Thomson Reuters (NYSE: TRI) is a brand that most of us will recognize because of its news segment. But they are actually an enterprise focused business on legal, tax and admin solutions for enterprise clients. They’ve been a beneficiary of the pandemic’s digitalization acceleration, and their growth rates have been organic and ample for years. The company has attractive economics and is a brand whose services are admin based, so a cost center, and aren’t really the focus of cost programs for clients, who will always need someone or another for these services. They are undergoing a change program, so margins are slumping, but we believe they’ll improve according to their guidance on top of other cost savings initiatives. The change program is a necessary speedbump in order for their services to be migrated to the cloud and better configured as remote working and digital backend increasingly becomes the norm.
A Look At the Financials
The change program is a major source of confounding in the company’s finances. There are two opposing vectors. One off costs from the change program, and long term cost saving being instituted as part of the change program and other cost control initiatives. At the moment the change program is winning out and hurting margins.
Adjusted EBITDA declined 14% to $ 452 million due to costs related to the Change Program, higher performance bonus expense, and a discretionary investment of $ 25 million to better position the business for 2022 which Mike will discuss. This resulted in a margin of 26.4%. Excluding Change Program costs adjusted EBITDA margin was 31.1%.
Steve Hasker, CEO of TRI
If you were to apply these change program adjusted margins to the current Q4 revenue, which has grown 6% organically from 2020, the EBITDA evolution would essentially be flat YoY, with the adjusted EBITDA (further adjusted for the change program) for 2021 at around $ 530 million excluding those change program costs.
The efforts to keep their digitalizing services updated to the current world order as far as cost center operations go have been proceeding smoothly. 37% of their revenue is now from cloud based solutions, and there is a plan to get it to 90% by 2023, as customers who were apprehensive about switching from a more traditional configuration become more open to the idea.
Thinking About Valuation
Supposing that we ignore for the time being the change program related costs and do a pro forma calculation for EBITDA assuming the saving program is fully realized, where would that leave us? Right now, the margins are slightly lower YoY, but TRI is guiding towards margins of 40% in 2023, once the cloud migration is almost fully realized and the cost saving plan comes into full effect.
We forecast an adjusted EBITDA margin of 35% for 2022 and between 39% and 40% for 2023.
Steve Hasker, CEO
Applying that margin to the current revenue would put us ahead to $ 2.539 billion in EBITDA, which is $ 600 million ahead of current EBITDA reflecting the expected cost savings, of which only about 33% is currently realized, also the proportion of cloud based sales relative to the plan target.
The best comp we could think of for TRI is a company called Intertrust (OTC: ITRUF), one of our successful investments from 2021, which was acquired at a multiple of around 12.5x on EBITDA. The company does fund administrations services, but it is not as comprehensive as TRI which also offers legal services, and also serves a much narrower vertical. Nonetheless, it is a cost center service and also increasingly digital.
TRI currently would trade at about a 20x multiple on this pro forma figure. But the key difference between TRI and Intertrust is the growth profile. Moreover, the TRI ROICs are slightly higher. Intertrust was clearly undervalued, but on a target multiple analysis basis, TRI is not a bad deal either despite the substantial premium to Intertrust.
Even with pretty conservative assumptions in terms of growth appreciation periods, ie just 4 years of the 6% organic growth, you get a fair multiple that is actually a little higher than TRI’s current multiple. TRI does not have much leverage, so the difference in multiples does not really create a big upside margin, and we always have to take cash flow based approaches like target multiple analysis with a grain of salt, but the valuation definitely does appear fair .
Of course it is essential for the cost saving initiatives and the cloud based transition related to the change program to be fully realized. We are currently at 33% of the plan target, but to justify the current multiple, the effects are fully priced in already by markets. We do not think this is an unreasonable expectation. As said, there is clear evidence of uptake of these cloud based solutions thanks in part to the pandemic, and the company should not have major problems convincing clients that what they’s offering is better. However, with the multiple already being rather fair, even if maybe we could give some more upside if we assume a longer GAP due to the quality of the company and its likely ability to keep growing earnings, we just aren’t interested enough in this sort of risk-reward to take a bite.