Dun & Bradstreet: No Durable Advantage, Increase in Revenues Over Past 5 Years

| About: Dun & (DNB)
Executive Summary:

Dun & Bradstreet (NYSE:DNB) is a good company with good cash flow from operations. It offers a competitive advantage, derived from its vast database of companies. However, the advantage is not durable, since its competitors are capable of developing similar products. Its revenues have not grown over the last 5 years, and do not bring profitability, even when they grow.

The debt situation is bad, and the company may struggle managing its working capital in the near future. It has negative equity, thus shareholders have a strong reason to stay away. In addition, the company continues to borrow money to repurchase shares, in order to increase the EPS. Lastly, the shares of D&B are not cheap. The company has a PE ratio of 16, and does not provide value when measured through the Gordon Growth model.

Competitive Advantage

Dun & Bradstreet is the world’s leading source of commercial information and insight on businesses. Their global commercial database contains more than 188 million business records, much more than that of any of its competitors.

D&B does have a monopoly in the business information market at this time because of the size of the offerings. However, the competition is tough. D&B competes with equally capable companies in the US, each with deep pockets. Its major competitors in the risk management business (credit ratings) are Equifax (NYSE:EFX) and Experian (OTCQX:EXPGF). The competitors in the sales & marketing arena are Experian and infoGROUP "infoUSA". In Europe and Asia, D&B's main competitors are Experian, and other local providers of information. The competitive advantage, thus, is due to the size of the database rather than the quality of the product. Such an advantage is not necessarily durable.

For example, Experian has a database of 40 million businesses. Thus far, Experian has focused more on the individual credit information business, but may direct its focus towards the business database in the future. Experian may decide in the future to invest in its business database and close in on the gap. Both Experian and Equifax have better cash balances, better profitability, and larger assets. Thus, the advantage that Dun & Bradstreet holds is only one dimensional.

In addition, the recent growth in revenue achieved by Dun & Bradstreet is not currently yielding high profits. This is because the costs of obtaining the data are sometimes higher than the revenue. If the situation were to change, more players would move in to capitalize on the opportunity.

The data D&B purchases is not exclusive, and any company with the right resources may purchase the same data, thus there is no exclusion of new entrants. To understand this better, let’s compare companies with exclusion built into their products, Coca Cola (NYSE:KO), Wrigley’s, etc. Thus, as long as a company can buy the same data and can create a CRM to streamline that data, it can compete with Dun & Bradstreet on quality. So, then, finally, to reiterate, the advantage has more to do with “I came here first” than any other durable reason.

Source of Revenue and Profits

Its major sources of revenue are the risk management business, sales and marketing, and supply management. Risk management solutions account for 62% of the total revenue. Sales and marketing account for 29% of the revenue.

The company draws most of its revenue from the North American market. However, this is a mature market with few opportunities for growth. For example, during 2010, revenue from sales & marketing fell 11% in North America, while that from risk management solutions fell 2%. In the last 4 years, total sales in North America have fallen 2.5% cumulatively. As a result, the company must innovate to grow. Having said that, D&B has a clear competitive advantage due to its larger database of global businesses, and the company is able to convert this advantage into large amounts of cash flow. The total revenue for 2010 was down 0.6%, while the Net Income was down 22%.

The other sources of revenue are foreign expansion. International revenue accounts for 25% of the total revenue. 60% of the international revenue is originated in Europe, but the competition is equally intense there, and the market is mature. Revenues fell 1.5% in Europe in 2010, after falling 13% in 2009. Asia/Pacific region is the dark horse for the company, with sales growing 31% in 2010, 70% in 2009, and 90% in 2008. Asia/Pacific region accounts for 40% of the total international revenue and 10% of the total company revenue, thus these increases have had little effect on the whole company. In addition, the profitability in Asia fluctuates wildly, due to higher expenses, as explained below.

The company’s operating margin has remained steady between 24% and 27%. However, the operating margin in North America is much higher at 40%. But revenue growth in North America is little or none, so this operating margin cannot sustain the company’s future profit margins. On the other hand, growing regions like Asia/Pacific have a much lower operating margin, between 4 and 12%. This clearly shows that growth in the future would not translate into equivalent profitability, unless the company manages to lower costs. It must also be noted that the company is focusing most of its attention on acquisitions in Asia/Pacific, for example the most recent one in Australia, at $209 million.

The company is thus left with two recourses to the problem of low growth. Either lower costs in the Asia/Pacific region, or innovate in the US. However, one way profitability would increase in Asia (in US Dollars) is if the currency exchange rates continued to turn against the US Dollar, a likely event. Conversely, if the US Dollar becomes strong again due to a recession, the company would be hit with a double whammy, where revenue from Asia would fall due to both the recession and lower exchange rates, while the revenue in the US would fall due to higher reliance on sales & marketing revenue.

One of the company’s most profitable innovations in recent times has been the DNBi online program. DNBi is an interactive, customizable online application that offers the customers access to the most complete and up to date business and risk management tools.

The company sees single digit price increases when existing customers renew their subscription plans, and double digit price increases when customers convert to DNBi. However, with more than half of their risk management solutions revenue derived from DNBi, the company has a much smaller base available for conversion in the future, thus eliminating a source of increased revenue. D&B is a market leader in the risk management solutions in the US.

Finally, it is difficult for D&B to increase its profits. There is little clarity on how the management can be certain of increased profits in the future.

Important Financial Data

The company offers a defined benefit plan to all its US based employees. The benefits to be paid upon retirement are based on a percentage of the employee’s annual compensation, and range from 3% to 12.5%. The company uses a discount rate of 8.25% to calculate its current pension costs. Every 0.25% change in the discount rate increases/decreases the Pension costs by $3m. The company has unfunded pension obligations to the tune of $431 million in 2010.

For the past decade, DNB has recognized restructuring charges of approximately $25 million each year. Restructuring charges are caused by changes in business plans and investment.

The company began a $200 million share repurchase program in December 2009. During the year ended 2010, D&B repurchased 1,108,148 shares at an average price of $73. $96.3 million of funding remains under the program, which the company plans to use by the end of 2011 to repurchase more shares. Large amounts of repurchases over the years have produced a deficit in the Shareholders Equity section. Treasury stock, as of 2010, stands at $2.2 billion, producing a deficit in Equity of $654 million.

The above has also led to a very high debt ratio, at 1.34. This means the shareholders would get nothing in the event of liquidation. In addition, it has caused the credit rating of the company to fall to A-. Amongst other debt, the company has used a $650 million, five-year bank revolving credit facility, which expires in April 2012. The company has used up $500m of that already. If the credit ratings fall further, the company would expect to see higher interest rates.

CFO is quite high, and the price/cash flow stands at 12.79. However, a large deficit in the Investing and Financing Cash flows has caused Cash balances to fall. The Current ratio of the company is 0.74, down from 1.1 in 2006. The Cash balances stood at $78 million, down 65% from the previous year’s levels. Working Capital stands at ($259 million).

Why Hold DNB?

  1. DNB carries the largest database of business related information. Their global commercial database contains more than 188 million business records. for example, Experian carries only 40 million business records. So, D&B definitely has a competitive advantage.
  2. Its risk management tool. DNBi is very popular and is holding up and tempering the otherwise slow risk management section of the revenue.
  3. Price to cash flows ratio is healthy at 12.79. This shows that the company is providing good value at the moment.
  4. The growth in revenue originating in the Asia/Pacific region is very high. Even though the profitability in that region is low at the moment, a decline in the value of the US Dollar can increase profits, in US Dollars.
Why Sell DNB?
  1. Little or no revenue growth in the US and in Europe. Dependence on Asia for future growth, but the Operating margin in Asia is too low. For example, revenue rose 9.8% in Asia in 2010, but the operating income fell 12%. Also, it is very difficult to increase sales in the North American region. Hence, at best, the profitability growth of the company would slow down, along with the growth in CFO. At worst, the company would see no growth in positive cash flows.
  2. Competition is very tough. Even though it carries a much larger database, both Equifax and Experian are in better financial positions, and have higher sales. They have the capability of growing their database records and competing in the future. Thus, D&B is not irreplaceable.
  3. The debt on the Balance sheet is too high, and the company has negative equity. The debt ratio is 1.34, with no sight of relaxation in these numbers. The company has unfunded pension liabilities worth $431 million. The credit rating is A-, but is likely to go down if the company does not manage its cash flows well. The company has resorted to the repurchase of shares, in order to increase the EPS. However, that continues to increase the debt. On this path, sooner or later, the ratings will decrease, thus increasing interest rates. The company's Current ratio has fallen from 1.1 in 2006 to .74 now. Even though CFO is high, Cash Flow from investing and financing are too far in the red and neutralize the positive effect.
  4. Sales and marketing constitutes 33% of the revenue in the North American region. The sales and marketing section of the revenue is highly volatile and fluctuates wildly with the business cycle. As a result, the company's profits can fall significantly during a recession.
  5. The company's stock price is too high based on the Gordon growth model. The current stock price is far above the intrinsic value produced by the model.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.