FactSet: A Wonderful Company At A Fair Price

Warren Buffet, arguably the greatest investor of all time has famously said:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

FactSet Research Systems Inc (FDS) is a wonderful company currently trading at a fair price. FDS is also part of our large cap U.S. equity model portfolio.

FDS is a growth company with a history of delivering solid results. Since going public in 1996, FDS has delivered a total return of 12,840% which compares favorably to the 1,040% total return delivered by the S&P 500 during the same time. While strong historical performance is not a guarantee of strong future performance it can often be an indicator of a high quality business with a durable competitive advantage.

High Quality Subscription Based Business Model

FDS is a leading financial data and enterprise solutions provider. FDS has a diverse client base including investment banks, asset management firms, wealth management firms, and institutional partners. Currently FDS has over 189,000 global users and more than 7,900 clients. ~98% of the company's revenue is subscription based. The subscription nature of FDS's business is part of what makes FDS such a high quality business.

Clients tend to become dependent on FDS offerings to run their day to day operations and thus the company does not experience a high degree of cyclicality. Switching costs can be fairly high as users have become familiar with FDS and often integrate it with other internal systems. The average tenure of existing FDS clients is 13 years and customer satisfaction is over 93%. Additionally, the company has 98.6% retention rate based on annual subscription value ("ASV").

As further evidence of the product's stickiness consider the fact that revenues and EPS increased by 8% and 19% respectively in 2009. This is extremely impressive given the pressures experienced by FDS customers during that time. Another data point that showcases FDS's high quality business model is the high and stable level of profit margins (see chart below.) While FDS faces competition from companies such as Bloomberg, Refinitiv, and Capital IQ the barriers to entry are very high for new players to enter the market. Any competitor would need to acquire vast amounts of data from disparate sources and integrate it with other platforms.

AI Represents A Powerful Growth Driver

While FDS has been a long-term user of machine learning and AI, the company recently noted that recent advances in AI have made it possible to accelerate development and thus AI is now one of the company's top initiatives in 2024. On the Q3 earnings call FDS CEO Phil Snow highlighted the AI opportunity:

“FactSet's content refinery provides us with a real competitive advantage. We have one of the most extensive suites of proprietary and third-party data in the industry, and we continue to invest in new categories of data to further power the workflows of our clients...We are reimagining the FactSet user experience and actively exploring innovative solutions. For example, a conversational user interface that allows bankers to ask questions, discover and source information, and initiate tasks...Second, on the buy side, we are enhancing our portfolio manager bot to answer questions in conversation with asset managers..Thirdly, in the front office, we are harnessing generative AI to create code in FactSet's programmatic environment, reducing the need to know Python...”

AI represents a major earnings growth opportunity for FDS for three reasons: Firstly, AI will make FDS products more valuable to end users thus increasing the number of customers who can benefit from FDS products. Currently, based on company midpoint FY 2024 revenue guidance of $2.22 billion FDS has captured just 6.9% of the company's estimated total addressable market of $32 billion. A higher value additive product will allow FDS to capture more of its total addressable market. Second, AI related product improvements will result in a product which becomes more value additive to existing users. Thus, the willingness to pay should increase for existing users and may allow FDS to raise prices more rapidly than has been the case historically. Finally, the third reason why AI is a growth catalyst for FDS is the potential for improved efficiency and cost savings. Labor costs represent a significant part of FDS cost of services. As AI improves efficiency FDS may be able to drive margin expansion from current levels by further rationalizing its cost structure.

EPS Growth Potential

Over the past 10 years, FDS has grown EPS at a 10.5% CAGR. This growth rate has shown no signs of slowing down. Over the past 5 years, FDS has grown Adj. EPS at a CAGR of 12.2%. For FY 2024, FDS estimates that EPS will grow by 9% while Wall Street consensus analyst estimates call for 10.5% growth. In the further out years, Wall Street consensus estimates call for growth to moderate to high single digits starting in 2027. I view this moderating as overly conservative in the context of AI related growth potential. I believe FDS will continue growing EPS at its long-term historical average of 10.5%.

Currently FDS is estimated to have just 5.5% market share and thus I believe the company has a significant growth opportunity in terms of market penetration. The financial data services industry remains highly fragmented with a lot of smaller players. Larger players such as FDS have the ability to benefit from scale as they are able to bundle more services together compared to smaller data service providers. FDS will also be in a position to offer an even better value proposition to clients in the coming years due to AI enabled offerings.

For FY 2023, FDS increased its total client count by 5.1% or 383 clients and its total user count by 5.6% or 9,990 users compared to the same period a year ago. In addition to gaining market share, I also believe FDS is poised to benefit from pricing increases which tend to come in at ~3% each year. Through a combination of acquisition related growth, client and user growth, as well as modest price increase I believe FDS will be able to continue growing EPS at ~10.5% for at least the next 10 years.

Valuation Underestimates Growth Potential

FDS trades at 29x estimated FY 2024 EPS and 26x estimated FY 2025 EPS. I view that level of valuation as attractive given the strength of FDS's business and growth potential. FDS’s closest public peer is S&P Global (SPGI) which owns Capital IQ among other businesses. FDS is currently trading inline with SPGI based on forward P/E ratios. Historically, SPGI has grown EPS at a rate of ~8% but is expected to grow EPS by low double digit percentages going forward. FDS trades at a discount to data providers such as Morningstar (MORN) and MSCI (MSCI) though those companies are growing faster.

Given the steady nature of FDS cash flow generation going forward, I believe a DCF represents a useful valuation tool. Key assumptions in my analysis include a levered 2yr trailing beta of 0.96, an equity market risk premium of 5.5%, 10.7% annual free cash flow growth from FY 2023 levels for the next 10 years, and a terminal free cash flow growth rate of 5%. Based on these assumptions, as shown by the chart below, I believe FDS is conservatively worth $593 per share which represents a ~30% premium to the current share price.

Currently, given the market price of ~$456, FDS is pricing in annual free cash flow growth of just 7.4% over the next 10 years assuming all other assumptions remain the same. I view this level of growth as much too conservative given the different growth drivers that FDS currently has. Alternatively, assuming a 10.7% annual free cash flow growth rate for the next 10 years the market is currently implying a terminal free cash flow growth rate of just 3.3%. I view this level as much too conservative. For these reasons I believe the market is currently underestimating FDS's growth potential and thus I believe shares are highly attractive at the current price.

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