Broadridge Financial Solutions offers value relative to Moody’s
admin | May 7, 2021
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.
As the leading third-party provider of investor regulatory-required communications and proxy voting services, Broadridge Financial Solutions (BR, Baa1 (n)/BBB+ (n)/BBB+) has proven that even a pandemic will not hinder its organic growth or impede its stable cash flow generation. Despite leverage increasing to fund an acquisition with a new 10-year deal in the market, management will look to rapidly repay debt over the next two years, bringing leverage at or below its 2.5x leverage target. The credit provides value and is good name diversification for investor portfolios. The new 10-year deal priced at +105 bp, coming 30 bp (g-spread) behind Moody’s Corp (MCO – BBB+/BBB+) 2029 paper; prior to the start of the pandemic BR traded 25 bp back. Fair value is closer to 20 bp, with the potential to collapse further as the company reduces leverage closer to that of MCO’s.
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 Moody’s (MCO – BBB+/BBB+) and S&P (SPGI – A3/A-) is 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.
BR’s results since the start of the pandemic have highlighted the minimal impact that the pandemic has had on both 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 third quarter 2021, recurring fee revenues grew 8%, which was fueled by 7% organic growth. This remains within management’s historic mid-to-high single digit growth performance and demonstrates the strength of the company’s recurring revenue growth model. From a business perspective, the most recent quarterly results were largely driven by underlying growth trends due to record equity performance as well as increased growth across mutual funds and ETFs. While equity volume growth has been strong throughout BR’s fiscal 2021 thus far, management is forecasting growth of 25% in fiscal 4Q, which if achieved, would mark the strongest quarter for the year. In fact, we note that BR has witnessed five consecutive quarters of double-digit internal trade volume growth. Furthermore, boding well for future performance, BR continues to post revenue retention above 97%.
Exhibit 1: BR Key Volume Drivers (Fiscal 1Q20-Fiscal 3Q21)
Adjusted operating income was up 8% year-over-year, while the adjusted operating income margin contracted 60 bp (to 20.4%) in fiscal 3Q. Management noted that the margin decline reflected investments in the company’s technology platforms that they discussed last quarter. Free cash flow is somewhat seasonal with the majority generated during the fourth quarter. For the first nine months of the fiscal year, BR generated $136 million of free cash flow, which was up $54 million versus the prior year period and reflected increased platform and software spending.
Acquisition Increases Leverage – Management Focused on Rapid Debt Reduction
BR ended 3Q with debt/EBITDA of 1.5x and net leverage of 1.2x. However, the company’s leverage is expected to increase with the close of the Itiviti acquisition for $2.5 billion, which was announced in March 2021. The deal is expected to be financed with term and public debt with the company issuing $1 billion in 10-year bonds this week. Leverage is expected to approach the mid-3.0x area post close. While its leverage metric will be above the threshold for the current ratings, BR plans to use its strong free cash flow to delever rapidly as management has explicitly stated its commitment to its strong IG ratings. Management noted that they expect to hit their 2.5x leverage target within two years from the close. Given the company’s deleveraging plans, BR’s high BBB ratings were affirmed by both Moody’s and S&P with both agencies revising their outlooks to negative from stable. Fitch not only affirmed its BBB+ rating but left the outlook at stable. Moody’s and S&P were concerned with the company’s increased leverage target which moved from 2.0x to 2.5x. However, both agencies recognize that they company’s free cash flow provides for deleveraging to the 2.5x area within a two-year period. Should management hit its leverage target by fiscal year-end 2023, outlooks should be revised to stable. Furthermore, the acquisition helps to improve both scale and product capabilities while increasing its international presence.
Exhibit 2: BR fiscal year 2021 guidance
Full Year Guidance Increased
Given the better-than-expected results year-to-date, BR substantially increased its guidance for the year (Exhibit 3). While the new guidance reflects the impact from the Itiviti acquisition, the bulk of the revised guidance stems from the strong organic growth. Full year recurring revenue growth is now expected to be in the 8%-10% range, up from previous guidance of 3%-6% (management had expected results to come in at the high end of the range). Additionally, total revenue growth was raised to the 8%-10% range, which was up from initial guidance in the 1%-4% range. Management left its adjusted operating income margin at roughly 18%, which would translate to a 50 bp increase from fiscal year 2020. Management also increased its adjusted EPS guidance to the 11%-13% range (up from 6%-10%).
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