Contents
Summary
- I like SPGI as an investment because once its benchmark is accepted by capital or commodity market participants it becomes difficult for a competitor to displace it.
- SPGI's business is diversified (it has four reportable business segments) and is less sensitive to changes in bond issuance volumes than some of its competitors.
- In FY2019, SPGI generated $7.3B of revenue of which 60% was recurring. INFO generated $4.3B in revenue of which 88% was recurring. Once the two companies merge, recurring revenue is expected to be ~76%.
- The cost and revenue synergy program is expected to have a ~$0.68B positive impact on EBITA and is expected to be accretive to earnings by the end of the 2nd full year after close.
- The nature of the transaction is such that investors should expect share count to increase significantly when the transaction closes in the 2nd half of 2021. The combined company's financial outlook, however, includes $14B of cumulative free cash flow (FCF) in 2021 - 2023. A component of this FCF will likely be directed toward the repurchase of shares.
- Investors should look at an investment in SPGI from the perspective of strong capital gains potential as opposed to dividend income potential.
Introduction
In my S&P Global (SPGI) article dated October 26, 2018 I disclosed that the company's valuation and future prospects prompted me to initiate a position @ $175.88/share in one of the side accounts within the FFJ Portfolio; I also initiated a position in Moody's Corporation (MCO) @ $143.61/share and disclosed same in this article.
In February 2019, I revisited both companies at which time their respective valuation had appreciated considerably relative to historical levels. In fact, SPGI's P/E ratio for 2011 - 2019 ranged from the mid-teens to the high 20s (this excludes FY2014 because SPGI reported a loss) but then it jumped to the low 30s and I figured SPGI's valuation would need to retrace somewhat before I decided to increase my exposure.
The same applied to MCO when I also reviewed it in February 2019. MCO's P/E ratio for the same time frame as above also ranged from the low teens to the mid 20s; MCO's earnings jumped significantly in FY2017 relative to FY2016 because FY2016 results were distorted by a ~$0.864B settlement charge. When I wrote my follow up MCO article, MCO's valuation had jumped much like SPGI's and I wanted MCO's P/E ratio to retrace to a more reasonable level.
Even though I viewed, and still view, both companies as 'growth' companies and am prepared to pay up somewhat for this growth, the valuation of both companies did not pull back as I had hoped. As a result, I have not added to my SPGI and MCO positions.
We now have a situation where SPGI announced an all-stock acquisition of IHS Markit (INFO) on November 30, 2020. In my opinion, this is a transformational acquisition since it values INFO at ~$44B (including $4.8B of net debt) from the low teens to the high 20s and INFO's current market cap is ~$36B and SPGI's market cap is ~$73.6B. If the merger occurs as planned in the 2nd half of 2021, we will be looking at a very different SPGI...one which has a greater degree of recurring revenue, much stronger FCF, and an even greater competitive advantage. For comparison purposes, the market cap of some of SPGI's largest peer group members is far smaller than the projected market cap of the combined entity (Moody's: ~$50B, Thomson Reuters: ~$40B, MSCI: ~$34.5B, FactSet Research: ~$12B).
Business Overview
A good overview of SPGI's business and the risk factors can be found in in FY2019's 10-K commencing on page 6 of 258. Similar information on INFO can be found in its FY2019 10-K commencing on page 6 of 146.
INFO's Q4 and FY2020 Financial Results
On January 13, 2021, INFO released its Q4 and FY2020 results with the accompanying investor presentation. We see that:
- share repurchases have been paused as a result of the impending merger;
- FY2021 adjusted diluted EPS ranges from $3.11 - $3.16 with $3.14 being the mid-point.
There is little value in reviewing these results given that the two companies are expected to merge within a few months and the combined entity will be materially different.
SPGI's Q3 and YTD2020 Financial Results
SPGI is scheduled to release Q4 and FY2020 results on February 9th so the most current available financial information is for Q3 which was issued October 27, 2020.
While Q3 2020 revenue increased 9% compared to Q3 2019, net income decreased 26% to $0.455B and diluted EPS decreased 25% to $1.88. This, however, was primarily due to the debt tender premium and fees associated with its senior notes tender offer.
In Q3, SPGI refinanced ~$1.1B of its outstanding debt and replaced it with new debt at lower interest rates. The net result was ~$0.2B of additional debt, a $26 million/year reduction in bond interest expense, and an extension of the weighted average tenor of the outstanding debt by ~5 years.
At the end of Q3, cash, cash equivalents, and restricted cash amounted to $3.2B. In the first 3 quarters of FY2020, cash provided by operating activities was $2.426B, cash used for investing activities was $0.204B, and cash used for financing activities was $1.95B. Free cash flow for the same timeframe was $2.24B, an increase of $0.645B from the same period in 2019. This increase was primarily due to increased net income.
Although GAAP diluted EPS guidance was decreased from $10.25 - $10.45 to $10.00 - $10.15 because of the debt tender premium and fees incurred in Q3, management increased adjusted diluted EPS guidance from $10.75 - $10.95 to $11.30 - $11.45 because of strong YoY financial performance and expectations for the remainder of FY2020.
Impending Merger
After having listened to the November 30th conference call in which the terms of the merger were communicated to the investment community and having reviewed this merger presentation, I am optimistic the combined company will generate significant investor returns over the coming years.
Source: S&P Global + IHS Markit Presentation - November 30, 2020
Credit Ratings
Moody's rates INFO's corporate family rating at Ba1 (the top tier of non-investment grade - speculative) so I would have never invested in the company because this level of risk is beyond my comfort zone; I could not find a rating assigned by SPGI.
Following a review of the proposed all-stock transaction, Moody's has affirmed SPGI's senior unsecured debt at the A3 level. This rating is the lowest tier of the upper medium grade investment grade category.
I feel comfortable with this level of risk.
Valuation
While the mid-point of INFO's adjusted diluted EPS guidance for FY2021 is $3.14, SPGI will only be providing its FY2021 guidance when it releases Q4 and FY2020 results in early February. In addition, there are severable variables to consider with this merger, and therefore, trying to determine the value of the combined company when it eventually merges in the 2nd half of 2021 is, in my opinion, a crapshoot.
I am relying on management's guidance that the combined company will be far more profitable in a few years on a combined basis than on a stand alone basis. Looking at the potential synergies I think an investment in SPGI at the current price of ~$307.50 is reasonable and have acquired another 100 shares.
INFO initiated a quarterly dividend when it announced on January 17, 2020 that a $0.17 dividend would be distributed February 14, 2020 to common shareholders of record as at February 6, 2020. On January 15, 2021, IHS declared a $0.20 dividend payable on February 12, 2021 to common shareholders of record at the close of business on January 29, 2021. Naturally, this quarterly dividend will be terminated if/when the proposed merger is completed the 2nd half of 2021.
SPGI's dividend history can be accessed here. Looking at SPGI's dividend history for the 2011 - 2019 timeframe ($1.00, $3.52 (this includes a 'special' $2.50 dividend distributed December 27, 2012), $1.12, $1.20, $1.32, $1.44, $1.64, $2.00, and $2.28) versus diluted EPS over the same period I see that SPGI's dividend payout ratio is quite conservative (below mid 30% of diluted EPS). NOTE: In FY2014, SPGI reported a $0.293B net loss from continuing operations attributable to McGraw Hill Financial, Inc. and details of various transactions which resulted in this loss can be found in the FY2014 10-K.
Based on the current ~$307.50 share price, the $0.67 quarterly dividend ($2.68/year) provides investors with a ~0.87% dividend yield. I anticipate a dividend increase will be announced when Q4 and FY2020 results are released February 9th. If history is any indication, I envision a ~$0.07/quarterly dividend increase. If this occurs, SPGI's new dividend of ~$2.96 on an annual basis is unlikely to entice dividend income seeking investors since there are other high quality, but slower growth companies, with far more attractive dividend yields. While dividend income certainly appeals to me, I much prefer to have a portfolio with a good mix of growth and value holdings as opposed to just one or the other. My rationale for investing in SPGI is to benefit from potential long-term capital appreciation.
While the average number of shares outstanding has declined over 2011 - 2019 (304, 285, 280, 272, 275, 265, 259, 253, and 247 million shares), share count will likely increase by in excess of 100 million shares given the INFO all-stock merger is valued $44B (including $4.8B of net debt). If management's projections materialize, the combined company could generate ~$14B in cumulative Free Cash Flow (FCF) in FY2021 - 2023 and I would expect that some of this FCF will be used to reduce the share count.
Final Thoughts
I have decided to immediately add to my existing SPGI position as opposed to waiting until the proposed merger occurs in the 2nd half of 2021; I fully expect the merger to receive the appropriate approvals (refer 'Timing and Approvals' in the November 30, 2020 Press Release).
The combined entity will be a force to be reckoned with and I think the margin and FCF improvements management has projected are not out of the realm of possibility.
SPGI is a growth company so if I overpay somewhat I am not nearly as concerned as if I overpay for a 'value' company such as Tyson Foods, Inc. (TSN), BCE Inc. (BCE), The Bank of Nova Scotia (BNS). In essence, I am prepared to pay up a bit for SPGI's growth potential.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom!
Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long SPGI and MCO.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
