Wednesday, 22 August 2012

Experian (EXPN) ... a lot of acquisitions, capex and director selling ...

I have a short position in Experian. I have shorted the shares for the following reasons:
  1. Despite having spent $4.5bn on acquisitions since 2006, I reckon its organic and acquisitive revenue growth for the past six years appears somewhat lacklustre.
  2. Margins have improved dramatically, but the group’s capex as a percentage of sales has also risen sharply and has significantly diverged from the rate of its competitor, Equifax.
  3. Experian has spent a considerable amount on acquisitions since 2006. As far as I can infer, they have been very expensive.
  4. I consider its balance sheet to be weak. Ex-goodwill and intangibles the business has net liabilities of $2.8bn. 
  5. The shares appear expensive and consensus has significantly downgraded its future EPS estimate over recent months.
  6. Management have bought £200k of stock during the past two years as compared to £42m of sales.

What does Experian do?

Experian is a credit and marketing services company. The company retains databases on persons and businesses to provide credit scoring/checking and monitoring to then sell to businesses and consumers.

Revenue and margins

Experian’s revenue increased from $3,064m to $4,487m during the period 2006-12; representing a CAGR in revenue of 6.6%. However, during this period the group has also spent c. $4.5bn on acquisitions. Experian’s accounts suggest that at the point of acquisition, the bought businesses were generating a combined c. $1.4bn in full year revenue. Certain parts of the business were also disposed of during this period, totalling c. $1.5bn, and c. $695m of associated revenue looks to have been lost through these disposals. I reckon that means about $720m of revenue has been gained from net acquisitions since 2006, or roughly half of the group’s total revenue gain. Given that the total CAGR in revenue was 6.6%, and net acquisitions have contributed half to the revenue gain, it doesn’t seem like the core business has been growing that strongly; maybe keeping pace with inflation. 




What has increased strongly over recent years is the group’s EBITDA margin. My estimate is that the group’s EBITDA margin has risen from 26.7% in 2009, to 33.1% in 2012. I would add that I have ignored the adjustments the group makes under its so-called “Benchmark” approach. Management’s performance and remuneration is set against this “Benchmark” measure. I find this odd as under this measure, while reported PBT totalled $600m, $656m and $689m in 2010, 2011 and 2012 respectively, Benchmark PBT was reported to be, 42%, 40% and 64% higher at $854m, $920m and $1,128m respectively. Others may choose to ignore these adjustments as “one-off”, but they don’t appear particularly “one-off” to me.

While the EBITDA margin has risen strongly, so has the level of capex as a percentage of sales. In 2006, the group spent $62m on the purchase of property, plant and equipment, and an additional $150m on the purchase of other intangibles (databases, internal use and generated software). This equated to 6.9% of sales in 2006. It rose to 8.5% of sales in 2008 and fell back to 8.1% in 2010. It averaged 7.8% through the period 2006-10. By 2012, the group spent $84m on the purchase of property, plant and equipment and $369m on the purchase of other intangibles. Capex as a percentage of sales had risen to over 10%.

A competitor of Experian is the US based company Equifax (EFX, mkt cap $5.5bn). This is a broadly similar although smaller business to Experian.

While Experian’s capex totalled 10.3% of sales in 2012, Equifax’s is expected (Bloomberg consensus) to be at 3.5% of its sales (down from 3.8% of sales in 2011). Figure 6, and the chart below shows the path of each company’s capex as a % of sales.






Acquisitions

When looking at the group’s acquisition expenditure and trying to estimate valuations paid, I came across this, which I found to be fairly amusing on one of Experian’s acquisitions.
In 2007, Experian sued a US based company called Mighty Net for trademark infringement. At the time, The President of Experian's Consumer Direct segment, Ty Taylor, was reported to have said "We believe it is important to not only protect our intellectual property, but also to protect consumers against such companies [Mighty Net]." My emphasis added.
In 2010, Experian bought Mighty Net for $208m.

Experian’s accounts detail what the group’s acquisitions provided in revenue from date of acquisition to its financial year end and the acquired businesses revenue generated from Experian’s financial year beginning to date of acquisition. From this it is possible to get an estimate of what I think the acquired businesses generated in revenue for an entire financial year. This is detailed in figure 9, below. 


Experian spent $4,520m in cash on acquisitions during 2006-12 and it appears that bought revenue totalled $1,512m at the various points of acquisition. This equated to 3x sales. On a profit after tax (PAT) level, the group also details what the acquisitions provided from date of acquisition to financial year end. Using the ratio of revenue reported from point of acquisition to financial year end and revenue reported from financial year beginning to date of acquisition, it is possible to get a proxy for what full year PAT may have been. I estimate this to have totalled $139m for the group’s acquisitions in the years they were purchased. I have then assumed that the tax rate was 28% to determine what a likely profit before tax (PBT) would have been. I estimate this to have totalled $193m that the acquisitions collectively achieved in the years they were purchased. On this basis, Experian appears to have paid $4,520m for companies which were collectively achieving $193m in PBT at the time of acquisition; or 23.4x PBT. I reckon that is expensive. I have also added a row to estimate what potential EBITDA may have been were a 28% margin to have been achieved against the acquired revenues. This would have totalled $423m and imply a price paid of 10.7x EBITDA. Again this seems expensive. 


Balance sheet

Having spent a significant amount on acquisitions, the bulk of this has been included in Experian’s balance sheet as goodwill. Given that the sector is typically tangible asset light, balance sheets stuffed with intangible assets are not out of the ordinary, but even so. Excluding goodwill and other intangibles would leave Experian’s balance sheet with net liabilities of $2.8bn. This compares to reported net assets of $2.9bn and a market cap of $15.6bn.

Lots of selling

Management has lobbed out a sizeable number of shares over recent years. In total the directors have sold £42m of stock since June 2010 and bought £0.2m. Some of this is to satisfy tax on option entitlements, but even so. £200k out of £42m is not much of a token gesture. 


Valuation

The shares trade on 18.7x current year earnings, falling to 16.7x 2014 earnings. On an EV/EBITDA basis the company is valued at 11x current year EBITDA, falling to 10x 2014 EBITDA. It pays a prospective dividend yielding 2.2%, and has c. $1.9bn of net debt. This is not a cheap stock either on a relative basis or by its historic average.

Experian 2013 consensus valuation 

It would also appear that it continues to receive downgrades to analyst consensus earnings estimates. Just since May, its 2013 EPS estimate has been cut but c. 19%, while the shares have rallied c. 10% during the same period.
Experian 2013 consensus earnings momentum

So for the above reasons, I have shorted the stock.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

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