2023-06-09 17:44:09 ET
Summary
- London Stock Exchange Group (LSEG) has shifted its business profile towards data & analytics following the acquisition of Refinitiv, offering good growth prospects.
- LSEG's current valuation of 24x forward earnings appears high, and investors should wait for a better entry point.
- The company's strategy to diversify away from capital markets provides a more recurring revenue and earnings profile, but its dividend yield remains unattractive at 1.25%.
London Stock Exchange Group ( OTCPK:LNSTY ) has changed its business profile toward data & analytics following the acquisition of Refinitiv, and has relatively good growth prospects. However, this seems to be reflected in its share price and investors should wait for a better entry point.
Company Overview
London Stock Exchange Group (LSEG) is based in the U.K. and is one of Europe’s largest exchange operators, being present across several industries segments beyond trading. Its market value is about $60 billion and trades in the U.S. on the over-the-counter market.
While historically it operated mainly in the trading segment related to capital markets, the company’s strategy has been to diversify its business over the past few years, being nowadays present in Data & Analytics, Capital Markets, and Post-Trade.
An important step to diversify its business away from trading was its all-share $27 billion acquisition of Refinitiv in January 2021, which changed the company’s business profile in a considerable way. To have this acquisition approved, it needed to sell Borsa Italiana, Group which decreased its exposure to cash trading. Much of the proceeds from this divestment were directed to debt reduction, helping to maintain financial leverage at an acceptable level.
Refinitiv provides financial information, security pricing, analytics, risk management, and compliance tools for the financial industry, increasing LSEG’s exposure to activities not directly related to trading. Refinitiv’s stand-alone revenues were twice the size of LSEG, showing that this deal was quite transformative for LSEG and has substantial execution risk.
LSEG plans to integrate its own operations with Refinitiv during a five-year period, showing that this deal is quite complex and the overlap between the two companies was somewhat low. Indeed, Refinitiv operated in different business activities, had a broad customer base, and a more broad geographic presence, being quite transformative for LSEG’s business profile.
One factor that is quite appealing for LSEG is that Refinitiv’s revenues are mostly subscription-based, while LSEG trading activities are more related to volume in the capital markets, and have relatively high retention rates. This reduces integration risk to some extent, making cost synergies to extract from this business combination more uncertain over the medium term, than revenue synergies.
LSEG’s targets are to achieve revenue synergies of between £350-400 million and more than £400 million cost synergies by end 2025, which seem easily achievable on the cost side taking into account what it has already achieved, while its revenue target seems to be more challenging given that the business overlap was not much.
Following the integration of Refinitiv, LSEG’s main business unit is now Data & Analytics, which generates some 67% of total revenue, followed by Capital Markets (19.6% of revenue), and Post-Trade (13% of revenue). Geographically, some 46% of revenue comes from the Americas, 39% from Europe, Middle East and Africa, while the rest (15%) comes from Asia. This profile is not expected to change much in the near future, as LSEG is executing Refinitiv’s integration and further M&A is not likely over the next few years.
Financial Overview
Regarding its financial performance, while LSEG has a positive track record, due to the transformative deal related to Refinitiv, its historical performance is not very meaningful regarding its future prospects.
Nevertheless, given that LSEG integrated Refinitiv in its accounts in 2021, during the last year its operating performance already reflects the combined business. LSEG reported a very positive year, despite the challenging macro backdrop, showing that its pivot to data analytics was successful and shifts its business to more recurring revenue and earnings, even though it still has some exposure to cyclical factors.
In 2022 , its revenues amounted to more than £7.4 billion, representing an increase of 19.6 YoY, benefiting both from organic growth and currency tailwinds. At constant currencies, its organic growth was 5.7% YoY, still a good growth rate during a difficult period for the financial industry. Its growth was broad-based across its business units, with capital markets being the best performer due to higher volumes, especially in fixed-income and derivatives.
In its largest segment (data analytics), its organic growth was 5.3% YoY, with all segments reporting higher revenues during the year, plus forex also boosted its revenues to more than £4.9 billion in the year.
Due to higher revenues and good cost control, its EBITDA margin was 47.8% in the last year, stable from the previous year, despite several headwinds that were offset by positive underlying business performance. Its goal is to have an EBITDA margin above 50% in 2023, which seems to be achievable considering both the cost and revenue synergies it can reach from the positive integration of Refinitiv. Its net profit for the year was slightly above £2 billion, an increase of 20% YoY, while free cash flow amounted to £1.6 billion showing a good cash conversion rate.
During the first three months of 2023 , its operating momentum continued in a positive path, showing that its business strategy to shift the business to data & analytics is bearing fruit. Its revenues increased by 7.5% YoY, with data reporting revenue growth of 7.1% YoY, Post-trade increased revenue by 16% YoY, while Capital markets were the weakest segment with revenues up by 2.5% YoY.
Note that related to Q1 the company only provides a trading update, thus it only reports data regarding revenue and gross profit, but has reiterated its guidance for the full year which is a positive sign. For 2023, it expects revenue growth between 6-8% (at constant currencies), an EBITDA margin about 48% and capex to be around £750 million (vs. £966 million in 2022). These positive expectations are supported both by the company’s integration gains from Refinitiv, and its recent 10-year partnership with Microsoft ( MSFT ) within its Data & Analytics division, to develop new offerings and improve LSEG’s platforms with Microsoft’s cloud and AI solutions.
This also means that free cash flow is expected to grow compared to the previous year, which is positive both for balance sheet deleverage and to provide an attractive shareholder remuneration policy.
While LSEG's balance sheet leverage increased considerably following the acquisition of Refinitiv, one of the company’s goals was to reduce leverage to a ratio of 1-2x net debt-to-EBITDA. This ratio was 0.3x at the end of 2020, and increased to 3.4x following the business combination, but after the Borsa Italiana divestment and due to its positive cash generation decreased rapidly to 1.6x at the end of 2022.
Therefore, LSEG is already at its desired medium-term leverage target, which means that further debt reduction is no longer a priority and can return a good part of its earnings to shareholders. Indeed, LSEG increased its annual dividend related to 2022 earnings by 13% YoY and started a £750 million share buyback program, showing that LSEG is clearly committed to providing an attractive shareholder remuneration policy. Despite that, at its current share price, LSEG’s dividend yield is only 1.25%, thus its income appeal is not particularly attractive and, according to analysts’ estimates , its dividend is expected to increase at mid-single digits over the next few years thus LSEG is not expected to become an income stock for the foreseeable future.
Conclusion
London Stock Exchange Group has an interesting business profile within the European financial sector, and its business strategy to shift away from capital markets to data & analytics seems to be a sensible move, providing it with a more recurring revenue and earnings profile over the long term.
This gives it relatively good growth prospects ahead, but not enough in my opinion to justify its current valuation, considering that LSEG is currently trading at 24x forward earnings. This premium valuation seems to be somewhat questionable and a strong reason why LSEG’s share price has been trading mostly sideways for the past three years.
Thus, while LSEG has good fundamentals and positive growth prospects, investors should wait for a better entry price, as the risk-reward at current levels doesn’t seem to be good enough.
For further details see:
London Stock Exchange Group: Good Company But Overvalued