I am initiating coverage of Morningstar, Inc. (MORN) with a buy rating and a price target of $72.00. Since going public in 2005, the company has put up double digit earnings and revenue growth, while doubling its assets under advisement from a year ago to nearly $81.5 billion. Favorable secular trends and a business model that achieves operating leverage will allow for further growth going forward. An economic moat is provided by the company's branding, unique content, and deep databases that are time consuming and difficult to replicate.
Excellent business model that includes operating leverage, a high percentage of recurring revenue with a diversified revenue base, and good earnings visibility: Morningstar's databases can be viewed as fixed assets that the company is able to use to achieve operating leverage. This is favorable because as revenues increase, there is a strong possibility for margin expansion, which I have incorporated into my valuation. Morningstar sees ~89% of recurring revenue, with 23% of revenue coming from subscriptions to Morningstar.com, and 66% of revenue coming from contract renewals. This allows management to more easily control the business and make future plans for growth, while creating visibility for shareholders. Revenue is also well diversified, coming from 5 main sources: Investment Consulting, Advisor Workstation, Licensed Data, Morningstar.com, and Principia.
Favorable Secular Trends: Half of the world's wealth is outside of the United States, where we are seeing an emerging middle-class that will likely have to plan for retirement. Morningstar is also levered to the baby boomer trend that will begin to accelerate in the next few years as more and more boomers reach retirement. The company is well positioned to capitalize on both of these trends through strong branding, proprietary tools, and deep databases.
Clear Growth Strategy: Morningstar has four key growth drivers going forward. First, management plans to continue to grow the company's internet platforms across all 3 of its segments- individual, advisor, and institutional. Next, the company plans to enter the fund of funds business and become a global leader by leveraging their extensive knowledge of managed investment products. Because the number of choices in fund of funds can be daunting, Morningstar aims to simplify this process which will add value by helping investors achieve better outcomes. Third, the company is planning to expand its range of products and services to meet investor's needs in the areas of hedge funds, equity research, and retirement income. Finally, Morningstar plans to continue to expand the company's international brand presence, products, and services. Morningstar's recent acquisitions of Aspect Huntley in Australia (4th largest fund market in the world), and S&P's mutual fund database has seen Morningstar make major strides to meet this goal.
Lack of sell-side coverage: The only sell-side analyst covering Morningstar, Oppenheimer's Marvin Loh, has left the firm and coverage has been discontinued. I believe the lack of institutional coverage will allow smart investors to achieve an edge in information flow, as MORN flies under Wall Street's radar.
Defensive Growth Play: Morningstar has strong growth potential and is insulated from bear markets and market volatility. The reasoning is that in difficult markets, people are more dependent on advice. Historically, Morningstar's revenue and earnings have been up in bad markets and in good markets.
I used an average of my DCF model, earnings multiples, P/S multiples, and EV/EBITDA multiples to arrive at my PT of $72.00. In my DCF I assumed a growth rate for the next 5 years of 35%, and the following 5 years of 15%, with a WACC of 8.1%. I based these growth rates on favorable secular trends in the economy that Morningstar's business is leveraged to, the opportunity for growth in new foreign markets which is seeing growth in their middle classes, and the company's strong recurring revenues, strong economic moat, and ability to achieve operating leverage through their databases which are fixed assets. I used a P/E multiple of 33, a P/S multiple of 6.1, and an EV/EBITDA multiple of 20, all of which are based on a combination of the above favorable aspects of Morningstar's business model and historical multiples.
Highly competitive industry: The financial data industry is very competitive, with better capitalized competitors including Thomson, Bloomberg, Lipper and Reuters (recently acquired by Thomson). These companies may be able to better respond to changes in technology and demand for products and compete better on price.
Failure to integrate recent acquisitions: Morningstar recently made 4 major acquisitions, the first time the company has made sizeable acquisitions. Over the past year, the company acquired S&P's mutual fund database business, Ibbotson, Aspect Huntley, and InvestorForce. Based on recent results, the integreation of these acquisitions appears to be going smoothly.
Government Regulation: Morningstar's investment advisory and broker-dealer businesses are subject to extensive regulation in the United States at both the federal and state level. Morningstar is regulated by both the SEC as well as the ERISA. Any changes in regulation could have an adverse impact on Morningstar's business.
Joe Mansueto: Mr. Mansueto founded Morningstar in 1984, and has served as chairman since inception and CEO from inception to 1996 and from 200 to present. He holds a bachelor's degree from the University of Chicago in business administration and an MBA from the University of Chicago Graduate School of Business. As the company's largest shareholder with 70% of shares outstanding, Mr. Mansuseto has a lot of skin in the game, a trait which I view as favorable. Under his guidance, the company has been extremely shareholder focused and uses the same metrics to evaluate their own business as they use to evaluate stocks: building intrinsic value over a long period of time. Mr. Mansueto has a serious passion for stocks and cites Warren Buffet as his inspiration after reading about him in John Train's acclaimed book The Money Masters. Mr. Mansueto says that the idea for Morningstar came from trying to teach himself equity analysis.
Morningstar has an excellent business model, excellent management, unique content, and deep databases that make me believe that there is plenty of room for future growth. Entry into the fund of funds business, entry into new foreign markets, and continued expansion of the company's hedge fund and equity universe look to drive revenue growth. With the company's operating leverage through its fixed database assets, margins could easily expand more, and I believe that my $72.00 PT is a conservative estimate of intrinsic value.