When Thomson Reuters Corporation (TRI) was formed in 2008, from the merger of Canada-based Thomson and UK-based Reuters Group, exceptional growth and profitability was expected. And although the company took on its leading role in the global information services industry, by providing data and content to a vast range of financial and professional markets worldwide, growth has been sluggish throughout fiscal 2013, raising concerns about the future. When investment gurus Joel Greenblatt (Trades, Portfolio) and David Dreman (Trades, Portfolio) then sold out their company shares, I began to wonder what was going on on the Reuters side of things.
Two Divisions and a Few Problems
Thomson’s scale advantage and diverse business portfolio have earned the firm a strong market leading position that would be very difficult for any competitor to replicate. Comprised of two divisions, the Financial & Risk division, and the Professional division, the company benefited significantly, in terms of expansion, from its merger with Reuters. Apart from gaining international exposure in Asia (3% increased to 14%) and Europe’s (12% jumped to 28%) emerging markets, the firm’s finance segment, which accounts for 55% of revenue, propelled Thomson to the top of the financial data space market. However, execution issues regarding the Eikon product release, in addition to an overall lackluster macroeconomic environment, hurting top-line growth, caused revenue in this segment to fall 3% in fiscal 2013.
Thus, management recognized that some restructuring will be necessary in order to obtain top-line results over the next five years. These efforts, ranging from investments in new product development and customer service improvements, in addition to re-adjusting the firm’s cost base, will not only keep margins under pressure but also slow near-term growth until the restructuring is completed. Nevertheless, results should be somewhat counterbalanced by Reuter’s professional division, which isn’t majorly susceptible to macroeconomic headwinds and operates in markets with stable revenue growth opportunities. The legal business, which accounts for 25% of overall revenue, for example, enjoys a duopoly position with Reed Elsevier Plc (ADR) (RUK) in the domestic market.
Although Thomson’s management team has been actively taking measures to improve growth, profitability and cash flow generation, last quarter’s results were far from impressive. With a flat year-over-year revenue of $3.2 billion and a 950 basis-point decrease in operating margins (9.2%), the company’s balance sheet is looking weak. Also, cash flow was down by 74% to $187 million, which could be detrimental as debt increased by over $1 billion from 2012 to 2013. With a large portion of financial division’s revenue gained from terminal subscriptions, which rely on employment levels in the cyclical financial-service industry, any decline in this area could hurt profits.
With the finance division projecting an estimated 3.5% compound annual revenue growth rate until 2017, the company is bound to rely on its professional segment to uplift stale growth. Given the solid demand of these services in the past, looking forward, this division should maintain a five-year revenue CAGR of 6%.
Overall company growth is estimated at 4.5% over the five year period, and in addition to 6.4% ROA, I feel uncertain regarding Thomson’s near-term profitability. Investors looking to gain medium-term benefits would be wise to abstain from buying this company’s stock, as the current trading price is at a 55% premium relative to the industry average of 21.6x. However, I believe that once the company has executed its restructuring strategy, it may be worth another look.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.