FactSet's Numbers Add Up
By Amrit Tewary
If repeat customers are the Holy Grail of business, then FactSet is in a truly enviable position. The financial data integrator has been able to maintain a consistently high customer-retention rate (above 95% for 12 consecutive years) in spite of heavy cost-cutting by its principal clients, investment managers and investment banks, over the past few years. This high retention rate combined with FactSet's subscription-based business allows for highly predictable and recurring revenue streams.
The upshot: Even though its clients are in a rather cyclical industry, FactSet has been able to increase revenues and earnings consistently through the ups and downs of the market due to its clients' dependence on its unique product offering. We at Standard & Poor's have assigned FactSet (FDS ) our highest investment ranking, 5 STARS (buy).
Based on estimates from industry trackers Veronis Suhler and Thomson Financial, as well as FactSet's management, Standard & Poor's believes that the global market for financial information services is approximately $14 billion, with annualized long-term growth of approximately 7%. Key players such as Bloomberg, Reuters (RTRSY ), and Thomson Financial (TOC ) control about half of this market. The other half is fragmented, with FactSet and S&P (like BusinessWeek Online, a unit of The McGraw-Hill Companies) among the largest players.
FactSet occupies a comfortable niche in this vast market. It integrates financial data from hundreds of databases and also provides related software and services to its clients. It has close to a 25% share of its addressable market of about $800 million, and it has maintained the leading position in this niche for more than a decade. (Addressable market refers to what its projected revenues would be if each of its targeted customers -- global asset managers and large investment banks/brokerages -- subscribed to FactSet at a targeted [higher] annual subscription rate.) FactSet's customer base already includes about 90 of the 100 largest money-management firms and most of the top investment banks and brokerages.
Future growth will likely be driven by a couple of factors. First, we expect FactSet to gain additional business at existing clients through cross-selling of new products such as the Portfolio Analytics product, which has gained a significant foothold among investment-management clients in the past few years.
Second, overseas business should create new opportunity as the international market is roughly equivalent to the domestic one. FactSet has been taking market share away from international competitors such as Datastream, and it should continue to increase international revenues (19% of total revenues) at a faster clip than domestic revenues.
PLENTY OF CHOICE.
Several characteristics set FactSet apart from its competition. First, it easily offers the greatest breadth of financial information products in its peer group. It provides clients with access to more than 200 databases from about 50 content providers. FactSet uses more than two vendors for each type of data, thus giving its clients a choice of databases. No competitor appears to come close to matching the selection that FactSet offers its customers.
Second, it has superior technology, as evidenced by its ability to seamlessly integrate data into a single source, monitor and ensure the data's trustworthiness, and offer a relatively low processing time to retrieve and utilize data. Third, FactSet offers user-friendly applications for customized data analysis. These applications become embedded in the client's workflow. And when that happens, it becomes difficult -- and costly -- for the customer to switch to another provider.
Fourth, FactSet has an impressive installed base of clients and strong relationships with these customers built through an emphasis on service and consulting. It offers training, dedicated consultants, and 24-hour customer service. Lastly, it's well positioned to take advantage of future growth opportunities due to its financial flexibility. It boasts a strong balance sheet, with no debt and about $139 million in cash and investments.
During the recent recession, investment banks and brokerages, which account for about 25% of FactSet's revenues, have sharply reduced headcount, cutting the number of user passwords under subscription. This has dampened FactSet's revenue growth rate, since a portion of business is dependent on the number of user passwords. However, FactSet was still able to achieve 17% revenue growth in fiscal 2002 (ended August) by increasing its client base and cross-selling additional products to existing customers.
We expect a gradual recovery in capital markets in 2003, with initial public offerings and mergers-and-acquisition activity picking up from the depressed levels of the last two years. Increased profitability for FactSet's investment-banking clients should lead to greater employment levels at these firms by 2004, which in turn should result in more user passwords. And that should provide FactSet with robust revenue and earnings growth.
We do have one caveat. If the recovery doesn't proceed as we expect and capital markets see further deterioration, FactSet's clients might need to make additional budget cuts. However, given that they're typically larger, diversified investment firms and that FactSet products are integral to their operations, FactSet will likely weather sustained market weakness among customers better than its peers will.
In fiscal 2003, we forecast as-reported earnings per share to grow 17%, to $1.37, on 10% higher revenues and a significantly wider operating margin, aided by tight control of discretionary expenses and leveraging of fixed costs. For fiscal 2004, we expect EPS to advance 16%, to $1.59, on 14% greater revenues. On an S&P Core Earnings basis, stock-option expenses would have lowered FactSet's as-reported EPS in fiscal 2002 by about 18%, which is fairly typical for a technology company. It doesn't have a pension plan and thus didn't need a pension adjustment in fiscal 2002.
We think FactSet deserves its premium price-to-earnings valuation vs. its peers because of its track record of sustained profitability through market cycles (as borne out by its five-year average return on equity of 28% and 10-year average ROE of 25%). Our blended valuation model, which combines a historical p-e to growth (PEG) analysis, a relative PEG analysis, and a three-stage discounted cash-flow analysis, arrives at a target stock price of $38, which offers about a 30% appreciation potential from where it is now.
Analyst Tewary follows technology and consumer discretionary stocks for Standard & Poor's