Morningstar (MORN) announced the nice bolt-on acquisition of PitchBook. The $225 million deal is one of the largest in its history. I like the deal given the relative attractive sales multiples given the strong growth rates reported by the acquired business.
The deal comes at a time when Morningstar itself is struggling to report organic growth, after having grown rapidly in recent years, providing a much needed boost to the overall organic growth profile of Morningstar.
Despite the nice move, I am still cautious with regard to Morningstar´s shares on the back of a still premium valuation at a time when the core business is facing some struggles.
Buying Much Needed Growth
Morningstar has agreed to acquire PitchBook Data, a provider of data, research and technology focusing on venture capital, private equity and M&A.
Morningstar is familiar with PitchBook which was founded back in 2007, as Morningstar already owned a 20% stake in the business following an early investment. Morningstar´s upcoming CEO Kunal Kapoor has been on the board of the company since 2012. The company will now pay $180 million for the remaining 80% stake in PitchBook, valuing the entire business at $225 million.
Morningstar points to the rapidly growing interest in private markets and private companies. By combining PitchBook´s knowledge of these markets with the research power of Morningstar and the global coverage, it is expected that PitchBook can continue to grow.
PitchBook generated sales of $31.1 million on a trailing basis, suggesting that the multiples are pretty steep at 7.2 times trailing sales. That said, bookings have surpassed $22 million in the first half of the year, translating into an annualized $44 million revenue number. If that is more realistic, the sales multiples fall towards 5.1 times revenues.
Growth Has Slowed Down, PitchBook Is Much Needed
Morningstar has grown from a $300 million business in 2006 to nearly $800 million in revenues in 2015. Organic growth has ranged anywhere between 5 and 9% over the past five years, as the company at times has made bolt-on deals to accelerate the reported growth numbers.
While these growth rates are very impressive, organic growth has slowed down in recent times. Organic revenue growth slowed down towards the lower end of the longer growth range at 5.4% in the fourth quarter of 2015, with reported growth coming in at just 2.6%.
Organic growth slowed down to 2.6% in the first quarter of this year and fell by 1.3% in the second quarter, marking a severe deceleration in operational momentum. Management attributes this to lower volumes in mortgage backed securities, uncertainty in financial markets at the start of the year and lower internet advertising revenues. These headwinds were only partially offset by some relative strength at the research business.
Revenues Are Flat, Margins Are Pressured
Morningstar´s growing revenue base is very lucrative, as operating margins have ranged anywhere between 22% and 27% of sales over the past decade.
Reported revenues are down 0.4% in the first half of the year to $390.3 million. Inflation with regard to the cost base has been hurting margins as operating margins fell by nearly two percentage points towards 22.2% of sales.
On the back of a lower tax rate, Morningstar has limited the fall in net earnings, which were down by 2% to $60.5 million. Continued buybacks, financed by the strong balance sheet, allowed for flattish earnings per share.
On the back of these trends earnings per share of $3 are attainable for 2016 although the multiple remains elevated. Even after shares have fallen 5% so far this year, trading at $75, shares trade at 25 times earnings despite a lack of organic growth at this point in time.
The company does have a strong balance sheet, with cash holdings of $245 million being offset by merely $75 million in debt. This net cash position of $170 million will evaporate overnight given the $180 million purchase of the remaining 80% stake in PitchBook.
Challenges Ahead, I Like The Deal
Morningstar itself trades around 4 times sales at the moment. This multiple reflects the solid earnings, and great track record of growth, while the business is facing some headwinds at the moment.
The $180 million remaining cash component for PitchBook will eliminate most of the current net cash position, but will add a business with $44 million in annualized sales. This move will grow revenues by 5-6%, but more importantly it will contribute in a meaningful way to the short term challenged growth profile. While we do not have any information regarding the margins reported by PitchBook, the 5 times multiple seems justifiable.
A Great Model, Requiring A Margin Of Safety
On a pro-forma basis, Morningstar is an unleveraged business which has improved its growth profile following the latest bolt-on move at a time when the core is facing some struggles.
Given the solid state of the balance sheet, low capital requirements, predictability of the business and long term track record, I consider a 18-20 times earnings multiple as being attractive. If the latest deal could boost the earnings number from $3.00 towards $3.25 per share going forward, such multiples translate into a targeted entry point around $58-$65 per share. As shares are still 15-25% removed from those levels, I will be a very patient buyer, applauding management on the nice deal.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.