Verisk Analytics (NASDAQ:VRSK) stock went into a parabolic fall following the jury verdict in the U.S. District Court for the District of New Jersey on September 25, 2019. The verdict states that Verisk and its Xactware Solutions subsidiary infringed the proprietary intellectual property of Eagle View Technologies, a provider of aerial imagery and data analytics. The jury awarded Eagle View $125 million in damages. The Court has also issued a temporary restraining order stopping, among other things, Verisk's sale of Property InSight, Roof InSight, Geomni Roof, and Geomni Property, as well as its sale or use of Aerial Sketch version 2, after September 25, 2019, and until October 8, 2019, when the Court will hold a hearing on a permanent injunction (see here). Since the newsbreak, the share price of Verisk has dropped by some 13%.
Such a steep share price decline may provide a rare entry opportunity into this company. However, before rushing to buy the dip, it is prudent to assess whether the courtroom setback has permanently damaged the core competency of the company. To that end, in this article, I provide an overview of its business model and competitive advantage, hoping to lay a foundation for an in-depth survey.
Verisk is a leading data analytics provider serving customers in the insurance, energy and specialized markets, and financial services industries (Fig. 1). Verisk reports in three segments, insurance, energy and specialized markets, and financial services, which contributed 71.8%, 21.4%, and 6.8% of the revenue as of the quarter ended June 30, 2019, respectively (see here).
Fig. 1. Business domains served by Verisk. Source.
History of acquisitions. Since 2000, the company has acquired dozens of new businesses, consolidating data analytics in the insurance, energy and specialized markets, and financial services industries. Through acquisitions, it became the largest data and analytics solutions provider to the U.S. P/C insurance industry, and a specialist in offering solutions for fraud detection in healthcare, mortgage, and supply chain industries, and for loss quantification and prediction in diverse contexts ranging from catastrophes to health insurance. Since 2012, it expanded into the financial services and natural resources verticals while retaining its core distinctions. Notable transactions include the acquisition of Argus Information & Advisory Services in 2012, Maplecroft in 2014, and Wood Mackenzie, in 2015.
Business model. In the industry domains that it entered, Verisk has built or acquired deep domain expertise; using that technical know-how, it gathered and collated an astronomical amount of records to create unique databases; tapping into its deep domain expertise and proprietary databases, it has been providing first-to-market risk predictive analytics and decision-support solutions that are integrated into customer workflows (Fig. 2).
Fig. 2. What sets Verisk apart. Source.
Its predictive analytics and decision-support solutions are designed to help customers in rating, underwriting, claims, catastrophe and weather risk, global risk analytics, natural resources intelligence, economic forecasting, and other fields to make decisions about risk, investments, and operations with greater precision, efficiency, and discipline.
Monopoly in the P/C insurance industry. From its start, Verisk has been essentially the de facto underwriting utility for U.S. P/C insurers, counting the largest 100 largest P/C insurers as the customers for its ISO service. The deep and lasting ties with these customers accord Verisk with around 90% of the market share in data analytics for the P/C insurance industry.
Verisk ISO's systems-level integration with its customers creates formidable barriers to entry for any aspirant entrants and prohibitive switching costs for its customers. Currently, hundreds of P/C insurers feed to Verisk billions of records per year, continually enriching its databases - the core of its durable competitive edge (Fig. 3). Verisk serves as a statistical agent in all 50 states, the District of Columbia, and Puerto Rico for numerous lines of P/C insurance, and provides claims data as required to state and local government agencies on behalf of insurers (see here). It is operationally and financially impossible to duplicate such databases.
Fig. 3. The breadth and depth of Verisk's databases and analytics. Source.
Thanks to the sustainable competitive advantage, Verisk has pricing power over its captive customers. Its risk assessment business has historically increased prices by 3-4% annually. Goldman Sachs analyst comments:
VRSK's property and casualty (P&C) insurance claims database has one of the strongest competitive advantages of any business we cover, with its very high pricing power translating into top quartile EBITDA margins" (see here).
Capital efficiency. Warren Buffett stated in the 2007 Berkshire Hathaway shareholders letter that:
A truly great business must have an enduring "moat" that protects excellent returns on invested capital."
In the 12 months up to the 2Q2019, Verisk generated a return on invested capital (or ROIC) of 14.65% on a weighted average cost of capital (or WACC) of 5.76% (see here). It clearly created value for its investors.
The $125 million litigation charge as a result of the jury decision mentioned above has a significant impact on the profitability in the 3Q2019. Excluding the effect of such a one-time event, the company actually generated greater organic adjusted EBITDA (Table 1).
Table 1. Adjusted EBITDA by business segment. Source.
Operating model. Verisk has an attractive operating model due to the recurring nature of revenues, the scalability of its solutions, and the low capital intensity of its business.
Fig. 4. Verisk's sources of revenue, subscription vs. non-subscription. Source.
Fig. 5. Scaled business model platform with industry-leading EBITDA margins. Source.
Fig. 6. Annual free cash flow growth as a result of low capital expenditures. Source.
Based on the discussion above, I believe Verisk's flagship insurance business segment enjoys a near-monopoly in data analytics for P/C insurers. Besides the wide moat therein, the company has expanded into energy and specialized markets and financial services industries, which share the same advantageous features including subscription-based, recurring revenue, scalable solutions, and low capital intensity. Overall, Verisk clearly has a sustainable competitive advantage (see here).
The jury decision only has an impact on a relatively small portion of Verisk's insurance offerings, i.e., Xactware and Geomni, with ISO, the main workhorse, entirely unaffected (Fig. 6). In addition, Geomni has been running at a loss (see here); given the poor financial performance of Geomni has not been able to drag down corporate-level profitability in the past, it follows that the division plays a relatively insignificant role in the sprawling business of Verisk. In the worst case, even if the company decides to write off Geomni entirely, it is unimaginable the impairment can be anywhere near the $3.51 billion market cap reduction caused by the 13% sell-off triggered by the jury decision.
Fig. 6. The insurance business segment of Verisk. Source.
Therefore, I believe the courtroom setback, as well as the $125 million penalties, leaves the durable competitive advantage commanded by the company largely unscratched.
The ensuing questions are to what extent the growth prospect of the company will be affected and, from a valuation point of view, whether a sufficiently large margin of safety has been created by the sell-off. These questions are beyond the scope of this article and will be discussed in forthcoming pieces.
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Disclosure: I am/we are long VRSK. 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.