Forrester Research (FORR) trades at a low relative valuation due to recent weakness in its Business Technology segment. However strength in the Marketing and Strategy segment, along with ongoing turnaround efforts and an increasing demand for technology research and advice, should result in improved financial performance in the intermediate-term. Investors are paid to wait by a shareholder friendly management through significant share repurchases and dividend increases.
FORR (started in 1983) provides technology-related research and advice to large companies (revenue >$1 billion) including senior management involved in strategy, marketing and IT. FORR generates revenue from licensing research, performing advisory services and consulting projects as well as hosting events. FORR has ~2,450 clients in 60 countries.
FORR is organized into two client and operating segments: Business Technology (BT) and Marketing and Strategy (M&S). The Events segment supports both client groups and provides clients an opportunity to meet with FORR analysts, network with peers and hear business leaders discuss business and technology issues.
The low relative valuation compared to its closest peer Gartner (IT) reflects the recent weak results and lower margins. This gap should narrow given the ongoing turnaround efforts, which should drive margin and EBITDA growth.
Investors should not ignore the multiple positive catalysts including a low capex requirement, stable recurring revenue driven by high renewal rates*, strong free cash flow (yield of ~7%) and a diversified client base (no single client company accounted for more than 2% of 2012 revenues).
Furthermore, the "asset light" business model, technology platform and research methodologies provide high operating leverage and position FORR for significant bottom line growth once underlying demand rebounds.
As the chart below shows, FORR deserves to trade at a lower multiple than Gartner and Survey Monkey due to the lower margins, however the size of the discount is unwarranted. For example, the EBITDA margin for FORR is only 2.7% lower (and temporarily depressed at that) yet the EBITDA multiple is 6x turns lower.
Although Survey Monkey is not a perfect competitor to FORR (its surveys do provide similar research though), the comparison highlights a critical point. The valuation for the former leaves almost no room for bad news while the latter arguably reflects only bad news and no possibility of good news and is therefore a lower risk investment.
*FORR discontinued its policy of offering all clients a service guarantee (e.g. right to cancel prior to the end of the contract term and receive a refund for unused products or services) in February 2013. This should increase revenue visibility even further.
Recent weak results mask ongoing turnaround efforts and multiple "green shoots"
In the mrq, revenue declined 1% as weakness in the BT and Events segments offset strength in the M&S segment. Operating income declined ~20% to $10.7 million as the margin fell 310 basis points to 13.7%. On the most recent conference call, management reduced the bookings forecast to the low single-digit range compared to the previous estimate of 8-10%. However, there are encouraging signs even during this challenging period including:
- FORR exceeded its pro forma operating margin and EPS guidance due to strength in the M&S segment, a 5.2% decline in discounting and aggressive cost controls. Moreover, strength in the Asia Pacific and North American markets offset weakness in Europe (although management reported an increasing retention rate).
- Management said it was unable to fully respond to increased demand in the M&S segment. This problem should be rectified in the intermediate-term as the dedicated project consulting group is expanded over the next two years.
- FORR began to realign the sales force in 2012 to increase productivity and simplify the sales process. Three previous client groups were collapsed into two. The direct sales resources now operate by geographic segment (e.g. North America, Europe, Asia Pacific) compared to customer revenue size. FORR plans to increase the sales force by ~10% in 2013. The near-term hit to earnings from severance payments and increased compensation for new hires should be viewed in context of the longer-term growth prospects.
- Client and dollar retention only declined 3% and 2%, respectively, from the year ago period. Moreover, dollar retention remained extremely high from an absolute standpoint at 89% and was 13% higher than client retention (see chart below).
Growing demand for technology research and advice to drive top line growth
There is a large and growing global opportunity to provide companies with objective and value-added research and advice. Furthermore, technology spending should continue to outpace GDP growth as companies seek to reduce costs and remain competitive by taking advantage of multiple long-term trends (see chart below).
Source: Company presentation
Since its founding 30 years ago, FORR completed seven acquisitions that helped expand its product and geographic profile. As a result, it can now grow organically by generating new business from existing clients as well as by gaining market share due to the low current market penetration.
Source: Company presentation
FORR has multiple competitive advantages including its strong customer relationships, long operating history, product depth and breadth as well as focus on emerging technologies.
For example, its continually refreshed data now cover more than 80% of global GDP and technology spending and provide business-to-customer and business-to-business clients insights on 1,400 brands and 300 attributes.
High shareholder yield rewards patient investors
FORR uses high free cash flow to reward shareholders in the form of regular dividends, special dividends and share repurchases.
In May 2013, FORR announced it repurchased ~$74 million of shares (~ 9.1% of outstanding) as part of a modified Dutch auction while no insiders tendered their shares. With its mrq results, FORR announced a $25 million increase in the current repurchase program, which brought the total available repurchase authorization to ~$80 million.
As the chart below shows, FORR has been slowly "going private" over the past five years. The increasing repurchases and high insider ownership provide a floor for the stock and should reassure investors during the turnaround period. This is probably why the stock has not declined more given the recent weak results.
Dependent on technology spending. FORR would be negatively affected by a decline in technology spending. For example, FORR recently experienced weakness in Europe due to lower economic growth and tighter company budgets.
The technology industry is subject to rapid change. FORR must continue to accurately anticipate and respond to rapidly changing market trends in order to maintain and attract client relationships.
Competition: FORR competes directly against other providers of research and advisory services (primarily Gartner). FORR competes indirectly against the internal planning and marketing staffs of its current and prospective clients, electronic and print publishing companies, survey-based general market research firms (such as Survey Monkey) and general business consulting firms. Moreover, FORR may face increased competition from internet-based research firms due to the relatively low barriers to entry. FORR faces competition in hiring and retaining professionals from direct and indirect competitors, which may result in increased compensation expenses or a loss of key employees.
The target price of $39.93 is based on a 12.5x EBITDA multiple. The stock should eventually grow into this valuation as the turnaround drives improving top and bottom line growth while overall increased demand for technology research and advice provides a growth tailwind.
The rising 200 DMA ~5.6% below provides a perfect place for a stop loss. The time frame is 12-24 months given the ongoing turnaround.