2023-10-04 13:16:08 ET
Summary
- FDS reported 4Q23 revenue in line with consensus, but deeper analysis reveals concerning trends such as decelerating organic growth and prolonged sales cycles.
- Management's guidance for FY24 implies further deceleration and FDS' exposure to the hedge fund industry adds to its challenges.
- Higher tax rates are expected to permanently impact FDS' financial performance.
Summary
Following my coverage on FactSet Research Systems (FDS), which I recommended a hold rating due to my expectation that FDS is going to face pain in the near-term due to current macro and market conditions, sales cycles getting longer for FDS among buy-side clients, and deceleration in demand from sell-side banking customers. This post is to provide an update on my thoughts on the business and stock. I continue to recommend a hold rating for FDS, but am leaning towards a very negative view on the business given my expectation that FDS is not anywhere near the trough of this downturn yet.
Investment thesis
A couple of days back, FDS reported 4Q23 revenue of $536 million which was in line with consensus. 4Q23 ASV growth was relatively broad based, with US up 6%, EMEA up 7.1% and APAC up 8.1%. EBIT performance were modestly better than expected with adj operating income [AOI] of $180 million performing 5% better than consensus. This implies an AOI margins of 33.6%, around 150bps higher than consensus estimates. Strength in AOI and margin was primarily due to headcount trimming and lower bonus accrual partly offset by higher salaries and tech costs. That said, adj EPS did not follow through with the same strength, coming in at $2.93 due to one-time adjustments of certain tax items.
While the results seem positive, meeting consensus expectations, I remain pessimistic about FDS' near-term performance after a deeper look into the earnings. For one, FDS ASV plus professional services organic growth of 7.1% in 4Q23 decelerated from 8% in 3Q23 and came below the low end of management's guide of 7.2-8.6%. This reinforces my previous belief of poor demand, delayed deals, longer sales cycles and smaller deal sizes. Forward looking guidance further solidifies my expectation as management is guiding for ASV plus professional services organic growth of 6 to 8% in FY24, which implies additional deceleration at the midpoint (vs. midpoint of 7.2% to 8.6%) and comes below management medium-term target of 8-9% organic growth. To make matters worse, the timing of the upcoming weakness is going to worse in 1H24 followed by a stronger 2H24. From a stock technical and capital flow perspective, this would mean that the stock will likely be rangebound for the next few months as investors stay on the sidelines, awaiting the recovery. The fact that management was not able to call out the exact timing of a bottom suggests to me that uncertainty over the near-term is extremely high. Performance could be way worse than expected, especially with the prevailing headwinds in banking .
Hi, Ashish, it's Helen. Thank you for that question. I think from our perspective, I don't want to say we've hit a bottom. That's too strong of a word. 4Q23 earnings results call
In addition, FDS' outsized exposure to the hedge fund industry is going to continue causing pain to the business. For reference, FDS generated 82% of ASV from buy-side clients in F4Q, creating outsized exposure to secular headwinds associated with the shift from active to passive asset management given the company's solutions are sold to active fund managers.
Last but not least, FDS financial performance is going to be permanently impaired by 3% due to higher tax rates. Management now expects a higher tax rate of 17-18% compared to an average of 15.5% over the past five years due to higher pre-tax income and a higher statutory rate in the UK.
As such, I remain cautious on FDS following the supposedly in-line 4Q23 results. The fact is that FDS saw a deceleration in organic ASV plus professional services growth and is expected to continue facing a challenging external operating environment, with headcount and budget pressures on the buy-side and sell-side accompanied by elongating sales cycles in an uncertain macro backdrop.
However, I do think FDS has done well from a product investment standpoint along with better price realization of late from improved sales force practices, both of which should help growth over the long run. Also, management has overdelivered on their targets, and reached their AOI margin target two years ahead of their initial plan. Given the improved cost rationalization and operating leverage, I believe FDS would be a much stronger business once it gets pass this weak macro cycle. Until then, I recommend avoiding investing.
Conclusion
My recommendation for FDS remains a hold rating, but I hold a highly pessimistic view on the business's near-term prospects. While the recent 4Q23 results met consensus expectations, a deeper analysis reveals concerning trends, including decelerating organic growth, prolonged sales cycles, and a smaller deal size. Management's guidance for FY24 implies further deceleration, and FDS's exposure to the hedge fund industry adds to its challenges. Moreover, higher tax rates are expected to permanently impact FDS's financial performance. While the company has made positive strides in product investments and price realization, it still faces a challenging operating environment.
For further details see:
FactSet Research Systems: Business Is Nowhere Near The Trough Yet