Markit Ltd. has made quite a business for itself by providing hard-to-find prices for certain financial products.
Do you want to know the price of an index tracking junk debt in Asian nations outside of Japan? No problem. Are you curious about the costs to borrow shares of Canada's most heavily shorted companies exposed to the nation's property market? Of course you are! Who isn't? And that's fine, because Markit is there with data in abundance. (Markit competes with Bloomberg in providing financial data, and some Markit data is available through the Bloomberg Professional Service.)
It's no wonder, then, that hedge funds, banks and other players in the investment world have found Markit's products indispensable. Investors have been impressed, too, bidding the company's shares up as much as 28 percent from the IPO price in May 2014 through a peak last month.
Even the ever-skeptical hedge fund firm Kerrisdale, famous for spectacular success in identifying short trades like last month's straight-down takedown of Straight Path Communications Inc., counted Markit as one of its biggest long positions in its latest filing.
There is, however, a price for an elusive financial product on Markit's own balance sheet that sticks out like a sore thumb: goodwill, or at least the "intangible assets" line item that encompasses goodwill and other items like patents. Of $3.5 billion in total assets reported by the company in its earnings report Tuesday, $2.9 billion was of the intangible variety. At 83 percent of assets, that is among the highest proportion of intangible-to-total assets for Nasdaq-listed companies.
Goodwill refers to the amount a company pays above book value when it buys another company. In other words, it's not an asset that can be monetized easily. And any later assessment that the company overpaid for an acquisition results in impairment charges that reduce earnings and asset levels.
In fact, goodwill has proved to be a time bomb for some companies in the past. It has caused huge headaches for the likes of Time Warner after the merger with AOL, or Macy's after the combination of Federated Department Stores and May Department Stores. More recently, Microsoft took a writedown of about $7.6 billion on its Nokia phone-handset unit.
Acquisitions have been an important part of Markit's growth strategy, but it has focused on smaller bolt-on deals such as this year's purchases of Options Computers Ltd., CoreOne Technologies, Information Mosaic and Halifax House Price Index. So rather than one huge time bomb potentially sitting on its books, it has a bunch of potential firecrackers. But those firecrackers add up: Its total intangible assets are equal to about two decades worth of net income, according to data compiled by Bloomberg.
Technology-based acquisitions are most famously the cause of bad will when it comes to goodwill. And financial technology innovation is moving at a breakneck pace. As Markit disclosed on Tuesday, the shift to electronic trading and clearing, coupled with low volumes in loan markets, reduced organic revenue by 14 percent in its processing business, which accounts for a quarter of revenue.
There's nothing to suggest that Markit will need to write down the value of any acquisitions anytime soon. Plus, a small debt burden gives it a lot of leeway. And Markit has a pretty captive audience on Wall Street, with about 94 percent recurring revenue.
Still, scrutiny of goodwill has grown this year as some investors fear that the merger boom is turning into a bubble that will reverberate through balance sheets with a wave of writedowns. So it's worth watching out for those firecrackers.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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