FactSet: How You can Invest in the Hedge Funds’ Biggest Investment, By Rutvij Thakkar

Tl;dr FactSet is an undervalued and financially stable SaaS/IT solution company with tons of upside potential.

If any of you have relevant experience or are friends with people in Investment Banking/other high finance, you know that FactSet may be the lifeblood of their financial analysis toolkit when it’s not Bloomberg (which isn’t even publicly traded). FactSet has been around since 1978 and it’s considered a staple like Bloomberg in many wealth management firms, and it offers some of the easiest to access and understandable financial data so many newer firms focused less on trading are switching to FactSet because it has a lot of the same data Bloomberg offers for half the cost and a much more user-friendly interface. When it comes to modern and accessible financial data, FactSet outcompetes Reuters and arguably Bloomberg as well due to their API services which makes FactSet much more preferable for quantitative divisions of banks/hedge funds as API integration with Python/R is the most important factor for vast data lakes of financial data, this suggests FactSet will be much more prepared for programming making its way into traditional finance fields. According to FactSet, their mission for data delivery is to “Integrate the data you need with your applications, web portals, and statistical packages. Whether you need market, company, or alternative data, FactSet flexible data delivery services give you normalized data through APIs and a direct delivery of local copies of standard data feeds. Our unique symbology links and aggregates a variety of content sources to ensure consistency, transparency, and data integrity across your business. Build financial models and power customized applications with FactSet APIs in our developer portal”. Their technical focus for their data delivery system alone should make it stand out compared to Bloomberg, whose UI is far more outdated and complex on top of not being as technically developed as Factset’s. Factset is also a key provider of sell-side portfolio analysis for IBs, Hedge funds, and Private Equity firms, and it’s making its way into non-quantitative hedge funds as well because quantitative portfolio management makes automation of risk management and the application of portfolio theory so much easier, and to top it off, FactSet’s scenario analysis and simulation is unique in its class. FactSet also is able to automate trades using an EMS based on individual manager risk tolerance and provide ML portfolio optimization for trading as well. Not only does FactSet provide solutions for financial companies, they are branching out to all corporations now and providing quantitative analytics for them in the areas of “corporate development, M&A, strategy, treasury, financial planning and analysis, and investor relations workflows”. FactSet will eventually in my opinion reach out to Insurance Risk Management a lot more in the future as that’s a huge industry which has yet to see much automation of risk management yet, and with the field wide open, FactSet will be the first to take advantage without a shadow of a doubt. So let’s dig into the company’s financials now:

Their latest 8k filing reported the following:

"Revenue increased 2.6%, or $9.6 million, to $374.1 million compared with $364.5 million for the same period in fiscal 2019. The increase is primarily due to higher sales of analytics, content and technology solutions (CTS) and wealth management solutions.

Annual Subscription Value (ASV) plus professional services was $1.52 billion at May 31, 2020, compared with $1.45 billion at May 31, 2019. The organic growth rate, which excludes the effects of acquisitions, dispositions, and foreign currency movements, was 5.0%. The primary contributors to this growth rate were higher sales in FactSet's wealth and research workflow solutions and a price increase in the Company's international region

Adjusted operating margin improved to 35.5% compared with 34.0% in the prior year period primarily as a result of reduced employee-related operating expenses due to the coronavirus pandemic.

Diluted earnings per share (EPS) increased 11.0% to $2.63 compared with $2.37 for the same period in fiscal 2019.

Adjusted diluted EPS rose 9.2% to $2.86 compared with $2.62 in the prior year period primarily driven by an improvement in operating results.

The company’s effective tax rate for the third quarter decreased to 15.0% compared with 18.6% a year ago, primarily due to an income tax expense in the prior year related to finalizing the Company's tax returns with no similar event for the three months ended May 31, 2020.

FactSet increased its quarterly dividend by $0.05 per share or 7% to $0.77 marking the fifteenth consecutive year the Company has increased dividends, highlighting its continued commitment to returning value to shareholders."

As you can see, there’s not much of a negative sign in sight here.

This was the guidance regarding COVID-19 for their last 10Q statement:

"Our revenue, earnings, and ASV are relatively stable and predictable as a result of our subscription-based business model. To date, we have not seen the COVID-19 pandemic having a material impact on our revenue or ASV,"

It makes sense considering how FactSet’s consistent free cash flow has never slowed down, primarily due to its subscription-based model:

FactSet’s annual subscriptions and professional services have made its way to foreign and developing markets, and many of them are opting for FactSet’s cheaper services to reduce costs and still get copious amounts of data and models to work with.

Here’s what FactSet had to say regarding its competitive position within the market of providing financial data in its last 10k: “Despite competing products and services, we enjoy high barriers to entry and believe it would be difficult for another vendor to quickly replicate the extensive databases we currently offer. Through our in-depth analytics and client service, we believe we can offer clients a more comprehensive solution with one of the broadest sets of functionalities, through a desktop or mobile user interface or through a standardized or bespoke data feed.” And FactSet is confident that their ML services cannot be replaced by anybody else in the industry either: “In addition, our applications, including our client support and service offerings, are entrenched in the workflow of many financial professionals given the downloading functions and portfolio analysis/screening capabilities offered. We are entrusted with significant amounts of our clients' own proprietary data, including portfolio holdings. As a result, our products have become central to our clients’ investment analysis and decision-making.” (https://last10k.com/sec-filings/fds#link_fullReport), if you read the full report and compare it to the most recent 8K, you’ll find that the real expenses this quarter were far lower than expected by the last 10k as there was a lower than expected tax rate and a 3% increase in expected operating margin from the expected figure as well. The company also reports a 90% customer retention rate over 15 years, so you know that they’re not lying when they say the clients need them for all sorts of financial data whether it’s for M&A or wealth management and Equity analysis:

https://www.investopedia.com/terms/f/factset.asp

FactSet also has remarkably good cash conversion considering it’s a subscription based company, a structure which usually takes a lot of days for accounts receivable to process and requires a lot of leverage.

Speaking of leverage, FDS had taken on a lot of leverage in 2015:

So what’s that about? Why were FactSet’s long term debt obligations so low and why’d they spike up all of a sudden? Well usually for a company that’s non-cyclical and has a well-established product (like FactSet) leverage can actually be good at amplifying returns, so FDS used this to their advantage to complete some acquisitions to capture global market share and this was able to help the share’s price during 2015. Also, as you can see debt/EBITDA is beginning a rapid decline anyway. This only adds to my theory that FactSet is trying to expand into new playing fields. FactSet obviously didn’t need the leverage to cover their normal costs, because they have always had consistently growing margins and revenue so the debt financing was only for the sake of financing growth. And this debt can be considered covered and paid off, considering the net income growth of 32% between 2018 and 2019 alone and the EPS growth of 33%

EBITDA has virtually been exponential for FactSet for a while because of the bang-for-buck (half the price of Bloomberg) for their well known product, but now as FactSet ventures into algorithmic trading and corporate development the scope for growth is broadly expanded.

P/E has declined in the past 2 years, indicating a decent value proposition as it stands.

Increasing ROE despite lowering of leverage post 2016

Mountains of cash have been piling up in the coffers increasing chances of increased dividends for shareholders (imo dividend is too low right now, but increasing it will tempt more investors into it), and on top of that in the last 10k a large buyback expansion program was implemented for $210m worth of shares, which shows how confident they are in the company itself.

SGA expense/Gross profit has been declining despite expansion of offices and costs to integrate new acquisitions since 2015.

FactSet also has great control of capital expenditures as shown above by the margins and efficient usage of equity financing, and efficient use of newly bought assets as shown by the ROE and ROA figures respectively. This makes it an extremely minimal expense FinTech firm that's financially sound beyond belief.

I’m a bit concerned about the skin in the game leadership has in this company, since very few executives/board members have significant holdings in FactSet, but the CEO himself is a FactSet veteran, and knows his way around the company. On top of that, Bloomberg remains king for trading and the fixed income security market, and Reuters beats out FactSet here as well. If FactSet really wants to increase cash flow sources, the expansion into insurance and corp dev has to be successful.

FDS also recently announced a partnership with Snowflake ($SNOW) for deploying its structured and unstructured data onto their platform to help make full-scaled digitization for portfolio managers simpler, which again shows their commitment to aggressive expansion through technology and their willingness to innovate.

On top of this, FactSet plans to move their ticker plant over to Amazon Web Services to provide faster data to their customers. Here's what the VP of sales at AWS had to say about this: "'By running their large-scale ticker plants on AWS, FactSet can leverage AWS’s global infrastructure and cloud services to provide fast access to financial data that investment professionals need to make time-sensitive decisions'", and even FactSet previously thought it was impossible to move the ticker from on-site to the cloud.

“Moving a full ticker plant onto the cloud is the holy grail of market data engineers,” said Gene Fernandez, Chief Product and Technology Officer, FactSet. “Many people thought it would be impossible. FactSet has worked with AWS to conduct rigorous testing and validation that proves it is not just possible, but that AWS provides a stable and secure environment for processing major exchange feeds. We are confident that this groundbreaking project will help us drive greater speed and efficiency to accelerate our clients’ digital transformations.”

Summary: FactSet has a lot of growth still left in its industry which is already fast-growing in and of itself, and it only has more potential at its current valuation. Earnings September 24th should be a massive beat due to investment banking demand and growth plus Hedge fund requirements for data and portfolio management hasn’t gone anywhere and has likely increased due to more market volatility which required more reliable and accessible information for trading and asset management.

I’d say it’s a great long term investment, and it should at least be on your watchlist especially before the earnings in 2 days.