Investment Summary:
Dealogic is a niche provider of software and data analytics to investment banks that currently trades at 6.5x '10 EBITDA and 11x '10 earnings on the AIM. A big driver of the valuation is the small float (insiders own 84%) that makes Dealogic very difficult to play in a big way. However, Dealogic has a defensible market position with strong client relationships and an attractive business model that generates substantial cash (~$25M over LTM 6/30/10) which is being returned to shareholders via buybacks and dividends. Additionally, its limited float and high insider ownership could make it a takeout play, while its niche position likely makes it an attractive acquisition target to larger financial services software providers, representing further upside opportunities. That said, while I think the company is easily a double, there is also no clear catalyst in the near future that I can point to.
Business overview
Dealogic sells a large portfolio of over 60 software and data products which are extensively used in the capital raising process by investment banks; most of you are probably familiar with the Dealogic league tables. Dealogic comprises two divisions:
¦ Solutions: Software products that help investment banks execute transactions, including bookbuilding (DealManager), new issue trading (TicketManager).
¦ Analytics: ECM / DCM analytics utilizes databases of deal data that are used to monitor ongoing capital market conditions and create league tables. This area is more crowded; competitors include SDC (Thomson Reuters), Bloomberg, CapitalIQ and Factset.
Dealogic has a very strong position in the niche market serving investment banking primary market processes. Some new products are starting to compete with other competitors (e.g. Dealinks competing with Intralinks), but generally, Dealogic does not play in larger, more competitive areas of financial services software like trading software (e.g. SunGard), portfolio analytics (e.g. RiskMetrics, Blackrock), real-time market data (e.g. Bloomberg, CapitalIQ, Factset) etc. It has strong client relationships, serving all of the top 50 investment banks; some of these relationships span 15+ years, and Dealogic's software products are tightly integrated into the workflow of their customers, increasing switching costs.
Additionally, it is worth noting that investment banks are generally not in the business of owning their own proprietary software solutions, and since the 1990's have made increasing use of 3rd party solutions - a trend that is likely to continue.
Dealogic's revenue model is a combination of transaction-based fees and annual subscriptions and is closer to a software-as-a-service (SaaS) model than a traditional upfront license model. This recurring model is especially attractive as there is significant visibility, and is more resilient as software costs become part of opex and less reliant on big capex outlays.
Dealogic was affected by the downturn as consolidation amongst investment banks and lower transaction volumes and value decreased revenues by 12% and EBITDA by 40% in 2008 vs. 2007.
As a result, the business generates substantial cash, with high operating margins (30%+ excluding 2008) and low capital requirements (capex limited to <3% of sales). Cash has been returned to shareholders via buybacks and dividends. In June 2010, Dealogic spent ~$69M to reduce its share count by 26% (repurchased 17.6M shares and reduced Exchange Rights Agreement by 3.3M shares) at a cost of £2.20 / share (16% premium). This was funded by cash on hand and ~$34M in new bank debt. Dividends are also being paid (current dividend yield is ~3.5%).
Takeout Potential
Although the company has not given any indication that they are pursuing a sale or buyout, I don't see Dealogic having a compelling reason for remaining a public company on the AIM. I believe there is potential that (a) the company is acquired by a larger financial services software company; (b) the company is taken private by insiders; or (c) the company is relisted on another exchange.
With a strong niche position serving investment banks in primary market transactions, Dealogic could represent a good target for other larger financial services software providers, especially as customers are increasingly looking to consolidate solution providers. Thomson Reuters (Loan Pricing Corp, SDC, ThomsonOne investment banking) is probably the most logical acquirer, butthere are several companies that would also see significant value in Dealogic, including Ipreo (BigDough), McGraw Hill (CapitalIQ, S&P), Intralinks and Bloomberg. Since the capital markets and the investment banking sector has stabilized, potential acquirers may be more willing to consider M&A
It is also possible that the company is taken private by insiders should they wish to remain independent, but I see this as less likely as there are minimal benefits to the status quo
Another interesting point is that the company is listed on the AIM, which is characterized by smaller companies with many duds (i.e. fertile hunting grounds for investors who don't mind doing their homework) and lower valuations. While Dealogic has not given any indications of doing this, I do know of several companies that are considering switching exchanges (e.g. Velti - which is another AIM-listed gem).
Investment risks
The largest driver of the low valuation is the illiquidity discount - insiders control 86%, with Chairman Peter Ogden and Philip Hume each owning 30% of the company. Management appears to be good stewards of cash to date, initiating the June '10 tender offer and continuing dividends. Despite this, there is a risk that the owners spend cash unwisely. Other risks include customer concentration (in 2003, top 10 customers accounted for ~50% of revenues), continued customer consolidation, and continued weakness in capital market volumes.