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Broadridge Financial Solutions - Great Company, But Is It Cheap Enough?

Broadridge Financial Solutions (BR) is a provider of services to the financial industry, particularly broker-dealers, mutual fund management firms, and publicly reporting companies. The firm has two business units. The first is Investor Communication Services (ICS), by far the larger at 71% of revenues and 73% of earnings. ICS deals largely with the processing and distribution of proxy materials, from paper or electronic delivery to tabulating votes on shareholder actions. This is not the only service though, with other offerings including distributing regulatory reports, corporate event notices, marketing communications, fund prospectuses, account statements, trade confirmations, and so forth.

The second unit is Securities Processing Solutions, or SPS, which was 29% of sales and 27% of earnings in fiscal 2012. SPS consists of an outsourced set of services for trade order execution, confirmation and accounting, as well as tools for aggregating and reporting portfolio data and performance. Using Broadridge allows brokers to avoid building out costly and troublesome infrastructure to support the basic back-end processes of electronic trading.

If I had to pick one word to describe Broadridge, it would be "stable". The company has some very strong competitive advantages. ICS handles proxies for 85% of the outstanding shares in the U.S., and 60% globally, dwarfing any competitors. SPS offerings are involved in $4.5 trillion in trades per *day*! The vast majority of revenues are recurring in nature, and Broadridge sports a nifty 99% client retention ratio. While event-driven communications and trading volumes affect revenues year-to-year, Broadridge rarely sees more than mid-single digit percentage fluctuations in sales. Stability, again, is the word here.

Growth, on the other hand, is more difficult. The securities and brokerage industries are quite mature in the U.S., and with increasing consolidation, there is little in the way of organic growth opportunity for Broadridge. The company has responded by looking for "tuck-in" acquisitions, such as Paladyne and Matrix to build out SPS offerings in 2011. However, Broadridge is not an aggressive acquirer, and as such I don't expect a lot of revenue growth here, perhaps in the 5-7% range annually moving forward.

As a slow growing, cash producing, competitively advantaged company should do, Broadridge rewards its shareholders mainly by returning cash. The firm has reduced shares by a 3.4% annual rate over the past few years, and pays a 3.1% dividend that is well-covered and easily raised, at just a 26% payout of free cash flow. In fact, the company has tripled its dividend since going public in 2007, raising it each year along the way. I expect both share buybacks and dividend hikes to continue.

Broadridge is no doubt a solid company, but as an investment opportunity it comes down to the price. And here is where I feel the investment case comes up short. At just an 8% EBIT/EV earnings yield, Broadridge is not especially cheap. Even assuming Broadridge returns to 13-15% margins after posting a 12% figure last year (largely on short-term transitional issues related to Penson's bankruptcy), the stock isn't that cheap against its historical 9.5% yield average. Even a discounted free cash flow calculation, assuming about 5% long-term growth, gives me a price of about $25. With the stock in the mid-$23 range, that's not enough margin of safety. I'd get interested if Broadridge got under $20. But for now we'll just throw out the "neutral" opinion - it looks about fairly valued. We're looking for better opportunities.

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