CA - Thomson Reuters: Love The Business But Dislike The Valuation

2023-05-11 07:49:36 ET

Summary

• Thomson Reuters is now entering a new phase of growth post its change program.
• Investments in AI should further enhance TRI products, thereby improving value proposition and retention rates.
• TRI's relative valuation is high when compared to peers.

Summary

Thomson Reuters Corporation ( TRI ) provides business information services via information-enabled software and tools for legal, tax, accounting, and compliance professionals. I am a fan of business information provider businesses as they are hard to replicate, very sticky when fully embedded into clients workflow, and have very predictable stream of cashflow. TRI is a classic example. Despite macro uncertainty, I think TRI will be able to meet its organic revenue growth outlook of 5.5-6% thanks to its stable recurring revenue streams and mission critical products. I commend the management team for successfully implementing the change program, which has significantly elevated the company's growth and margin compared to the historically modest single-digit growth and low 30s adjusted EBITDA margin. This achievement marks a significant advancement for the company. The next phase of reinvestment focus would be on generative AI which I expect to further enhance TRI product and value proposition to clients. The issue with TRI is that is trading at a very expensive multiple when compared to other information services providers, especially when the growth profile is roughly similar. I believe the relative attractiveness of TRI is a lot lower here, and we could see multiples reverting to peers' level, as such I recommend a hold rating.

1Q23 results

TRI reported strong financial results for the period, with revenues reaching ~$1.74 billion , reflecting a 3.8% year-on-year increase. This was essentially in line with consensus of 3.9%. Within the Legal segment, organic revenue grew by 5% year-on-year, fueled by recurring revenue growth. However, transaction revenue experienced a slight decline of 1% organically, mainly due to lower Elite professional services revenue. The Tax & Accounting segment achieved remarkable organic revenue growth of 11% year-on-year. In the Corporates segment, organic revenue expanded by 8% year-on-year. TRI also exceeded expectations in terms of EBITDA margins and EPS. EBITDA margins expanded by 300bps year-on-year to reach 38.8%. This margin improvement was driven by operating leverage and the benefits derived from the Change Program. Lastly, EPS reached $0.82, exceeding the consensus estimate of $0.80.

Business update

Cycling back to the business model of TRI, given the nature of its business, it is often well embedded into the business / operation workflow of underlying clients. For example, in Legal, which TRI sells through the brand Westlaw Classic, it enables legal personnels to find related law materials. While not the best example, it is something akin to Bloomberg in finances where it is a large database. As such, it is a very sticky business that gets stickier with time if more and more employees in the organization uses it. This stickiness is well demonstrated in the recent results, where TRI recurring revenue (3/4 of the business revenue) retention rates stood at 91%. The resilience of this model is also shown through the 6% recurring revenue growth. Importantly, management is focusing their investments on their Big 3 segments to make its product even stickier, thereby increasing retention rates. As the product gets stickier, it also means that TRI have more negotiating power to up/cross sell more products, in turn supporting its growth targets. Some of the recent upgrades were the introduction of Westlaw Suit upgrade in September 2022, which I expect the Legal segment's organic revenue growth. Though I see a bright future for the company and its prospects in the long run, there is one near-term concern (though it is not yet a major threat): management has noticed that sales cycles are lengthening as a result of macro uncertainty, with deals being postponed from one quarter to the next. The good news is that the wider spread in sales cycles is having some effect on the company, but not nearly enough to warrant revising the full-year organic revenue forecast.

AI

The latest in trend - AI - is also a focus for TRI. While we are not able to exactly quantify the impact of AI, we can have a sense of how it can enhance TRI products, and thereby increase its competitive advantage. The product that would probably see most gains from the infusion of AI is in the areas of enhanced search and legal document workflow. With AI, the search process could be a lot more automated and done through a "conversation" mode, with experience akin to ChatGPT. Searcher could possibly provide information of underlying case and some criteria to search for relevant materials. To achieve this, management has allocated $100 million a year to drive R&D in this field, which I do not think is an extravagant amount. I believe the strategy to tap on AI to improve the product is the right decision.

Valuation

TRI is not cheap from a valuation standpoint. The stock trades at 36x forward PE which is higher than peers like Gartner ( IT ), Moody's ( MCO ), FactSet ( FDS ), MSCI ( MSCI ), Fair Isaac Corp. ( FICO ). While they are not exactly direct peers, the nature of their business is similar. These peers typically trade in the high 20s to low 30s, and are expected to grow at similar or higher revenue growth rates. As such, from a relative standpoint, TRI is a lot less attractive here.

Conclusion

TRI has demonstrated its strength as a provider of business information services in law, tax, accounting, and compliance. With its stable recurring revenue streams and mission-critical products, I believe TRI is well-positioned to achieve its organic revenue growth outlook of 5.5-6%. The next phase of reinvestment focusing on generative AI is expected to further enhance TRI's product and value proposition to clients. However, TRI's valuation is relatively expensive compared to similar information services providers, suggesting a lower level of attractiveness. Therefore, I recommend a hold rating for the stock.

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