The IPO market is carrying its post-labor day momentum into autumn with four U.S. listed deals slated to price this week, including two of the largest proposed domestic offerings since Visa’s (V) landmark IPO in March 2008. Banco Santander Brasil (BSBR), a carve-out of the Spanish banking giant and the fourth-largest bank in Brazil, plans to float $6.7 billion worth of ADRs on the NYSE on Oct. 6. Our featured IPO for the week, risk management specialist Verisk Analytics, expects to raise $1.7 billion on the same day by offering 85.3 million shares at a range of $19-$21. BofA Merrill Lynch (BAC) and Morgan Stanley (MS) are the joint book runners on the deal, and shares are expected to begin trading Wednesday on the NYSE under the ticker VRSK.
A highly profitable former nonprofit
Formed in 1971 as a nonprofit association of U.S. property and casualty (P&C) insurers, Verisk Analytics’ predecessor was originally responsible for gathering data from its members to meet state-level reporting regulations. However, access to a broad stream of P&C industry data enabled the organization to build out value-added products that make up the core of its business today, including standardized policy language, proprietary risk classifications and actuarial loss estimates.
Then called Insurance Services Office, Verisk successfully converted to a for-profit enterprise in the late ‘90s, but its turnkey solutions continue to serve as P&C industry standards. Over the past decade, the company has grown its data assets and expanded the scope of its analytics capabilities to the mortgage and healthcare industry verticals through a series of tuck-in acquisitions. As a result, its revenues have grown at a 13% CAGR over the past five years and are projected to exceed $1 billion in 2009, with a 34% operating margin.
A “premium” cash generator
Counting each of the top 100 U.S. P&C insurers as customers, this industry leader generates 52% of its revenues (over 99% recurring) from a suite of deep-rooted P&C services that dates back to the company’s nonprofit days. Management believes this extensive P&C insurer installed base represents more than $400 million in cross selling opportunities for the newer fraud detection, risk modeling and loss estimate solutions that make up its decision analytics segment (48% of revenues). Overall, Verisk targets 10-12% annual organic growth, led by 13-15% growth in the decision analytics segment, which is gaining traction in mortgage and healthcare industry applications.
Verisk maintains an impressive 98% renewal rate across all lines of business, and 72% of its revenues are booked via prepaid subscription. Given the company’s scale and efficient technology platform, this translates to attractive and stable free cash flows (27% LTM margin) which should ramp in-line, if not ahead of revenues, thanks to the model’s limited capex requirements.
Although the company has been a highly profitable cash flow machine, all the equity has been stripped out of its balance sheet via $1.8 billion in share repurchases over the course of its history. Insiders and executives have collected $764 million in buybacks since the beginning of 2006 alone, yet they will pocket 100% of the $1.7 billion in proceeds from the IPO. The motivation for the offering is clearly to provide liquidity for key shareholders (and customers) including The Travelers Companies (TRV), CNA Financial (CNA), American Financial (AFG) and AIG. As such, IPO investors are buying a moderately leveraged company (1.3x trailing operating cash flow) with negative shareholders’ equity, though the huge cash flow generation potential and low capital intensity of the business makes capital structure less of a concern. Finally, Verisk does not directly own the information in its databases, relying instead on customers and third party suppliers for low-cost access to data.
Crunching the numbers
Verisk’s high renewal rates reflect the deeply-embedded nature of its risk management solutions, particularly in the P&C insurance industry, where its products are entrenched as industry standards. A long-tenured management team and a scalable technology platform have produced an impressive track record of profitability, and margins should scale nicely as the company deploys new solutions over its existing infrastructure. While we would rather see a portion of the IPO proceeds end up on the balance sheet, we believe the insider selling reflects more on the liquidity needs of Verisk’s insurance industry shareholders than it does on the long-term prospects of the business. The muted performance of recent IPOs Select Medical (SEM), Shanda Games (GAME) and Artio Global Investors (ART) serves as a reminder that deals need to be priced right to deliver positive initial returns in a healing IPO market. That said, we believe Verisk is being valued at an attractive discount to its data solutions peers (10x EV-to-2010-EBITDA versus 12x for key peers), which positions it for a strong debut.