Euromoney Institutional Investor — Update 24 March 2016

ERM operates a portfolio of brands supporting the business community in the financial and other sectors around the world. It seeks to be the authoritative ‘voice’ in the segments in which it operates, supplying research and data that inform decision making, staging conferences and events that bring together key individuals and providing the content in online and offline form to give those individuals the background and context in which to drive their own businesses forward. Its revenues come in the form of subscriptions, sponsorship, delegate fees and advertising, with the Research and data division the largest of the four operating divisions. The group has grown through a combination of organic growth and acquisition, a recipe that has delivered a comparatively resilient performance over the cycle. The transition from a business that was effectively a specialist publisher into an extensive online resource has opened up the possibilities to leverage further the brand portfolio and the expertise and the IP that has been built within the group over the years.

The stock has traditionally traded at a premium to other B2B media stocks, reflecting its good record on acquisitions and integration and its strongly cash generative characteristics, with many of its customers paying subscriptions and events well ahead of their provision. The weakness of its core capital market target sector has eroded sentiment and the stock currently trades a little under the peer group average on a PE basis

This report follows the group’s capital markets day, at which no new financial information was provided and we have made no adjustments to our forecasts since the publication of the Q1 trading update back in January. FY16 is set to be a difficult year, with underlying markets under continuing pressure and with advertising revenues, and those from smaller conferences, still in retreat. The strategic review identified a new discipline within the portfolio to determine the most efficacious applications for capital resource and indicated a greater degree of active management of the portfolio’s constituents. The group has very strong cash generation and a growing pool of cash on the balance sheet, giving it considerable firepower for suitable acquisitions. The actions already identified should start to come through in the numbers for FY17; more strongly in FY18.

The group generates significant revenues from global financial institutions.

ERM is an international digital media group with leading brands in B2B markets, primarily financial and commodity markets. It has transitioned from a traditional print business to one which derives the bulk of its revenues from subscriptions and events, with advertising now reduced to 12% of group revenues (FY15). ERM has a long-standing, supportive majority shareholder in DMGT, which holds 67.9% of the equity and has two non-executive board members.

ERM owns leading brands across a number of different verticals, with the most important centred on financial publishing for the investment banking, asset management and commodities markets, including the main autonomous brand, with other core areas including telecoms and energy. It also has businesses providing digital resource – information and tools – for research and investment markets. Across various brands, the group runs conferences, seminars and training courses primarily focused on the financial and the commodities markets. ERM is also well known for its long-standing expertise in emerging markets and derived 28% of its revenues from them in FY15, either directly or indirectly.

The group generates and curates large amounts of content across its business areas and the underlying principle is that customers should pay to access it, based on the premise that content must be good quality and of value. With over 70 brands across the group, the five largest are:

Between them, these brands account for c 60% of overall revenues, with the long tail of others (listed within the divisional descriptions below) delivering the balance. 52% of FY15 group revenues were from subscriptions, with robust retention rates giving a degree of visibility to the top line. The group’s long-term record (below) shows the resilience of the business model over the cycle, as well as the emphasis on building the proportion of recurring income.

ERM invested a total of £9.4m from late 2012 in building a common content production management and distribution system across all its editorial products across the group, known as Project Delphi. This was achieved on time and on budget and has facilitated the transition from a print-hearted group to a digital information provider, opening up new products and solutions, speeding new projects to market and allowing for greater levels of engagement with customers.

The group was founded in 1969 by Sir Patrick Sargeant, who was then City Editor of the Daily Mail, backed with a corporate loan, which is the origin of DMGT’s majority holding in the group’s equity. He remains on the board as a non-executive and is the group’s President. Since inception, the ethos has been throughout one of independent business run by entrepreneurs, with a small head office team supporting with professional services and co-ordination. On the retirement of Executive Chairman Richard Ensor at the end of the last financial year (after 39 years with the group), Andrew Rashbass was appointed to the board, shortly after changing the role to a more conventional CEO position and announcing a search for a new non-executive chairman. Senior non-executive John Botts is currently occupying that position and the operational management are no longer main board members. DMGT has two representatives and further new non-executives are being sought to realign the structure to one more appropriate to the group’s size and status.

Andrew Rashbass was previously CEO of Reuters, the news division of Thomson Reuters, which he joined in 2013. Before that, he spent 15 years at The Economist Group, where from 2008 he was CEO, leading its transformation from a traditional print business into a leading digital title. He was also MD of Economist.com and publisher of The Economist Newspaper. Colin Jones remains as CFO, the other executive board position, having joined the group in 1996. Christopher Fordham, previously group MD, is now MD, Corporate Development, overseeing mergers and acquisition policy and implementation and post-acquisition integration.

With a large and comparatively disparate portfolio built over a long period, it is inevitable that not all group companies will be operating at the same points of their business cycles and that not all will be structurally well placed. The recent strategic review has been designed to identify where in the group capital should best be allocated to drive the top line at sensible margins.

The business has been built through a combination of organic growth and expansion through acquiring and boosting the growth of the acquired businesses. There is no change to this central plank of the strategy. The acquisition policy has revolved around attracting businesses with strong, entrepreneurial leadership, encouraged to stay with the business after the transaction. Historically, though, the constituent companies have been relatively siloed, with little transference of expertise, best practice or contact, drawing on a small head office resource as and when required. There has also been little in the way of active portfolio management. Companies have been bought and have mostly grown well post acquisition, but where the underlying opportunity has failed to live up to its original promise, they have slipped into the ‘long-tail’. Post the strategic review, group companies now need to justify their retention within the portfolio.

ERM’s financial results are presented in two formats; broken down by product division and by revenue type. Management has also historically described the group through the proportions of revenue stemming from end markets, in particular that around two-thirds of the business comes from the capital markets. Drawing attention to end markets of banking, asset management and commodities may have masked the true diversity of the business drivers.

The strategic review has sought to define where each operating company lies within the four quadrants of stronger or weaker cyclicality against stronger or weaker structural positioning. In the top right quadrant, where clear strengths have been identified (with greater granularity than historically), are included products and services addressing the industries of; asset management; insurance, telecoms, infrastructure finance, aviation finance and other specialist finance. Of these, asset management is the largest element and the area of key focus. ‘Top right’ companies account for 59% of FY15 revenues, with growth running at around 4%. These are the areas on which investment (sales and marketing, new product development, IT etc.) and acquisition policy will be focused. In ‘Top left’ are those group companies with good positioning but in a poor part of the cycle, with Metal Bulletin a clear example. Here the strategy is categorised as ‘battening down the hatches’, optimising the operations and competitive positioning, taking advantage of opportunities as they emerge. This segment carries about 16% of group FY15 revenues, with top-line decline of 4% in the period. ‘Bottom right’ companies are those where the cycle is acting in their favour but where there are weaknesses in the business model. For these, the choice is either modest investment to correct the underlying issues or optimising performance with the aim of obtaining a better price for any sale, ie ‘using the time wisely’. These businesses produced 9% of FY15 revenues, down c 5% on prior year. This leaves a balance of 16% of group revenues in the ‘bottom left – the real drag on overall performance, with revenues down 15% in FY15. Here, neutralising the drag is the priority, either through disposal, downscaling through maximising the short-term profit/cash, or a supported short-term plan to move the business into an adjacent quadrant.

The strategic review also identified three overriding big themes that should inform capital allocation; the asset management sector, price discovery for markets where transparency is poor and other pools of faster-growth opportunities, where the group either has or can acquire an anchor business from which can provide the foundation to build a business of scale. These latter include telecoms, risk and compliance, fintech, insurance, soft commodities/agriculture and infrastructure finance. Whilst many of these areas could still fall under the ‘capital markets’ umbrella, the increasing diversification and specialisation should provide greater resilience to the business model in times of downward cyclicality and political pressure on the global investment banking sector.

Acquisitions have always formed a core element of the growth strategy and in the period from 2005-2015, the group spent a total of £460m. Revenue growth over that period can be attributed 25% as organic, 40% from net acquisitions/disposals and 35% from post-acquisition growth. The formal acquisition criteria are that opportunities should be able to produce total shareholder returns greater than 15% pa. Preferred candidates should have:

There is no current intention to adjust the reporting categories and we give brief profiles of each below and show ‘quadrant’ positioning as described above where the information is available.

32% group revenues, 37% operating profits

ERM’s research and data division is subscription driven and online, with none of the classic print legacy issues that have dogged other providers. Its key customers and targets are in the asset management sector, with the division clearly in the ‘top right’ segment as defined above. As with any subscription business, renewal rates are a key metric, alongside the obvious ones of new business generation and additional sales and bundling of services.

The key operations are BCA Research and Ned Davis Research (bought August 2011). BCA is based in Montreal, Canada, and is one of the world’s leading providers of global macroeconomic research; Ned Davis is US-based and provides independent financial research to institutional and retail investors. Both BCA and Ned Davis are clearly in the top-right quadrant. The group also specialises in products for emerging markets, with the EMIS (Emerging Markets Information Services) brand and CEIC, which provides time-series data. Emerging markets, with many economies dependent on commodity prices, have clearly been difficult over recent periods and no immediate recovery is in sight. One of the key strengths of the Delphi platform is that it makes the process of bringing new products and services to market quicker and easier, as all content is in one place. This is facilitating the expansion in adjacent markets. BCA has clearly benefited from the Delphi platform, launching BCA Analytics, an interactive charting tool and BCA Edge, an online research service and it is this extra value added that our model assumes as a growth driver.

Again predominantly centred on the global financial services industry, the group organises sponsored conferences and seminars around group brands such as Euromoney, Institutional Investor, Metal Bulletin, Coaltrans and IMN.

The events are often key occasions for the particular industries (examples include Euromoney’s Covered Bond Congress or Metal Bulletin’s International Ferro Alloys Conference) with a focus on building larger and more influential gatherings and leveraging the value of the group brands. The portfolio was extended with the acquisition of Mining Indaba in July 2014. Subscription revenues are an unusual element of this division and are derived from Institutional Investor (II) memberships. This is a firmly ‘top right’ activity, which has been the major driver of divisional growth in the last two years.

Apart from the subscription revenues referred to above, this division has seen typical cyclical trading. Larger events (which comprise around 30% of the portfolio) continue to perform well, but with smaller events and training suffering from constraints in client budgets. Although most events are run yearly, some are biennial and exact timings can affect the seasonality of the business between quarterly or half-yearly reporting periods. This was particularly apparent with the FY15 results, when the prior year had had a very strong and profitable September. With the additional factor of weakness in commodity markets, which particularly affects training budgets, Q116 saw a further consecutive quarterly drop in revenues (at constant currency) down 7% (Q315: -9%, Q415: -2%), while delegate revenue fell 19% (Q315: -11%, Q415: -14%).

17% revenues, 20% operating profits

This division produces both print and online information for a broad set of target markets, including metals, minerals and mining, legal, telecoms and energy. Its most important brand is Metal Bulletin, bought back in 2006, which epitomises the authoritative market voice that other group brands aspire to and which clearly lies in the ‘top left’ quadrant. The division’s performance, with underlying revenues up by 2%, was supported by good contributions from the telecoms-facing business more than compensating for the soft metals and mining markets. Metal Bulletin is not (and has not been) an advertising-driven publication and has been steadily driving its subscription revenues. Its clear focus is on price discovery and news reporting and that has helped hold revenues steady in FY15, despite the cyclical headwinds from underlying market conditions. Its family of brands are now being delivered via a single portal, which should open up new revenue opportunities.

18% revenues, 15% operating profits

Historically, the financial publishing business has been the most dependent of the group’s divisions on advertising revenues and has therefore been the most structurally challenged in the face of changing patterns of consumption. Management’s focus has been on improving the quality of the earnings by shifting divisional revenues further in favour of subscription-based models, driven by data rather than by advertising, and by launching new products into the market.

Financial publishing had a difficult year in FY15, with the impact of the pressure on capital markets translating to lower advertising spend. Full year figures showed a decrease of 6% in divisional revenues, despite the continuing modest growth in subscription revenues. While this transition has been fairly painful, the quality of the earnings generated is obviously improving and the group is shifting to a stronger base for when the cycle turns. The autonomous brand has been one that has been positioned in the ‘bottom left’ quadrant but where the structural inadequacies are being addressed to shift it into ‘top left’. This primarily involves leveraging the brand through awards and content that aspires to thought leadership, which can be delivered across multiple channels. Rather than a publisher that carries advertising, Euromoney wants to be viewed as a marketing partner. Institutional Investor is also extending its brand reach through Forums (reported within conferences), which facilitate high-level networking and through the new capital introduction networks. These should deliver revenues from introduction fees, data service and platform fees, but also from basis points on the capital.

We consider ERM’s share price valuation against quoted UK B2B peers, albeit that they have varying business models. It has traditionally traded at a premium to this group, reflecting its consistent history of delivery on expectations, operating margins and balance sheet strength. Performance over the last year has seen the share price trend lower, falling 8.6% (with the FTSE All Share having retreated by 7.9% over the same period). There have been very mixed performances from the other quoted B2B groups, reflecting corporate changes and geographic or sectoral exposure. Informa has clearly had the strongest share price performance over the last twelve months, appreciating by 19.8%, while ITE has seen its share price fall back by 21.9%. The charts below show ERM’s relative market valuation based on annualised numbers to December.

ERM traditionally traded at a premium. This has been justified by the strong balance sheet and also management’s accomplishments on transitioning the business from print-based to digital, as well as its enviable record on acquisition integration. With a strong portfolio of brands and a clear focus on driving both top line and operational performance, we see no reason why the premium should not be regained as the resumption of growth moves into clearer sight for FY17/FY18.

The group has a very resilient longer-term financial record, particularly considering the cyclicality of its underlying markets and the substantive structural shift that has been implemented away from a print-based, advertising-driven model to a digital one, where investment in IP drives high levels of recurring income through subscriptions. With the added headwinds of the travails of financial markets, broadly maintaining revenues over 2012-2015 is a creditable performance.

FY16 has started with little change in trend from H215 and we made only minor adjustments to our forecasts on the Q1 trading update back in January. Given the underlying markets and in the absence of acquisitions, we are expecting the top line to dip by 3.3% for the year to September 2016. Price increases much in excess of inflation continue to be difficult to achieve in current market conditions, but the additional functionality of Delphi is helping to give greater pricing flexibility. Retention rates in subscription products are good, although deferred revenues at end September 2015 were flat for subscriptions and down by 9% in other areas of the business.

Looking at the conclusions of the strategic review, a purely mechanistic work through, taking the percentage of revenues given for each of the four quadrants, combined with their broad potential for organic growth, points to an overall organic group revenue potential growth rate of 3-4% on a medium-term basis (excluding acquisitions). This assumes no material changes to underlying market conditions, with the bulk of the improvement stemming from reducing the drag from the ‘bottom left’ companies. This would start to be reflected in the FY17 numbers but show through in full in FY18. Our model of top line growth of 1.9% in FY17 sits comfortably with this scenario.

People costs in FY15 were at 39% of revenues, with generally below market salaries and higher incentive-based costs (sales commission, bonuses for delivery), with around half of total pay variable by performance. FY15 also had higher property costs (+£2m) with the relocation of the London office. The current incentive schemes, including the Capital Appreciation Plan, are currently all under water and it is likely that a new scheme will be put in place once the action plan stemming from the strategic review is put into place.

Changes to the group’s constituents and business models, in particular the Dealogic transaction as described in previous notes, and the investment needed to sustain and grow the targeted portfolio companies, means that the ‘traditional’ historic level of around 30% operating margin is no longer tenable. The switch from print to digital does not of itself have significant margin impact. Print and distribution costs have not been that meaningful given that subscriber numbers are comparatively low for these specialist publications. If anything, editorial costs are increased with the need for more frequently updated content provision. The sales process is also different for selling an online corporate access subscription, with a longer sales cycle. Contracts tend to be on a service basis rather than by number of users, with retention helped by the inherent conservatism of the user base, who will often have integrated the input into their own systems and products.

Expectations have been set for operating margin, based on the achieved level of 25.8% in FY15 on the company’s definition of ‘normalised’, being core EBITA per-impairment and option costs. The reduction from previous levels reflects the higher property and IT costs, but with a greater impact from the reduction in high margin advertising revenues and smaller conference activity. Our model shows a further slight diminution in the current year, based on the ongoing reduction in advertising income coupled with continuing investment, before starting to pick up through FY17 as the first benefits of corporate action start to be felt. This is, however, all based on the portfolio as currently configured.

The build-up of cash, from both underlying cash generation and the Dealogic deal proceeds, will lead to lower interest payments for the year. Earnings per share were diluted by around 2% by this transaction, which involved swapping out pre-tax profit for an associate interest and a £13.5m cash payment. Partly offsetting the impact was a lower underlying tax charge of 18% (FY14: 21%), a function of (i) reducing UK corporation tax rates; (ii) amortisation of goodwill relating to acquisitions; and (iii) mix. Our model shows a slight tick up to 19% for FY16e and FY17e.

The dividend is set with regard to 3x cover.

ERM is an inherently strong generator of cash. With so much of the group’s revenue based on subscriptions and events, the bulk of the cash comes in from customers before the product is delivered. This has enabled the group to invest in growth and fund its acquisition programme, and more recently, its capital spend, without running up any significant amount of debt.

Underlying cash conversion was 101% in FY15 (FY14: 100%, FY13: 103%). This has only dipped marginally below the 100% figure twice in the last 20 years.

At end September 2015, the group ended the year with a net cash position on the balance sheet for the first time since 1997. If no deals were to be done, and with the benefit of the Dealogic proceeds, our model shows the cash balance building to around £85m by September 2016 and £139m the following year.

The group also benefits from a loan facility granted by its majority shareholder, DMGT. This amounts to $160m and is due to expire in the current year. Its renewal will depend on the acquisition pipeline at the time of the renegotiation.

This means that the group has considerable firepower to invest in its own most promising opportunities and to pursue acquisitions. Its focus on attracting vendors who want to stay with their business means that it is less likely to be in competition with PE for deals and is also more likely to have worked alongside them and got to understand their operations and potential over a longer period, reducing the acquisition risk. The ‘sweet spot’ is most likely to lie with businesses generating in the order of £50m of revenues – big enough to make a difference but small enough to benefit from being part of a larger concern.