Markit Ltd. (MRKT) Q4 2015 Earnings Conference Call February 10, 2016 8:30 AM ET
Matthew Kolby - Head of Investor Relations
Lance Uggla - Chief Executive Officer and Chairman of the Board
Jeff Gooch - Chief Financial Officer
Toni Kaplan - Morgan Stanley & Co. LLC
Paul Ginocchio - Deutsche Bank Securities Inc.
Manav Patnaik - Barclays Capital Inc.
David Chu - Bank of America Merrill Lynch
Andrew Steinerman - J.P. Morgan Securities LLC
Joseph Foresi - Cantor Fitzgerald
Vincent Hung - Autonomous Research LLP
Alex Kramm - UBS Securities LLC
Andre Benjamin - Goldman Sachs & Company, Inc.
Gerald Bisbee - RBC Capital Markets Wealth Management
Welcome to the Markit Fourth Quarter and Full Year 2015 Financial Results Conference Call. My name is Ellen and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.
I will now turn the call over to Matthew Kolby, Head of Investor Relations. Mr. Kolby, you may begin.
Thank you, Ellen. Welcome to Markit’s earnings conference call to discuss our results for the fourth quarter and full year 2015. With me today is Lance Uggla, Founder and Chief Executive Officer; and Jeff Gooch, our Chief Financial Officer.
We’re excited to do the call from our Head Office in London today for the first time. And we’re looking forward to meeting investors here in the UK over the next few days. As usual, Lance will begin by walking through some key highlights during the quarter, and Jeff will cover our financial performance in greater detail before we open up the call for Q&A.
As a reminder, call is being webcast and a replay will be available later today on Investor Relations section of the Markit website. The press release and supporting documents can also be found on our website.
Before we get started, I’d like to remind you that the call may include certain forward-looking statements based on our current expectations. Actual results could differ materially from those implied or expressed by our comments today. Information about the factors that can affect our future performance or events is summarized at the end of our press release, as well as contained in our recent SEC filings, including our Annual Report on Form 20-F.
The call may also include certain forward-looking non-IFRS financial measures. A reconciliation of such measures to the most directly comparable IFRS financial measures is not available without unreasonable effort.
And now, I’ll turn it over to Lance.
Thanks, Matt. Well setup. Good morning, everybody, and thank you for joining us on our fourth quarter and full-year 2015 earnings call. So let’s get started.
2015 was our first full-year as a public company and I want to tell you what we did. So we invested across our businesses, strengthened our management team, launched products in all three divisions, announced four acquisitions, built stronger relationships with our customers and partners, and additionally, generated shareholder value through effective capital management.
When I look at what we’ve accomplished this year - last year, sorry, I am confident it puts us in a strong position as we go into 2016. So let’s get into some of those details. First off, I want to talk about financial performance. Overall, our 3.6% organic revenue growth for 2015 was not as strong as we would have liked and is below our trends for the past three years.
Despite this result and the current market environment that may drag to the next few quarters. I am confident that we are well positioned to meet our long-term objective of 5% to 7% organic revenue growth.
The second objective we always give you is double-digit growth with acquisitions. And I have to say that with four 2015 acquisitions and our current pipeline, we are well-positioned to achieve this objective. And third, we’ll continue to be vigilant on costs as we were in 2015.
Since we have now seen a full year of public company costs and have successfully managed our expenses across divisions, especially in Processing. We are moving up our long-term objective for adjusted EBITDA margin to the mid-40s, which we believe we are well-positioned to meet.
From a capital management perspective, I’d like to announce today that earlier this month our board approved $500 million of additional share buybacks over the next two years. Even before this, we believe the combination of revenue growth, acquisitions, cost control and disciplined capital management puts us in a good position to return to DEPS growth in 2016 from our $1.44 level in 2015.
Jeff, will get into the detail on these results, but it’s important for you to know that the long-term financial objectives we have laid out are firmly in place as we head into 2016.
Switching now to people, a key competitive advantage for us is the breadth and depth in our management team. This year we strengthened our team through recruitment, acquisition, as well as promotion. Ranjit Moses and Yaacov Mutnikas joined us as external hires, Chief Marketing Officer and Head of Analytics in Cohead of Solutions respectively. Rob Flatley joined us through the acquisition of CoreOne. And we promoted both Sarah Bateman to Global Head of HR; and Sari Granat, General Counsel; as Adam Kansler moved to Cohead our Information division.
This demonstrates our ability to attract talent as well as promote from within the firm, developing depth in our bench and our increasingly diverse team.
Moving to Products, we’re highly focused on developing products in order to generate organic growth. Some of those that we have talked about through the year have made significant progress including KY3P, which is our third-party risk management platform; KYC, which is our client on-boarding platform; Credit Manager that allows loan market participants, including the growing direct lending segment to select and manage the credit exposures; and finally, our private equity valuation service, which last year grew to over 90 customers.
There has also been a lot of activity in 2015 in and around the global index market. Ever since our IPO, we have been talking about the exciting opportunities in the index space, but couldn’t give you many details, other than announcing the Halifax House Price Index, which we did in March last year. However, we can now share with you many of the things we are working on last year.
First, on January 15, we announced the HSBC have transferred their market leading Asian bond indices to us and we launched three successor indices, which are being well received by our customers, who are eager for our independence and expertise in this domain.
Second, we have always said to you that besides acquisitions there are exciting opportunities to administer and calculate third-party indices. And on January 20, we announced that market has been chosen to be UBS’s calculation agent for their investible indices.
And third, on February 8, just the other day, we announced the launch of iRxx, a new tradable emerging markets interest rate swap index that we have been working on with our customers, three great business developments that expand our index capabilities.
Separately, we are spending a lot of time looking at how new technologies can help build our business, blockchain is one area where we have been very engaged, and also is the keen focus of our industry.
Here we’ve been working with our customers in taking the central role in blockchain projects in both loans and derivative processing. We are in active test mode here and we’ll continue to update you as we go forward with respect to new technologies that can enhance our market position.
On the sales side in 2015, we successfully leveraged our new account management structure to deepen our customer relationships. We are now better positioned globally to cover accounts effectively and build pipeline across the firm. I’ve held a lot of meetings with customers over the past two months with our account managers and it’s clear from their relationships that the focus on understanding and solving the needs of our customers is working really well.
When I look forward into 2016 we see it being similar in a lot of ways to the past several years. We’ll see more regulation being implemented and costs being taken out of the industry. Three big regulatory initiatives that we focused on in 2016 will be the fundamental review of the trading book, Solvency II and Mifid II.
We remain well-positioned to help the industry comply with regulation and provide much needed cost reducing solutions.
Finally, let me talk about acquisitions.
We had a good year for acquisitions in 2015, announcing the Halifax House Price Index, Information Mosaic, DealHub and CoreOne Technologies. And we’re already seeing examples of revenue synergies coming through. We see a similar year in 2016 and we started off the year with the acquisition of DTCC’s Loan/SERV technology assets and this month’s system integration technology developed by J.P. Morgan.
Neither of these are large transactions, but they continue to position Markit as the leading service provider in the global loan market, as we seek to drive greater efficiencies. The overall pipeline for acquisitions is strong and we see a lot of opportunities. You should expect to see other acquisition announcements through 2016 as we focus on growing our business to meet our customers’ needs.
To close, I want to reaffirm our long-term objectives for 5% to 7% organic revenue growth, double-digit revenue growth with acquisitions, and as we focus on costs, adjusted EBITDA margins in the mid-40s. We’ll continue to manage our capital structure to support diluted earnings per share growth. I’ve great confidence in the Markit team on delivering this for our shareholders.
Now, I’ll hand it over to Jeff, who will take you through our financial performance in greater detail.
Right. Thanks, Lance, and good morning, everyone. I’ll now walk you through a summary of our fourth quarter and full-year results on Slide 7.
In Q4, reported revenues grew 7.4% or 9.4% on a constant currency basis. Adjusted EBITDA with $132 million for the quarter, up 5.7% year over year, with strong margins at 45.6%. Adjusted earnings was $69 million, down slightly year over year, primarily as a result of higher interest expense in the quarter associated with our increased leverage and debt turnout.
The adjusted earnings expected tax rate came in slightly above our expected range at 29.1%, due to true-ups as we finalized our 2014 tax returns. Adjusted earnings per share for the quarter was $0.37, bringing us to $1.44 for the full year.
Finally, diluted share count was 188 million shares in the Q4 and approximately 190 million for the full-year. We believe these numbers show the success of our capital management strategy in terms of managing diluted share count. I’ll talk a little bit more about this on a later slide.
On Slide 8, organic revenue growth is 1.1% for the quarter, bringing us to 3.6% for the full year. The organic growth rate for the quarter is primarily driven by tough comparators for Processing and Solutions. The acquisitions we announced in 2015, Halifax House Price Index, Information Mosaic, DealHub and CoreOne, delivered a combined 8.3% of revenue growth in the quarter.
Lastly, FX movements adversely affected the quarter reducing revenue growth by 2% primarily due to a strengthened U.S. dollar against sterling and the euro.
We discussed last quarter our presentation of acquired revenue growth and bringing our methodology in line with our peers. Starting from Q1 2016, revenue from new acquisitions will be treated as acquired for the first 12 months only.
Few of you asked more information on how this change would reflect at our historic results, so we provided a table in the appendix. The slide shows the impact in 2014 would have been minimum and in 2015 it would have increased our organic growth rate to 4.1%.
As you can see on Slide 9, we continue to maintain total recurring revenues above 90%. Recurring fixed revenues for the quarter grew to 58.2% from 53.8% last year due to both new business and acquisitions.
As expected, recurring variable revenues were down year over year, due to the decline in Processing revenue. Non-recurring revenues grew from 5.3% to 7.7%, primarily due to new business wins across Solutions and the acquisitions of Information Mosaic and CoreOne. Renewal rates for Q4 remain steady at approximately 90%, in line with prior quarters.
Turning now to Slide 10, I’ll discuss operating expenses. Q4 operating expenses increased 11.6% compared to the prior year. This is largely driven by acquisitions in addition to continued investment in product development, was partially mitigated by movements in foreign exchange. Overall expense growth for the year was 5.5%, enabling us to maintain strong margins.
Now, let’s move on to talking about our operating segments in more detail.
Information organic revenue growth was 4.7% in the fourth quarter, bringing the full year to 5.2%. Q4 and full year performance was largely driven by solid growth across our fixed income pricing data and indices products. I’m particularly pleased with our bond pricing business, which helped had another strong quarter, growing almost 25% year over year.
In addition, loan pricing grew due to increased participation in the asset class. Indices continue to show double-digit organic growth this quarter, as we saw new business wins and AUM inflows into ETFs. iBoxx based ETFs grew 15% this year to over $90 billion.
Our PMI franchise also showed solid growth following the new sponsorship agreements earlier in the year, and increased geographic and industry coverage. We remain bullish about the index business. And as Lance mentioned, we’ve recently announced deals with two of the largest global banks. In addition this week, we announced the launch of iRxx, a new emerging markets interest rate swap index.
Adjusted EBITDA margin continue to be strong at 49.6% for the quarter.
Let’s turn to Processing on Slide 12. Organic revenue declined 14.7% in Q4, bringing the full-year organic revenue decline to 8.2%. Derivatives processing continue to see strong volume growth in our rates business, driven by overall market volatility. However, revenue continues to be offset by price changes and adverse FX movements.
In credit derivatives, market consolidation continued to lead to weaker volumes as we have seen throughout the year. The year-over-year comparison was significantly impacted by the one-off reporting revenues of $3.6 million in Q4 last year.
Looking forward to 2016 for our rates and credit business, we expect both of these volume trends to continue. In loan processing, secondary volumes were maintained at last year strong levels. As expected, primary issuance volumes were down year over year, due to regulations and the overall risk of market environment. We do not anticipate a significant bounce back of primary market for loans in 2016.
We continue to focus on growing our FX business and DealHub in integrating well.
Lastly, we delivered solid margin of 51.7% in the quarter, bringing us to 52.3% for the year. Margin improvement was a result of our continued focus on cost savings, which remains a priority for 2016.
Looking ahead, with Mifid II implementation in European increasingly looking as it’s going to be delayed until 2018 at least, we now anticipate that the impact of electronic trading and clearing will be spread over number of years and hence less significant to our annual results going forward.
Let’s move on now to Solutions. Organic revenue growth with 9% in Q4, bringing full-year organic revenue growth to 12.3%. As I highlighted in the last call, this lower quarterly growth rate was primarily caused by the first time recognition of KYC revenue in Q4 2014.
Looking at our three biggest businesses, we saw strong performance across the board.
First, On Demand continued to show solid revenue growth consistent with prior quarters. Second, EDM had an outstanding close to the year, almost 30% growth for the quarter. We signed additional deals and put in place a solid pipeline for 2016. We’re particularly excited about our hosted service offering which launched in Q2, and already has six customers. The offering will allow us to tap a broader market of asset managers and mid-size banks.
Finally, WSO had a strong overall performance, achieving high-single-digit organic growth, but we were particularly - particularly pleasing with the strong double-digit growth in WSO Services as customers continue to adopt our hosted loan portfolio management offering. We also had a strong contribution from acquisitions with 18.8% growth in Q4, and 11.1% for full-year.
Adjusted EBITDA margin for Q4 of 36% reflects revenue growth, tight control of compensation expense and a strong contribution from Information Mosaic, when non-recurring revenue is recognized on software contracts. We are very pleased with the quarterly performance and the full-year margin of 33.7%, but we continue to expect margins to run in the low-30s, whilst we invest in KYC and KY3P.
Looking ahead to Q1, we expect both a low organic growth rate and adjusted EBITDA margin for Solutions for the quarter. We have a strong prior year comparator due to Analytics software revenue recognition and we anticipate the lower primary loan volumes, reduced growth in AUM for WSO Services. However, our long-term objective is to list the Solutions organic growth to be made unchanged.
Turning now to Slide 14, you can see our leverage has increased to 1.36 times adjusted-EBITDA, primarily reflecting the recent acquisitions and accelerating share repurchase program. Despite doubling leverage over the last 12 months, we continue to believe we remain under-levered.
Free cash flow was up 17.8% to $288.5 million for the year compared to revenue growth of 4.05%. This result is from improved working capital management and tight CapEx control and was in spite of the one-off cash flow associated with class-action settlement of principle. For the full year 2015, CapEx reduced as a percentage of revenue from 11.7% in 2014 to 10.5%.
Let’s turn to share count on the next slide. We originally presented this slide after our Q2 earnings. It now makes sense to update you to show the actual outcome to the end of the year. The initial $150 million, of about $200 million ASR was delivered on December 8. So the impact on average share count for the quarter was 1.3 million shares. And we will see a full quarter impact in Q1 2016 of 3.8 million shares.
As you know, we actively take steps to manage dilution from annual compensation awards and option exercises. As Lance mentioned, we have received a new board authorization for a $500 million share buyback over the next two years, which is subject to completion of the ASR.
On the next slide, let’s talk about down long-term financial objectives. Whilst we don’t provide annual guidance, we often provide commentary around long-term objectives for our business. We’ve added this slide to aggregate this in one place to aid clarity.
As Lance mentioned, we’ve updated our margin objective to mid-40s, as we become more confident over processing margins. Also as you will note from our prior comments, CapEx as a percentage of revenues reduced. We’ve put in place a long-term objective of 9% to 11% of revenue. However, we expect to be above this range in 2016, as we consolidate our New York presence into a single new office location.
A few of you have asked about depreciation and amortization for modeling purposes and we expect that to be in the 8% to 10% range. From a divisional perspective, the highly recurring nature of the Information division, gives us confidence in the 4% to 6% long-term organic growth target. In terms of Processing, given market volatility and the variable nature of revenue, we haven’t provided a target. But with our ability to managed costs we’re confident that we can maintain margins at approximately 50%.
And I’d like to reconfirm the target for Solutions of 10% to 15% organic revenue growth; although as I mentioned earlier, this will be subject to quarterly fluctuations due to the timing of software revenue recognition. As we’ve said, we don’t manage market on a quarterly basis. These are long-term objectives, so we expect to see quarterly variance.
In all, this is a solid quarter for Markit as we close out the year. I look forward to continued momentum in 2016. I’d also like to add, I’m excited to be at first Investor Day on May 23 in New York. We hope to see many of you there.
And I now like to hand the call back over to Matt.
Thanks Jeff. That concludes our prepared remarks. Ellen, we’d like to open up the call now for Q&A.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question is from Toni Kaplan with Morgan Stanley.
Hey, good morning.
Can you give us an update on the current environment? It just seems like things are getting a little bit tougher and financial institutions are cutting spending. So, I guess, my question is have you already seen any budget tightening in some areas? And just can you give us a sense of historically what the moving pieces are in terms of the business in this kind of environment. Thanks.
Okay. Thanks, Toni. So first off, you just have to open the newspapers to see it’s a challenging time for our customers. So we see that surrounds us, so I think that goes without saying. But when you look at what market is focusing on, we really focus on two things to help our customers. One, we’re helping them lower costs. So that’s a good thing. It’s positive in a tough marketplace and one that gives us a tailwind.
And so when you look at our managed services and the things we’re doing there, it’s about reducing costs of market participants globally. So I think that’s a great business to be in and its one that will continue to bear fruit as we go forward. But like Jeff said, it can be lumpy. And in tougher environments decisions take a little bit longer. So I would expect that to continue.
The second thing we do for customers is help them adapt to and initiate, install, get ready for regulatory change. And so when you’re looking at some of the initiatives that Markit’s engaged in, talked about Mifid II, talked about the financial fundamental review of trading books, we talked about Solvency II, these all have deadlines in dates that financial institutions that are going to be in the market and participating anytime in the future in any size or shape will need to comply. And we’re helping them comply with the implementation of those regulations.
So I feel both of those are tailwinds for market in a tough environment that support our long-term 5% to 7% organic growth. But I agree with Jeff that some of these things are lumpy, but don’t change our view.
So I think sales cycle a bit longer, Toni. That might be something that is important to look at. I do see - I really liked how our Information division has come through with solid recurring revenue. We expanded the recurring revenue nature overall. Information and content is valuable to the regulatory initiatives. So I see good take-up there.
Processing, definitely susceptible to the market, but sometimes if we get a lot more volatility we could get a positive impact from that. But generally, when you read the press, you think there is going to be less activity. A lot of what we do is measured by the number of trades or the number of positions. And sometimes more difficult volatile markets means a lot more smaller trades, which is a positive. General business decline is a negative. So I think that’s a double-edged sword. And then Solutions, a little bit lumpy.
So I think we’re well-positioned, but we have to be cautious. We’ll keep an eye on costs. We’ll be focused and that’s why we’re comfortable to reaffirm of our long-term objectives. And if you look at it, we were behind this year on the 5% to 7%. We are above it last year. And we’re dead in the middle of the two years before.
I think you should expect much the same from market as we look forward, targeting 5% to 7%. We may be a bit below. We may be a bit above. We got lots of initiatives that can support those long-term objectives.
Okay. Great. And then, you mentioned a few new products that you’re developing. Just how should we think about investments over the next few quarters? It seems like you’re very confident on the margins. But just wanted to think about sort of that pace of investment or is that just normal course? Thanks.
Okay. I’ll let Jeff do the financial piece. But I’ll talk about how I look at as CEO, how do I look at KYC and KY3P success. So first of all, KYC, I think the first time I got the KYC question was early after the launch we had 800 buy-side firms registered and we had four banks. The second time we’re at eight banks and just over a 1,000. And today, we have 12 banks implementing and 1,500 buy-side firms now registered and a little teeny bit of revenue.
So how do you measure success? This is an ecosystem that we’re building and we need to complete the ecosystem. And then we need people to be repetitively buying the entities from the platform. And so we are going to invest, we will continue to invest. I feel we still have the leading solution by a bit of a margin. And it is an ecosystem. And ultimately, it’s a cost saving ecosystem and one that everybody needs to participate with.
But it takes time, we’re hitting good targets. And we’ll continue to update you and it will be obvious when the revenue is coming in. And then it will be obvious when the profit comes in. But right at the moment those are investment forms.
KY3P, there you have to look at the number of contracts we’ve signed, what the pipeline is like, and the network we’re building around vendors, and the users of vendors. And that’s going very well. And we haven’t given any numbers or counts on any of how many vendors, how many users of vendors yet. But what I can say is I’m bullish on the product.
We’ve seen strong early demand. We’re definitely in the sweet-spot when we’re talking about things. And the marketplace is spending millions on consultants and others to get vendor compliance in place. Even something as simple as a due diligence questionnaire is foreign to many of the global asset managers.
So we’ve got lots of work to do here; lots of demand. It fits the regulatory and the cost theme. And we’ll be able to give you some guidance on that as we go forward. But right at the moment, little revenue, no profit, and it will be obvious when that comes in as well.
Jeff, may be you want to add the financial background on that.
Sure. Yes. I think if you think about it more broadly, Toni, we’re always in investment mode. You can see that in our CapEx levels. We always believe in developing new products, whether they’re big initiatives that Lance have talked about or smaller initiatives like Credit Manager or so many other products we are working on.
There is nothing unusual about 2016 compared to 2015 or prior years. If you look at 2015, we brought the CapEx down as a percentage of revenue. But to be honest, that wasn’t about us doing less. It’s just being a bit smart. We’ve done more things in India. Roy Flint and the team have done some clever things in terms of hardware procurement.
We’ve used cloud-providers to bring down some of our systems cost. So I would say, we’ve brought that down more by doing things smarter rather than making fewer investments. So we’ll continue that investment profile, but I don’t see any big uptake on that side in 2016 other than the New York office, which I mentioned, probably cost us 2% of revenue given the price of New York real estate these days.
Thanks a lot.
The next question is from Paul Ginocchio with Deutsche Bank.
Hey, thanks. I just wanted to go sort of following up with Toni’s earlier question. Back in ‘08, ‘09 did you see a pick-up of enquiries around your Solutions in and Managed Services business as banks started to see profitability take a hit? Is that something that you would expect, as you talked about, a tough banking environment?
I think it’s a hard one to compare for. I mean, honestly, to answer you, in 2008 we didn’t have much in the way of Solutions and Managed Services businesses. We were very much more of a data and processing company. Actually, both of those businesses did surprisingly well. I mean, we have - it’s actually a boom year for us back in 2008, but partly because the nature of the crisis, derivative - credit transparency was a big thing. There was a lot of demand for the products. I’d imagine it would have done quite well, had we had those products back in 2008, but we don’t really have an apples-and-apples comparison.
Great. Thanks, Jeff. And then, I know you don’t give guidance. You talked about info - sorry, Solutions being, I think you said high-single-digit or slightly lower than your long-term target in the first quarter. Do you think - are you going to be towards the lower end of your long-term target for 2016, is that the plan or you want to give color to that?
I don’t think we’d probably want to for the full-year. I think the thing I highlighted in my remarks is where I look at Solutions at Q1 then we expect that to be a tougher quarter. We now have a lot of big software projects with banks. Some of those, with the exception of States, have been pushed out, so we know already that’s going to be a tough comparator for Q1.
And we don’t know where loans, assets under management are going to come out. But given we are now sizing in to comparing to quarters after the loan market shrunk, where previously we have been focusing on the previous ones. We don’t expect the same growth. We are not expecting a contraction, but we were pumping in some pretty big growth rates over the last four quarters. So we don’t think that’ll be better with the same in Q1.
Great. And then, just finally on Processing, if I take out that $3.6 million of revenue from a year ago for that regulatory revenue, it looks like organic revenue growth was down 10%. Can you just disaggregate the price cut from the regulatory change, and then, what - versus the rest of the - I guess, the rest of volumes?
And can you just give us a - how strong was rates, was it strong the entire quarter in the fourth quarter? And would that have a bigger positive impact on the first quarter? Thanks.
Okay, a lot of questions there, Paul.
I mean, generally speaking, I think we let - the price change was roughly about the $5 million impact for quarter, we’re always talking about it. I think it was just under rightly for the quarter. So you can see that very clearly. Yes, rates were a very strong grower in terms of underlying volumes, so sterling business on quarter revenues it was down. But, yes, I think we’re in the double-digit level more or less in terms of underlying volumes there. Obviously, credit continues to decline.
So if you look at the group level, I mean, one thing interesting to think about, the 1.1%, if you backed out the $5 million for the electronic trading impact, when you back out the $3.6 million for the one-off reporting we had in Q4 for last year, and then you back out the kind of technicalities of the KYC comparator, actually the group level would have been just about in a 5% to 7% range anyway. So it’s really around - the story for Q4 is really around the comparators rather than the in-quarter performance.
And just to be clear, you cycled off the sort of $5 million price reduction on April 1, correct?
That’s correct. So the Q1, that will still be a quarter-on-quarter comparison. [As you said,] [ph] I’ll expect that to show in the numbers. The Q2, the price change will be in there. But, if you remember Q2, we had a really strong volume performance both in derivatives and in primary loan. So we imagine Q2 will continue to be a tough comparison.
Okay. Thank you very much.
Your next question is from Manav Patnaik with Barclays.
Yes, thank you. Good afternoon to you, guys. I just wanted to follow up on some of the last recession color as well. I know you said you didn’t have Solutions in there. But maybe you can talk a little bit about what the organic growth in Information and Processing, what the trends there were. I mean, I think if you look back, you guys did do a good amount of M&A there. So should we expect a pickup in that front as well?
Yes. So I mean talking about how we ran at a very different accounting standard in 2008, but [for Lloyds there are lot of] [ph] equating the numbers. But the reality was, I think we saw a strong double-digit growth in both of those businesses in 2008. And you’re rightly said, we certainly took the opportunity to buy a number of assets. It seemed to be quite recently priced given the stress that the market was under.
So I think - if every recession was like 2008 we’d be very pleased. But the reality was it’s quite an unusual set of circumstances. It really was a global crisis driven by lack of transparency in credit market. So the market at the time was very much about providing transparency to the credit market. So I think we were uniquely positioned, so I think it’s hard to draw an analogy from 2008 for the current performance.
I think, one thing it did do, Manav - it’s Lance - is that at that time we were unlevered, clean balance sheet, and in a great position to acquire assets that would participate in our long-term growth story. And I see us very well situated as a firm right now with 1.3 times lever lot - levered, lots of free cash flow, and that gives us a lot of choice in terms of how we look at acquisitions in 2016.
So I think we are very well-positioned relative to the peers and more importantly that cheap money that was available to private equity to lever up five, six times, which is generally been the winning bids versus it hasn’t been always about strategic to strategic. I know it was in the IDC, but outside of that it generally been a story of private equity.
And I think the tides have swung there and that’s going to change the price of assets and put market in a great position in 2016.
Got it. And then, just the one question I had was on the Solutions business. I know you called out this quarter and the next quarter in terms of your decelerating organic growth as comp issues. But even if I look at your long-term guidance, I think at the time of the IPO you said high-teens, more recently you said mid-teens, and now in your slide you got 10% to 15%. So what are the moving parts there that have caused that sort of deceleration numbers and guidance?
Yes. I think two things there now, Manav. Each of those businesses are very lumpy. Certainly, in times of the IPO we were bit more optimistic. We thought KYC, KY3P will be in the number little bit more quickly than they have. I think in terms of the mid-teens, they’re actually 10% to 15%, a lot of that’s around which businesses we acquired, which ones are included in the numbers. It’s only an hour ago the papers came.
If you look in the appendix, where we map organic growth based on the more common 12-month definition, you would have seen it at 14% for the year. Each of those businesses got them down depending on which basket you include in the numbers, you get a slightly different result.
So I think it’s kind of hard to draw any challenges. I think the 10% to 15% we are very comfortable about and we are very happy with how things turned out. For all the businesses we owned here in 2015, the dividing line on organic growth got cut in slightly different place for our numbers.
But I think we feel pretty bullish around that. But I think we’re definitely in that 10% to 15%, not high-teens until we really see KYC, KY3P coming in. Do you want anything to that, Lance?
No, I think just as a bit of a follow-up, KY3P and KYC, when you see us in high-teens, because those two assets are performing. And that will be a great earnings call and a great call to be presenting.
Until those are in place, 10% to 15% is a good guidance or a long-term objective to apply to the Solutions division. But it won’t please - it will please me as much or more than anybody else, when we see ourselves in that high-teens or through that, because those two products are grab and hold. And so that’s it.
I think Jeff you said the numbers and that’s my feeling, is that these things are taking a little bit longer than we thought. But I wouldn’t change any of the strategy whatsoever.
All right. Fair enough. Thanks a lot guys.
The next question is from Sara Gubins with Bank of America.
Hi, this is David Chu for Sara Gubins. So should we expect a near-term, I guess, period of investment for the new indexes in trading products that you mentioned earlier, Lance?
Yes. There is not a lot of investment there. Those investments have been done over prior years. So it really is just OpEx.
Okay. Great. And so I don’t know if you answered this, but do you think that organic revenue declines seen in 4Q is a good run rate for Processing in 1Q or should we see a slight improvement as we don’t get that, is that a negative impact from the year-ago quarter?
I mean, obviously, your crystal ball is as good as mine in terms of how volumes come out for Q1. But certainly the comparative will be slightly easier, because primary loans were quite in Q1 last year. So that comparator will definitely be easier for the first quarter. It’s hard to know where derivative volumes will come out. Certainly, January was a slow start, but it often is in the year. It depends on the calendar - factoring with the holiday period. So I think it’s too early to say.
Okay. And then just lastly, so I know you guys have been working on exploring costs for Processing given the price reductions. So are we at like a full run rate in savings at this point or should we see additional cost savings coming out?
I think we have a multi-year program to reduce costs and make that business more efficient. Brad Levy, David Legg and the team is doing outstanding job of that. We’re far from done. So I think we feel confident. We continue to maintain margins at least around 50%. We’re doing slightly better over the last 12 months. And we’ll see how that pans out.
Okay. Great. Thanks guys.
The next question is from Andrew Steinerman with J.P. Morgan.
Hi, there. Given that you sort of [rejigger and compolated] [ph] these long-term objectives, I just want to know what timeframe you think of long-term, is that speed of five years. And I know you do say explicitly what your processing assumption is and your long-term objectives. But if you’re giving kind of two of the division and the total 5 to 7, aren’t you implicitly making a comment about the Processing revenues during that period of time?
Okay. Yes, so hi, Andrew, it’s Lance. If I get too financial, I’ll pass it to, Jeff. But so I quite like this slide, because I think it lays things out really nicely and just states exactly how we feel. I think Information division, I got to applaud the guys, the recurring revenues, the product innovation, the need for the product, the approach in working with IOSCO and regulators, cross-selling and working with valuations, fundamental review of trading book, developing new products, private equity valuations, drive data.
Great job, feel really comfortable with, Jeff, putting the number on the page. What did he put? 4% to 6%. Okay? Rate in the middle of that. We could be higher. If we have additional index flow through that would be the one area I think that could drive things higher. Valuations of alternatives is new. I mentioned that we added 90 customers, like that it’s not moving the dial 1% yet.
But it’s a positive, so I feel very good about that guidance. And I think we have been very consistent, and that plays well into 5% to 7% overall.
Processing as a piece of a whole is getting smaller. And when we IPOed we worried that we were going to have a margin decline, because we couldn’t get the costs out fast enough. And Brad and David kicked butt, they got in there, they got the costs out. The thing has been running over 50%. We have been living through the decline that we said would come. And it’s been manageable, and we are much closer to the bottom now. And Mifid II has been pushed out.
So feel pretty good that, we’ve given guidance on margins. You know that we are going to protect that. We moved our guidance to mid-40s. So we are not seeing low-to-mid in hedging ourselves. So we’ve tightened that up a bit. I like that, but I don’t know what the top line will be on that.
That’s a variable component. That has a bunch of assumptions that I make. And if I look at long-term guidance, I can quite easily see many periods, where we will have positive organic growth year over year in Processing. And I can describe many scenarios with more volatility, more trade account, our FX products kicking in, but I don’t want to give pie in the sky. I want to give facts. And the facts that we know is the 50% margin, and the top line is a bit volatile.
In Solutions, I would love to say high-teens, but my partner and counsel, Mr. Gooch, likes to be very conservative. And he says 10% to 15% long-term. And long-term to me is any three or four year period that we’re going through. It’s not 5%, 7%, 10%, 20%. Although, I feel comfortable the opportunity set for us carries on in time. And when strengthened with acquisitions, I feel very comfortable with that.
And so I do view that most scenarios, we will be able to deliver that long-term five to seven. And we might be a bit lower, a bit higher or dead in the middle. But the combination that we’ve laid out is a conservative picture for our long-term objective of 5% to 7%, moving to mid-teens margins. And we are already positioned to have double-digit acquisition with acquisitions for next year.
So I think the teams done a good job. They clarified CapEx. This is stuff we are learning from you guys. You are telling us clear on CapEx, clear on depreciation-amortization. We are getting clearer. We are getting more confident. Unfortunately, we are in a tough world right now. And so, we may be a little bit lumpier than we use to be, but long-term we make no difference. Jeff, you need to add to that or…?
No, I think you’ve covered everything.
No, I appreciate the clarity. Thank you.
The next question is from Joseph Foresi with Cantor Fitzgerald.
Hi. Just wanted to see if we could get maybe a little bit more clarity on the Processing headwinds, I know, you spent some on it. But in our assumptions for 2016, 2017, I think you got pushed to little bit into 2018. What type of headwind from a revenue perspective are we expecting there and what impact could that have on the margin?
Yes, I’ll take that one, Joe. I think in total that has $35 million estimate of the impact, yet to go through the numbers, it hasn’t changed. As you think what’s going to crystallize that, it’s SEC rules here in the U.S.
It will be single name appearing in the credit default swap markets. It will be the Mifid II implementation in Europe, which is the big one which will impact both the credit and rates market in Europe and a bunch of other very small items. I think our feeling is at the moment, Mifid II, there is no new date yet. It’s clearly going to be early 2018 at the earliest. You can push back a year. Talk in Brussels about being pushed back more than a year.
So that’s clearly being pushed out. On the other hand, there’s lots of talk about voluntary clearing of credit derivatives in the U.S. that could happen in Europe as well.
So I think at the moment, I’ll continue to say our track-record of predicting these stuffs are falling. It does keep moving. But I would probably see that $35 million spread over next three or maybe four years frankly. So I think on the annual basis, it seems to be big issue for us.
Okay, got it. And then, as we talk about a return to better organic growth rate, obviously, there are some puts and takes there. Maybe you could just talk about the two or three biggest swing factors. Obviously, you have given a lot of different opportunities for growth like KYC and stuff like that. But I was wondering, if you could just talk about that and in particularly over the next 12 months.
Okay. I think there are a few things to put in there. So Information, I think the real - I think the 4% to 6% is a good way to look at it. But there are some possibilities for some upside to that. I don’t see a lot of downside outside of that range, because it is very recurring. So it’s highly predictable recurring. But a couple of areas, index growth to valuations in new asset classes and drive data, those are three things that we’ve talked about.
We are also betting in the CoreOne acquisition. And we’ve got some potential in the Information division there for some new sales that play into the regulatory themes around Mifid II with transaction cost analysis, commission management, research management and broker boat.
As marketplaces that we’re in, that will produce an opportunity as we develop our product out to meet those demands. So that will be my info division. Good with the core number, it’s got some positives that could add to it, not a lot of downside.
Processing is tricky. I do think it comes down to sets of comparisons year over year, which we are living through and almost out the back end of. And then, we’ve got a volume component there, primary loan market issuance has been down, still remains somewhat quite. We’ve got - I think generally we have a view right now that rates can continue down. You had 10-year rates heading to 1.5% in the U.S.
I think as people see these turn and start to tick up, you get strong primaries. And in general, the secondary market has been pretty good. So - but it is, I can’t predict that, that’s crystal ball stuff and I don’t have the prediction on that.
On derivative side, interest rates, volatility positive; credit, tough market. We haven’t seen any uptick for many quarters in credit, it’s all been downside. I was reading the press the other day, saying that credit default swaps were back in vogue, because many people were hedging financial risk in terms of banks. I went to Jeff and go, are we seeing that volume in there yet. And he said, no. So that is - it’s never been lucky since 2008, in terms of credit.
FX, new investments, DealHub: betting in. I think they got lots of opportunity. Volatility, tough markets, FX and interest rates are good asset classes. Lumpy, volumes can’t predict, like our position. And the margins are good, and it’s good free cash flow. So I think we are in well-positioned there. So then you get to Solutions. You got two stories there: you got software, you got managed services.
Software, people are going to drag their feet on every software decision. So every software company I think is going to feel that stuff gets pushed out quarter by quarter. That’s the fact. Our guys are feeling that in some assets versus others. EDM, because it reduces cost, that software asset sells more. Information Mosaic is all about managing corporate actions. And that’s a potential costs saving initiative. People are still buying there.
People that are looking forward in their companies to transform their companies to make more revenue are spending money with Markit On Demand, because it’s digital transformation. But those decisions can be slowed down, keep your old website, don’t have Android versus Apple device slowdown a bit. But we have seen double-digit growth in that or high-singles double-digit in that asset, that software, or that managed service.
That real swingers for us that can make all the difference are of course are new investments and we’ve invested significant capital. You can tell by the margins. Don’t let the 36% look like we’re taking out 3 or 4 extra margin points. That’s not the case.
We’re running that in the low 30s margins. We want 10% to 15% as a long-term objective. But if either of the two starts to hit that tipping point as their ecosystems grows that can produce long-term growth in any market environment. It’s not tied to where our current revenue base is in Solutions. Anything is additive. And if you got the ecosystem and there are people in the marketplace doing KYC and you believe regulation needs to be implemented and compliance, this is the cost saving growth opportunity for us.
We also have new regulations coming in which will drive growth, fundamental review of the trading book. This is all about a demand for transaction inputs to determine whether a factor is - whether it’s [more reliable] [ph]. And it should benefit us, because guess what, we have all the derivative trades in the marketplace. So we can feed into those solutions coupled with our data and our analytics capability in market analytics, what a great position.
Any revenue yet? No. If we get some, positive for several divisions. Mifid II transaction reporting: best execution. This is a really important area. We’re one or two or three providers that have products to sell into that. Mifid II, we’ve got a year extension. I like that. It allows us to get more competitive with our product.
I think we’ve got some good positioning. And then, finally, Solvency II, this is the insurance firms complying. We’ve got opportunities there in our pricing data, OTC derivatives data, portfolio valuations. I think we got some nicely positioned offerings. So bit lumpy, but well-positioned. I think that market still sits - if you believe in regulations coming and cost needing to be taken out, Markit is a great company to play that theme with.
Great. And I’ll try one last quick one. On KYC, any timeframe you want to tag to the impact or positive impact to numbers? Could we see that in the end of 2016? I figured I’d give it a shot, to see if you…
Well, I think we definitely add revenue in 2016. But how the revenue comes is one bank, then two banks, then three banks, ask for an entity on the platform. So when I say there are 12 banks implementing, it means they’re readying their systems to be able to take documents from our platform. And we’re getting buy-side firms, getting ready to be able to put their documents there. So the sell-side can consume them.
It’s free for the buy-side. And you’d think you’d just walk in and say, hello, can you put your documents on the platform. But it’s a lot of approvals and loops to go through. But we got it 1,500.
So that puts us - that means that there is many more than 1,500 entities, because every buy-side firm has many entities. When the entities are on there and can be consumed multiple times, it will start to add and contribute to the platform that Genpact and ourselves have built. So definitely revenue, and as I’ve said before, 2017 should be the point where we can get revenue and contribution in that platform.
Got it. Thank you.
The next question is from Vincent Hung with Autonomous Research.
Hi, how is it going?
Can you tell us how year-to-date trading is trending in Processing?
How is trading impacting Processing?
How trading is trending these days for you guys?
Okay. So I want to pick that one up. I mean, I think, for January, relatively slow month. But it often is that first week or two in January often known as the holiday period. So it’s very hard to draw any conclusions about that in terms of the rest of the year. I think if I look at the trend, I think both the rates in credit markets were quieter than they were in December. I think the loan business did relatively well in January, particularly on the secondary side, but been busy throughout that business ourselves, outside of January definitely no indicator for the rest of the year. So it is too hard to say.
Certainly, February partly started, but that’s been relatively strong the first couple of weeks. So I’m not - probably, I would make a call for the 40 here.
Okay. And in Processing, you said the $35 million impact is yet comes through the numbers. And single names, clearing of CDS and Mifid II could be the key drivers of that coming through. Did you assume that, we don’t do much progress or further progress in the electronification of OTC swap-trading?
Yes, I think our sort of base assumption would be the U.S. in terms of CFTC regulated products. We’ve had those regulations in there for a couple of years. I think that’s a relatively stable position. That’s already in our numbers. Obviously, the equivalent change in Europe will come around with Mifid II, which is looking like a couple years away.
And we’ll see, it’s been the U.S. people really didn’t swap until - switch until the regulations actually came into place. So the one outlier from that single name credit derivatives, because they’re SEC regulated in the U.S. rather than CFTC regulated, so there yet to be new electronic trading or clearing rules for those.
I would anticipate before 2018 that would kick-in. So for timing of that, there’s no clear indication from the SEC. So I would see small impact through the back-end of this year, 2017. Mifid II is probably the big chunk of that $35 million, but that’s probably a couple years now.
So I am probably thinking, if you spread that over three, four years, which is the way it feels like, then it’s easier to kind of the story, because $10 million bucks in a year, whatever that comes out isn’t really that significant here for the group.
Okay. And, I guess, a picture question, on IDC, do you see them as a more fierce competitor now that it is owned by ICE. And one example I would point to is fixed income index business agent guys recently?
No, I don’t think they’re any more fierce. They may have more capital available to them than they once had. And definitely ICE has got lots of free cash flow they could give to them. But I don’t think it changes the competitive nature. We competed against IDC before. We will compete against them going forward.
I think relative to us, the Barclays sale to Bloomberg is more negative for them than it is for us. So, yes, I think they have - they have got their work cut out for them. But they’re a good competitor and one that we competed with for many years.
Great. Thanks a lot.
The next question is from Alex Kramm with UBS.
Hey, good morning, everyone.
So first of all sorry to come back to the whole discussion about environment. I think you gave a lot of great color, so I appreciate that. But the one thing, I think, Lance, in your last remark, you acknowledge that there are certainly some areas where pipelines are getting pushed out a little bit. And I guess, I appreciate there are lot of must-have products that you have and they help clients. But there are certainly some nice-to-have products.
So maybe just a quick answer, like how much of your Solutions business and maybe even on the Information side, how much do you think is this kind of like nice-to-have, where people can drag their feet or might even choose a cheaper competitor or something like that?
Right. Well, I think, everything in life can be nice to have until it becomes must-have. And I think that’s the story of Solutions. You don’t need Enterprise Data Management, but the cost of managing data are really high and increasing. The cost of complying to regulation and making sure that you didn’t touch a piece of data twice in the wrong way and distribute it to somebody amongst your clients in the wrong way that could put you into a legal situation; the cost of not managing data better are higher than the cost of spending money to implement a solution.
So I can’t see an environment where we don’t grow our Enterprise Data Management business. But I can see some of the people that we might want to grow it with delay decisions to participate, so good pipeline, good opportunities, maybe the sales-cycle is a little bit slower in that case.
If you look at KYC and KY3P, these are real cost reducing solutions. These are the ability for a bank to say, we don’t need a client on-boarding team, we can use the platform. The platform becomes successful when many entities are on there and the teams can actually be reduced. Then it’s a very easy process.
We can buy there for X or we can produce it for 5X internally. So that to me is all about entities on the platform. That’s what you should be looking at and measuring and looking to see how that develops. So those are again can be a little bit slower. But I think the slowness is more technology and internal compliance in decision-making, more than desire to use the product.
KY3P - vendor compliance to the level required today is something quite new. I’ll give you an example. I was with an asset manager, they never did a due diligence questionnaire before. They’ve got 100 vendors. They spend 75 grand on a consultant to help them develop a due diligence questionnaire and send it out to a random sample of their vendors. That’s what this platform does, allows you to do due diligence and then track, monitor, repeat and remediate that due diligence. It’s a new opportunity set.
So again, I think it’s going to help reduce cost. It takes explaining. It’s a tough market to get appointments. There are lots of things that could make me describe a slow scenario. I’m not a glass half-empty sort of person. I think about the upside and the opportunity. And I know my teams are working hard. They’ve developed a great product and the revenue will come through. I wouldn’t do anything different.
And you can do that product by product, give you the upsides, the downsides. We don’t manage the company by quarters. We have long-term objectives. And I’m very comfortable with our long-term objectives. I wouldn’t change them. We’ve got time for two more questions, Matt’s told me, operator.
Thank you. The next question is from Andre Benjamin with Goldman Sachs.
Guys, good morning. Excuse me for my cold here. So a pretty quick one here. I know you said you have a strong pipeline for acquisitions to hit the double-digit revenue growth. And you also put your expectations for EBITDA margins at mid 40s. I wonder if you could talk about how you’re thinking about the margins for the assets that you are looking to buy, and whether we should be prepared for any potential dilution if you’re buying assets and businesses more for capability than revenue and cost synergies.
That’s a good question. I would think, obviously, when you buy companies that with different points in their development, fundamentally, we don’t want to be in businesses that can’t run in our mid-40s EBITDA range or better. It doesn’t mean every asset in there you buy is delivering those numbers.
So we also need a trade-off. The growth potential in business is about the day-one EBITDA margin. So, yes, you may find the old quarter, we bought something large. It’s a bit lower. We’ll have to compensate the margins a bit low. But fundamentally, we’re not going to buy into businesses that run in the 30s long-term. We want stuff that will be consistent with our overall target.
Okay. And you provide a lot of color on some of the products that you’re working on. I guess, with all the focus on loans and getting more efficient these days, I was just wondering is there anything that you could call out for us in terms of additional steps or technologies that you believe that you need to build out to deliver the needs for the industry or that we should be expecting you to go and buy on the back of yet another acquisition announced just a couple days ago?
Yes. I think the technology is a great game-changer in the world today. And so to me a good chunk of our CapEx, whether it’s 8%, 9%, 10% as we go forward, has to be spent on technology to reduce our cost long-term, expand margin and create more free cash flow for future investment in growth.
So I do think we have to be very attuned. So, if you take blockchain for an instance, if blockchain can get adopted in the loan space and help us reduce cost of connectivity, improve the transparency and ability for more participants to be in the loan market, we want to be participating that.
Hence, why we have work going on with market participants, both the technology companies with the banks to test and see how Markit Clear, WSO which is a big loan accounting software platform can adapt to a ledger that’s a distributed ledger technology that is available and needs to be adapted to the industry. And we see that as very positive for us. So we’re right at the forefront.
Other things that we see are that we have a lot of costs in processing, managing and producing our data. And technology is meaning we can do that cheaper. But it takes investment. So we’re constantly investing in improving and managing margin by looking for ways to leverage our position with improved technologies. It might be using the cloud; it’s definitely a big way for us to both change our cost structure from CapEx to OpEx; but two, to improve time to close with a sale of a software product. So we like the cloud.
We like the fact that things can be processed faster, because if we can analyze our data and produce signal, factors, information faster than we could do it yesterday that potentially offers our customers a new product on the back of that and we like that as well.
So real-time evaluated prices can support ETF growth; we like that. There is exchange traded funds based on fixed income that want real-time pricing behind them. That’s good for us. It means we can sell more EVB and we can help develop new products. So we’re right at the front of that stuff.
Every one of our divisions has got a CTO. They are embedded in new technologies. They’re working with improving old technologies and we definitely see that as a competitive part of our future as a company that has a growing fintech presence.
One last question from…
The final question…
…is from Gary Bisbee with RBC Capital Markets.
Hey, thanks for squeezing me in. Just two quick ones; number one, on the fourth quarter contribution from M&A, is that a reasonable assumption to use in the first quarter? Or do the fourth quarter and earlier this year M&A activity potentially lead to a bigger contribution?
Well, I’ll take that one. I mean, the deals we’ve announced so far this year are not really material. So we wouldn’t worry too much about those. I mean, Lance said, it brings a few million dollars’ worth of revenue, but the others are more technology assets. So I think the fourth quarter numbers probably are pretty good proxy for where it was and kind of contribution were being queued up.
Great. Thanks. And then, just the last one, what level of option in indoor RSU issuance did the company make in 2015 or are you planning for 2016? I realized pre-IPO there was substantially higher level of equity issuance. But it seems like the number of outstanding options has been declining since then. And I’m just trying to think about how much you’re doing now as I think about how much that could fall in the next few years. Thank you.
Yes, so I think in terms of options issuance it’s our regular annual comp, we’re no longer issuing options. We’re doing so in M&A situations or we’re bringing in senior executive, it might be appropriate to issue a few. But essentially our option call is diminishing and that trend will continue. In terms of restricted stock, I think in terms of annual process, we wish to run a much more around the 1% now than the 1% to 2% we used to. Obviously, as a result some of the deals we did, we used stock in some of those.
I think overall issuance for the year I’m looking to those about 1.7%, but know that’s payment aid driven rather than annual compensation cycles.
Great. Thank you.
And we have no further questions at this time. I’d like to turn the call back to the presenters for closing remarks.
Thanks, everyone, for joining us today on the call. And we look forward to speaking to you guys over the next few days and throughout the coming quarter. Thanks.
Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.
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