RiskMetrics IPO Analysis: Both Business Segments Look Good Despite Debt

by: Bill Simpson

On January 15, Bill Simpson wrote an analysis of RiskMetrics Group (RMG). The company raised $245 million by offering 14 million shares near the bottom of its estimated price range of $17-$19 a share on January 25. The stock closed that day at $23.75.

The text of Mr. Simpson's original writeup follows:

• • •

RiskMetrics Group plans on offering 16.1 million shares (assuming over-allotments) at a range of $17-$19. Insiders are selling 4 million shares in the deal. Credit Suisse, Goldman Sachs and BofA are leading the deal, Citi, Merrill Lynch and Morgan Stanley are co-managing. Post-ipo RMG will have 59.9 million shares outstanding for a market cap of $1.078 billion on a pricing of $18. The bulk of ipo proceeds will go to repay debt.

General Atlantic Partners will own 22% of RMG post-ipo.

From the prospectus:

'We are a leading provider of risk management and corporate governance products and services to participants in the global financial markets. We enable clients to better understand and manage the risks associated with their financial holdings, provide greater transparency to their internal and external constituencies, satisfy regulatory and reporting requirements and make more informed investment decisions.'

RMG operates under two segments, risk management (RiskMetrics) and corporate governance [ISS]. RMG acquired their corporate governance segment ISS in January 2007 for $542 million in total consideration. RMG has 3,500 clients in 55 countries. Clients include asset managers, hedge funds, pension funds, banks, insurance companies, financial advisers and corporations. Among clients are 70 of the 100 largest investment managers, 34 of the 50 largest mutual fund companies, 41 of the 50 largest hedge funds and each of the 10 largest global investment banks.

RMG is a play on the growth of managed assets globally coupled with the ever increasing complication and intertwining of securities and derivatives.

RiskMetrics - Multi-asset, position-based risk and wealth management products and services. What does that mean? RMG's products help investment managers quantify portfolio risk across a broad range of security products, geographies and markets. Interestingly, RMG utilizes transparent processes and algorithms to model risk and portfolio positions.

RMG first published their processes in 1994 and continuously updates. Customers subscribe to RMG's applications, interactive analytics and risk reports based on consistently-modeled market data that are integrated with their holdings. RMG's database includes over four million active global securities across 150,000 issuers, spanning 200 countries, 220 exchanges, and 11,000 global benchmarks updated daily. RMG believes their dbase covers nearly all equity, fixed income and derivatives in clients portfolios.

RMG's risk management products allow customers to:

1) measure their trading, credit and counterparty risk;

2) monitor and comply with internal or external exposure and risk limits;

3) deploy and optimize their use of capital;

4) communicate risk in a transparent fashion to regulators, investors, clients and creditors;

ISS - RMG's corporate governance segment, acquired in January 2007. RMG offers an outsourced proxy research, voting and vote reporting service to assist companies with their proxy voting responsibilities. RMG's web based product offers a full proxy voting solution, from policy creation to comprehensive research, vote recommendations, reliable vote execution, post-vote disclosure and reporting and analytical tools.

ISS growth in recent years has been derived from the increase in corporate regulatory oversight. In 2006, ISS provided proxy research and vote recommendations for more than 38,000 shareholder meetings across approximately 100 countries and voted approximately 7.6 million ballots on behalf of clients, representing almost 700 billion shares.

Revenues are derived primarily on an annual subscription basis. Through the first nine months of 2007, 93% of revenues were derived from annual subscriptions with a strong renewal rate of 91%. The high renewal rate leads to strong recurring revenues annually.

Customers breakdown is as follows: 35% investment managers; 21% alternative investment managers; 15% banking and trading; 6% mutual funds; 6% pension funds; 5% corporate; 5% custodians; 4% insurance and 3% other.

63% of revenues is US, 37% international.

Financials

In addition to the acquisition of ISS, RMG also recently acquired CFRA. To fund these acquisitions RMG took on debt. Post-ipo, RMF will have approximately $314 million in debt on the books.

RMG does not plan on paying dividends.

Revenues from both segments (RiskMetrics/ISS) are roughly equal. The bottom line in 2007 has really been negatively impacted from the ISS acquisition due to increased debt servicing and amortization costs. The acquisition doubled RMG's total revenue stream and in the long run should be beneficial. However, as far as GAAP earnings go, the ISS acquisition will really put a damper on the bottom line in 2007 and beyond.

As ISS wasn't acquired until 1/07, we have to combine the two entities for historical revenues. Total revenues were $177 million in 2005, $205 million for 2006 and through the first nine months of 2007 on pace for $235-$240 million.

2007 - Revenues are on pace for $235-$240 million, a 15% increase over combined pro-forma 2006 revenues. *Note that the expense numbers that follow take into account the removal of one-time acquisition expenses as well as debt paid off on ipo. Gross margins are a solid 66%. Operating expense ratio should be 38%, putting operating margins at 28%. So far, so good. The issue here is the debt laid on to acquire ISS and the amortization charges.

Amortization charges (which do not impact cash flows) should eat up 1/4 of operating margins and debt servicing (which does impact cash flows) should eat up 1/3 of operating margins. Net margins after taxes should be 7%. Earnings per share should be $0.25-$0.30. On a pricing of $18, RMG would trade 65 X's 2007 earnings. Removing the amortization charges related to the ISS acquisition would mean RMG would net between $0.45-$0.50 per share. In my opinion this second number is more indicative of RMG's cash flows and real earnings.

2008 - Both RMG's segments have a proven track record of 10%-15% organic growth and there is every indication that should continue into 2008. Risk management assessment and corporate governance are two segments that should not be negatively impacted by a slowdown in the financials or the worldwide economy. RMG's subscription fees are not based on assets under management. Assuming a 10%-15% revenues increase in 2008 to $270 million, RMG should be able to put $0.40 on the GAAP bottom line. RMG will continue to carry acquisition amortization expenses through 2008, folding those out would bring $0.60 on the bottom line.

Conclusion - RMG has 'GAAP handicap' due to the acquisition of ISS. The $300 million in debt-post ipo is a very real earnings drag here, however this debt was brought on to double RMG's revenues and bring in a new segment, corporate governance. As mutual and investment funds utilize both RMG's risk management products as well as corporate governance proxy services, the acquisition was a good fit overall for RMG. It does however negatively impact the bottom line.

As separate entities, RMG/ISS would earn a combined $0.75-$0.80 in 2007. Together with the added debt/amortization, that number drops to $0.25-$0.30. The bottom line here doesn't really indicate the nice niche and strong underlying business of RMG. Based on the organic strength of each underlying segment and the estimated 2008 cash flows, RMG is a recommend in range. Keep in mind RMG will look expensive on a PE level over the next 2-3 years which in this environment is probably reason enough not to pay up here. However, I like both segments here quite a bit and even with the debt on hand post-ipo, this is a recommend in range. The two parts here are greater than the sum on ipo....I suspect eventually the 'sum' will catch up.

Disclosure: Tradingipos.com does have a position in RMG.