Description

Executive Summary:  Gartner is a leading provider of research and expertise designed to help key decision-makers in all business functions solve their most mission-critical challenges. It is a trusted advisor and objective resource for more than 15,000 enterprises across over 100 countries. The company has enjoyed strong and consistent growth, delivering double-digit or better growth in revenues, profits, and cash flows for 15+ years now, and its subscription-based business model provides a high degree of predictability as well as resiliency in tougher macros.

Gartner research offers a strong value proposition to customers in that it helps key decision makers (1) get up to speed solving their most mission-critical challenges, (2) save money in negotiations with vendors through pricing and success data, and (3) provide a ‘CYA’ benefit to users who can shift the blame to Gartner if their decision fails to work out. This value proposition, however, isn’t immediately obvious to customers and requires a skilled and aggressive salesperson to get C-level decision makers’ attention and sell them on the benefits. Gartner understands this and the company has consistently invested heavily to build out their sales capabilities which has supported their growth.

Gartner research has an exceptional business model. It’s a subscription business with a high degree of visibility. Contracts are at least 12 months – the majority are multi-year – and clients are billed annually in advance. Its products are never discounted, and the company typically raises prices 3-4% annually. It’s a ‘build once, sell many times’ business model so the business enjoys a degree of operating leverage, and as customers pay in advance, the business consistently generates strong FCF above earnings. The business is resilient in downturns – earnings only fell 16% in the Global Financial Crisis – and its mix of business today suggests that it will prove even more defensive in future downturns.

Despite growing double-digits for 15+ years now, the market opportunity remains substantially under-penetrated. Gartner believes its 15,000 enterprise clients are but a fraction of the 140,000 potential enterprise customers. Moreover, the company believes it can continue to drive user per enterprise higher over time particularly outside of its core IT business. Over the medium-term, the company expects contract value growth of 12-16% annually, supporting double-digit revenue growth, with modest margin expansion and share repurchases driving profit and FCF per share growth close to 20% annually.

At a recent ~$330, shares are trading at 35x/30x consensus 23/24 earnings (31x/27x our estimates), which is in-line with historical averages. On a free cash flow basis, shares are trading at 28x/25x consensus (~21x/18x our estimate which implies a historical conversion of 150% of net income), which seems like a reasonable price to pay for business with IT’s attributes and growth outlook.

 Notably, the company takes an extremely conservative approach to guide, choosing to offer up numbers it can confidently beat. Gartner has meaningfully outperformed its orginal guidance in each of the last 3 years, exceeding adjusted EBITDA, adjusted EPS, and adjusted FCF guidance by 40%, 71%, and 59%, respectfully. Consensus does take the over on their guidance but only by a marginal amount (it is only 4.5% above EBITDA guidance and 7% above EPS) which suggests to us that there is room for consensus to continue to raise numbers through the year.  

Company Description: Gartner is a trusted advisor and objective resource for more than 15,000 enterprises in ~100 countries and territories across all major business functions, industries, and enterprise sizes. Through their team of ~2,200 research experts, Gartner provides research designed to equip executives and decision-makers in every business function (IT, HR, supply chain, marketing, legal, and finance) with actionable and objective insights on their most-mission critical challenges. Gartner provides its research, as well as direct access to its analysts, on a subscription basis, which have twelve-month minimum contract terms (>60% multi-year contracts) that are paid in advance on an annual basis. In addition to its core research product, the company offers consulting services for customers looking for custom analysis and on-the-ground support, as well as industry-focused events/symposiums designed to give clients more in-depth insights into their challenges as well as an opportunity to network with industry peers.

Gartner’s products and services are delivered through 3 business segments: (1) Research; (2) Conferences; and (3) Consulting. The Research segment is by far the largest segment, accounting for 87% of 2021 revenues and 92% of gross profits, followed by Consulting (9% of sales / 5% of gross profits) and Events (4% of sales / 3% of gross profits). The Research business is the least cyclical whereas Conferences are the most cyclical, still down ~35% vs. 2019 levels. Consulting falls in the middle; revenues fell 15% peak to trough in the global financial crisis but were more resilient during COVID, declining only 4% in 2020.

The business has enjoyed very strong and consistent growth. Since 2007, revenue, adjusted EBITDA, adjusted EPS, and free cash flow have all increased at strong double-digit rates, and revenues only declined in 2 years (2009 -11% and 2020 -3%). Owing to a capital light business model and favorable working capital characteristics (i.e. its customers pay in advance), the company consistently generates free cash flow well in excess of earnings (143% of net income since 2007 and 154% excluding 2017/2018 when cash costs related to the CEB acquisition were elevated). Gartner’s returns on capital are off the charts, while return on assets have averaged 12%+ and are approaching the high teens level currently. After organic growth and strategic M&A, Gartner’s favored method of returning capital to shareholders is buybacks. Since 2006, diluted shares outstanding have declined 31% (36.5mn share reduction) despite adding 7mn shares as part of the CEB acquisition price.

History: The company was incorporated in 1979 by Gideon Gartner. Formerly an IBM employee, Mr. Gartner initially focused on helping corporate customers decide which IBM products were best suited for their needs. Gartner quickly became known for its insider’s perspective on IBM, so much so that IBM actually sued them in the early 1980s for illegally revealing trade secrets (the suit was eventually settled out of court). Over time the company branched out into different products/offerings helping customers assess IT needs. The company IPO’d in 1987, was purchased by British communications firm Saatchi & Saatchi for $90mn a year later, was bought back by Gartner’s management team in an LBO assisted by Bain Capital and Dun & Bradstreet in 1990, and re-IPO’d in 1993.

Through organic and inorganic investments, Gartner sales grew 24% annually through 2001, peaking at $963mn in FY01 before declining ~11% peak to trough through 2003 as IT spending was challenged in the post dotcom fallout. In 2004, current CEO Eugene Hall joined the firm and introduced the growth strategy in place today which is to invest heavily in research that provides key decision makers with actionable and objective insights to solve their most critical challenges while also investing to build out a strong sales capability to grow a product that most non-customers don’t realize they need.

Over the years, the company has used M&A to build out its capabilities and enter new verticals/geographies, acquiring Meta Group in 2005 ($162mn, capabilities enhancement/geographic expansion), AMR in 2010 ($64mn, strengthen capabilities in IT/add new supply chain vertical), IDEAS International in 2012 ($19mn, international expansion), and Nubera and Capterra in 2015 ($207mn, international expansion). In 2017, the company acquired CEB for $3.3bn – it’s largest acquisition to date – to enter into the HR, Sales, Finance, and Legal verticals.

Today, the company breaks down its Research segment between its traditional Technology business (Global Technology Sales or GTS) and all the other functional leaders (Global Business Sales or GBS). GTS constitutes most of the segment, comprising 78% of contract value (a.k.a. the annualized dollar value attributable to all their subscription-related contracts in effect at a specific point in time), but GBS is the larger opportunity and has grown at a faster clip than GTS for 9 consecutive quarters (by an average of ~750bps).

Investment Highlights

Strong value proposition for customers. Gartner’s value proposition is that it helps users quickly get up to speed on the relevant issues within their field. The company seeks out key decision maker’s most mission critical problems (sourced by client feedback, attendance at sessions of their conferences, analyzing search trends on its websites, etc…) and then creates actionable and objective research designed to solve these problems. Effectively they do the hours of background work on important topics so its users don’t have to. In addition to offering research reports, the company also offers users direct access to their 2,200 research analysts to help further the client’s understanding of the topic at hand and ultimately make the best decision for a given situation. Gartner can even provide pricing and success data to help customers benchmark their contracts vs. peers and ultimately drive down their costs. This provides users with tangible cost savings which often can justify the $40-50k/seat price tag on its own, let alone the more difficult to quantify savings that come from decision makers being able to avoid allocating time/budgetary resources to doing the research internally.

And perhaps most important of all, Gartner provides a ‘CYA’ benefit for users. Similar to how purchasers of IT ‘couldn’t get fired for choosing IBM’ once upon a time, choosing a product blessed by Gartner (e.g. in the top tier of its Magic Quadrant) gives executives the ability to outsource the blame if they end up choosing the wrong vendor or take the wrong approach to solving an issue.

Investment in salesforce supports sustainable growth. At its roots, Gartner is a sales-focused company and for good reason. Research is a product that needs to be sold. Potential customers usually aren’t choosing between Gartner or its smaller peers Forrester and IDC. Usually, they are choosing between Gartner and inertia because it isn’t on their radar that research is even a need. This type of sale requires a skilled and aggressive salesperson to get the attention of C-level decision makers, understand his/her priorities, and create a compelling narrative that convinces the decision maker to sign up. Gartner understands this and the company has consistently invested heavily to build out their sales capabilities by both expanding capacity (i.e. headcount growth) and effectiveness (i.e. increased training and support tools). The company is also known as an excellent place to work if you are a strong performer as salesforce pay potential is uncapped. It isn’t for everyone, though, as annual churn is ~25%. For a business growing headcount double-digits annually, this means that upwards of 35% of salespeople are new in any given year.

Currently the company employs ~4.5K salespeople, meaning the company needs to hire ~1,600 – 2,000 salespeople annually to replace employees that have churned out / been promoted up and support its 12-16% contract value growth target. Through 2019, the company successfully increased headcount 13% annually though headcount growth slowed in the depths of COVID as the company did not adequately invest in its HR/recruiting capabilities. All told, headcount declined on a year-over-year basis from 2Q20 to 3Q21 but the company has since expanded its capabilities and returned to double-digit growth in sales headcount (+14% YTD through 3Q22).

The return on investment of adding sales associates is compelling. It takes a sales associate 3-6 months for their first sale and most sales associates are at ~50% of average productivity (i.e. % of average net contract value increase / associate) in year 1. Sales associates ramp to ~85% of average productivity in year 2 and are fully ramped by year 3. We estimate sales associates reach cash flow breakeven early in year 2 and generate very healthy profits thereafter.

Very attractive business model that generates strong, sustainable cash flow. Gartner research has an exceptional business model. Research is a subscription business with a high degree of visibility. Contracts typically are at least 12 months and over 60% of contracts are multi-year, and clients are billed annually upfront. The company does not discount its product, and annual pricing escalators are typically in the 3-4% range (in-line with historical research cost base growth). Like other data & analytics companies, Gartner research is a ‘build once, sell many times’ business model. Incremental costs to deliver research is limited so gross margins on the next dollar of revenue is ~80% for its Research business. As customers pay in advance and the business requires limited amounts of capital to grow, the business consistently generates free cash flow well in excess of reported earnings.

Long growth runway. The market for Gartner research is large and under-penetrated. Gartner sizes the market at ~140,000 enterprises (i.e. the firms in the 100 countries they operate with revenues >$100mn that spend $10-50mn annually on technology) with a total addressable market of $200bn split between GTS (~$55bn) and GBS (~$145bn). For GTS, the typical enterprise spends ~$250K annually (<0.25% of the enterprise’s sales), equating to ~5 user seats whereas Gartner estimates that a typical customer should have upwards of 5-10 users. For GBS, the typical enterprise spends ~$200K annually, equating to ~4 user seats across its main business functions (HR, Finance, Marketing, Supply Chain, and Legal) whereas the potential users are far higher as Gartner continues to penetrate these verticals.

Gartner has a long runway to increase the number of enterprises as well as spend per enterprise. Over the past 11 years the company has increased its enterprise customer base by 6% annually yet the company remains only 11% penetrated. On the per user front, we estimate that its GTS product is 50-75% penetrated at existing customers whereas its GBS product has yet to really scratch the surface. Assuming the company can continue to hire and support its growth, we see no reason why penetration of new enterprises and within existing customers can’t continue for years to come.

Business mix is far more defensive vs. 2008-2009. Gartner is a very resilient business. It has a high degree of subscription-based recurring revenue and enjoys high enterprise retention rates - client retention averages well over 80% with the majority of churn coming from smaller companies taking a chance on 1-2 seat license contracts while enterprise dollar retention averages >100%. Additionally, the company’s high salesforce turnover gives it the ability to quickly flex salesforce capacity in tougher macros, which helps preserve profitability. Even in the Global Financial Crisis, Gartner was able to manage its business well with sales only declining 11% and adjusted EPS declining only 16%.

As it stands today, though, we think Gartner will prove even more resilient in the next economic downturn due to the following reasons:

·         Mix: Research is a much larger piece of Gartner, accounting for 86% of 2022’s estimated sales vs. just 61% in 2008. In 2009, research revenues only fell 4% and gross profits only fell 1% as the company managed expenses to limit the impact of the decline.

·         More multi-year contracts: Currently over 60% of subscription contracts are multi-year compared to ~30% in 2008. So, while churn will be elevated in a tough macro, less contracts will be up for renewal.

·         More focus on what matters to clients in a downturn: In the GFC, Gartner did not offer much content designed to help decision makers prioritize spending in a constrained budget environment. Today, the company has meaningful content designed to help clients save money & prioritize investment spend.

·         Pricing: Gartner historically realized 3-4% pricing on renewals though over the past 1-2 years this has moved up to 5-6% to help offset the impact of inflation in its own cost base.

·         Conferences business is at a different point: The conferences business is a cyclical business, declining ~40% from 2007 to 2009 but the starting point today is from a different point. Conference activity continues to be meaningfully below pre-COVID levels (2022E revenues ~30% below 2019 levels) suggesting macro deterioration would be off of a much smaller base. In a more sharp downturn, the company also has the ability to preserve some profitability by pivoting back to virtual conferences (which weren’t an option in 2009).

Taken together, we would expect Gartner to perform better in a 2009 repeat scenario and continue to grow profits through a shallower economic decline.

Financial model will deliver attractive growth: Gartner’s medium term financial model calls for double-digit revenue growth and modest EBITDA margin expansion off normalized levels resulting in attractive profit growth. Free cash flow is expected to grow at least as fast as EBITDA, and capital deployment is expected to continue to favor share repurchases after investment in organic and inorganic growth initiatives.

·         Revenue growth: Gartner’s growth outlook is supported by Research contract value growth of 12-16% over time, somewhat offset by slower conference and consulting growth.

·         Margins: Gartner expects gross margins to expand modestly from mix (i.e. Research grows faster than Events & Consulting and is higher margin) along with some operating leverage on its Research Analyst cost base. Sales costs are expected to grow in-line with revenues, while G&A is expected to provide modest operating leverage.

Note – Gartner is currently delivering abnormally high margins due to COVID-related cost savings and under-hiring demand in 2020/21 which skewed the salesforce towards more productive salespeople. Adjusted EBITDA margins, which were just 16% in 2019, reached a high of 27% in 2021 and are expected at ~25% in 2022. Management believes normalized margins are in the low 20s range and thinks that the company can grow margins off this base. Our and consensus estimates show continued margin declines in 2023 as the company returns to normalized levels.

·         Free cash flow: Owing to its limited capital requirements and favorable working capital dynamics, the company generates significant free cash flow. Management believes FCF margins should be 3-4% below EBITDA margins (as cash taxes and interest expense are offset by negative working capital in Research) and continues to guide FCF to work out to ~150% of net income over time.

·         Buybacks: In the last 2 years, Gartner has spent $2.8bn repurchasing its shares, reducing diluted shares outstanding by 11%. With just $1.9bn in net debt ($2.5bn gross debt, ~90% fixed due in 2028 and 2030), net leverage of only 1.6x, and a business model that prints cash flow we would expect Gartner to dedicate 100% of FCF to repurchases going forward. This implies Gartner can buy back 4-5% of outstanding shares annually without the aid of additional leverage.

As EBITDA margins continue to decline in 2023, earnings growth will be muted. However, BFM is estimating the company reaches normalized margins in 2023 and can generate operating leverage off this level, resulting in ~20% earnings per share growth in 2024/25.

Valuation looks reasonable: On a price to earnings basis, Gartner screens expensively, averaging 36x/33x/29x forward earnings over the past 5/10/15 years. This is because of its strong free cash generation which has consistently equaled ~150% of adjusted earnings and effectively translates into a Price-to-Fwd FCF average multiple of 24x/22x/19x over similar time periods. Interestingly, the historical lows in valuation over the course of a year are also creeping up over time. Since 2014, the annual low in IT’s forward P/E has only been below 25x once (at the COVID trough in 2020) and shares tend to bottom out at ~27x forward earnings. This suggests to us that the market is increasingly giving the company credit for its defensiveness and sustainably strong free cash generation. Notably however, is valuation on the company is very volatile – the difference between the annual low and high in valuation is 10 turns on average.

At a recent price of ~$331, IT is currently trading at 35x/30x consensus 2023/2024 earnings and 31x/27x our more bullish outlook. And assuming its historical relationship between earnings and FCF holds (which management has endorsed as sustainable), this equates to 25x/21x consensus FCF and 21x/18x our estimates.

Management/Compensation: Gartner is lead by Eugene Hall, who has been CEO since 2004 and is the architect of the growth strategy the company has been executing on for the past 18 years. Mr. Hall came from ADP where he was president (and a former Gartner client) and was at McKinsey for 16 years before ADP.

During Mr. Hall’s tenure, shares and earnings have compounded at ~20% annually and the company has meaningfully outperformed mid- and large-cap benchmarks. His beneficial ownership is almost $450mn (1.7% of outstanding shares).  Mr. Hall is 65 years old and IR informed me that he is under contract through 2026.

Gartner’s CFO, Mr. Craig Safian, has been in his role since 2014 and has been at Gartner for almost 20 years. Prior to becoming CFO he was a Group VP in charge of Global Finance and Strategy & Business Development. He is a former CPA. Mr. Safian is 53 years old.

As for compensation practices, base salary accounts for 7% of the CEO’s compensation and 17% of all other named executive officers, the cash bonus, which is based on achieving revenue and adjusted EBITDA targets, accounts for 9% and 14%, respectively. Long-term incentive compensation accounts for the balance and is based on the company achieving contract value – it’s most important metric for measuring research revenue performance - targets.

Catalyst

Continued execution

Guidance revisions