2023-04-06 11:34:01 ET
Summary
- Clarivate has a strong business model with high barriers to entry, including high pricing power and excellent top-line visibility due to its recurring revenue model and high customer retention rates.
- CLVT has set new medium-term financial goals focused on accelerating organic revenue growth through investments in content and technology, with a target of growing organic revenue by around 6%.
- Margin expansion will be achieved through organic measures rather than previous strategies of M&A and cost optimization.
Thesis
Clarivate ( CLVT ) is an attractive business model with high barriers to entry, which includes high pricing power and excellent top-line visibility due to its recurring revenue model and high customer retention rates. My thesis was that CLVT has undergone restructuring and improved its profitability, which I expect to continue in the future. Based on my model, I expected the stock to have a 32% upside with a price target of $14 previously.
Despite the fact that the stock price has underperformed, the company itself has performed as expected. CLVT reversed its trend from the previous quarters by exceeding expectations across the board. This included revenue, EBITDA margins, and earnings per share. In my opinion, the company is positioned favorably to speed up its organic revenue growth in 2023, which will be a major factor in the stock's upward valuation. In particular, I anticipate the increased organic revenue growth to originate primarily in the Life Sciences & Healthcare segment, due to a healthy multi-year backlog established in 2022, and consulting revenue should increase due to recent increases in capacity. I think the investor day that took place on March 9th, 2023, set a very optimistic tone for the future of CLVT. Over the next three years, management has laid out new financial goals for the medium term and a plan for achieving those goals through enhanced operational performance. CLVT plans to increase its organic revenue by the mid-single digits, which is in line with my predictions, although the company's target margins may be slightly impacted by the investments it will make to spur growth. In my view, for the stock to perform well, there needs to be an increase in organic revenue growth and margin expansion. This will drive high single digits EBITDA growth which will be a catalyst that drives valuation upwards. I reiterate my buy rating.
4Q22 financials
The 20.4% year-over-year growth in revenue to $675.3 million exceeded consensus expectations of a 15.9%. Subscription and recurring revenue each grew by 2.5% year over year to contribute to the overall 0.5% organic growth in revenue, while transactional and other revenue fell by 5.9%. Despite a decline in transactional sales and consulting services, organic revenue growth was driven by higher subscription revenue as a result of favorable pricing and net installation benefits, as well as higher recurring revenue from increased patent renewal volumes and gains in yield per case. Despite falling 70 basis points year over year to 45.1%, EBITDA margins beat expectations of 41.7% due to higher operating expenses that were partially offset by acquisition synergies. Also, the company's $0.22 EPS was higher than the expected $0.17.
Medium-term targets
The new medium-term financial goals set by CLVT are reasonable and doable, in my opinion, as they are focused on accelerating organic revenue growth through investments in content and technology and a more effective go-to-market strategy. CLVT plans to grow its organic revenue by around 6% in 2025, which is in line with the 6% annual growth rate of the markets it serves. Just as I stated my previous post, I believe CLVT should be able to grow roughly inline with the market, as such the targeted 6% growth (1% than my forecast of 5%) was in line with what I had expected going into the event. CLVT has shown a degree of conservatism that I find to be wise by noting that it is not dependent on a bettering macro environment in order to achieve its organic revenue growth target. Which means, if things turn for the better, there might be a surprise in store - albeit I do not have huge faith in things turning for the better in FY23. Furthermore, I believe management's expectation of medium-term price increases of 3-4% is realistic, since normalized inflation should already account for at least 2% of that projected increase. Margin wise, management's decision to support growth through reinvestment into the business has resulted in a softer than expected annual margin expansion target of 50 basis points for adjusted EBITDA from a base of 41.8% in 2022 through 2025. Given the inherent operating leverage, I suppose this is acceptable so long as the company demonstrates that it can drive consistent revenue growth. In addition, between 2023 and 2025, management hopes to generate a total of $1.8 billion in FCF. Furthermore, they hope to convert at least 50% of their EBITDA into FCF by the end of that time period. Over time, I anticipate management using FCF to reduce debt, bringing the leverage ratio within the desired range. With a healthy financial position, CLVT can pursue value-adding mergers and acquisitions or repurchase its own shares.
Margin expansion
I like the new focus on driving EBITDA margin expansion through organic measures, rather than the previous strategy via M&A and cost optimization. I believe this strategy would be easier to pull through and would have a cleaner impact on the financials (i.e. results can be seen faster than an M&A + cost cut which often makes the financials messy). Specifically, an extra $100-150 million in opex and capex will be spent over the next 36 months, with a focus on product innovation. The investment of $100-150 million is expected to generate a return to management in about 2.5 years. Although the target for increasing the EBITDA margin has been set until FY25, I think CLVT has a chance of increasing its EBITDA margins even after 2025 if organic revenue growth reaches 6%.
Conclusion
CLVT has shown strong performance in the 4Q22 financials, with revenue growth exceeding expectations and EBITDA margins beating expectations due to higher operating expenses offset by acquisition synergies. I also believe the company's medium-term financial goals of accelerating organic revenue growth through investments in content and technology, and a more effective go-to-market strategy, are reasonable and doable. CLVT's decision to focus on driving EBITDA margin expansion through organic measures is a sound strategy that should be easier to implement and have a cleaner impact on the financials. The increased organic revenue growth and margins will be major factors in the stock's upward valuation. I reiterate my buy rating as I anticipate the company to deliver high single digits EBITDA growth, driving valuation upwards.
For further details see:
Clarivate: Organic Growth To Drive EBITDA Expansion