IN 2003 LANCE UGGLA, a Canadian stockbroker, founded a financial-data startup in a British barn. Endowed with just $17m in seed funding and ten employees, Markit started off by providing pricing for the opaque market in credit-default swaps, hoping to tap investors’ growing appetite for derivatives. That proved a more fertile ground than even he probably imagined. By 2014 a share offering valued the firm at $4.5bn. Markit quickly swelled through a series of bold acquisitions, culminating with a merger in 2016 with IHS, a Colorado-based rival. The combined firm now has 13,000 staff.
It now turns out Mr Uggla had much more to reap. On 30th November S&P Global, a financial-information firm based in New York, said it had agreed to buy IHS Markit for $44bn. After the all-stock deal completes, which is expected in the second half of next year, S&P shareholders will own about 68% of the combined company, with Douglas Peterson, its boss, set to helm the combined entity (Mr Uggla is to stay on as a “special adviser” for “at least a year”). The transaction marks the second-largest corporate acquisition announced so far this year, behind only a $56bn Chinese oil-pipeline deal in July. How to explain such a massive deal?
S&P’s move can be seen as partly defensive. In recent years, as finance has computerised and algorithms have come to dominate markets, data has evolved from being a byproduct of transactions to “the lifeblood of finance”, says Audrey Blater of Aite Group, a research firm. From banks and asset managers to brokers and issuers, market participants are ravenous for it, making the sale of financial information a juicy business: S&P has an operating margin of 56%, 16 percentage points more than five years ago; IHS Markit’s stands at a lower—but still rich—40%. The share prices of both have more than tripled since 2015. Covid-19 is doing little to erode this. Data revenue tends to be sticky, because it is typically sold in the form of subscriptions, and switching costs are high. S&P’s share price has risen by 78% since March, while that of IHS has doubled.
But the huge profits have attracted buyers from related businesses, and the industry is being remodelled through mega-mergers. These allow ever-larger providers to reap economies of scale while creating data bundles that appeal to clients. Like the giants of consumer technology, financial-data firms are seeking to create comprehensive “ecosystems” that clients never have to exit, says Ms Blater. Last year the London Stock Exchange (LSE) agreed to buy Refinitiv, the former financial-data service of Thomson Reuters, for $27bn. In September ICE, another stockmarket group, bought Ellie Mae, a mortgage-information provider, for $11bn. The value of Bloomberg, another industry giant, is estimated at $50bn. IHS Markit had been widely considered a potential takeover target ever since LSE announced its intent to buy Refinitiv last year. S&P—which has a market capitalisation of $84bn—may have wanted to prevent a rival from snapping it up first.
But the biggest motive for the deal is probably offensive. For one, it should allow both parties to shave costs. The companies have budgeted around $480m in annual savings, but Hamzah Mazari of Jefferies, an investment bank, thinks they could end up closer to $600m. The transaction should also create revenue-generating synergies, which the pair estimate at an annual $350m. That is because they have complementary core businesses and serve the same pool of clients, so there is great cross-selling potential. S&P provides world-famous equities indices, for instance, whereas IHS Markit looms large in the pricing of bonds. A more comprehensive offering will allow the combined entity to sell a greater share of its products under enterprise-wide contracts, charging clients a fee for all-you-can eat data. S&P derives a chunk of its income from bond issuances, which are volatile, so for it this should mean more resilient revenue: 76% of it is expected to become recurrent. Overall the combined company expects organic revenue growth of 6.5-8% in 2022 and 2023.
On top of synergies the combined entity will also have more heft to invest in new areas of potential growth. That includes information on sustainable investments, private markets, small and medium firms, supply chains and data emanating from non-traditional sources, such as satellite images or foot traffic, that investors use to make their picks. S&P reckons this market is worth $20bn and growing by at least 10% a year.
Greater “organic” profits, finally, should give it the firepower it needs to consider further acquisitions. The two parties today said the deal should boost the combined group’s earnings before interest, tax and amortisation (EBITA) margin by two percentage points. It will also seek to keep its balance-sheet relatively tidy, with total borrowing of about 2.0-2.5X EBITA. On a conference call on November 30th Ewout Steenbergen, S&P’s chief financial officer, said he expects the company to generate $5bn a year in free cashflow by 2023, which it will aim to “deploy in a number of ways: we’ll have the flexibility to fund investments to accelerate organic growth and pursue strategic M&A”.
All this should please investors—all the more so as the company has promised to return 85% of future free cashflows to them in the form of dividends and share buybacks by 2023. Regulators, who are increasingly concerned about the growing market power of a shrinking group of data-providers, may be less chuffed: the LSE is still negotiating with European Union watchdogs over its deal for Refinitiv. But they may not do much to block this latest deal. Mr Mazari says overlaps between S&P and Markit’s respective businesses do not amount to more than 10-12% of their revenues, so concentration in the various segments they cover will not rise by much. A counter-offer is also unlikely: few of S&P’s rivals can expect enough synergies from a merger with Markit to place a higher bid. Rich pickings abound in the field Mr Uggla first thought to harvest.
Source: Finance - economist.com
