Sunday, April 01, 2007

Broadridge Financial Solutions, Inc (BR)

ADP has just spun off its Brokerage Services Group into a separately traded company called Broadridge Financial Solutions (BR.) The basis of the spin off was a tax free dividend of 1 BR share for every 4 ADP shares leaving about 139 million shares outstanding.The distribution was completed on March 30th, just this Friday.

The company has a 40 year history and is an outsource solution to the financial services industry. It provides integrated systems and services include investor communications solutions, securities processing solutions, and securities clearing and operations outsourcing solutions.

The company enjoys some long-standing relationships with its clients and some 70% of its revenues are recurring. Some parts of its securities processing solutions are used by 7 of the top 10 US broker dealers so there is tremendous market share. On average, the firm processes $2 trillion in fixed income trades daily.

These are large markets. Globally, investor communications is a $3-5 billion market with revenues at Broadridge last year constituting $1.4 billion of BR's almost $2 billion revenues. The Investor Communication Solutions business involves the processing and distribution of proxy materials to investors in equity securities and mutual funds, as well as the facilitation of related vote processing. ProxyEdge, their electronic proxy delivery and voting solution for institutional investors, helps ensure the participation of many companies’ largest stockholders. This is important from a corporate regulatory standpoint in that it provides regulatory reporting, tax reporting and corporate actions/reorganization processing solutions for its clients. In addition. this division provides financial information distribution and transaction reporting services to both financial institutions and securities issuers.In this business, the company gets a fee for each item processed and/or distributed.

This has been a decent growth segment for the business with YOY growth in revenues for the June 06/05 period of 15.6% and growth for the first half of 07 fiscal versus corresponding 06 of 14.5%. Earnings from continuing operations for the year were up 16.2% reflecting slight margin expansion to 14.7% from the prior year's 14.5% but mostly revenue growth.

Proxy communication represents about 65% of this segment and there is a cloud on the horizon. Let me quote from their recent filing:

"Prior to recent amendments, SEC rules required affirmative written consent from a stockholder before proxy materials could be delivered electronically to that stockholder. On December 13, 2006, the SEC adopted amendments to its proxy rules that will allow public companies an option to follow a “notice and access” model of proxy material delivery. The new rules go into effect on July 1, 2007 ."

What does this mean?

"Under the new rules, public companies may furnish proxy materials to stockholders by posting them on an Internet website and providing stockholders with notice of the Internet availability of the proxy materials. "

As the company indicates:
"The adopted changes, and the proposed changes, if adopted, will have a significant effect on our business. For those companies that choose the notice and access option, we will continue to mail notices to those stockholders who have not elected to receive proxy materials electronically. Therefore, the volume of items to be mailed will most likely remain unchanged. However, the weight of the packages will be less, resulting in lower revenues per distribution. At the same time, some stockholders may elect to continue to receive paper copies of proxy materials. Certain of these mailings may not receive the benefit of volume discounts, resulting in higher revenues per distribution. We also anticipate deriving additional revenue from the fulfillment services that we expect to provide for individually ordered paper proxy materials and for the establishment of procedures such as toll−free numbers and websites to accommodate the requests of stockholders to receive paper proxy materials for up to one year after the conclusion of the meeting or corporate action to which the materials relate. Additionally, we may derive revenue from new services such as the creation of access notices and the creation and maintenance of a new database of stockholders requesting paper proxy materials. We do not at this time know how many companies will choose the notice and access option, nor do we know how many stockholders will elect to continue to receive paper copies of proxy materials. As a result, we cannot at this time predict the net effect of the SEC’s new electronic access rules on our Investor Communication Solutions business."

My guess, at least for the foreseeable future, revenues should stay intact. Growth is driven by increasing levels of share ownership. High levels of activism and merger activity provide incremental revenue opportunities.Delivering of trade confirms, account statements, prospectus information, etc is another important aspect of this business. This aspect of the communications business integrates well with the securities processing business.

Securities processing is another decent revenue recurring business which operates under long term contracts. It is a scalable business where many firms choose to outsource their clearing systems. Brokerage industry consolidation provides both challenges and opportunities to be the platform onto which to consolidate. Pricing is a struggle. Securities processing solutions represents about 25% of the total revenues and generates pre-tax margins of almost 27%. Pure clearing operations for correspondent brokers at this point is a smallish business, less than 5% of revenues and generates a loss.

This is a very international business. BR has securities processing capabilities for more than 50 countries and voting platforms available for over 90 countries.

There is some concentration risk. The top 5 accounts represent about 25% of revenues. Hence, consolidation trends can hurt as clients merge.

The cash flows of this business are quite interesting. CFFO was $426 million last year, well above net income, and representing some 22% of revenues. Since capex has been about $34 million for the last several years, considerable free cash flow was generated, in fact, well in excess of net income. The 2006 CFFO was augmented by the liquidation of a "required regulatory deposit reserve" of $176.8 million in the the Clearing and Outsourcing Solutions segment. Hence, a more sustainable and realistic CFFO would have been about $250 million. Given the burden of interest expense, going forward CFFO, somewhere around $225. FCF should be around $180-$200 million

The equity market cap is about $2.7 billion, hence a FCF yield of almost 7%...seems quite cheap to me at least initially.

There is considerable debt, a good slug of which was paid out as a dividend upstreamed to ADP of $690 million. With about $85 million in cash, this works out to an EV of $3.3 billion. On an EV/EBIT basis this is a valuation of a modest 5 times trailing EBIT.

There is an excellent roadshow document that the company has provided here.

Disclaimer: Neither I, my family, nor clients have a current position in ADP or BR.

1 Comments:

At 10:56 AM, Blogger Eric J. Fox said...

Interesting Spinoff. I found three spinoff/restructuring situations that I am doing some more work on before I buy.

They are TARR, WRP and AZL. They are micro caps and a little scary, but if you know anything on them let me know.

 

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