2023-03-17 14:33:16 ET
Summary
- Gartner is a leading research report, competitor benchmarking and consulting company.
- The company announced strong financial results for Q4,22 as it beat both revenue and earnings growth estimates.
- Gartner bought back over $1 billion worth of stock in 2022 and authorized another $1 billion for share repurchases in 2023, which is a positive sign.
- My discounted cash flow valuation model and forecasts indicate the stock is undervalued intrinsically at the time of publication.
Gartner (IT) is a leading technology research and consulting firm that has a fairly unique place in the market. The company is most famous for its "Magic Quadrants" which effectively benchmark various software applications against competitors. This makes Gartner the go-to resource for enterprise/business software buyers. In addition, the company has deep relationships with many of these organizations, which pay a fee for the privilege to be included in its analysis charts. There are competitors in the space such as G2 and Forrester, but Gartner has an immense scale advantage. For example, Forrester has a market capitalization of ~$600 million, whereas Gartner has a staggering market cap of close to $25 billion. Thus although it looks as though both players offer similar products (Research reports and competitor benchmarking), Gartner is on another level entirely, especially with its enterprise penetration. In addition, Gartner leverages its deep industry connections with companies to offer them IT consultancy, which has become essential given the trends around digital transformation. In the fourth quarter of 2022, Gartner continued to produce solid financial results as it beat both top and bottom line growth estimates. In this post, I'm going to break down its quarterly results, before revealing my valuation model and forecasts for the stock, let's dive in.
Solid Financials
Gartner reported solid financial results for the fourth quarter of 2022. Its Contract Value [CV] (similar to ARR) was $4.7 billion, which increased by 11.9% year over year, or 12.3%, if we adjust for the exit from Russia. This metric can be thought of as the true "top line" and is a great indicator of both the short-term and long-term health of the company.
Breaking down CV by segment, its largest segment Global Technology Sales [GTS] contributed to 76.6% of total CV and increased by 10% year over year.
This was driven by steady enterprise growth from 13,073 in Q4,21 to 13,878 by Q4,22. In addition to solid double-digit industry growth across transportation, manufacturing and retail segments.
Its Global Business Sales [GBS] grew its contract value [CV] by a rapid 18.9% year over year to over $1 billion, contributing to 21.9% of total CV. This was driven by steady enterprise growth of 4.56% year over year to 4,980. This was further driven by solid growth across HR and the supply chain, which grew CV by over 20% year over year.
GBS (Gartner author annotation)
The "new business" derived GBS CV, increased by 3% year over year. This was surprising given the macroeconomic environment, but it looks as though Gartner's customers still continue to see value in its offering.
Wallet Retention is also a great measure of company success; this represents the amount of contract value [CV] retained by clients over 12 months. In this case, Wallet Retention was 112.3% in Q4,22. This is down slightly from the 114.5% rate in the prior year, but still solid overall. Anything over 100% means clients are generally sticking with the company and spending more which is positive. We can also see Client Retention was 89.3% in Q4,22, up from the 86.8% in Q4,21, again this is a very positive sign given the macroeconomic environment.
For some background, the Global Business Sales [GBS] and Global Technology Sales [GTS] team generally focuses on selling Gartner's research reports, marketing materials and IT consulting to customers. Given I have vast experience in enterprise marketing (Digital Agency Owner), I am completely aware that Gartner materials such as its "Magic Quadrant" are often embedded into a company's value proposition and go-to-market [GTM] strategy. Therefore, it doesn't surprise me that companies are sticking with its services even during tough economic times. Sales is the lifeblood of any business and thus continuing to be competitive is a solid advantage. From an I.T. strategy perspective, the trend of "Digital Transformation" is not going away and in fact accelerated during 2020. Companies are realising that they need to become more "data-driven" and even more to the "Cloud" in order to drive success. The cloud industry is forecast to grow at a 17.9% compounded annual growth rate [CAGR] and reach a value of over $1.24 trillion by 2029.
Given Gartner provides IT Consulting on Cloud migration, the company is poised to benefit from this growth trend. This is especially important, given many studies such as this report by Accenture on banks indicate "a lack of staff with cloud expertise" as a major barrier to migration.
Gartner's overall revenue increased by 15.2% year over year to $1.5 billion. This was driven primarily by its core Research segment, which increased revenue by 8.97% year over year to $1.178 billion. The company also reported a solid 17.1% increase in its consulting revenue for Q4,22, with $138 million reported. In addition, the business continued to see a strong rebound in its Conferences since the lockdown of 2020. In Q4,22, its conference revenue increased by a blistering 76% year over year to $188 million. I forecast this trend to continue moving forward and will discuss more in the valuation and forecasts segment.
Margins and Balance Sheet
Moving onto margins. The company reported a solid gross contribution margin of 39%, which increased by 140 basis points year over year. Its earnings per share [EPS] was $3.21, which beat analyst forecasts by $0.95 and increased by 28% year over year. This growth was helped by lower SG&A expenses, which declined by 3% year over year.
Gartner did see its operating cash flow impacted with $203 million reported in Q4,2021, down 7% year over year. A positive is this was mainly impacted by a one off event as Hurricane Ian hit its office in Fort Myers during September 2022.
The company has a strong balance sheet with $698 million in cash and cash equivalents. Its debt balance is fairly high at $2.453 billion, but the vast majority of this is long-term debt, with just $7.8 million in current debt, thus this is manageable.
Valuation and Forecasts
In order to value Gartner, I have plugged its latest financial data into my discounted cash flow valuation model. I forecast $4.92 billion in revenue for "next year" or the calendar year of 2023, which represents a growth rate of ~7% and is in-line which managements guidance. I expect this to be driven by continued growth in conferences, which are forecast to increase by 14% year over year to $445 million. Keep in mind this growth rate is fairly conservative given the company previously grew its total revenue by more than double this level (15.2%) year over year in Q4,22.
Therefore, I expect the forecasted recession to impact growth somewhat. In years 2 to 5, I forecast a faster 19% revenue growth rate per year. This is slightly higher than the Q4,22 growth rate and driven by a forecasted improvement in economic conditions, post-2023. In addition, I expect the trends across digital transformation and enterprise marketing to help drive continued growth.
Gartner stock valuation 1 (created by author Deep Tech Insights)
To increase the accuracy of my model, I have taken into account the company's effective tax rate of 21.6%, which is below the marginal tax rate of 25%. I forecast a pre-tax operating margin of 24% over the next 5 years. This may seem optimistic, but this only assumes a 2.78% increase of its strong 21.22% level achieved in 2022. Given CPI inflation is currently on a downward trend, I don't deem a slight margin increase to be unreasonable. In its earnings call, management has also forecast operating leverage improvements, if revenue beats guidance for 2023, which given the conservative level (7%), is very achievable.
Gartner stock valuation 2 (created by author Deep Tech Insights)
Given these factors I get a fair value of $348 per share, the stock is trading at $315 per share at the time of writing and thus it is ~9.51% undervalued, according to my model and forecasts. As an extra data point, Gartner trades at a forward price to earnings [P/E] ratio = 37, which is ~38% cheaper than its 5-year average.
Risks
Recession/Longer Sales cycles
Many analysts forecast a recession for 2023, with Statista data indicating over a 57% chance as of January 2023. Given the uncertainty around the macroeconomic environment, Gartner could see a slowdown in revenue growth as decision-makers delay extra spending on expensive consultants. I have reflected conservative growth rates in my model.
Final Thoughts
Gartner is uniquely positioned in the market as the go-to-company for technology software reviews, industry reports, and competitor benchmarking, especially in the enterprise. The company is poised to benefit from the growth in the cloud with its IT consulting arm and its conferences are rebounding strong. My valuation model and forecasts indicate the stock is undervalued intrinsically at the time of writing and thus it could be great long-term investment.
For further details see:
Gartner: Solid Financials And Undervalued Intrinsically