DNB’s most attractive segment is its Risk Management Solutions (“RMS”) business line which accounted for 62% of revenues the past fiscal year. DNB maintains the world’s largest credit information database which serves as a formidable economic moat. If someone is looking for credit information on a business, they are likely to turn to DNB since it has the most records. Similarly if companies are looking to make their credit information available they turn to DNB since that is where everyone looks first. This network effect makes it difficult for competitors to break in to DNB’s core market. It also allows DNB to earn outsize returns as evidenced by its five-year average Return on Assets (ROA) of 17.3%.
After the initial capital expenditures to build the databases the DNB’s core business requires very little in the way of additional capital to operate. Over the past three years capital expenditures have averaged $5 million for the domestic business segments and $3.2 million for the international business segments.
While DNB faces competition, none can match the breadth and depth of DNB’s credit information. In fact the competition section in their 10-K makes this clear. From the 10-K: “We are subject to highly competitive conditions in all aspects of our business. However, we believe no competitor offers our complete line of solutions or can match our global data quality resulting from our DUNSRight Quality Process.” [emphasis mine]
Of course the fact that it is difficult to break in to DNB’s core market doesn’t mean that other companies aren’t trying. In domestic markets DNB faces competition from Experian and Equifax. However, these two competitors mainly focus on personal credit information. In recent years they have been attempting to expand their offerings.
The international market is a different story. Here DNB really does face substantial competition with regards to business credit information. Their major competitors include SinoTrust in China, Experian in the United Kingdom, Teikoku Data Bank in Japan, and Experian again in India. In international markets DNB does not benefit from the same network effects that its substantial domestic credit databases provide. It does have one advantage in that it has a worldwide scale and in an environment of increasing globalization this wide scope could work to DNB’s advantage. Indeed this is even mentioned as a reason for their increase in international revenue in 2010. From the 10-K: “Increased revenue from providing cross-border data to members of our D&B Worldwide Network attributable to fulfillment services and product usage.”
The main risk for DNB is a mature core market. Revenue from the North American segment has declined over the past three years (as shown below) and management is only predicting 5-8% core revenue growth for 2011.
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Also, demand for credit mirrors the economic cycle. During recessions and periods of slow growth business expansions drop off and thus the need for credit information on suppliers or customers diminishes. The U.S. and much of Europe are currently mired in a balance sheet recession marked primarily by household deleveraging. The focus of consumers on paying down has led to a lack of demand and in turn slowly growing (or even shrinking) economies.
International revenues might seem like a bright spot at first glance since they are showing increasing demand. A closer look reveals that these revenue increases have mainly come from acquisitions or the consolidation of financial results from joint ventures. These acquisitions included ICC and D&B Australia. Consolidated joint ventures have included RoadWay a joint venture in China, D&B India, HC International, and Tokyo Shoko Research/D&B Japan.
One thing investors can take comfort in is that DNB’s core revenue has been steady through the past three years. This highlights just how ingrained DNB’s products and services are in customers' operations.
A discounted cash flow valuation would be appropriate for Dun & Bradstreet. Being in business (and the same business at that) for 170 years is certainly proof that the company has a wide economic moat and demand for its core products will not be going away soon. Therefore, we should be comfortable projecting cash flows out in the indefinite future.
With its durable business model we will project terminal growth at 3%. Management is predicting core revenue growth in the range of 5%-8%. Management’s projections from growth this year are operating income growth of 2%-6% and EPS growth of 6-10%. Management is also spending $55-$65 million on revamping several of its products. Because this product revamp does not represent an ongoing expense we will back it out of our model. We’ll assume starting free cash flow of $320 million (adding back the $55 million to $65 million to management estimates) and a five year short term “high” growth rate of 5%. With an 11% discount rate this values the equity of DNB at approximately $74. With a wide economic moat you might judge DNB to be a safer investment. Using a lower discount rate like 10% yields a price of $86.
One last note on the valuation is that DNB’s balance sheet shows an equity deficit of $615.8 million as of second quarter 2011. The equity deficit is a reflection of the fact that DNB is not an asset intensive business. The value of 188 million business credit records simply does not show up on the balance sheet at its true value. In fact, DNB's balance sheet has shown an equity deficit for many years. In a manufacturing or other asset-intensive business the equity deficit might be a concern, but with DNB it is not.
DNB has an excellent economic moat in its core North American market. However, this great advantage is to some extent offset by slow growth. This means DNB will have to depend on riskier international expansion. Additionally, the challenging economy means the demand for DNB’s products and services have been relatively flat.
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Disclosure: Long DNB