DFIN - Donnelley Financial Solutions Continues Transformation Efforts

2023-12-27 11:49:55 ET

Summary

• Donnelley Financial Solutions, Inc. is focusing on transforming into a recurring revenue, software-driven firm.
• The company's revenue is declining, but at a slower rate.
• The global market for regulatory compliance management software is expected to grow at a CAGR of 12.5% from 2021 to 2026.
• Until management can reignite top line revenue growth, my outlook on Donnelley Financial Solutions stock is Hold.

A Quick Take On Donnelley Financial Solutions

Donnelley Financial Solutions, Inc. ( DFIN ) provides a range of financial regulatory and compliance software and related services.

Management is continuing to focus on transforming DFIN into a recurring revenue, software-driven firm.

Revenue is continuing to drop, albeit at a slower rate of decline.

My outlook on DFIN is to Hold until management can reignite revenue growth.

Donnelley Financial Solutions Overview And Market

Chicago, Illinois-based Donnelley Financial Solutions was founded in 1983 to provide investor communications products and has since expanded into various types of risk and compliance software solutions.

The firm is headed by President and Chief Executive Officer Dan Leib, who has been with the predecessor company, RR Donnelley, since 2004.

The company’s primary offerings include the following:

• Capital Markets – Software Solutions

• Capital Markets – Compliance and Communications Management

• Investment Companies – Software Solutions

• Investment Companies – Compliance and Communications Management.

DFIN acquires customers through its direct sales and marketing efforts and through partner referrals.

It sells its solutions to public companies, private companies, advisors & law firms, government and fund & investment companies.

According to a 2021 market research report by Industry ARC, the global market for regulatory compliance management software was estimated at $27.8 billion in 2020 and is forecasted to reach $56.4 billion by 2026.

This represents a forecast CAGR (Compound Annual Growth Rate) of 12.5% from 2021 to 2026.

The main drivers for this expected growth are the growth in regulatory requirements by local and federal governments worldwide, increasing complexity and the desire by companies to reduce their risks from non-compliance.

Also, the chart below shows the approximate market sizes for the industry by region in 2020:

There are numerous compliance and regulatory software service providers across subscription and perpetual license types and for various client sizes and configurations.

Donnelley’s Recent Financial Trends

Total revenue by quarter (blue columns) has trended lower in recent quarters due to a drop in transaction business and capital markets compliance activity. Operating income by quarter (red line) has dipped partly due to seasonal effects but has been trending lower over time because of ongoing transformation expenses and higher capital expenditures in its software development efforts.

Gross profit margin by quarter (green line) has risen in recent quarters as a result of its ongoing cost control efforts and growth in Software Solution sales; Selling and G&A expenses as a percentage of total revenue by quarter (amber line) have also moved up most recently due to incremental business transformation expenses and higher bad debt expense.

Earnings per share (Diluted) have varied seasonally but have been trending slightly lower over time:

(All data in the above charts is GAAP.)

In the past 12 months, DFIN’s stock price has risen by 67.44% vs. that of much larger firm Broadridge Financial Solutions, Inc.'s (BR) gain of 49.13%:

For balance sheet results, the firm ended the quarter with $11.7 million in cash and equivalents and $165.9 million in total debt, all of which was categorized as long-term.

Over the trailing twelve months, free cash flow was $64.7 million, during which capital expenditures were $57.8 million. The company paid $22.5 million in stock-based compensation in the last four quarters.

Valuation And Other Metrics For Donnelley Financial

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

Below is an estimated DCF (Discounted Cash Flow) analysis of the firm’s projected growth and earnings:

Based on the DCF, using a discount rate of 10% (10-year Treasury (US10Y) at 4% plus 6% equity risk premium) and forward earnings per share assumption of $3.56, the firm’s shares would be valued at approximately $58.22 versus the current price of $63.41, indicating they are potentially currently fully valued.

A larger competitor to DFIN would be Broadridge Financial Solutions. A comparison of their major metrics is shown here:

(Source - Seeking Alpha.)

DFIN’s most recent unadjusted Rule of 40 calculation was only 4.2%, so the firm is in need of substantial improvement in this regard, per the table below:

(Source - Seeking Alpha.)

Commentary On Donnelley Financial

In its most recent earnings call (Source - Seeking Alpha ), management’s prepared remarks highlighted the focus on its evolution toward a profitable recurring subscription mix, with its Software Solutions accounting for 40.7% of net sales, an increase of 3.9% year-over-year.

The firm is constructing a unified cloud-based compliance platform in its Arc Suite "while also maintaining market-specific capabilities within the individual products."

This strategy enables the company to sell an integrated solution or an a la carte menu of standalone products, providing greater flexibility to customers.

Management noted increased ESG reporting laws in California and the EU, which will begin to take effect in 2025 in the EU and 2026 in California. The company expects the SEC to "follow suit" with national-level ESG requirements in the future.

On capital allocation, management intends to continue investing in its transformation efforts, repurchasing its stock and reducing debt.

Analysts questioned the leadership about recurring revenue growth, competition and its capital markets outlook.

Management replied that it is focused on expanding its more predictable revenue-generating software solutions since its event-driven offerings can be more volatile.

In the post-pandemic environment, the company has improved its offerings and sees the breadth of its selection as an important competitive differentiator, although competitors are upping their game as well.

Leadership indicated that the capital markets sector has been unpredictable, with the IPO market being uneven and M&A also showing a wide range of activity from quarter to quarter.

The firm sees a normalizing business environment as contributing to the potential for an improved 2024.

For the quarter’s results, total revenue declined by 4.6% year-over-year, even as gross profit margin increased by 5.1%.

Selling and G&A expenses as a percentage of revenue grew by 2.5% YoY, a negative signal, but operating income rose by 0.7%.

The company's financial position is reasonably good, with liquidity for a portion of its long-term debt but strong free cash flow.

DFIN’s Rule of 40 performance has been poor and dragged down by its recent revenue decline.

Management did not disclose any customer or revenue retention rate metrics.

Looking ahead, the full-year 2023 top line revenue decline is expected to be 5.2% versus 2022’s decline of 16.1% versus 2021.

In the past twelve months, the firm's EV/EBITDA valuation multiple has more than doubled, as the chart from Seeking Alpha shows below:

A potential upside catalyst to the stock could include an improved IPO and M&A environment as cost of capital assumptions fall and valuations improve.

Management is continuing to seek to transform the company to a more recurring revenue, software-driven business model and has potential new sources of compliance requirements with new regulations in California, the EU, and potentially nationwide in the U.S. in the coming years.

However, the firm’s revenue decline is dropping, and my discounted cash flow calculation suggests Donnelley Financial Solutions, Inc. stock may be fully valued here, so my outlook is a Hold until management can reignite top line revenue growth.

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