IHS Markit: Merger Of Two Information Giants Bearing Fruits

| About: IHS Markit (INFO)

Summary

IHS Markit is seeing improvement in each of the legacy segments.

Higher free cash flow is expected for 2017 without the one-off items.

Guidance for 2% to 4% organic revenue growth is achievable and I outlined my belief.

Background

IHS Markit (NASDAQ:INFO) announced 2016 Q4 results today and the stock closed 3.5% higher. However, it gave up some gains in after-hours trading, losing 0.88%. As the company is underfollowed, I would begin with some introduction. Post-merger in the middle of last year, the company simply adopted the combination of the names of the two constituents, IHS and Markit. As the ticker symbol for Markit, INFO, was used by the merged entity, you might be looking at incomplete historical data on certain platforms. IHS Markit claims to serve 85% of the Fortune Global 500 companies and 94 of the 100 largest U.S. corporations. Separately, IHS is in the intelligence business and predominantly provides information and analyses to industrial customers while Markit primary targets are financial institutions. As the merger is still rather fresh, the 2016 fourth-quarter results still include a breakdown by the three legacy IHS segments and Financial Services, which essentially refers to contributions by Markit. Resources encompass the Energy and Chemicals businesses, while Transportation includes the automotive revenue including CARFAX, as well as maritime and trade, and aerospace. Defense, which is also categorized into Transportation, includes the acclaimed Jane's magazine. The third and final category, Consolidated Markets & Solutions, or CMS, house the other products and services like Economic and Country Risks. Chairman and CEO Jerre Stead is no new face to the M&A scene. There were no less than four acquisitions per year since 2004, the year before Jerre led the IPO of IHS in November 2005. Along the years, Jerre and his executive team have honed their skills in integrating acquired companies into the fold. The acquisition of Markit, or rather, merger, as the management prefer, was the largest ever orchestrated by IHS. Lance Uggla, President of IHS Markit, is himself a master in integration, growing Markit through various acquisitions. The experience of the team from both constituent companies provides confidence that the merger would escape the perils of mergers and acquisitions.

Discussion of Q4 2016 Revenue by Segment and Outlook

The Q4 results already show signs of merger-related benefits such as cost savings from eliminating duplication and economy of scale, with legacy IHS margin expansion of 300 basis points year-over-year. Due to the acquisitive nature of IHS, one has to look at the organic growth data to determine the health of the existing business, rather than just looking at absolute revenue gains.

In Resources, the energy side of the business continues to experience declining annual contract value as expected with ongoing cost-cutting moves especially by customers within the upstream energy sector. The 9% drop in Q4 is an improvement over Q2 and Q3 where the declines were in double digits (13% and 12% respectively). This is a positive indication that the recovery in the energy sector is translating into higher spending into market intelligence. The Chemicals division proved to be resilient amid strong industry margins. The plunge in crude oil prices brought down feedstock costs for the petrochemical producers, but product prices were relatively unscathed. With good profitability enjoyed by the customers of the Chemicals division, there is relatively less pressure than the energy counterparts to drop services, particularly when many of the services are essential for day-to-day operations and specialized market updates not available in the public domain. Planned investments into chemical projects both in the US and globally are still healthy and would mean continued active consulting business.

The Transportation segment produced an impressive organic growth of 11% for the quarter, continuing the strong momentum from previous quarters. Jerre attributed the good showing to innovation-driven offerings through up-selling and cross-selling to customers in areas such as recall solutions, digital marketing, vehicle compliance and performance, and technology and components analytics. Note that IHS in recent years acquired numerous companies holding large databases of used cars. The full potential for cross-selling most probably has not been reached given the time required for assimilation. The company is also benefiting from higher incidents of recalls as you would also be familiar either through personal experience or through the news.

The Consolidated Markets and Solutions segment continues to be weak and the company seems to be able to work on customer satisfaction through platform enhancements and creating larger recurring revenue product bundles, rather than coming up with new offerings like it did for the Transportation business. Nevertheless, heightened uncertainties leading to increased volatility could translate into more decision makers signing up for insights by IHS Markit.

On the legacy Markit side, organic growth has been improving steadily, with the latest quarter showing a 4% year-on-year increase, compared with almost flat growth for combined legacy IHS businesses. In the earnings call, Jerre cited the strengthening of the indices franchise with key wins within the index administration business and ETF AUMs. The bond pricing business also completed major wins with the world's largest asset managers and distribution platforms.

IHS Markit Q4 2016 revenue segment view

Source: IHS Markit Q4 2016 slides

Looking at organic growth within a segment, it is important to track the trend for the recurring portion, which is essentially the subscription business. Due to the strategy of securing multi-year contracts for subscriptions, a slowdown in a customer's business might not immediately affect IHS since the customer might wait until the expiry of the subscription since the cost was already budgeted for. On the other hand, when the business environment improves, we would expect higher capital spending and that entails engaging consultants for project evaluation. Thus, an improvement in non-recurring growth (consulting projects) alongside an improving business climate is a good indication that the positive momentum would translate into recurring growth. The Q4 results is an example of this scenario possibly being played out, as the oil prices for 2017 extend the uptrend from mid-2016 (see chart below). The decline in non-recurring organic growth of the Resources segment has slowed considerably to -3%, compared with -21% in Q3 and -36% in Q2. The recurring organic growth for Resources is not showing an improvement yet, due to the lagging effect discussed earlier.

IHS Markit Revenue Category view

Source: IHS Markit Q4 2016 slides

Oil price forecast

Discussion of Q4 2016 Cash Flow and Outlook

IHS historically generated strong cash flow due to the stable and low CapEx nature of its information-based businesses. With the solid balance sheet, IHS could rely on acquiring companies to support growth. The additional beauty of acquisition for IHS was the fact that the P/E of IHS had been very high in the range 40-60. Currently, the trailing-twelve-months P/E is 59. Since most, if not all (details of some transactions were not publicly announced), of the acquisitions were likely to be accretive, the deals were immediately helpful in lowering the P/E and increasing the attractiveness of the company as an investment.

Despite the cash flow for the year negatively impacted by restructuring and acquisition-related costs paid (approximately $140 million), the company still managed to achieve a trailing 12-month free cash flow of $491 million, representing a conversion rate of 50%. Excluding these costs, the conversion would have been approximately 64%, in line with the long-term objective in the mid-60s. Q4 free cash flow rose an impressive 27% to $115 million. Hence, we would expect higher free cash flow for 2017 after the passing of one-off items.

Conclusion

IHS Markit has guided for 2% to 4% organic revenue growth. This compares with just a 1% increase in organic revenue growth in 2016 on a combined basis (accounting for the full-year results of legacy Markit). I believe the outlook is realistic and achievable, given the improved business environment across all the segments, synergies yet-to-be-unlocked from the merger (as well as prior smaller acquisitions e.g. OPIS) both from the cross-selling front as well as cost-savings from the ongoing integration. In an era of fake news, IHS Markit is all the more critical to company executives. IHS Markit is well-positioned to ride on the thirst for credible information and analyses.

Variant

The company is not immune to any possible economic slowdown in the year. The positive oil price forecasts might also not materialize. If the oil market reverses its uptrend and falls back below the mid-$40s, capital spending would be curtailed once again and that would inevitably badly impact the revenue of the Resources segment.

Disclosure: I am/we are long INFO.

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.

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