Ron Baron on FactSet Research Systems, Inc., Sonic Corp. and SEACOR Holdings, Inc.
FactSet Research Systems, Inc. (FDS)
FactSet is a rapidly growing supplier of financial intelligence to the global investment community. FactSet’s core applications include tools that help investors perform detailed, data driven analysis on individual companies and industries, screen for new investment ideas, monitor markets via real-time news and quotations, and better understand the components of portfolio performance. FactSet, which competes with such household names as Bloomberg, Reuters, and Thomson, offers a differentiated product in an increasingly undifferentiated industry. The company’s data offerings are significantly broader than its competitors because it offers users licensed data from multiple sources (including from competitors Reuters and Thomson) in addition to its own proprietary databases. Since competitors only offer internal data sources, FactSet’s users are able to employ a much broader array of analyses. We believe FactSet’s portfolio analytics (PA) suite is the most advanced amongst its competitors, and enables money managers to understand portfolio performance at extremely detailed levels. PA users upload their portfolio holdings to FactSet daily, thereby increasing the stickiness of the product. Finally, the company offers an “always available” customer service model that users, consultants, and competitors all concede is far and away the best in the industry.
FactSet is currently serving just a small part of its addressable market. We estimate that the company’s existing product line currently address a $6-$10 billion subset of the financial intelligence market, implying an opportunity 12-20 times larger than the $480 million in revenues earned in 2007. On a user basis, FactSet currently has just 39,000 subscribers out of a market that currently includes 600,000 potential users and could continue to grow in our opinion at a mid-single digit rate over the long term. The company’s culture of persistent innovation should continue to expand its addressable market opportunity, which is best exemplified by its recent entry into fixed income analytics. Interestingly, not all of FactSet’s revenue growth will necessarily come at the expense of its competitors. Historically, financial intelligence services have proven to be extremely sticky due to their low price relative to their value added and their tight integration into the research process via data uploads and Excel formulas. Therefore we expect more users to have the opportunity to improve significantly the breadth and depth of their financial analyses via the FactSet platform regardless of whether they retain their legacy business information systems. This quarter, Baron Growth Fund took advantage of the market’s aversion to stocks with financial end market exposure to purchase FactSet at what we believe to be attractive prices. While almost all investors agree on FactSet’s tremendous long-term market opportunity, many remain concerned about its near term growth prospects in light of job losses on Wall Street. We believe that several misunderstood aspects of the business model will enable the company to continue to grow revenues at or above high-teen rates despite challenging end markets. FactSet’s sophisticated analytics platform is a critical component of an investor’s workflow, and thus is a non-discretionary item as long as that user remains employed. The company’s unique revenue model, which is heavily weighted towards fixed access, data and integration fees rather than per-seat user fees, means that just 25-30% of the company’s revenues are tied directly to seat count, with the remaining 70-75% being earned as long as that customer remains in the investment management business.
FactSet’s primary users are buy-side institutions (78% of revenues), which tend to exhibit more stable hiring and firing practices than sell-side institutions, insulating the user base from the dramatic declines in headcount currently plaguing Wall Street. International users also represent a growing portion of the company’s revenue base, reaching 30% of contract value in February 2008, up from just 20% during the last cycle and providing further diversification away from U.S.-centric economic problems. We expect the pending Thomson/Reuters merger to be a catalyst for FactSet, as integration efforts are likely to lower service levels and eliminate certain programs, leading to increased churn in the Thomson/Reuters subscriber base. Finally, FactSet’s constantly expanding product line, which includes such products as news, quotes, transcripts, estimates, wireless, and the Portfolio Analytics suite which were not available during the last market downturn, should facilitate cross-sales to existing Portfolio Analytics customers. The average spend per client is up more than 50% since 2001, and continued to grow at 15% last quarter despite broader economic issues. (Neal Rosenberg)
Sonic Corp. (SONC)
It’s hard to be unique in the crowded quick service burger business, but Sonic Drive-ins has achieved it. While the stores can serve the typical fare of burgers and fries, Sonic is best known for its extensive and creative food and drink offerings. The company does a solid business outside of the traditional lunch and dinner day parts by offering differentiated drinks, ice-cream, breakfast sandwiches and snacks. In addition to the creative food, the unique in-car dining has led to lower building costs and higher store returns. We believe its franchised business model and escalating royalty fees makes this a restaurant we believe is well suited to handle consumer slowdown and higher commodity costs that are currently plaguing competitors.
The company’s long history started in Oklahoma in 1953 and has since expanded significantly in its backyard. There are nearly 1,200 restaurants in Oklahoma and Texas today. In the few immediate surrounding states, there are approximately 2,650 locations or 75% of the store base. Stores outside these few key markets are sparse. Florida, for instance, has only 123 locations while both Wendy’s and Burger King have nearly 600 stores each. There is only one store in the Northeast, located in New Jersey. California has fewer than 40. Sonic is now expanding beyond its core into new markets. Expanding into new geographies has been a problem for other chains, but Sonic has been able to navigate this potential stumbling block. Stores opened in new markets are now averaging higher volumes than stores opened in its core markets. The company has utilized a successful national cable marketing strategy in order to build awareness in distant markets while creating buzz and demand for new products in existing markets. A few years ago, Sonic made this push into national cable ads even though its store base was fairly concentrated. National cable now represents $95 million of the $190 million advertising budget and we feel it is well spent. Recent stores opened in new states have sales exceeding $2 million compared to $1.1 million at mature stores.
Sonic also has a distinct relationship with its franchisees. Sonic’s ascending royalty rate allows the company to receive a greater percentage of earnings as locations achieve higher volumes. In addition, new franchisees are signing deals at higher royalty rates than previously. The current new franchisee will pay 4.6% of sales to Sonic for a store with $1.1 million in revenues. 70 bps higher than the average rate paid in the first quarter of 2008. In addition to achieving higher royalty rates as unit volumes improve, half of the system is paying below market rates. As these contracts expire, we believe their rates will be renegotiated upwards. And while the terms for new franchisees are improving for Sonic, the company gave all existing franchisees the opportunity to open additional locations under the preexisting agreement. As a result, 481 stores were signed under that agreement before 7/1/07 which we believe should open over the next five years. With a very high flow through on this revenue, we feel this could result in over 30 cents per share of sustained additional annual earnings for the company.
Sonic is now revitalizing its stores with a $130,000 per store retrofit. This has resulted in a sales lift of approximately 1.5-2% for the renovated stores. 40% of the company stores are completed. Franchisees have only recently began retrofitting their locations in late 2007 but have progressed at a much faster rate than anticipated. With only 20% of franchised locations complete, retrofits should provide a nice tailwind for same store sales improvements without company capital expenditure.
The company is having success attracting new franchise agreements in new markets given the attractive and stable returns. In early 2008, there was a 60% increase in the number of commitments. With 15% of all area development agreements going to new franchisees, the company is providing more assistance to this group to ensure proper real selection and operations. These franchises have been able to get financing from local banks (not major institutions whose lending has dried up early in 2008) without much difficulty.
The combination of the growing national marketing and the franchised model allows the company to rapidly introduce and support new products and initiatives. Sonic has constantly enhanced its offerings, not with gimmicks, but with what we believe are programs that will generate sustainable higher average revenue per store. We feel that Sonic can grow its top line by approximately 10% but should grow earnings per share closer to 20% because of its franchised model and propensity to buy back shares. (Michael Baron)
SEACOR Holdings, Inc. (CKH)
(Market Capitalization: $1.9 billion) SEACOR Holdings shares declined over the last three months despite the general upward trend in energy-related stocks in the first quarter. The underperformance appears to have been caused by shortterm issues that were both fundamental and technical in nature, and we used the recent weakness as an opportunity to add to our position. SEACOR is primarily focused on the offshore oil and gas and marine transportation business in the United States with significant support vessel, product tanker and helicopter transportation businesses in the Gulf of Mexico. The company should benefit from increased exploration and development of offshore oil and gas fields driven by today’s record commodity prices. In addition, SEACOR owns inland river barges and a marine disaster cleanup operation. The company is led by Charles Fabrikant, who has a long track record of creating value by opportunistically upgrading the fleet through the sale of older assets and purchase of newer equipment.
In terms of SEACOR’s first quarter share performance, operations were hurt by poor weather that disrupted business and led to estimate cuts for 2008 earnings per share. Also, the company is leveraged to the shallow-water Gulf of Mexico, which has been out of favor with investors due to a slower than expected ramp in activity despite the year-to-date increase in natural gas prices. Finally, from a technical standpoint, the sell-off coincided with the downgrade of shares by one of the three analysts who cover SEACOR, which likely triggered program selling. (Geoff Jones)