Broadridge Financial Solutions: Your proxy awaits
admin | May 15, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The leading third-party provider of investor regulatory-required communications and proxy voting services, BR (Baa1/BBB+/BBB+), has proven that even a pandemic will not hinder its organic growth or impede stable cash flow generation. With net leverage comparable to Moody’s (MCO – BBB+/BBB+) and guidance left relatively unchanged for their fiscal 2020 ending June 30th, there is value in BR 2.9% 2029 paper relative to MCO 4.25% 2029 bonds. A swap provides for roughly a 25 bp pick-up in g-spread while taking out nearly 12 points.
BR has built up a sizeable client base as 900+ banks and brokers rely on its proxy management business, which has become the industry standard given its strong execution track record. Additionally, BR processes $7 trillion worth of fixed income and equity trades per day. As ubiquitous as MCO and S&P (SPGI – A3/A-) are to credit ratings, BR garners the same recognition when it comes to proxies. BR’s business profile can be classified as strong, as it is underscored by a sizeable recurring revenue base. With comparable net leverage to MCO and guidance left relatively unchanged for fiscal 2020 (ending June 30th), there is value in BR 2.9% 2029 paper relative to MCO 4.25% 2029 bonds. A swap provides for roughly a 25 bp pick-up in g-spread while taking out nearly 12 points.
Exhibit 1: BR vs. MCO Spread Curve
BR’s most recent quarterly results highlighted the minimal impact that COVID-19 is having on top line growth and cash flow generation. BR’s stable results are largely driven by its resilient recurring fee revenue base, which accounts for roughly 70% of total revenues and growing. For fiscal 3Q20, recurring fee revenues grew 9%, and 3% on an organic basis. From a business perspective, the growth was largely fueled by higher trading volumes associated with COVID-19 market volatility. Management expects organic recurring fee revenue growth to be even higher in 4Q20 as volatility in 3Q shifted some proxy work into the subsequent quarter. We note that during the 2008/2009 financial crisis, BR posted positive organic recurring fee revenue growth each fiscal year (FY08-FY11). This demonstrates the resilience of its top line in turbulent economic times.
Exhibit 2: BR Total Recurring Fee Revenue Growth During Financial Crisis
Adjusted operating income margin of 21% in fiscal 3Q, expanded 10 bp year-over-year, reflecting increased recurring fee revenues more than offsetting lower event-driven revenues. Free cash flow is somewhat seasonal with the majority of annual free cash flow generated in 4Q. For the first nine months of the fiscal year, BR generated $82 million of free cash flow, which reflected lower net earnings from the year-ago period coupled with higher capital expenditures. Increased capital spending for the year was expected as the company has been making a large investment in an industry management platform.
Leverage Expected to Improve
BR ended 3Q with debt/EBITDA of 2.4x and net leverage of 1.9x. This is on par with MCO whose net leverage is currently 1.9x as well. Management explicitly stated its commitment to its strong Investment Grade rating, which remains an important factor in its capital planning. As such, BR takes a balanced and disciplined approach to both M&A and shareholder remuneration. That said, given the current environment, management remains committed to its 2.0x leverage target by FYE20. BR will be using free cash flow generated in the quarter to reduce debt to hit its target. BR has $400 million of debt maturing on 9/1/20, which they could look to redeem early, or repay borrowings under its revolver which stood at $442.5 million as of 3/31/20. BR maintains very strong liquidity with $400 million of cash on hand and $1.1 billion of availability under its revolver.
Exhibit 3: BR FY20 Guidance
Full Year Guidance Largely Reaffirmed
As more companies pull full year guidance due to lack of visibility, BR has not only provided full year guidance but has kept it largely unchanged with only a few updates. Management feels comfortable with providing guidance due to its recurring fee revenue base coupled with its revenue backlog. Recurring revenue backlog stood at $330 million, which was up from $295 million in the year ago period. The current backlog is equivalent to 11% of the company’s $3 billion in recurring revenue. This provides them with a strong starting point to generate revenue growth in the absence of any new sales. Additionally, BR has been able to achieve as 97+% client revenue retention rate. Importantly, management left its recurring fee revenue growth guidance unchanged as well as its operating margin guidance. Total revenue guidance is now expected to be at the low end of its previous 3%-6% range. MCO expects revenues for the full year to be down in the mid-single digit range.