2023-06-05 05:23:38 ET
Summary
- London Stock Exchange Group (LSEG) has experienced strong growth in recent years, with a focus on M&A, data and analytics, and product development.
- LSEG's diversified business lines, monopolistic position, and innovative platforms allow it to adapt to changing market dynamics and capture new opportunities in the evolving financial ecosystem.
- Key risks to the investment thesis include global economic and geopolitical factors, and market volatility.
- The company recently announced a deal with Microsoft and continues to integrate Refinitiv, generating accretive returns.
- Revenue has grown at a CAGR of 25% and EBITDA is expected to increase from the current 46%.
Investment thesis
Our current investment thesis is:
- The Refinitiv transaction is developing as planned. Our expectation is for increased demand for data, product development, and cost synergies to generate financial improvement in the coming years.
- The outcome of the Microsoft partnership remains uncertain and to speculate now would be foolhardy. That said, at a minimum, LSEG will benefit from best-in-class backend operational capabilities.
- Capital Market & Post Trade remain on a growth trajectory, which we expect to continue. Uncertainty around the attractiveness of the UK could slow said growth, but the impact remains unclear, especially if LSEG continues to diversify internationally.
- LSEG has fantastic margins which we believe could improve further.
Company description
London Stock Exchange Group plc ( OTCPK:LNSTY ) (LDNXF) is a leading financial markets infrastructure and data provider. The company is organized into three main segments: Data & Analytics, Capital Markets, and Post Trade.
Data & Analytics segment offers a variety of information and data products, including indexes and benchmarks.
The Capital Markets segment of the company encompasses a wide range of markets, such as international equity, fixed income, and exchange-traded funds. These markets are accessed through platforms such as the London Stock Exchange, AIM, Turquoise, FXall, Matching, and Tradeweb.
In the Post Trade segment, LSEG provides essential services for clearing, risk management, capital optimization, and regulatory reporting.
Share price
LSEG's share price has generated strong gains in the last several years, riding impressive growth, both organic and inorganic, as well as the development of capital markets.
Financial analysis
LSEG Financial analysis (Tikr Terminal)
Presented above is LSEG's financial performance for the last decade.
Revenue
LSEG has grown revenue at a CAGR of 25%, representing an impressive period of expansion for the business. The company is in a monopolistic position in the UK, as well as its key international geographies. It has leveraged this to develop its product offering and expand its remit. Growth is distorted by the hefty Refinitiv acquisition, with consideration of c.$27bn paid.
Data and Analytics
Refinitiv
The Refinitiv transaction was fueled by LSEG's desire to expand its product offering, leveraging its deep expertise and brand value to achieve scale. This propelled LSEG into a leading position in the data and analytics industry, particularly in FX, a highly lucrative segment.
Key concerns for investors were the integration of the two businesses, as well as the expenditure required to modernize the business. The concern with Refinitiv's products was the lack of investment by its former owner, contributing to an uptick in Capex expenditure by LSEG in order to execute value enhancement. This looks to be yielding results, with the Data segment growing by c.4% in the most recent year. The success or failure of cultural integration remains to be seen but the development of integration costs looks positive. Since the acquisition, LSEG has continued to post exceptional costs, as synergistic benefits are realized. This is partially the reason for the margin decline in the current year. LSEG is currently forecasting £500-600m in exceptional costs in the coming year and an improved run-rate cost saving of c.£400m.
With such a large transaction, it is far too early to judge the success or failure of it. Investors were initially hesitant but thus far, developments look positive. Realistically, we must see where growth and margins land once a material portion of the synergies and Capex investment has been realized.
Microsoft agreement
The demand for data-driven insights has increased substantially in recent years, as technological development and operational complexity have contributed to a greater need for reliable analytics to support informed investment decisions.
Refinitiv is a leader here with its Workspace product but beyond this, LSEG has recently announced a partnership with Microsoft ( MSFT ). This will allow LSEG access to Microsoft's suite of products and capabilities, as a means of enhancing LSEG's infrastructure. The objective of this partnership is to "build intuitive next-generation productivity, data and analytics and modelling solutions". This does not look to be a novelty partnership either, with Microsoft taking a noticeable equity stake in the business as part of this. The current expectation of the partnership is:
- New product development contributes to a "meaningful" increase in revenue.
- Total incremental cash costs over between 23-25 of £250-300 million, including around £100 million in capex and a 50-100 basis points impact on EBITDA margin.
We are highly positive about this partnership. Infrastructure modernization is highly beneficial for most businesses, but more so for one which is focused on data analysis. The cash cost to the business is less impactful given the large cash generation, and the margin impact will be offset by Refinitiv synergy gains.
Regulatory Technology
Regulatory compliance is a complex and resource-intensive aspect of the financial industry. This has become increasingly costly due to changes in compliance regulations resulting in the cost of non-compliance being significantly higher. The adoption of RegTech solutions, such as automation, artificial intelligence, and machine learning, has seen a rapid rise in recent years as a means of streamlining a primitive industry. This is the perfect industry to expand into for LSEG, as its brand and client base (Many of the large banks, who are highly regulated and in need of such a service) positions the business perfectly to gain market share. From a financial perspective, LSEG receives recurring revenue at a low marginal cost due to the nature of tech-driven services. LSEG acquired GDC in 2022 to gain access to the market.
Capital Markets & Post Trade
The legacy/core LSEG business is its Capital Markets operations, alongside its Post Trade services.
Globalization and increasing cross-border investment are continuing to represent an area of opportunity for Western exchanges as international funds flow into what is perceived to be safer markets. This is becoming increasingly critical as growth shifts from the West to regions such as Asia, driven by China and India. LSEG has committed strategic resources to this across many avenues, one of which is its partnership with Chinese exchanges. The "Shanghai-London Stock Connect and Shenzhen-London Stock Connect" now allows :
- Foreign companies to list in China for the first time
- Companies listed on Shanghai Stock Exchange and Shenzhen Stock Exchange can, for the first time, raise capital abroad through instruments fungible with their domestic shares.
- Chinese investors can access international stocks from within China without being subject to domestic capital controls for the first time.
- The first time international investors can access A-shares from outside of China and through international trading and settlement practices.
This represents a fantastic opportunity for LSEG to develop a market-leading position in the dealing of Chinese securities. The interest in this announcement is partially muted by the steep decline in Chinese stock prices and the risk of delisting. We see this as a temporary headwind. Continued development in China will only draw further interest in its equities in the coming years.
The demand for capital market financing remains overarchingly strong, driven by the need to raise funds for expansion, mergers and acquisition opportunities, and other strategic initiatives. The London Stock Exchange is the 6th largest in the world , trumped only by the 2 main US exchanges, as well as the Tokyo, Shanghai, and HK exchanges. The size of the exchange is not just a reflection of the quality of UK businesses but also a reflection of the UK's commercial attractiveness relative to other nations (Legal and regulatory conditions). LSEG is the most international stock exchange, with over 3000 businesses across 70 countries.
Downside consideration
Although the demand for fundraising has been on an upward trajectory, we are seeing market hesitancy more recently. This is for two primary reasons.
Firstly, the UK is seen as less attractive than it once was, as investors demand the valuations seen in the US. For this reason, we are seeing an increasing number of British and International companies choosing to list in the US over the UK. This could contribute to a slowdown if this view persists.
Secondly, Global economic conditions and geopolitical events have turned negative. The war in Ukraine, the US and China's fight over semiconductors, the lifting of rates in the West for the first time since the GFC, and rampant inflation have all contributed to market uncertainty and a bear market. Although these are near-term headwinds, they remain concerning should there be long-term issues caused.
Margin
LSEG's margins are fantastic, with an EBITDA-M of 46% and a NIM of 17%. Across the historical period, we have seen EBITDA-M and NIM improve between FY14 to FY19. This is a reflection of Management's ability to optimize and benefit from its attractive monopolistic model.
These margins are highly valuable due to the company's impressive cash conversion. This allows LSEG the opportunity to continually fund growth, both organic and inorganic. Further, with investment in scale, LSEG can support rapidly increasing distributions.
With the Refinitiv integration in full swing, margin improvement is still in progress. In order for this transaction to be a holistic success, we would like to see NIM return to its pre-acquisition level of c.20%. This said, increased data services certainly have scope for generating margin improvement given the recurring and low-cost nature.
Balance sheet
Despite the large transaction, LSEG remains conservatively financed, with a ND/EBITDA ratio of 1.9x. This gives the company flexibility to conduct further M&A where opportunities present themselves.
Historically, LSEG's distributions have come in the form of dividends, with payments increasing at a 23% rate annually. This has been supplemented by buybacks in the most recent year, as cash generation has substantially increased. We believe these levels are defensible.
Outlook
Wall Street outlook (Tikr Terminal)
Presented above is Wall Street's consensus view on the coming 5 years.
Analysts are forecasting revenue growth of 4% in the coming 4 years, which we believe to be conservative. Given the inability be accurately forecast M&A, we understand the underlying assumptions. This said, we expect M&A to support growth closer to an annualized rate of 5-10% over a 5-10 year period.
Margins are expected to noticeably improve, with NIM reaching 25% by FY26. This implies belief in Management's current execution of its Refinitiv integration, as well as improvement in its product allowing for an increase in GPM.
Valuation
LSEG valuation (Tikr Terminal)
LSEG is currently trading at 24x its NTM earnings. This represents a c.20% premium on its historical average multiple.
The premium is warranted in our view. The business is substantially more diversified, reducing the cyclical risks that come with exposure to capital markets. Further, we believe the data industry to be attractive, with growth potential and scope for margin improvement.
Final thoughts
LSEG is a highly attractive business. The company has achieved high growth through acquisitions supplementing its monopolistic position over UK capital markets. Margins are high and defensible, with improvement in the coming years possible. Looking ahead, we believe further improvement will stem from a consolidation process, with a focus on cost optimization and product improvement. M&A will likely supplement this, allowing further growth.
For further details see:
London Stock Exchange Group: International Financial Behemoth With Impressive Margins