Euromoney Institutional Investor: Spewing Cash

Posted on 28/02/2011

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Euromoney Institutional Investor (ERM LN) is a business-to-business media group. From the company’s 2010 annual report, it describes itself as: “focused primarily on the international finance, metals and commodities sectors. It publishes more than 70 magazines, newsletters and journals, including Euromoney, Institutional Investor and Metal Bulletin. It also runs an extensive portfolio of conferences, seminars and training courses and is a leading provider of electronic information and data covering international finance, metals and commodities, and emerging markets.” The business is well-diversified by product/service type, geography and by nature of revenue. In 2010 databases and information services generated 27% of revenues, financial publishing 23% of revenues, conferences 23%, business publishing 18% and training courses 9%. By nature of revenue, 46% comes from subscriptions (which I view as high quality, particularly given that such subscriptions typically form a tiny proportion of their clients’ cost bases), 21% from conferences and training course delegates, 17% from advertising and 13% event sponsorship. Clearly, these revenue types are much lower quality given the ability of clients to cut back spending at short notice if they need to reduce costs. 43% of revenues are sourced from the UK, 45% from the US and 14% from the rest of the world (the remaining -2% being intercompany eliminations). While the UK and US dominate, I would argue that the performance of the global economy and international financial markets are more important determinants of ERM’s revenue than is growth in the local economies in question.

ERM’s directors have described the company’s strategy as follows:

  • Driving top-line revenue growth from both new and existing products;
  • Building robust subscription and repeat revenues and reducing the dependence on advertising;
  • Improving operating margins through revenue growth and tight cost control;
  • Investing from profits in new businesses, technology and the online migration of its publishing activities;
  • Leveraging technology to launch specialised new electronic information services;
  • Making acquisitions that supplement the group’s existing businesses, strengthen the company’s market position in key areas and have the capacity for organic growth using the existing knowledge base of the group; and
  • Keeping its debt within a net debt to EBITDA limit of three times.

Looking at the business within the Porter’s five forces framework, the following factors appear to me to be relevant to ERM:

  • Access to distribution channels. ERM sells its products and services to a huge number of different clients. In order to capture market share, any potential new entrant has to convince a large number of subscribers to switch to a new and untested product/service in order to then capture any advertisers and sponsors. This therefore acts as a significant barrier to entry.
  • Differentiated products. ERM publishes leading financial titles such as Euromoney, Euroweek, Metal Bulletin, Institutional Investor and Eurohedge, which are important reading for executives within particular sectors of the financial services industry.
  • Customer switching costs exist. With regard to databases and publications, clients typically purchase twelve month contracts, meaning that any client wishing to switch to another service has to either wait until the contract expires or pay-up for the remainder of the term. With regard to databases and training courses, then these are often integrated into the clients own IT systems (for databases) or employee training programmes (for training courses). To make changes to such arrangements can often involve an upfront expense.
  • ERM’s product and services saves/makes its clients money. By providing business and market intelligence in its publications, improving the skills of its clients staff with its training courses, providing networking and marketing opportunities at its conferences, delivering important market data via their databases, and providing high-earning “eyeballs” for its advertisers and sponsors. By adding-valuing for clients in so many ways, customers are loathe to cut-back on their spending in any significant manner or length of time.
  • Low exit barriers. Publications and services which do not make money can be sold to larger players in the industry who can often make them profitable by extracting both revenue and cost synergies. Such an easy exit prevents uncompetitive participants from forcing-down prices within the market (as can happen when exit barriers are high).

In summary, I view ERM’s competitive position as strong, although I would note that the transition of publishing activities to the internet does create opportunities for potential new entrants given the lower barriers that exist in this publishing arena. Consequently, there is some risk that ERM’s competitive position could deteriorate. However, I would expect ERM to attempt to purchase new entrants before they begin to threaten the business.

The company is highly cash generative. Between FY06 and FY10 ERM has generated operating free cash flow (defined as cash from operations – capex) totalling £329m, which compares to the company’s current market capitalisation of £829.1m. This cash flow has been used to make acquisitions (£223m) and to pay dividends (£71m), as can be seen in the chart below.

Over the five year period, ERM has taken on additional indebtedness of £36m, though in recent years it has concentrated on paying-down the debt taken-on as part of the Metal Bulletin plc acquisition in FY07. Given that net debt is now well below the 3x EBITDA limit set-down as part of the company’s strategy, I would not be surprised if the company was to releverage the balance sheet in order to make another significant acquisition. Unless it does this, ERM is going to find itself with a large amount of cash building-up on the balance sheet, with the most likely alternative use being higher dividends.

Given the lack of capex requirements in the business is unlikely to change (publishing, events and databases are unlikely to ever need large capex outlays) and customers are generally willing to pay upfront given the tiny proportion of their costs which are used for such products and services, I believe the business is likely to continue generating a large amount of free cash flow.   This thesis is supported by the fact ERM still managed to generate £62m of cash in the year-ending Sept-09 during the financial crisis.  FY10 operating free cash flow of is equivalent to a free cash flow yield of 10.6% on the current market capitalisation. Other financial criteria are strong too. Margins are high at 70% gross, 17.5% operating and 11% net, each data-point being a five-year average. Return on equity is very high at an average of 38% over the last four years (adjusting for goodwill impairment in FY09; and a four year average is used as book equity was negative in FY06).

The current degree of financial leverage on the ERM balance sheet is relatively low, with net debt (as at 30th Sept 2010) of £130m compared to LTM EBITDA of £100m and operating free cash flow of £87m, giving ratios of 1.3x and 1.5x respectively. As a proportion of the enterprise value, net debt contributes 14%, while equity contributes 86%. I would argue that such leverage ratios are relatively low.

The group’s current trading is strong, having reported 18% constant currency revenue growth for 1Q11 within the Interim Management Statement released on 20th January. Management do however, note that they expect that growth will be slower later in the year and that rising costs will impact the business: “The board expects this revenue growth to be offset by a number of factors in the first half: lower margins from the group’s investment strategy; the absence of one-off cost savings of £2million in 2010; and an increase of approximately £4 million in long-term incentive expense relating to the acceleration of the cost of the group’s Capital Appreciation Plan.”

ERM is 66% owned by Daily Mail and General Trust Group, a parent company which may in the future wish to take its ownership to 100%. However, their 66% stake prevents any other acquirers from competing, while regardless of the “independence” of the non-executive directors, I am sceptical as to how resistant they will be to their ultimate employer, potentially leading to a takeover taking place at a price which minority shareholders find unattractive.

In summary, I view Euromoney Institutional Investor as a well-diversified business with interests in a large number of leading publications and services. Fixed asset and working capital requirements are negligible, allowing the company to generate a large amount of cash flow, which I would expect to continue to be used for dividends and acquisitions. The market for ERM’s services grows over time as businesses seek to expand by increasing their own market knowledge and that of their staff. Competition is present, but a number of factors are at work which somewhat insulate ERM from the full force of the free market. The price of the business is cheap as well, with the key price/cash-flow ratio modest at only 9.5x.  My key concerns about the business are: (1) how the transition to the internet impacts the publsihing division; (2) the volatility of the share price given the large component of advertising/sponsorship revenues; and (3) the blocking stake held by DMGT plc which prevents shareholders from benefiting from a takeoever battle.

Note: I do not at present own shares in Euromoney Institutional Investor, though as can be deduced from the article, this is under serious consideration. You thoughts and comments are much appreciated.

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Posted in: Investment Ideas