Interactive Data Corp
Latest Research Note
Today IDC announced that it has agreed to be acquired by private equity funds Silver Lake and Warburg Pincus for a total value of $3.4 billion dollars. Current shareholders will receive $33.86 in cash for each share owned, and the deal is expected to close by the end of IDC's third quarter, which would be sometime in September. The price is a 33% premium to IDC's trading price before it was first announced that the company was putting itself up for sale, and over 40% premium to the trading price before the rumors started.
Currently, IDC's stock price is around $33.20, just 2% below the deal price. Considering this, and the fact that the cash distribution probably won't go through for several months, MagicDiligence is selling the IDC position at the close of the market today, and recommends anyone holding the stock do the same. The price is a fair valuation, and since this process seems to be well considered, it looks unlikely that somebody else will come along and bid higher. Meanwhile, we can take the 51% gain in 9 months (beating the market by 32%) and put it into other MFI stocks with more upside potential in the near term.
Interactive Data Corporation (IDC) is a financial data and information provider. The company has 4 business lines grouped into 2 major categories. The Institutional Services category contributes 88% of revenue and consists of 3 businesses. Interactive Data Processing and Reference (63% of total sales) provides information such as quotes, dividends, credit ratings, and background information. Interactive Data Real-Time Services (20%) provides service for real-time quote applications. Interactive Data Fixed-Income Analytics (4%) sells data and analysis tools for researching bonds and other fixed income instruments. The second category is Active Trader Services and consists solely of the eSignal business (12% of sales). eSignal is geared towards technical analysis tools for individual investors. IDC earns most of its revenues through subscriptions to its services, and also makes a small amount on website advertising. 70% of sales come from the U.S., about 27% from Europe, and the rest from Asia. IDC's data is delivered through software application programming interfaces (APIs) which can be integrated into custom applications like websites and computer programs.
IDC has several avenues for growth. The first is through developing new products and then cross-selling them to existing customers. The company has been focusing on products to assess risk, a particular concern after the 2008-09 market meltdown. International expansion is another focus, as over 70% of sales are inside the U.S. IDC has utilized acquisition to acheive this, purchasing a a controlling interest in Japanese financial data provider NTT Data Financial (NDF) and Italian data firm Klers in 2008. IDC also benefits from the development of new financial products, and recently won contracts to service real-time data for Wilshire indexes and ETF.com. More generally, financial tools and websites continue to proliferate, creating a growing market for IDC's services. A recently expanded data center is expected to reduce costs while doubling IT capacity.
IDC competes with several well-known data providers in its main businesses. In Pricing/Reference and Real-Time services, the primary competitor is Thomson-Reuters (TRI), and in Fixed-Income Analytics, FactSet Research (FDS) provides similar products. eSignal's only major direct competitor is TradeStation (TRAD), although IDC is significantly larger and eSignal is generally recognized as a best-in-class product. IDC's scale (the firm is smaller than Thomson but much larger than FactSet or TradeStation) allows it to under-price smaller competitors if the need arises. The company has a wide and varied customer base, serving over 4,000 institutional customers. Switching costs seem to be relatively high, as the firm enjoys a 95% renewal rate on its subscription businesses. Once IDC's APIs are implemented, switching them out for a competitor's is time consuming and error prone, and only undertaken if the benefits are great.
The financial services industry has been in upheaval since late in 2008, with many large banks and brokerage firms consolidating or going under entirely. This leads to lower overall customer count, lower subscription volumes (what was previously 2 subscriptions becomes 1), and less pricing power as larger customers can exert influence over pricing. IDC has a history of overpaying for acquisitions, as nominal ROIC 5-year average is a pedestrian 13% and the majority of assets are in goodwill accounts. These large goodwill accounts are subject to impairment charges which can greatly affect the bottom line in any given quarter. Negative currency effects have been a thorn for the past year or so, as 30% of revenues are repatriated from offshore, although this can work in the opposite direction as well. Pearson, a large international media company, owns a majority 62% stake of IDC's shares and can obviously have significant influence over business decisions and direction.
Raymond D'Arcy recently succeeded Stuart Clark as IDC's President and CEO, as part of the formal succession plan the firm has adopted. He is a company insider, having served in a variety of marketing and product management roles at IDC during his 30-year career there. Executive compensations are reasonable, with the majority coming in restricted stock and option awards, aligning the long-term interests of management with shareholders. Insider ownership is low at under 3%. IDC instituted a dividend 4 years ago and has consistently raised the payout each year, including a large "special" one-time dividend in 2008. Share repurchases have limited share dilution to low rates. Overall, stewardship has been fairly good, although a history of overpaying for acquisitions is concerning.
IDC is in good financial health. The company has no debt and cash reserves of about $270 million. Returns on capital, including the effects of goodwill, have been just okay at about 13% over the past 5 years, but on a Magic Formula basis (subtracting out goodwill and intangibles) they come in at near 197%! Regardless, the business model is highly profitable, with operating margins averaging 26%, and also a strong cash generator with free cash flow margins averaging over 18%.
IDC has a nice business model that is highly profitable and relatively non-capital intensive. The main capital investment is in computing equipment for storage, which can be leveraged across IDC's wide customer base. Also, revenues are recurring with a 95% renewal rate, and IDC has the ability to grow by cross-selling new or existing products to current customers, which saves significant resources on new customer acquisition through marketing. While the turmoil in financial markets is a concern, the firm is still expecting single-digit revenue growth for 2009, and long term analysts forecast a 10% annual profit growth. This kind of growth potential, combined with a highly profitable, cash generating business model; scale and lock-in competitive advantages; and a 3.6% dividend yield make this a very attractive MFI stock worthy of a Top Buy recommendation.
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Steve owns IDC.
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