My Equity Investing Philosophy: Application to the Nielsen N.V. IPO

Posted on 15/01/2011


Nielsen Company

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Nielsen NV is currently planning to float on the New York Stock Exchange in an initial public offering.  They describe themselves as:

“A leading global information and measurement company that provides clients with a comprehensiveunderstanding of consumers and consumer behaviour. We deliver critical media and marketing information, analytics and industry expertise about what consumers watch (consumer interaction with television, online and mobile) and what consumers buy on a global and local basis. Our information, insights and solutions help our clients maintain and strengthen their market positions and identify opportunities for profitable growth. We have apresence in approximately 100 countries, including many developing and emerging markets, and hold leading market positions in many of our services and geographies. Based on the strength of the Nielsen brand, our scale and the breadth and depth of our solutions, we believe we are the global leader in measuring and analysing consumer behavior in the segments in which we operate.”

The business is split into three segments: Watch (media audience measurement and analytics, 45% of YTD10 operating income), Buy (consumer purchasing measurement and analytics, 55% of YTD10 operating income) and Expositions (business-to-business trade shows, 10% of YTD10 operating income).  Note that -10% of operating income relates to unallocated central costs.

Nielsen was acquired by a consortium of private equity groups (including AlpInvest Partners, The Blackstone Group, The Carlyle Group, Hellman & Friedman, Kohlberg Kravis Roberts & Co. and Thomas H. Lee Partners) in May 2006, and now the company is seeking to IPO on the New York Stock Exchange (see the preliminary prospectus here), targeting an equity capital raise of $1.43-1.57bn (plus a mandatory convertible bond offering of $250m) in order to pay-down $1.56bn of (mainly) junior debt and return $103m to the existing shareholders, with the private equity consortium reducing their stake from 98% to 78%.  Such an offering will give Nielsen NV a market capitalisation of $6.95bn (at the low-end of the price range) to $7.88bn (at the upper-end of the range with the over-allotment option).  Upon completion of the transaction, the company expects to have $7.5bn of debt, giving an enterprise value range of $14.45-15.38bn.  EBITDA for the purpose of calculating the banking covenants in the 12 months ending 3Q10 was $1.4bn, so this would place a valuation on the business of 10-10.6x EBITDA.  After FY11e interest costs, FY09 capital expenditure and FY09 taxes (but before debt principal repayments), we can expect cash flow generation of $564m.

I will now consider Nielsen NV against each of the criteria I discussed in the recent post, My Equity Investing Philosophy.

  1. Does it generate high levels of cash flow? Yes. Relative to its expected market capitalisation of $6.95-7.88bn, I estimate that Nielsen should be able to generate recurring free cash flow to equity of $564m, giving a free cash flow yield to equity of 7.2-8.1%. Free cash flow generation for the business is so strong because capital expenditure and working capital requirements for are very low.
  2. Are the financial statements understandable? I certainly wouldn’t describe Nielsen’s IPO prospectus/financial statements as the most straightforward I have ever read-through, but in reading them I haven’t seen anything sufficiently worrying to prevent an investment.
  3. Are revenues growing? Yes. The company has increased revenues at a compound annual growth rate of 3.9% from FY07-09, a period of recession for many other sectors of the economy, while in YTD10 year-on-year revenue growth is 7%.  Given the semi-monopolistic nature of Nielsen as a company and the structural growth of advertising, marketing and market research at a rate above the level of GDP growth, I believe that we can expect Nielsen to continue reporting revenue growth for a number of years to come.
  4. Is indebtedness low? Not exactly. Upon completion of the IPO transaction, net debt/EBITDA is expected to be 5.1x, a level that many investors would consider too high.  However, I would note the low capex and working capital requirements, the diversity of the revenue base (in terms of geography, service and more than 20,000 individual customers) and the likely path of deleveraging over the next few years means that investors should be relatively comfortable with Nielsen’s debt load.  In the next two years, assuming no EBITDA growth, Nielsen should generate $1.1bn of free cash flow.  Assuming this is all used to reduce net debt, then net leverage will decline from 5.1x to 4.3x.  Assuming EBITDA growth of 5% per annum over the same period (entirely reasonable given the recent history of the business, 10.2% per annum for FY07-09 and 8.4% in YTD10), then net leverage would reduce to around 3.9x.  This should make a full debt refinancing or principal extension a mere formality by the time that the $3.8bn of bank debt principal matures in May 2013.
  5. Does the business have a sustainable competitive advantage? Nielsen’s business model is to provide companies with data and analytics on consumer habits with respect to their purchases, what they watch, read and download. Nielsen does this via a vast network of IT systems and employees the world-over.  Such a network is incredibly difficult for any potential new entrants to replicate, as it requires massive investments in IT systems and operating losses before the business is able to attract any clients.  Attracting clients is difficult too, as the diversity of Nielsen’s customer base means that any potential entrant has to encourage a vast number of clients to switch in order to provide the start-up with a sufficient amount of business.  In summary, Nielsen is the beneficiary of hugely powerful network effects.  The value of a network increases exponentially as new members join. Consequently, as Nielsen signs-up more customers and monitors additional data-points, the value of Nielsen’s business not only increases, but also increases the barriers to entry facing any potential new entrants to the market.  This is not to say that Nielsen has no competitors – indeed there are a large number of companies that provide similar services to Nielsen – only that Nielsen is usually the market leader in the segments in which it operates, often facing only one or two competitors of any strength.

In summary, based on the criteria discussed above, Nielsen NV appears to be attractive investment opportunity.

Posted in: Investment Ideas