2023-08-16 23:18:56 ET
Summary
- Hold rating recommended due to lack of visible catalysts for stock improvement until significant positive organic growth is achieved.
- CLVT's 2Q23 earnings showed a decline in revenue, particularly in the Life Sciences and Healthcare segment.
- Management's revised organic growth guidance for 2023 indicates the need for accelerated growth to regain market confidence.
Investment action
Based on my outlook and analysis of Clarivate Plc's ( CLVT ) 2Q23 earnings, I recommend a hold rating, as I do not see any visible catalysts that will drive the stock up in the near term until CLVT posts a significant amount of positive organic growth. I believe the equity story for CLVT is somewhat impaired as organic growth for 2Q23 disappoints. While expectations are low now after the sharp drop in share price, I recommend staying on the sidelines until CLVT reports strong organic growth.
Basic Recap
CLVT is a provider of proprietary and comprehensive information, analytics, professional services, and workflow solutions. They offer scientific and academic research, biopharma, medtech, IP intelligence, consulting, and data products and services.
Review
CLVT revenue declined by 2.6% to $668.8 million (but only by 0.4% organically). The slowdown in recurring revenue and transactional and other revenue drove the overall decline, while subscription revenue grew by 2.9%. Analyzing the factors, it was encouraging to see that price increases and net installation benefits were driving the organic growth in subscription revenue. However, the timing of expedited patent renewals in the prior-year period was responsible for the drop in organic reoccurring revenue. Additionally, declining sales in Life sciences, healthcare, and Intellectual Property contributed to a drop in transactional and other revenue, which is cause for concern. However, EPS and margins exceeded expectations. As a result of efficiencies gained through integration initiatives, EBITDA margins grew by 270 bps to 42.6%. EPS of $0.21 also beat expectations of $0.19. Below, I state my thoughts and outlook on each segment.
Academia & Government [A&G]'s organic growth in 2Q23 was 1.8%, which may seem low in absolute terms but is more meaningful when viewed over a longer period of time. When compared to where it was two years ago, this segment is up 5.2% overall. Note that this strong growth (relative to other segments) was not due to luck. CLVT's initial product investments were focused on the A&G market, and the results provided a clear picture of the success or failure of those bets. This also makes me feel slightly bullish in the medium term about the other segments, as CLVT could see growth accelerate if they start investing in other segments as well.
Intellectual Property [IP] continues to see persistent headwinds. In 2Q23, CLVT saw an organic drop of 1.1%. The results were driven by the ongoing weakness in recurring revenues, most notably patent renewals, which were identified as a headwind in Q2 due to the early timing of payments in 1H of FY22. I believe if this were to be a standalone factor impacting the segment, I would not be so worried. But I anticipate continued sluggish growth in the near future in light of the current economic climate. In particular, clients have reduced spending because of the Japan Yen's weakness, and some APAC countries have reduced spending because of post-covid difficulties.
in Japan, the weakness in the yen has caused clients to dramatically managed and reduce costs and call the patent portfolio.
in a couple of other countries in Asia, national governments, driven by post COVID budget challenges, have redirected their financial support investments in IP protection. 2Q23 call
Last but not least, LS&H (the Life Sciences and Healthcare segment) faces persistent headwinds. Organic growth in LS&H was down 5.4% y/y in 2Q23, a sharp slowdown from the 1.9% drop recorded in 1Q23. Weakness in commercialization of products based on real-world data and some softness in consulting both contributed to Q2 organic decline at CLVT. I see this as a sign of poor execution, which is a major cause for concern. Furthermore, given the reduced funding in the biotech sector and the presence of smaller drug pipelines, I anticipate that this segment will face challenges in the short term and exhibit subdued levels of organic growth.
Overall, performance in 2Q23 was lackluster. Instead, it has made me even more skeptical that CLVT will be able to execute smoothly and sustain organic growth throughout the remainder of 2H23. Even though profits and margins were satisfactory, the issue at hand is slow organic growth. Additionally, management revised organic growth guidance for 2023 from 2.75–3.75% to 0-2%. This is a big step down and effectively tells the market that 2H23 could continue to see negative organic growth. With this setup, I believe the equity story for CLVT has been impaired, and the market is unlikely to react positively in the near term unless management shows an acceleration in organic growth to positive areas. Management creditability is also at stake; if they were to miss their FY23 guidance, I think the stock will be left in the cold for a while as the market "gives up" on the stock.
Valuation
My DCF model above is to show the bearish scenario for CLVT. Suppose there is an impairment to CLVT's growth story. The business can still grow FCF at 5% for the next 5 years, driven by 2% revenue growth (inflation rate) + margin expansion (which is definitely possible given that FY22 EBITDA margin is at 50%) + debt paydown (leading to higher FCF). Using a 10% discount rate, I got a fair value of $7.20, which is around the level that CLVT is trading today. Ironically, this bodes well for the stock in terms of expectations, as the market is pricing in very low FCF growth. If CLVT can show positive organic growth over the next few quarters, the stock could rally simply because expectations are resetting upward.
Risk and final thoughts
The risk to my hold rating is that CLVT manages to execute and turnaround its organic growth trajectory. As seen from my DCF model, expectations are low. If CLVT beats 3Q23 expectations and comes ahead of the high end of its FY23 organic growth guide (2%), I expect a strong rally as the market regains confidence in management and also the organic growth outlook for FY24.
To conclude, I recommend a hold rating based on my analysis of their 2Q23 earnings. Until CLVT demonstrates substantial positive organic growth, there seems to be limited catalysts for short-term stock improvement. The revised organic growth guidance for 2023 highlights the need for management to accelerate organic growth to regain market confidence. My valuation analysis suggests that the market has low growth expectations, indicating potential for a positive stock response if organic growth improves. The risk to my hold rating is that CLVT manages to execute a turnaround in organic growth trajectory. A positive performance in the upcoming quarters could boost confidence in management and the outlook for FY24.
For further details see:
Clarivate: Business Has To Show Positive Organic Growth To Convince The Market