2023-10-27 11:56:19 ET
Summary
- TransUnion is seeing its quarterly financial performance materially slow in line with economic conditions, contributing to a share price decline of over 35% in the last few weeks.
- Investors are afraid of a material decline in economic conditions, with debt origination slowing, consumer spending looking shaky, and inflation remaining stubborn.
- We believe the fundamentals of the company remain strong and investors are purely spooked. This said, there is near-term pain ahead.
- TransUnion is outperforming its peers and developing its business model well. It has overpaid for acquisitions and seen margin dilution, but it does not mean its future has issues. The company has built an impressive competitive advantage.
- TransUnion, a broadly low-risk investment over the long term, is trading at a NTM FCF yield of ~7%. We consider this a fantastic opportunity at a time when investors are petrified.
Investment thesis
Our current investment thesis is:
- When we first covered TransUnion (TRU), we rated the stock a buy. Although we had reservations ( discussed later ), we felt its competitive positioning and diverse offering were sufficient long-term to offset any immediate concerns. The company is one of three undisputed leaders in a monopolistic industry that's critical to global services, positioning it for healthy long-term growth with substantial margins. Despite a dramatic few weeks, with changing forward outlooks, we fundamentally hold the same view.
- The company's business model remains extremely strong, with high barriers to entry within its industries and several well-regarded brands. It has exposure to growth in emerging markets, while having a monopolistic core offering that can only grow well long term due to its importance in modern-day society.
- Markets are terrified of a recession, a debt crisis, and consumer spending falling off a cliff. Although all these factors remain a risk, TransUnion continues to grow well, GDP growth remains positive, inflation is slowly declining in key geographies, and unemployment remains low. We see near-term pain but nothing that will hurt this company in five years.
- Management is addressing investors' concerns and can use this time while sentiment is low. At a FCF yield of ~7%, however, we think markets will very quickly catch on to this bargain.
Company description
TransUnion ((TRU)) is a global consumer credit reporting agency that provides risk and information solutions. It has three segments:
- U.S. markets segment offers consumer reports, actionable insights, and analytic services to businesses.
- International segment provides credit reports, analytics, technology solutions, and other risk management services to customers in various industries.
- Consumer Interactive segment provides credit reports, scores, monitoring, identity protection, and financial management solutions to consumers through online and mobile interfaces.
Share price
TransUnion's share price response to its most recent quarter has been substantial, with a ~35% decline in the last month. Investors are turning bearish again, following a period of uncertainty, particularly with certain financial services stocks linked to consumer spending (Worldline decline >50%).
Financial analysis
Presented above are TransUnion's quarterly results.
Recent performance
TransUnion's recent performance has not been as poor as its share price response may suggest, with top-line revenue growth of +14.2%, +2.1%, +2.1%, and +3.3% . In conjunction with this, its margins have continued to decline, which is a wider issue but not necessarily directly linked to its revenue issue ( Discussed later ).
The company's revenue slowdown is a reflection of the wider macroeconomic environment. We must first highlight how uncertain the outlook is - we went from a guaranteed near-term recession in the West, to likely avoiding a recession, to discussions again of a potential recession. This is important to understand as investors can only respond to the consensus outlook. So as this develops and changes, markets move in a volatile fashion.
The issue is that in order to control inflation, the actions being taken are negatively compounding consumers, while inflation itself is causing issues. The cost of living has soared, and although wages have done well to follow and unemployment remains low, consumers are still struggling. This can only happen for so long before resilient demand falters. Consumers already have cut back on large-ticket purchases and many high-discretionary segments, although their resiliency in other spending has been one of the primary reasons for inflation stickiness. US GDP growth in Q3 was 4.9% and ahead of forecast, principally due to consumer spending, inventory levels rising (in response to the first and the holiday period), as well as government spending.
We believe cracks are beginning to show, particularly as price increases by businesses will need to subside as supply-side inflation declines. Markets currently are pricing US rates to remain flat, with the Bank of England and ECB following suit. Investor sentiment is responding harshly in response. Looking ahead, we struggle to see how a continued sequential step-down is avoided, with sentiment primed to worsen if the holiday period is weak. This is not to say a recession is certain, although much will rest on if we see interest rate hikes and the subsequent knock-on effect on consumer spending and the housing market.
The following are key takeaways from Management's communications in its most recent quarter:
- Management stated " TransUnion executed well against weakening lending and marketing activity over the course of the quarter " which is how we see it, also. market conditions are weighing heavily to outlook rather than results. Management has shot itself in the foot by guiding low in its first two quarters and exceeding, while now slightly underperforming.
- This said, it's worth highlighting that management is seeing a softening across several markets, most notably of which is the U.S. and the U.K.
- Demand for credit services remains strong, with issues being tighter lending standards and capital constraints.
- Management is executing against its growth strategy, benefiting from its current focus on innovation and increasing its services suite, diversifying its business model away from its core offering.
- TransUnion announced a strategic partnership and minority investment in Truework, which provides a one-stop platform for VOIE information while also giving consumers greater control of their personal and financial information. This further expands its capabilities within its sphere of expertise.
US
The US segment is seeing its core business weighing heavily, although growth continues to be strong from its Emerging Verticals. This now represents almost 50% of TransUnion's revenue, positioning the company well for less cyclical demand in the future.
Consumer Interactive
Further, weakness in the consumer segment is reflected in its Interactive segment, with a decline of (3)% on an organic basis. Although this is concerning, margins remain strong.
International
Many of TransUnion's core International markets are doing well, namely APAC (+13%) and India (+26%), attributable to superior economic conditions and emerging growth. TransUnion has strategically expanded its business in these regions to safeguard its future growth story as economic development shifts to Asia.
The issue for TransUnion is that the UK is mild, primarily due to FX but also a wider slowdown that appears to be felt in the US as well. In relation to this, TransUnion took a ~$495m impairment charge against its UK business, which is the reason for its negative NI. We fundamentally think the UK market will be fine. It's similar to the US, with a culture of elevated consumer debt usage, high investment, and high consumer spending. These lend well to TransUnion's business model. Near term, however, we suspect the entirety of the West to experience weaker credit development.
Neustar acquisition progress
TransUnion acquired Neustar in 2021, with reasonable progress since then. We criticized this acquisition in our prior analysis, primarily due to it being margin-eroding ( discussed later ). From a business development perspective, however, we are seeing strong progress. Revenue growth continues to outperform the wider business (+7%), with strong subscription growth, driven by both new bookings and renewals. Management believes the pipeline remains healthy, although suspect a slowdown is ahead to MSD.
Overarchingly, we do not see any fundamental cause for concern in its quarterly results. We see near-term headwinds and a slowdown, not a capitulation.
Fourth quarter guidance
With the economic weakness being felt, management is remaining aligned to its more recent organic trajectory, forecasting 2%-3% organic revenue growth, with a ~2ppt mortgage impact to uplift this. In conjunction with this, EBITDA is expected to decline (2)%-(6)%.
These assumptions are clearly more bearish than prior guidance, which we prefer given the market uncertainty. It's extremely difficult to provide forward guidance, however, we consider these levels to be broadly appropriate. Neustar and particular Emerging markets will drive the majority of its positive growth, with reasonable expectations for the West to remain resilient. The key is whether we see a material divergence to historical levels during the holiday season, which has the potential to spook investors.
Margins
TransUnion's margin development in recent years has been poor. The company has experienced consistent dilution, principally due to dilutive acquisitions (Neustar being one). Management is convinced that its strategy is the correct one, namely growth into related sectors, supported by acquisitions with synergistic potential. Although we concur with this approach, we believe management has made two key errors in this approach:
- Oversold synergies - We believe the company has been far too aggressive with its synergy assumptions. Neustar's margins are not developing as expected and continue to dilute its core business.
- Overpaying - As the ROE above illustrates, management has not accretively acquired businesses. This again is partially due to synergies not materializing but also the belief that there would be sufficient scope for cross-selling and shared benefits.
We suspect margin improvement will be realized, as management turns focus to justifying this capital allocation through operational improvements. This said, we struggle to see EBITDA-M returning to the ~36% levels seen historically.
Balance Sheet and Cash Flows
TransUnion's aggressive M&A strategy is beginning to bite, with interest comprising 8% of revenue and coverage of only 4.3x. This is not an unusual position for the company, but the difference is now, growth is not in the double-digits. Management's response has been to deleverage, which we suspect will need to continue for the coming 1-3 years.
We are not overly concerned by this, primarily due to TransUnion's strong FCF. The business has shown a consistent ability to generate a FCF margin in the high teens, which will return following a WC unwind from its depressed ~9% level.
Our biggest issue with this company is its M&A execution, which we highlighted previously. This is a fantastic business which we hope Management will now focus on optimizing (next 3-5 years), rather than seeking the next large-cap deal.
Outlook
Presented above is Wall Street's consensus view on the coming years.
Analysts are forecasting a continuation of its strong organic trajectory, with a CAGR of +6% into FY27F. In conjunction with this, margins are expected to exceed FY22 levels from FY25F onward.
These assumptions appear extremely sensible in our view. TransUnion is fundamentally extremely strong and we like its diversification and wider business development (new services, introduction of subscription-based services, emerging market exposure, etc.). We see minimal risk in the continued execution given its good platform.
Margin improvement also appears reasonable given the renewed focus by management. We suspect M&A will slow and so greater focus will be turned to optimization. An adjusted EBITDA-M of 36.5% in FY25F represents a definitional EBITDA-M of ~32.5%, which is fantastic relative to its peak of ~36% (when you appreciate that irreversible mistakes have been made and growth has at least been good).
Industry analysis
Presented above is a comparison of TransUnion's growth and profitability to the average of its industry, as defined by Seeking Alpha (31 companies).
TransUnion is performing exceptionally well relative to its peers. The company has exceeded the average growth of this industry, despite its mature level. This is attributable to acquisitions principally, but also a healthy organic trajectory. Prior to the economic slowdown, TransUnion's organic growth was comparable. Its outperformance is expected to slow in the forecast period, owing to its exposure to credit.
TransUnion's primary strength is its margins. The company has double the EBITDA-M of its peers, while on a normalized basis would also have comfortably outperformed on a NIM level. This is a reflection of its strong competitive position ( which we discuss in detail in our prior analysis ). The company's monopolistic position is not expected to be challenged ( The big three have carved the world up and have neutral competition in shared markets ).
Valuation
TransUnion is currently trading at 12x LTM EBITDA and 10x NTM EBITDA. This is a premium to its historical average.
A discount to its historical average is warranted in our view, owing to the margin dilution experienced and inefficient capital allocation, as well as the near-term economic conditions faced. As long-term investors, we do not believe the weighting toward the near-term should be high (although this is a personal decision), and so we consider this discount to be unjustified. Once economic conditions improve, which they inevitably will, TransUnion will continue to be the incredible, monopolistic business that it is, returning to MSD/HSD growth with >30% EBITDA-M.
Further, TransUnion is trading at a ~89% LTM EBITDA discount and a ~56% NTM P/E discount. This is undeniably unjustified. Markets are heavily punishing the company for what it perceives to be a negative market outlook. We conceded that the bottom is likely ahead but this is not fundamentally "damaging" TransUnion. It's not losing market share and it's not being forced to turn defensive (such as making redundancies and closing divisions). The business will ride this downturn just fine.
Confirming our view we feel is its FCF yield, which has almost doubled to 7.1%. Our view is that most of the companies trading above ~5% are usually far too risky (weak business model, etc.), heavily cyclical (high growth, substantial declines), or niche/small (commodities, lack of scalability, etc.). TransUnion is not any of these. There's minimal risk to its business model and competitive position. It's cyclical to an extent but still growing and diversifying, and its cash flows lack volatility.
Following a period of deleveraging, FCF can be directed to shareholders through buybacks and dividends. This is likely why Wall St. analysts see upside of 51%.
Key risks with our thesis
The risks to our current thesis are:
- Financial crisis.
- Collapse in consumer demand.
- Extended period of heightened interest rates.
- Negative legislative changes in Emerging markets.
- Slowdown in the growth rate of acquisitions below the wider firm's average.
Final thoughts
TransUnion is clearly facing near-term headwinds, with management not doing itself any favors with its capital allocation strategy in recent years. This said, we do not think this is a broken business or even one with cracks. Despite this, investors are pricing the company for a fundamental change in its financial profile, which appears wrong to us.
We have not discussed its business model in detail, but would like to highlight that there are certainly improvements that we would like to see from management, including pausing M&A, deleveraging, focusing on optimization, and greater M&A disclosure so as to allow for routinization.
We were early with our buy rating previously, and regarding a "bottom," are likely early now. TransUnion likely faces another two quarters, at least, of similar flat growth / small decline. This said, we fundamentally do not see a change to its long-term trajectory, so long as there is no change to that of the nations it materially serves (US, UK, India, etc.).
At an FCF yield of ~7% and a >50% discount to its peers, we believe this is one of the best opportunities in the market. We would suggest incrementally building a position so as to reduce near-term timing risk given the uncertainty ahead.
For further details see:
TransUnion: 35% Collapse In Share Price Presents Once In A Lifetime Bargain