Valuation Is Finally Reasonable At FactSet, But Growth Is Now A Concern

By Stephen D. Simpson, CFA | June 18, 2013 AAA

For much of its history as a public company, FactSet (NYSE:FDS) shares have frustrated the value and GARP crowds. Now the shares look more reasonably valued, but the cause is yet another reason for concern. With sluggish employment trends in the financial sector and worries about competition from the likes of BloombergMcGraw Hill Financial's (NYSE:MHFI) S&P Capital IQ, now growth appears to be an issue for the company. While the company is likely to do better over the long term, investors considering these shares today need to be prepared for a little more volatility than with the average equity.Fiscal Third Quarter Results Look Pretty OrdinaryAlthough FactSet didn't miss this time out, there weren't any particular signs of re-acceleration in the business, and management confirmed that market conditions remain pretty challenging.Revenue rose about 6% as reported, or close to 5% on an organic basis. While the user count was basically flat on a sequential basis, the annual subscription value (ASV) increased almost 7% from the year-ago level, while remaining flat on a sequential basis. Even with the revenue growth, FactSet is finding it difficult to grow its margins. Gross margin fell almost two points form the year-ago and about 20bp sequentially. Operating income was up about 5% from last year (and down slightly on a sequential basis), with operating margin down relative to both periods.SEE: Analyzing Operating MarginsCompetition Isn't Getting Any EasierAlthough providing data and analytics services to the financial industry is a pretty lucrative proposition (the company's operating margin is above 33%, as is the trailing return on capital), it's an intensely competitive business. To that end, neither Bloomberg nor S&P Capital IQ are easing off their efforts to build their businesses. Bloomberg in particular seems focused on adding functionality and growing the data sets available in its fixed income platform. While Bloomberg is more expensive than FactSet in this market, the greater functionality of Bloomberg makes it more challenging for FactSet to get users to switch.Thomson Reuters (NYSE: TRI) is another interesting case from a competitive standpoint. Although FactSet has been doing pretty well against TRI on balance, the introduction of the new Eikon platform for investment management could generate some interest. Likewise, I continue to believe that Morningstar (Nasdaq: MORN) may be an underrated emerging competitor in the field; it's history is much more retail-oriented, but it looks like the company is bulking up its professional offerings and increasingly targeting the professional market(s).FactSet Needs Better Sector Employment, And That's Not Coming SoonCompetitive share gain clearly matters in this industry, but so too does the absolute level of hiring and employment in the financial services industry. Unfortunately, I see little reason to expect a big near-term improvement. Almost every bank with a trading, investment banking, or asset management operation, ranging from Bank of America (NYSE:BAC) to U.S. Bancorp (NYSE:USB) is talking about trying to reduce labor costs and staffing levels.Moreover, it's not as though the buy-side is able to gobble up all of this newly surplus workers. While it's too simplistic to say that near-record levels for the stock market and strong trading activity ought to be good for the banks, the reality is that it's not stimulating any particular hiring wave in the sector.The Bottom LineFactSet has generally been overvalued for so long that it's tempting to pounce on the shares now that they're more reasonably valued. Still, I suspect that the markets are going to react pretty dramatically to the quarterly updates regarding subscriber numbers, ASVs, and so on – meaning that these shares could bounce around quite a bit around quarterly earnings. Across the longer term, though, I do believe this company can grow revenue at roughly 8% rate, with broadly similar growth in free cash flow.That level of growth suggests a fair value for FactSet shares of about $98.50. More or less in line with the current price, FactSet doesn't seem like much of a bargain apart from the fact it has often historically traded at an even higher premium. A decent enough stock for the long haul, I can't really summon up much enthusiasm for the shares as a buy or sell at today's price. 

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