2023-07-10 04:44:53 ET
Summary
- TransUnion is a global consumer credit reporting agency.
- Revenue has grown at a CAGR of 13%, driven by both organic growth in market share, as well as inorganic expansion.
- Margins are strong, allowing the business to deleverage its balance sheet.
- TRU stock is trading at a discount to its peers and average trading multiple, suggesting an upside.
Investment thesis
Our current investment thesis is:
- TransUnion is one of the 3 largest companies in a monopolistic industry. It has high barriers to entry and gives TransUnion the ability to grow for an extended period through geographical and product expansion.
- Although we are hesitant about the most recent acquisitions, Management has a clear strategy to improve profitability. Execution so far has been strong.
- Market conditions will make FY23 tough but from there, strong growth should return.
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 has performed well over the last decade, returning over 150% to shareholders. Since reaching the company's all-time high, we have seen a sharp correction of almost 50%, reflecting a change in the credit landscape.
Financial analysis
Presented above is TransUnion's financial performance for the last decade.
Revenue
Revenue has grown at a CAGR of 13%, representing what has been a strong period of market share improvement for the business. Growth has been very consistent, with no down years and only 3 years with growth below 10%.
One of the primary reasons for this is the current industry dynamics, with 3 large players dominating the market (TransUnion alongside Experian ( OTCQX:EXPGF ) and Equifax ( EFX ). This allows these businesses to tacitly collude, driving up margins and building strong barriers to entry. Further, this has allowed each of these businesses to expand overseas unrivaled beyond themselves, giving a substantial runway for long-term growth. The question then becomes, is competition not fierce between these 3? Well of course, but there is enough market for all 3 to perform well. TransUnion achieved a 10Y growth rate of 13%, Equifax achieved 9%, and Experian achieved 3.4% (The largest of the 3).
The reason there is "enough market for all 3" is due to the expansion in debt across the last 2 decades. The following graph illustrates this, with both housing and non-housing debt on a consistent upward trajectory, outside of the GFC.
The key segments outside of housing look to be student loans and auto. TransUnion has seen resilience in both auto and cards while consumer lending has declined.
This development in credit expansion is also seen in other Western geographies, as well as developing nations, although closer to infancy. This has been a supportive driver of growth during difficult trading conditions in the West (Which we will explore later in this report).
TransUnion has also been active with inorganic growth, conducting M&A to expand its product offering. Neustar was acquired in 2021 for $3.1BN. Neustar is a "premier identity resolution company with leading solutions in Marketing, Fraud, and Communications, enables customers to build connected consumer experiences". This has been part of a strategy to become the go-to provider of identity solutions .
From a financial perspective, the acquisition has not been fantastic in our view. Although the growth is good, it is currently dilutive on an EBITDA basis, achieving an adjusted EBITDA margin of 26.5% for the year. This is compared to a 5 year average definitional EBITDA of 35%. Management is forecasting margin improvement through synergies to continue in the coming years.
Furthermore, Sontiq ( acquired in 2021 ) is an identity security business, which is growing at a better level but again is dilutive on a margins basis. This being said when integration costs are adjusted for, FY22 EBITDA-M is 38%, which suggests this business can be accretive going forward.
Finally, we have Argus ( acquired in 2022 ), both lacks strong growth and are worse for margins.
Despite the concerns we have around dilution, Management is happy with how these businesses are performing. This is clearly part of a wider strategy and so judging margins today is not wholly fair, but our view is that acquisitions should always be accretive, not dilutive. A company can theoretically buy profitable businesses and make a "gain" on them vs. the acquisition price over an extended period but this is not a good allocation of resources. Management has highlighted in its FY23 guidance that EBITDA margins will slip, primarily due to the impact of acquiring Argus.
Economic considerations
TransUnion is strongly impacted by changes in economic conditions, given the company is impacted by credit conditions. With heightened interest rates, lenders are far more careful with extending credit due to the default risk while many consumers are no longer eligible for debt. As a result, we have seen a slowdown in activity which reduces the demand for TransUnion's services.
Looking ahead, our current forecasts are for rates to remain at current levels for most of the year, before beginning to decline. The key will be how quickly inflation will fall, which so far has been slow.
Margin
TransUnion's margins have seen improvement, especially between FY12 and FY19, but have since declined. This is a reflection of a change in product mix, with dilutive acquisitions. On an absolute basis, they are still attractive but Management's number 1 objective should be improvement which looks to be the case. Should synergy and integration developments occur as expected, we could EBITDA-M approach 38-40%.
Q1 result
TransUnion's topline performance is strong, with organic growth and an improvement in margins. This suggests resilience during tough market conditions.
The consumer interactive segment has expectedly experienced a decline, with reduced demand for credit monitoring products. This will continue so long as rates deter lending activities.
US Markets have fared better, with a small level of organic growth achieved, although margins have slipped. As mentioned previously, this was driven by auto loans and cards, which we are surprised to see doing well.
Finally, the international segment continues to remain strong, generating healthy growth.
Balance sheet
TransUnion currently holds a substantial amount of debt, as the business has expanded aggressively. With a ND/EBITDA ratio of 4.3x, our view is that the company requires a period of deleveraging. Management concurs, intending to focus on repayments in the coming years. We believe 3x is a good level although given how acquisitive the company is, getting below this would be fantastic. For this reason, distributions are likely to be low in the coming years.
Outlook
Presented above is Management's forecast for the coming year. Growth is expected to materially slow, with current market conditions continuing to make trading difficult. This looks to be a reasonable estimate based on our current outlook, namely that consumer interactive and new loan activity will slow.
Conversely, presented above is Wall Street's view on the coming years.
Revenue is forecast to come in at the bottom of Management's range, suggesting analysts are less positive in the coming year. Following this, however, strong organic growth is forecast, continuing in a similar vein. We consider this a reasonable view, as once rates begin to decline, we will see activity increase and a normalization in market conditions.
Margin improvement is expected, although not to a substantial degree. This is likely due to analysts taking a conservative view on synergy achievement, waiting on hard evidence. Again, we concur with this view, although we believe margin improvement is a necessity given the dilutive acquisition.
Management's 2025 target looks optimistic, with >$5BN in revenue and an adjusted EBITDA margin of 40% (c.35% on a definitional basis). Analysts currently do not buy into this and neither do we, as the assumptions look aggressive. M&A is the wildcard but on the assumption of organic, it looks like a stretch.
Peer analysis
To judge TransUnion on a relative basis, we will compare the business to its key 2 peers.
TransUnion is outgrowing its peers, primarily due to the wider strategy of expansion. This outperformance is forecast to continue, both on a revenue and EBITDA basis.
Further, TransUnion performs well on growth, only marginally behind Equifax. Assuming the business achieves its forecasts, it would lead the pack. Due to noise below the line associated with M&A, it is difficult to directly compare NIM.
Valuation
On an EBITDA basis, TransUnion is trading at a discount to both Equifax and Experian, as well as its historical trading average (NTM 15.8x & LTM 19x). Markets are pricing in a tough year, alongside discounting for margin risk. Our view is that this is reasonable but looks priced in based on the most recent decline in share price. Analysts concur with this view, with a target upside of 7% ( Source: Tikr Terminal ).
Key risks with our thesis
The risks to our current thesis are:
- A difficult FY23 beyond what is already forecast. We have seen 18 down revisions in the last 3 months with Seeking Alpha rating the stock a D+. It is clearly difficult to assess where things will land but the key is to maintain positive growth.
- An inability to achieve margin expansion through synergies within the acquired businesses. Margin dilution is becoming a problem with investors quelled by the promise of future improvement beyond the company's peak. If this does not occur, we could see a rerating of the stock.
- TransUnion's debt burden remains elevated, which elevates risk but also reduces distributions which could offset downside issues.
Final thoughts
TransUnion has achieved impressive growth, through a combination of organic and inorganic growth. Margins remain strong regardless of dilution, with forecasts suggesting improvement is likely.
FY23 will likely be a difficult year but Management continue to forecast growth, which creates greater risk with investing now. Equally, if the year ends up in line with forecast, we could see positive price action as TransUnion returns to "business as usual".
Downside risk is minimized somewhat by the business trading at a deep discount to its peers, as well as its historical trading range.
For further details see:
TransUnion: Strong Margins And Undervalued