Summary

London Stock Exchange Group (LSEG) is a collection of market leading secular growth businesses with monopolistic and defensive characteristics that we expect to grow revenue ~8% annually and EPS ~18% annually over the medium-term.  Despite this attractive revenue and EPS growth profile, LSEG trades at only ~20x NTM P/E, a ~20% discount to that of similarly growing information services and exchanges comps.  Two years of high-teens EPS growth and modest multiple expansion to 22x NTM P/E should provide for 50+% upside to the stock by the end of 2024, which we believe is a very attractive return for a high quality and recession resilient business. 

Business Overview

·         LSEG is a leading provider of financial markets infrastructure products used for data analytics, investment benchmarking, trading & clearing and risk intelligence.  LSEG derives ~70% of revenues from recurring businesses and ~25% from businesses that outperform during market drawdowns.  In addition, ~85% of EBIT is exposed to high single digit to low-teens revenue growth businesses where LSEG is a market leader. 

·         The legacy LSE businesses are leading providers of financial markets infrastructure used for trading, clearing, benchmarking, and reporting.  Their largest customers include the top 10 investment banks, the top 20 ETF issuers and 98/100 top asset managers. 

o   These businesses have dominant market positions in high growth end markets which has led to the business growing at double-digit revenue and EBIT growth rates in recent years.   

·         The former Refinitiv business, acquired in early 2021, is a leading data provider to financial firms and corporations, and an owner of leading financial trading venues.  It was formerly known as the Thomson Reuters Financial & Risk segment before it was renamed Refinitiv as part of a sale of 55% of the business to Blackstone in 10/2018.

o   The business is 85% recurring revenue, 75% subscription with a high concentration of multiyear contracts and has 90% retention rates.  The former Refinitiv business has 40,000 customers including large banks, institutional investors, corporations, and governments.

·         The geographic business mix by revenue is 46% North America, 15% EMEA and 39% Asia.

Segment Overview & Drivers

·         Data & Analytics (~65% of revenue / ~60% of EBIT)

o   Data

§  Description: The leading provider of global financial markets data for trading, investing and compliance use cases.  The business has the most breadth of data at 2x the closest competitor. 

§  Industry Trends: The market for financial data based on revenue has been growing mid-single digits to high-single digits driven by secular trends driving data demand including passive investing and indexation, quantitative investing, the increased usage of data in investment processes, and regulatory requirements for using and reporting data.

§  Growth Algo: ~6-7% = 3-4% volume (mainly more products to existing customers) + 3+% price

§  Competitive Position: Refinitiv is the strong market leader, and the market is an oligopoly (Bloomberg is #2) because it’s challenging to assemble a competitive offering of historical data; Refinitiv has data on 100MM instruments from 10K sources. Switching costs are high because all applications built on the data would need to be re-written for competitor data models.

·         Indices

§  Description: FTSE Russell is the dominant provider of index benchmark and analytics solutions on US Smidcap and UK equities, and is well positioned in derivatives and fixed income / ESG / APAC index benchmarks.

§  Industry Trends: There is a continued shift to passive investing strategies in equities.

§  Growth Algo: ~10% = 6% passive investing / more analytics + 2% price + 2% market appreciation.

§  Competitive Position: The top 3 index providers (S&P Indices, MSCI, FTSE Russell) have had relatively stable market shares over time and make up 80% of the market. FTSE Russell is the strong market leader in US Smidcaps and UK indices.  Switching costs are high because investors are brand loyal and switching benchmarks can lead to significant investment performance leakage due to front running.

·         Desktop

§  Description: The desktop business is the number two provider of financial markets desktop software behind Bloomberg.  This has been the “problem child” for the company in recent years and is the lowest growth business in the portfolio.

§  Industry Trends: The desktop business has been facing industry headwinds (shift to passive investing, headcount reductions at sell-side firms) and strong competition.

§  Growth Algo:  Flat overall.  The financial desktop market has seen +/-2% growth in recent years (1-3% terminal declines partially offset by 1-3% price increases) due to headcount reductions at sell-side firms, fee pressure at active investment managers, and the shift to passive investing and algorithmic trading.  In addition, the high-end portion of the business, Eikon Premium, has ceded share to Bloomberg and FactSet in recent years. 

·         Capital Markets (~20% of revenue / ~25% of EBIT)

o   Description: Fixed income (Tradeweb, which is 2/3rds of the segment), FX (FXAll) trading exchanges used by buy-side and sell-side firms, and Equities Exchanges.

o   Industry Trends: The industry is the in the early to middle innings of a shift from phone / messaging based trading to electronic / on platform trading.  Tradeweb’s (“TW”) end markets are currently ~40% electronic on average (range from 10-70% electronic) vs. the earliest markets to go electronic which are 80- 90% electronic (i.e. equities, futures). 

o   Growth Algo (TW): ~12% = 5% from electronification of markets + 4% from market share gains + 3% from market growth

o   Competitive Position: FXAll is the market leader in FX with 35% market share (nobody else is greater than 10%), and Tradeweb is the market leader in rates trading and a fast growing number two in credit trading behind MarketAxess in the US and Bloomberg in Europe.  Both are likely to continue growing market share driven by strengthening marketplace network effects leading to more liquidity and better pricing.

·         Post Trade (~15% of revenue / ~15% of EBIT)

o   Description: Clearinghouses primarily for swaps, CDS and FX derivatives used by sell-side firms and their corporate clients mainly for medium to long-term hedging purposes. 

o   Industry Trends: Since the financial crisis, regulators and trading counterparties having increasingly mandated that derivatives trades get cleared through a central clearinghouse to reduce risk to the financial system and individual company balance sheets.  Growth has historically accelerated when market volatility is high because of more trading activity and/or increased trading counterparty requirements to centrally clear due to heightened risk levels.

o   Growth Algo (LCH): ~12% = 5% more swap clearing + 2% more FX clearing + 3% price + 2% market growth.

o   Competitive Position: The LCH Group ("LCH") is the dominant clearinghouse for OTC swaps with +90% market share and has a leadership position in the more nascent FX and repo clearing markets.  Switching costs are very high because this is a network effects business where higher clearinghouse market share leads to lowers trading costs for customers through more efficient use of collateral and more counterparty collateral liquidity.  We count at least four historical attempts where a well-capitalized exchange competitor attempted to enter and gain market share against an established clearinghouse and none of them currently have more than 2% market share.

Thesis Points

·         With the acquisition of Refinitiv in 2021, LSEG further increased the quality of its business and today ~85% of LSEG’s EBIT comes from high growth / high quality businesses that are recession resilient.

o   LSE has evolved from a 68% low growth commoditized business (equities exchanges) in 2005 to its current state by identifying attractive future verticals within financial markets, often before its competitors, and acquiring crown jewel assets to build organically upon (FTSE indices, Russell indices, LCH clearing).

§  ~85% of LSEG EBIT comes from businesses that are market leaders, have very high switching costs and are likely to grow at a high single digit to low teens revenue growth CAGR for the next 3+ years.

§  We expect revenue to CAGR at ~8% over the medium-term as the company’s higher-growth segments (Data, Indices, Fixed Income Capital Markets, Post Trade) well more than offsets the minority of businesses that have flat/LSD% growth (Desktop and Equities Exchanges), and the company executes on the revenue synergies from the Refinitiv acquisition. 

o   LSEG is recession resilient business.

§  We estimate that the current LSEG business mix grew modestly through the GFC driven by its stable recurring revenue data assets (70% of revenue), secular growth index and growth exchanges assets, and defensive post-trade business.  Equities exchanges was the primary area of weakness during the GFC driven by fewer IPOs; this part of the business only represents 3% of LSEG revenue / EBIT today. 

§  In addition, LSEG revenue growth in ~25% of its business (trading, clearing) tends to accelerate rapidly during times of heightened market volatility.

·         We expect LSEG to expand adj. EBIT margins by ~500bps from ~37% in 2022 to ~42% in 2025, roughly equally driven by business a mix shift to higher margin segments, segment level operating leverage/cost efficiencies, and cost synergies from the Refinitiv acquisition.

o   Mix shift to higher margin segments: LSEG's fastest growing segments are also their highest margin business segments. 

o   Segment level operating leverage: We calculate operating leverage at ~60% supported by high incremental margins and segment specific efficiency opportunities.  Additionally, the company’s margins in Post Trade and Indices are 10-15% below that of public comps of similar size and structural make up, providing cost efficiency opportunities. 

o   Cost synergies: We expect an incremental £100mm - £150mm in cost synergies by the end of 2025 from the Refinitiv acquisition. 

·         The technical overhang from the lock-up expiration of Thomson Reuters and Blackstone’s shares will slowly dissipate over the next couple of years.

o   After the Refinitiv acquisition, Thomson Reuters and Blackstone owned a combined 33.7% of LSEG.  3.8% was sold to Microsoft in December when LSEG and Microsoft announced a strategic partnership, leaving the Thomson Reuters/Blackstone consortium with 29.9% ownership. 

o   12% of total outstanding shares, or ~40% of this came off lock-up in late January, and the consortium sold ~5% of total outstanding shares in early March in a very well covered offering.  That deal left the consortium with ~25% ownership.  ~7% of total outstanding shares can be sold in the short-term, and LSEG plans to acquire ~2% from the consortium if the buyback is approved at the May AGM.  ~5% will likely come with another deal over the next 6 months. 

o   Another ~10% of total outstanding shares will come off lock-up in January of 2024, and the final 7-8% of total outstanding shares will come off lock-up in January of 2025. 

Valuation

·         We’re expecting £5.13 in 2025 Adj. EPS; applying a 22x P/E multiple to that and adding dividends results in a target price of £117 over 1.8 years, 55% upside, or a 27% IRR. 

·         The appropriate information services and exchange comps (including VRSK, SPGI, CME, ICE, FDS and NDAQ) currently trade at ~24.5x NTM P/E and are expected to CAGR revenue at an average of 6.5% from 2022 to 2024.  We expect LSEG to CAGR revenues at ~8% from 2022 to 2024, so believe our 22x NTM P/E assumption on 2025 EPS is conservative. 

Risks

·         Execution Risk: LSEG is still in the process of executing on the revenue and cost synergies from the Refinitiv acquisition.  Execution so far appears to have gone well, as the company recently increased its overall revenue synergy target, and now expects to achieve cost synergies earlier than in initially expected. 

·         Cost Inflation: The biggest hiccup the company has experienced since the Refinitiv acquisition occurred when the company provided 2021 guidance in March of 2021 shortly after closing on the acquisition.  LSEG modestly increased cost inflation guidance above what was communicated prior to the closing of the deal and quickly lost credibility on integration execution.  Since then, management has managed to keep cost inflation in-line with expectations, but another guidance adjustment could impair credibility once again. 

·         Desktop Business:  The desktop business represents 22% of total LSEG revenues and has been the “problem child” for the company in recent years.  The financial desktop market has been declining by 1-2% annually (3-4% terminal declines partially offset by 1-2% price increases) due to headcount reductions at sell-side firms, fee pressure at active investment managers, and the shift to passive investing and algorithmic trading.  The Refinitiv desktop business has also been a share donor to Bloomberg and FactSet because TRI underinvested in the business.  While in 2018, Blackstone took a stake in Refinitiv and increased investment in the desktop business to modernize the platform resulting in market share stabilizing, we still expect flat growth from this segment.

·         Equities Trading Business:  Equities secondary trading and IPOs represent 3% of pro forma LSE revenue / EBIT.  Equities trading as an industry has seen fee compression and LSE faces competition from low-cost competitor BATS (owned by CBOE) particularly in its non-core continental European equities trading businesses.  While we see limited fundamental impact from headwinds in this business, it may receive outsized media coverage given its historical importance as LSE’s main business.

Disclosure:

We and our affiliates are long London Stock Exchange Group (LSEG LN) and may buy additional shares or sell some or all of our securities, at any time. We have no obligation to inform anybody of any changes in our views of LSEG LN. This is not a recommendation to buy or sell securities. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion.