues are a little light, but EPS is ahead of estimates. Essentially the story here is of an industry that is reliant on its customers to make hires and in turn that depends on them expanding their assets under management (AUM). These drivers usually make the industry a great way to play recovering financial markets. Indeed, with equities doing well over the last year and FactSet’s heavy exposure to this asset class, it is reasonable to expect it to likewise be doing well. Unfortunately this is not really the case, and we can see this in the underlying fundamentals.

FactSet’s Annual Subscription Value (ASV) is a strong indicator of future revenues, and it appears to be slowing even as client growth continues to expand:

Analysts have revenue of $860 million forecast for the year through August. Since this number is around the current ASV of $863 million it implies that growth will slow in the next two quarters. Furthermore, this is borne out when breaking out the growth rates for ASV and client growth. Both numbers are for YoY growth.

So with equity markets doing well and the Federal Reserve throwing the kitchen sink at you in order to get you to buy risk assets, why isn’t growth stronger for the industry?

Who Does What in the Industry

The answer to this question rests in an appreciation of the various asset class exposures of the leading firms. FactSet’s principle competitors are Bloomberg, Thomson Reuters $TRI and Standard & Poors. Thomson’s share price has been doing well recently, but this is largely a function of the market’s belief in its restructuring plan and investors’ fixation with high yield stocks.

In reality earnings estimates have fallen over the last three months, and sales growth of negative 1.2% for 2013 and positive 2.6% for next year is hardly encouraging for the industry. Thomson has wide exposure across asset classes; its problem has been dealing with weaker growth in areas like Europe.

A more specific view can be garnered by comparing Bankrate $RATE and Morningstar $MORN. The former is heavily exposed to fixed income markets and sells primarily to banking and insurance companies. Meanwhile Morningstar tends to distribute information on mutual funds to investment and wealth managers.

With authorities determined to keep rates low and everyone wondering whether the mother of all fixed income bubbles is going burst, it's understandable that Bankrate has had difficulties while wealth management is doing fine for Morningstar. It is growing revenues in high single digit figures. In a sense FactSet is aware of this because it is trying to expand its wealth management solutions.

MSCI $MSCI is also a major player in the industry, and its trends are illuminating. Growth is coming from its index and environmental, social and governance segment (ESG), which was up 17% in the last quarter. Risk management is doing okay with a 7% rise, but portfolio management analytics declined 5% with increasing competition cited. This may well be due to FactSet, which reported good growth in portfolio analytics. MSCI's varied performance highlights how much the industry has changed since 2008.

One of the key developments has been the demise of supply side research, and FDS has consistently reported weakening numbers here. Indeed, they currently only make up 18% of revenues with the buy side contributing the rest.

Where Next for FactSet?

With the company forecasting continued weakness on the sell side and underwhelming guidance for Q3 it’s clear that the industry is not forecasting any major pick up soon. The bulls will be hoping that equity markets continue to do well and that investment banks and asset managers will start to increase hiring this year. In addition, FactSet must be hoping M&A activity comes back this year to help out its supply side sales.

In conclusion, FactSet must lie in the pile of stocks considered as cyclically exposed. Moreover, the banking industry remains conservative and affected by the financial crisis. Given its EV/EBITDA multiple of 13.4x I think the stock is still no more than fair value for the risk.

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