It has been a few years now since I've had a regular Wall Street desk job, but I still miss having FactSet's (NYSE:FDS) databases and analytic tools close-at-hand. Not only does this financial information company offer a very sticky product, but the company also continues to add functionality and breadth to its platform. Unfortunately, the Street has long had a love affair with the stock as well, and I am worried that the process of transitioning from growth stock multiples to those of a more mature company could be a tough one for shareholders.
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Fiscal Fourth Quarter Shows Some Deceleration
FactSet didn't report a bad fiscal fourth quarter, but it seems apparent that there is some deceleration in the business.
Revenue rose about 8% this quarter, with U.S. revenue growth of 7% and non-U.S. growth of 10%. Client count increased nearly 7%, but user count growth lagged behind this number significantly, rising just 3%. Annual subscription value rose about 8% as reported, but was closer to 7% when excluding the impact of the StreetAccount acquisition.
Gross margin weakened some (down about 70 basis points from last year), but operating income jumped nearly 20% on a better than three-point operating margin expansion, as SG&A expenses declined slightly.
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Wall Street Still Isn't Back to Normal
Even though most of the financial markets in the U.S. have been looking pretty healthy lately, the same is not really true of Wall Street. As the discrepancies between client count and user count might suggest, hiring and employment levels aren't back to normal, with headcounts at leading firms such as Goldman Sachs (NYSE:GS), Barclays (NYSE:BCS) and Deutsche Bank (NSYE:DB) still below prior levels. So while FactSet continues to do well from a client retention perspective, there's not really anything that the company can do about the employment conditions on the Street.
Quality Vs. Opportunity
Because there's little FactSet can do to improve the underlying potential demand, the company has to continue to focus on making its products must-have essential tools and not a "nice-to-have" perks. To that end, the company continues to invest resources in improving functionality, producing proprietary databases and expanding its position in areas such as fixed income and portfolio analysis.
Certainly the competition is not standing still either. Thomson Reuters (NYSE:TRI), Bloomberg, Moody's (NYSE:MCO), Morningstar (Nasdaq:MORN) and News Corp (Nasdaq:NWS) have all been investing in their own platforms, looking to add functionality and build loyalty. The good news is that FactSet's success to date has made it harder to displace, but just as FactSet exploited gaps in what Bloomberg and Thomson Reuters offered, the company cannot afford to stop investing and improving its product.
The Bottom Line
I have no qualms with the quality of FactSet as a company. What worries me today, however, is that investor expectations are too high. There's no such thing as an infinite addressable market, and I think investors have to transition their expectations from FactSet being a consistent double-digit grower that deserves a rich growth-based multiple. Certainly there's still room for Wall Street hiring to rebound and the company can continue to expand beyond its core buy-side equity strengths, but I've seen too many stocks of high-quality companies languish during these transitions to be blase about it.
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Even if FactSet can deliver another decade of double-digit annual free cash flow growth, the stock just isn't cheap enough today. While I'd love to reconsider these shares on a significant pullback, I think a reset of growth expectations (and the appropriate multiples for that growth) could lead this stock to underperform despite ongoing high-quality financial results.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.