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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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