BROADRIDGE FINANCIAL SOLUTNS BR
September 29, 2010 - 5:30pm EST by
msdonut940
2010 2011
Price: 22.89 EPS $1.605 $1.803
Shares Out. (in M): 132 P/E 14.3x 12.7x
Market Cap (in $M): 3,012 P/FCF 1.8x 12.7x
Net Debt (in $M): -113 EBIT 0 0
TEV ($): 2,908 TEV/EBIT 0.0x 0.0x

Sign up for free guest access to view investment idea with a 45 days delay.

 

Description

Overview:

 

Broadridge (ticker: BR) is the dominant player within the niche business of proxy distribution, which constitutes the majority of its profitability.  Given Broadridge's extremely high market share, the significant barriers to entry in the industry, and the recurring nature of the business, this represents a very attractive cash flow stream.  Broadridge currently trades at an undeservedly cheap valuation, with several catalysts that should help narrow the discount to fair value.

 

Business:

 

Mack885 did an excellent job writing up the business a few years ago, much of which still applies today.  I'll quickly run through the dynamics of the various segments, though feel free to reference the prior write-up for additional detail.

 

Broadridge began as a segment of ADP, building its dominant position within the proxy distribution industry in the 90's both organically and through acquisition.  Over the years, it also developed two smaller segments, trade processing and clearing.  In 2007, ADP spun the business out as an independent entity into its current form.  The CEO and COO have run the business since the late 80's/early 90's and stayed with the company post-spin.

 

Broadridge has two primary segments today:

 

Investor Communications (ICS):

 

This is Broadridge's largest segment, representing ~71% of revenue and ~65% of EBITDA.  ICS is by far the dominant player within the proxy distribution, having close to a monopoly position of the "street name" portion of the industry, which in turn represents 75-80% of US equity shares.

 

Given the somewhat obscure nature of the business, some quick background is helpful in understanding their very strong position within the industry.  In order to facilitate trade clearance and settlement, the Depository Trust Company serves as a central depository allowing ownership changes to take place without a physical exchange of documentation required.  Its related entity, the National Securities Clearing Corp allows multiple trades to be netted against each other, further facilitating trade settlement.  The DTC only tracks the economic ownership of the broker dealers with which it interacts, while the broker dealers maintain the records containing the beneficial ownership of these shares.  The majority of the US market operates under this system (~75-80% of shares).

 

Complexity arises from the SEC mandates requiring public issuers and mutual funds to provide shareholders with various pieces of information (proxy materials, annual/semi-annual reports, etc.).  For the significant number of shareholders whose accounts are held in "street name", the broker dealers are responsible for distributing proxy information and are compensated by the issuer on a per-unit basis for this service.  Given the economies of scale, Broadridge serves as the outsourced platform that broker dealers then hire to interface with issuers, maintain ownership data, and ultimately distribute the proxy information.  This results in an attractive dynamic where Broadridge is actually hired by the broker dealers, though their fees are ultimately paid for by the issuers.  The costs to issuers are insignificant for most companies, with pricing generally set by the NYSE in consultation with Broadridge.  As a result, Broadridge essentially has a monopoly business where their direct customers are not focused on pricing, and where the small scale of the fees merits little attention from the issuers who ultimately pay the fees.

 

There were initially some concerns about recent changes to the fee structure known as notice & access meant to increase shareholder participation and reduce costs through increased electronic distribution of proxy materials.  However, the changes implemented end up substituting a high revenue/low margin product (physical mailing of proxy materials), for low revenue/high margin products (compensation for suppression of multiple mailings and electronic delivery of materials) that ends up being neutral to beneficial to Broadridge.

 

The underlying growth driver of the business is stock record and mutual fund position growth, historically in the low-to-mid single digit range with some cyclicality introduced around event-driven business (i.e. proxy fights, merger votes, etc.).

 

Securities Processing (SPS):

 

Representing ~35% of EBITDA, SPS is Broadridge's other primary segment.  Through SPS, Broadridge is a provider of outsourced trading operations to many of the large US broker-dealers.  Revenue tends to be relatively recurring, with their broker relationships protected by long-term contracts, though a majority of revenue is derived from transaction-based sources.  The business is roughly 75/25 US/International, and largely equity based (though there is a small fixed income portion as well).

 

Within this business, Broadridge provides outsourced trade capture, execution, confirmation, settlement and execution, as well as individual productivity tools that interface with their solution.  Given the economies of scale, Broadridge seeks to provide cost savings to customers versus the use of in-house systems.

 

This segment has been less attractive than ICS historically, with the biggest issue being continued consolidation of their customer base.  That said, trading growth over the longer-term is very beneficial to margins, given the operating leverage inherent in the segment.

 

Another issue within the segment is that management believes a strong balance sheet is required in order to be a credible competitor within this segment, limiting the ability of the company to take on leverage.  This contrasts significantly with ICS, which given its recurring nature and low capital intensity should be able to support substantial leverage.  As there are limited obvious synergies between the segments, this certainly creates inefficiency within the overall company's capital structure.

 

Clearing and Outsourcing (COS):

 

This has been a very small loss-making portion of the company that was historically marketed as an adjunct to their Securities Processing products.  Broadridge recently exited the business, selling it to Penson.  BR still provides securities processing and back-office services, but the sale importantly has allowed them to release ~$240m of balance sheet cash as well as receiving cash proceeds for the sale itself.

 

Potential catalysts:

 

1) Share buybacks: Given the closing of the Penson acquisition and overly conversative balance sheet, continued share buybacks by management would be beneficial

 

2) Capital Structure:While management seems reluctant to separate the segments, A significantly more efficient capital structure could be achieved with a separated ICS business allowing it to take on the higher amounts of leverage it could support

 

3) LBO: Again, management has seemed resistant, but the ICS segment in particular would be an attractive target for private equity

 

Risks:

 

1) Continued customer consolidation

 

2) Regulatory change that significantly modifies the proxy distribution system

 

3) Exposure to trading volumes

 

 

Valuation:

 

Capital Structure:

 

Stock Price

$ 22.89

FD Shares OS

132

Market Cap

3,021

 

 

Remaining COS Cash

25

Cash

413

Debt

324

Net Debt

(113)

 

 

Enterprise Value

2,908

LTM FCF Yield

8%

 

Historical Financials:

 

 

 

 

 

 

 

 

 

Year End 6/30

2007

2008

2009

2010

Revenue:

 

 

 

 

ICS

1,554

1,575

1,531

1,670

SPS

510

514

534

536

COS

94

96

101

0

Other / Eliminations

(20)

22

(17)

4

Total Revenue

2,138

2,208

2,149

2,209

 

 

 

 

 

EBITDA:

 

 

 

 

ICS

253

281

272

296

SPS

156

146

152

111

COS

(7)

(2)

(7)

0

Other / Eliminations

(41)

(58)

(31)

(24)

Total EBITDA

360

367

387

383

% Margin

17%

17%

18%

17%

 

DCF Returns:

 

 

 

 

 

WACC

 

$ 30.95

9.0%

9.5%

10.0%

 

0.0%

$ 24.66

$ 23.45

$ 22.36

Long

0.5%

$ 25.96

$ 24.61

$ 23.40

Term

1.0%

$ 27.42

$ 25.90

$ 24.55

Growth

1.5%

$ 29.07

$ 27.36

$ 25.85

Rate

2.0%

$ 30.96

$ 29.01

$ 27.30

 

2.5%

$ 33.14

$ 30.89

$ 28.94

 

Catalyst

1) Share buybacks
2) Move towards a more efficient capital structure
3) LBO
    sort by    

    Description

    Overview:

     

    Broadridge (ticker: BR) is the dominant player within the niche business of proxy distribution, which constitutes the majority of its profitability.  Given Broadridge's extremely high market share, the significant barriers to entry in the industry, and the recurring nature of the business, this represents a very attractive cash flow stream.  Broadridge currently trades at an undeservedly cheap valuation, with several catalysts that should help narrow the discount to fair value.

     

    Business:

     

    Mack885 did an excellent job writing up the business a few years ago, much of which still applies today.  I'll quickly run through the dynamics of the various segments, though feel free to reference the prior write-up for additional detail.

     

    Broadridge began as a segment of ADP, building its dominant position within the proxy distribution industry in the 90's both organically and through acquisition.  Over the years, it also developed two smaller segments, trade processing and clearing.  In 2007, ADP spun the business out as an independent entity into its current form.  The CEO and COO have run the business since the late 80's/early 90's and stayed with the company post-spin.

     

    Broadridge has two primary segments today:

     

    Investor Communications (ICS):

     

    This is Broadridge's largest segment, representing ~71% of revenue and ~65% of EBITDA.  ICS is by far the dominant player within the proxy distribution, having close to a monopoly position of the "street name" portion of the industry, which in turn represents 75-80% of US equity shares.

     

    Given the somewhat obscure nature of the business, some quick background is helpful in understanding their very strong position within the industry.  In order to facilitate trade clearance and settlement, the Depository Trust Company serves as a central depository allowing ownership changes to take place without a physical exchange of documentation required.  Its related entity, the National Securities Clearing Corp allows multiple trades to be netted against each other, further facilitating trade settlement.  The DTC only tracks the economic ownership of the broker dealers with which it interacts, while the broker dealers maintain the records containing the beneficial ownership of these shares.  The majority of the US market operates under this system (~75-80% of shares).

     

    Complexity arises from the SEC mandates requiring public issuers and mutual funds to provide shareholders with various pieces of information (proxy materials, annual/semi-annual reports, etc.).  For the significant number of shareholders whose accounts are held in "street name", the broker dealers are responsible for distributing proxy information and are compensated by the issuer on a per-unit basis for this service.  Given the economies of scale, Broadridge serves as the outsourced platform that broker dealers then hire to interface with issuers, maintain ownership data, and ultimately distribute the proxy information.  This results in an attractive dynamic where Broadridge is actually hired by the broker dealers, though their fees are ultimately paid for by the issuers.  The costs to issuers are insignificant for most companies, with pricing generally set by the NYSE in consultation with Broadridge.  As a result, Broadridge essentially has a monopoly business where their direct customers are not focused on pricing, and where the small scale of the fees merits little attention from the issuers who ultimately pay the fees.

     

    There were initially some concerns about recent changes to the fee structure known as notice & access meant to increase shareholder participation and reduce costs through increased electronic distribution of proxy materials.  However, the changes implemented end up substituting a high revenue/low margin product (physical mailing of proxy materials), for low revenue/high margin products (compensation for suppression of multiple mailings and electronic delivery of materials) that ends up being neutral to beneficial to Broadridge.

     

    The underlying growth driver of the business is stock record and mutual fund position growth, historically in the low-to-mid single digit range with some cyclicality introduced around event-driven business (i.e. proxy fights, merger votes, etc.).

     

    Securities Processing (SPS):

     

    Representing ~35% of EBITDA, SPS is Broadridge's other primary segment.  Through SPS, Broadridge is a provider of outsourced trading operations to many of the large US broker-dealers.  Revenue tends to be relatively recurring, with their broker relationships protected by long-term contracts, though a majority of revenue is derived from transaction-based sources.  The business is roughly 75/25 US/International, and largely equity based (though there is a small fixed income portion as well).

     

    Within this business, Broadridge provides outsourced trade capture, execution, confirmation, settlement and execution, as well as individual productivity tools that interface with their solution.  Given the economies of scale, Broadridge seeks to provide cost savings to customers versus the use of in-house systems.

     

    This segment has been less attractive than ICS historically, with the biggest issue being continued consolidation of their customer base.  That said, trading growth over the longer-term is very beneficial to margins, given the operating leverage inherent in the segment.

     

    Another issue within the segment is that management believes a strong balance sheet is required in order to be a credible competitor within this segment, limiting the ability of the company to take on leverage.  This contrasts significantly with ICS, which given its recurring nature and low capital intensity should be able to support substantial leverage.  As there are limited obvious synergies between the segments, this certainly creates inefficiency within the overall company's capital structure.

     

    Clearing and Outsourcing (COS):

     

    This has been a very small loss-making portion of the company that was historically marketed as an adjunct to their Securities Processing products.  Broadridge recently exited the business, selling it to Penson.  BR still provides securities processing and back-office services, but the sale importantly has allowed them to release ~$240m of balance sheet cash as well as receiving cash proceeds for the sale itself.

     

    Potential catalysts:

     

    1) Share buybacks: Given the closing of the Penson acquisition and overly conversative balance sheet, continued share buybacks by management would be beneficial

     

    2) Capital Structure:While management seems reluctant to separate the segments, A significantly more efficient capital structure could be achieved with a separated ICS business allowing it to take on the higher amounts of leverage it could support

     

    3) LBO: Again, management has seemed resistant, but the ICS segment in particular would be an attractive target for private equity

     

    Risks:

     

    1) Continued customer consolidation

     

    2) Regulatory change that significantly modifies the proxy distribution system

     

    3) Exposure to trading volumes

     

     

    Valuation:

     

    Capital Structure:

     

    Stock Price

    $ 22.89

    FD Shares OS

    132

    Market Cap

    3,021

     

     

    Remaining COS Cash

    25

    Cash

    413

    Debt

    324

    Net Debt

    (113)

     

     

    Enterprise Value

    2,908

    LTM FCF Yield

    8%

     

    Historical Financials:

     

     

     

     

     

     

     

     

     

    Year End 6/30

    2007

    2008

    2009

    2010

    Revenue:

     

     

     

     

    ICS

    1,554

    1,575

    1,531

    1,670

    SPS

    510

    514

    534

    536

    COS

    94

    96

    101

    0

    Other / Eliminations

    (20)

    22

    (17)

    4

    Total Revenue

    2,138

    2,208

    2,149

    2,209

     

     

     

     

     

    EBITDA:

     

     

     

     

    ICS

    253

    281

    272

    296

    SPS

    156

    146

    152

    111

    COS

    (7)

    (2)

    (7)

    0

    Other / Eliminations

    (41)

    (58)

    (31)

    (24)

    Total EBITDA

    360

    367

    387

    383

    % Margin

    17%

    17%

    18%

    17%

     

    DCF Returns:

     

     

     

     

     

    WACC

     

    $ 30.95

    9.0%

    9.5%

    10.0%

     

    0.0%

    $ 24.66

    $ 23.45

    $ 22.36

    Long

    0.5%

    $ 25.96

    $ 24.61

    $ 23.40

    Term

    1.0%

    $ 27.42

    $ 25.90

    $ 24.55

    Growth

    1.5%

    $ 29.07

    $ 27.36

    $ 25.85

    Rate

    2.0%

    $ 30.96

    $ 29.01

    $ 27.30

     

    2.5%

    $ 33.14

    $ 30.89

    $ 28.94

     

    Catalyst

    1) Share buybacks
    2) Move towards a more efficient capital structure
    3) LBO

    Messages


    SubjectCheap?
    Entry09/29/2010 11:04 PM
    Memberotaa212
    I'd be interested to hear why you think BR is cheap at 12-13x FCF, which is an issue I am undecided on. What is the annualized return you expect?
     
    As you said, the ICS business is very steady but the growth is very modest. My understanding is that ICS fees are set by the SEC, and they are defined in absolute dollar terms. If this is true, then BR can't be said to have pricing power, despite its monopolistic position. I also believe it is true, what ad188 said, that the fees are thought of as too high. If all of this is correct, then it would not be attractive to own BR in an inflationary environment, and this has implications for the cap rate one should apply to the ICS cash flows. Any thoughts would be appreciated.

    SubjectEconomics and risks
    Entry09/30/2010 09:04 AM
    Memberdeerwood
    msdonut940- Do you have a sense of unit economics on the ICS side and how margin differ between paper and electronic distribution? Also, why wouldn't entry barriers decline once the ICS business becomes more electronic? Can't the brokers just handle this themselves as they already have their customers' email addresses?

    SubjectRE: Economics and risks
    Entry09/30/2010 05:58 PM
    Membermsdonut940
    The primary driver of the margin difference between paper and electronic is due to postage, which as it's largely a pass-through, ends up inflating revenue but reducing margins vs. their other services.  There's a June '09 initiation report from Merrill that runs through the economics in a lot more detail.
     
    Regarding your second question, I think that there is strategic value in being able to leverage a largely fixed-cost  platform across such a large customer base.  In addition, a portion of their fees is based on suppressing duplicates, from which more revenue can be created by having an aggregated database of nearly all shareholders, as opposed to just those of a single broker.  Another way to look at it is that you could make the argument brokers should have been in a position to compete historically as they already had customers mailing information and were sending out statements on a regular basis, but for cost reasons it hasn't been worth their while.
      Back to top