THOMSON-REUTERS CORP TRI S
May 29, 2013 - 8:15pm EST by
msbab317
2013 2014
Price: 34.68 EPS $2.15 $1.61
Shares Out. (in M): 833 P/E 16.1x 21.5x
Market Cap (in $M): 28,900 P/FCF 17.3x 18.1x
Net Debt (in $M): 7,171 EBIT 2,405 2,202
TEV ($): 36,572 TEV/EBIT 15.2x 16.6x
Borrow Cost: NA

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  • Financial technology
  • Dividend yield
  • Canada
  • Family Owned
  • Complex Accounting
  • volume declines

Description

Thomson Reuters is a closely held information services company.  While most people know the firm by name, some brief history is below.  Thomson had merged with Reuters back in April 2008 creating a 34bn USD enterprise and leaving Woodbridge (The Thomson Family with a 55% interest). 

Woodbridge, the Thomson family office, has gone through a recent management change.  Geoff Beattie, the main architect of the transaction, was removed as head of the family office (end of 2012) and recently from the board of TRI (May 2013).  This highlights even the family’s impatience with the turnaround – a situation that might simply lead to a perpetual turnaround story with ongoing restructuring.  It is worth noting that any margin improvement that appears in the headline 2012 numbers is actually just the anniversary of restructuring charges that TRI had not historically adjusted for.  The real adjusted margins are below and highlight the true margin degradation in the business:

  

            Q1
    2010 2011 2012 2013E 2013
Adjusted EBITDA Margins   27.4% 28.1% 27.4% 26.4% 24.4%
Financial & Risk   25.9% 27.0% 25.6% 24.7% 21.5%
Legal   37.9% 37.6% 37.8% 36.1% 34.8%
Tax & Accounting   31.3% 31.6% 31.2% 31.0% 30.9%
Intellectual Property &   Science   33.3% 34.7% 33.9% 33.5% 30.0%
Corporate & Other   (includes Media)   -65.1% -67.6% -71.0% -71.0% -58.0%

Combining this shift with a similar management shake-up at TRI itself shows the difficulty in stabilizing the business.  Tom Glocer (Reuters side) was removed a year earlier and replaced by Jim Smith (Thomson side) - someone arguably even further from the inner workings of platform consolidation (housed mostly in the Reuters side).  Meanwhile, the Eikon platform roll-out is still only ~33% done.

Eikon currently has about 46k terminal out on the Eikon platform vs. 160k on legacy Reuters.  The roll-out has accelerated; however, it started in Q4 2010.  Management has indicated that they are not providing many price concessions, but my own diligence appears to show larger firms getting 6mo plus free of charge just to get a foot in the door (with no commitment).  While pricing for both Bloomberg and Eikon are very dependent on many variables a rough cost for Bloomberg is ~$1,700/mo vs. ~$1,000+ for Eikon.  Though Eikon is cheaper it notably does not have IB.

On the other side of TRI’s business (Legal), you now have a formidable competitor in Bloomberg.  In late 2011, Bloomberg acquired BNA.  While it will take time for Bloomberg to build market position, this should notably provide an increased level of competition and pressure margins.

As further background, below is a summary of TRI’s business 

    2010 2011 2012 2013E
Revenue Composition (ex   Media)          
Financial & Risk   59% 59% 57% 56%
Legal   26% 26% 26% 26%
Tax & Accounting   8% 8% 10% 10%
Intellectual Property & Science   7% 7% 7% 7%
           
Segment EBITDA Composition          
Financial & Risk   51% 52% 49% 47%
Legal   33% 32% 33% 33%
Tax & Accounting   8% 9% 10% 11%
Intellectual Property &   Science   8% 8% 8% 9%

 

 

The main aspects of my thesis are:

1.    Management has had significant difficulty in forecasting financial service ‘net sales’ which generally represents a 12 to 18 month lead before being reflected in revenue.  At the end of 2012, management was still relatively vague on why they think net sales will improve later in 2013 after coming off vague 2011 commentary which seemed to indicate an expectation of positive ‘net sales’ by YE (see below)

a.     2012 Q4 Call: “Turning to net sales, I think it's now safe to say that the fourth quarter of 2011 marked the trough in our net sales performance. And while 2012 was far more difficult than we anticipated, net sales did show improving momentum throughout the year. This year, we expect net sales to continue this gradual improvement and turn positive in the second half, given the roll-out of Eikon and Elektron.”

b.    2011 Q4 Call: “And as Jim mentioned, net sales were clearly negative in the second half of last year, and that obviously creates a negative momentum for revenues as we enter 2012. I think what's going to be quite important is to look at the momentum and the trend of net sales over the course of 2012, and what will be critically important not so much what the overall average level of net sales will be in the year, but more what the run rate is as we exit the year. Because that's what's going to be critical as we enter in 2013. And what we are expecting is a gradual improvement in net sales over the course of the year.”

 

2.    The business is very opaque.  Specifically:

a.     Management’s  reliance on a ‘net sales’ metric where they will only provide a broad direction leaves significant room for interpretation

b.    Even on a call with IR, I was unable to get a hard number of platforms which remain operating.  Instead I got the answer – “a lot.”  Thus it seems the complexity of the business is not just an outsider view.

c.     Last year TRI re-constructed their segment reporting which appears to have inflated segment margins for both Legal and Financial and improved the margin trend for Legal.  

New Margin Less Old Segment Margin (As   Reported) 2010 2011   Chg from '10 to '11  
Legal       1.1% 1.7%   0.6%  
Markets / Financial &   Risk       0.7% 0.4%   -0.3%  
Tax       0.8% 0.4%   -0.4%  
Intellectual   Property & Science     0.0% 0.0%   0.0%  

 

 

3.    I suspect partially due to the large number of running legacy platforms and partially due to the business model, TRI has very high incremental/decremental margins.

      2011 2012 2013E
Incremental Operating   Margins     28% -87% 70%
Financial & Risk     32% 174% 43%
Legal     25% 35% 211%
Tax & Accounting     24% 15% 28%
Intellectual Property &   Science     44% -5% 12%
           
Incremental Margins (Op Lev)     1.4x -4.7x 4.0x
Financial & Risk     1.7x 10.3x 2.8x
Legal     0.9x 1.2x 7.7x
Tax & Accounting     1.1x 0.7x 1.3x
Intellectual Property &   Science     1.6x -0.2x 0.4x

 

4.    Growth has been buoyed by acquisitions and real organic growth has been weak with Financial & Risk and Legal reporting the lowest organic growth rates in several years.

Organic   Growth FY10A Q111A Q211A Q311A Q411A FY11A Q112A Q212A Q312A Q412A FY12A Q113A
Total -1% 2% 2% 2% 2% 2% 0.7% 0.7% -1% 0%    
Financial & Risk -2% 1% 0% 0% 1% 1% -1.2% -0.8% -2% -1% -1% -3.0%
Trading -3% 0% -1% 0% -1% -1% -2.0% -2.0% -4% -3%   -6.0%
Investors -5% -1% -2% -3% -3% -2% -3.0% -1.0% -1% -1%   -1.0%
Marketplaces 7% 10% 10% 8% 10% 10% 4.0% 1.0% -2% 0%   -2.0%
GRC             16.0% 18.0% 17% 0.18   6.0%
                         
Legal 0% 4% 3% 2% 1% 3% 2.0% 2.0% 1% 1% 1% 0.0%
Tax & Accounting 3% 3% 7% 6% 6% 6% 9.0% 5.0% 3% 1% 5% 5.0%
IP and Science 4% 5% 2% 8% 6% 5% 3.0% 4.0% 0% 3% 3% 4.0%

 

 

Over the last several months, I believe the dividend yield has attracted investors causing the recent out performance.  It is my understanding that it was added to a conviction buy list for this reason on a private wealth platform or two.  I believe management will continue to disappoint on the top line and margins and have 2013 EPS at 1.62 vs. consensus at 1.83.  Further, I believe that an opaque shrinking business does not deserve to trade at a premium to the market.  Therefore, by my math I believe there is about 35% downside in the name at a 14x fwd multiple vs a fwd mkt multiple of 15x.  This does create a high dividend yield which should lend some support to the name.  Over the medium term, I believe there will be pressure to their acquisition strategy as my numbers leave approximately $500mm of cash flow left after dividends vs. 2.4bn spent in the last 3 years. 

    2013E Implied multiple
  Consensus 1.83 19.0x
  My View 1.61 21.5x
       
  Reasonable Multiple 14.0x  
  New Share Px 22.54  
  Implied Downside -35.0%  
  Implied Dividend Yield 5.8%  

 

 

Risks:

1.     Woodbridge actively starts selling of more assets to distribute more cash flow (ultimately, I believe they will not be able to sell most assets at multiples higher than they paid).

2.    Dividend yield lends significant support to the equity

3.    TRI uses increased leverage to re-capitalize the company and distribute cash

4.    Regulation pressures Bloomberg to make IB compatible with other types of terminals; thus, weakening Bloomberg’s competitive moat

5.    Revenue and earnings weakness are not drastic enough to cause meaningful risk to dividend or necessary acquisitions

 

 *Please note that non-core asset sales are reflected in the capital structure but 2012 is not pro forma for those sales

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Continued revenue and free cash flow deterioration and discussion about weaker net sales/organic revenue growth
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