Individual investors may hear the occasionally quip about "paralysis by analysis," but the fact remains that institutional investors (on the whole) love their data. Feeding this endless appetite has been a boon for companies like IBM (NYSE:IBM), EMC (NYSE:EMC) and Bloomberg, as well as smaller players like FactSet (NYSE:FDS), and it does not look like the data deluge is in any danger of drying up soon.
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A Solid End to the Fiscal Year, or Is It?
FactSet closed out its fiscal year with a solid financial report relative to Wall Street expectations, but careful examination is a little more concerning. Revenue rose 14% this quarter, with 15% growth in the U.S. helping to offset 12% growth in foreign revenue. While FactSet did do a solid job of adding new clients (and getting more paying seats at existing clients), the company is not doing quite as well in terms of wringing more revenue out of each client - client count increased 6% this quarter versus last year, while the number of users increased 12%. In terms of revenue per customer, then, the company saw very modest growth of just 1.5% (to about $3,990 per customer) while revenue per client rose a bit less than 8% to just under $86,000.
Profitability is also somewhat disappointing. The company's cost of services rose 22% this quarter, and reported GAAP operating income was up just 3%. Reported operating income was hurt by higher stock-based compensation expenses, but the adjusted non-GAAP growth rate of 12% still represents some margin erosion. (For related reading on operating income, see Understanding The Income Statement.)
Still Plenty of Growth to Come
FactSet does report a useful forward-looking number called annual subscription value (ASV). This figure was up 14% for the fourth quarter, with about $779 million in revenue in the pipeline. Relative to the Street's prior estimate for fiscal 2012 of $822 million, then, quite a lot is already in the bag so to speak. Not surprisingly, buy-side clients (that is, asset-managers like T. Rowe Price (Nasdaq:TROW), Fidelity, hedge funds and so on) continue to make up over 80% of the forward revenue base.
Downturns and Regulation Don't Change Fundamentals
There has been no shortage of volatility in the equity, credit and commodity markets this year, but volatility often means an even bigger appetite for risk. Moreover, while the U.S. government has tried to implement regulations to curb some of the activities of financial enterprises like Goldman Sachs (NYSE:GS), Citigroup (NYSE:C) and Bank of America (NYSE:BAC), the fact remains that so long as there are large pools of money seeking active management, there will be managers to provide it and they will want data.
How Best to Compete in the Future?
FactSet operates in a very difficult market. News Corp (NYSE:NWS), Bloomberg, McGraw-Hill's (NYSE:MHP) Standard & Poors and Thomson Reuters (NYSE:TRI) have advantages of size and scale that are not inconsiderable. There are also more specialized players like RiskMetrics (acquired by MSCI (Nasdaq:MSCI) about a year ago) and Dealogic that fight hard to defend their respective niches. While it may be true that large asset managers are not going to risk losing alpha to save a few basis points of expenses, there is only so much money to go around and clients will flock to those who provide the most impactful data at the lowest cost.
I wonder whether FactSet can, or should, do more to source ("create," if you will) its own data. FactSet has done well in aggregating data from 3rd-party vendors, but does leave it vulnerable as a middleman and the company must often negotiate to acquire data from those it would compete with in the market. With nearly $200 million in cash on the books, perhaps it's at least worth considering if the company should invest some of that in developing more proprietary (and presumably, more profitable) data sources.
The Bottom Line
Barring a full-scale abandonment of the financial markets, it is hard to see FactSet running out of profitable business opportunities. Moreover, even as American retirees begin to withdraw and consume their savings, the rise of middle and upper class investors elsewhere in the world should be a net positive for the global financial services industry.
FactSet is not cheap today, but it seldom has ever been. Prospective investors may wish to wait for another (and seemingly inevitable) market washout before buying in, but existing shareholders may want to just sit tight and continue to reap the benefits of cash-rich growth. (For related reading on cash rich companies, see The Essentials Of Corporate Cash Flow.)
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