Many readers will now identify that whenever I choose a stock to analyse, I usually conduct one of the most thorough qualitative analyses that an investor can do. I look at products & services, management, trends in business operations, supply chain management, raw materials and gauge for myself a sense of what a company is all about. I believe that quantitative analysis is an important tool to assess a FMV of a stock through a variety of metrics and something that is required before a purchase, but I’ve always held the belief that an understanding of the qualitative dynamics of a company show more promise over the long-term based on what predictable fundamentals I can find.
I’ve made it no secret that for a period of time now I’ve had a mentor who enjoys providing me insight into a much different style of thinking towards companies and how to evaluate them. The main theme I’d like readers to focus on during this post is something I’ve written about in the past regarding what a competitive advantage can provide a company and its impact on the success of a business in an environment of high competition.
It’s been just over a full year since Thomson finished its corporate re-alignment prior to its announced intention to merge with Reuters and during this time it’s been both surprising and exciting to watch the progression evolve. I’ll acknowledge that to many investors Thomson is a tough pill to swallow due largely to its poor historical stock performance and anemic rise in valuation. But as I’ve outlined in past posts (I & II) a value investor at times needs to look beyond where a company has been and look instead towards where it is now going.
So why am I so intrigued and committed to a stock that everyone else clearly loves to hate? Ego aside, it’s largely because I know something that many don’t. While others have bid this stock down near a new 52-week low, I’ve been steadily buying into a full position knowing where this company will be in the future and satisfied that I’ve gotten a cheaper price with each subsequent purchase. Any other investor may argue that I’ve only dug myself a deeper hole of misery, but I disagree for the points I’ll make in this post.
Any reader who has followed the company is most likely asking the question:
“But what about the financial industry, it’s in RECESSION!”
True and I’m not suggesting that any investor ignore this crucial point. But it is important to keep an open mind and look beyond this problem to focus in on the rest of the company. An important tool for any value investor is to examine an investment and assess the value of all parts/functions instead of the most apparent.
Let’s first examine the traditional view of Thomson that so many investors currently relate the corporation to: a print media & financial services company.
Thomson in recent years has undertaken a slow and tedious transformation from a corporation strangled by slow print information into a company that can now embrace and compete in the new millennium with a single strategic focus: electronic information services. What does that mean?…No More Books.
Thomson’s re-organization is an important clue to focus in on from the perspective of my beloved Value Rule of “Do What You Do Best”. Let’s examine these five strategic business units (SBU’S) more closely:
Financial: broker, corporate investment banking, wealth management, fixed income & global finance
Tax & Accounting: tax and accounting professionals
Legal: legal, intellectual property, business & government agencies
Scientific: research, science, academics, corporations & government
Healthcare: physicians, medical corporations & government
Question: Which SBU is the largest driver of revenue for Thomson’s bottom line?
If you said Financial, you’d be wrong. If you said Scientific or Healthcare, you’d still be wrong. In fact, the Legal SBU for Thomson is nearly 46% of all their revenues with Financial comprising 30%. That might appear to be a large amount allocated to only two segments of their business, but it’s the basis for their position of strength and something very few investors take notice because the most obvious thing to do is compare the financial SBUs’ market share between Thomson, Reuters and Bloomberg. When you consider the attention brought to accounting scandals in the past decade (Enron, Hollinger & WorldCom) and the insane amount of litigation that takes place in US courts its not difficult to comprehend how something as simple as electronic legal services can be so meaningful to a companies total revenue stream.
Another important point is that the dotcom bubble of 2000 wasn’t originally based solely on insane valuations of companies with little or no revenue as we’ve come to easily remember. Lost in the past eight years is the continuing struggle many businesses have with accumulating, deciphering, processing and utilizing information from their customers, suppliers, global breadth and everyday operations. Storing and maintaining all of that information is very time consuming and capital intensive when you figure in the costs of acquiring, retaining and upgraded computerized systems able to handle large quantities of information. Add onto all of this that most of that information is only needed a fraction of the time, yet extremely valuable that a company might be at significant loss without it. Recent acquisitions by Oracle and IBM of B2B software companies shows an even more evident change in focus to information management and how it’s handled by businesses around the world.
What we are finally beginning to see is the earlier visions of many individuals (such as Bill Gates) materialize in the corporate environment. Healthcare companies with large drug pipelines have massive investments at stake and protecting their intellectual property (IP) is becoming increasingly important as can be seen in mishaps with patents and generic competition. One molecule forgotten on a patent can lead to erosion of billions of capital invested by one of these companies. Add the demands by investors, governments and the private/public sector for new medical improvements and this puts large strains on pharmaceutical corporations to deliver products faster and more efficiently in a cost-effective process. The issue becomes that due to limited time, capital and employee resources large companies are willing to spend in order to increase the needed efficiencies and decrease the time spent on such projects to get products to markets sooner.
Put yourself in the shoes of a researcher or scientist attempting to search countless closed networked databases in order to accumulate data for a project or compare results from a study group. Or imagine being a legal professional searching library records for hours in order to organize legal precedents to strengthen the case of an affluent client where the success of your firm and countless millions are at stake. What price do you place on time if it’s of the essence? More and more companies are finding that it’s too expensive to keep or accumulate all these resources in house and placing such resources in the hands of others to manage out of your control can leave you in a very compromising situation due to confidentiality.
Thomson itself doesn’t supply all of these services, but my holdings in TIBX and another non-disclosed stock complete this circle of services that I feel provide substantial value along this line of strategic thinking. What I’ve found offered by Thomson combines years of tedious work, capital expenditures and resources in order to present to the market products that allow them to achieve many of the outlined dilemmas.
80% – The total amount of revenues in 2006 that Thomson received from electronic sources.
82% – The total amount of revenues in 2006 that Thomson received from subscriptions
Next: Accounting, Healthcare & Scientific SBU’s comprised only nine, six and nine percent respectively of Thomson’s 2006 revenue base. But these divisions include nearly 50% of all new products offered by the company in the past three years. Each of these SBU’s is highly specialized and becoming increasingly tooled to offer a larger and broader diversity of businesses focused products that operate on subscriptions and are on the rise. When we think of Google we think of the awesome amount of information they gather and assimilate in order to focus advertising and products back towards their front-line users. Thomson in an extremely bullish view could be the Google of the professional corporate community. Consider all of this and we haven’t even gotten to the Reuters acquisition yet.
Remember – information is knowledge in today’s global economy and there is a price that companies and professionals are willing to pay for it. Reuters offers the final piece in completing the puzzle giving Thomson the direct access it wants to global media. Reuters currently is a global provider of public, financial and technology related news to the world’s financial institutions, businesses and media. The most important element likely is the combined strength of the financial services the merged company will offer. Thomson excels in the North American economies where Reuters excels globally into Europe, the Middle East and Asia and a wide range of products, personnel and databases (these being the real gems). Databases equal data and that can be utilized to sell specialized products beyond North America.
But what about the balance sheet, the debt, countless other factors? You have to be flexible in your vision of the company and where it will be tomorrow, not where it’s been the past few years. I’ll admit that I’ve had difficulty putting a book value or other metric on this stock that quantifies easily the value of its reinvented corporate structure. This is what I know: when I consider the forward cashflow generation, the current arsenal of products in the markets today and in the pipeline in production for the future this company is cheap on literally all traditional metrics. When I go through my Value Rules nearly every one of what I consider to be my most concrete disciplined set of criteria are met through my analysis of Thomson.
My prediction is when the cashflow generated by this new structure is up and running on all cylinders the company will be able to pay off debt, increase dividends and continue to focus on its core revenue as a point of stability. This strong revenue base will provide the company stability to continue targeting higher margin information services to large corporations outside of the legal & financial industry in their remaining SBUs.
The easiest comparison I can make is if Cisco is your hardware investment, Thomson would be your software investment.
Experience and strategic analysis has taught me a very important lesson over the years: a sustainable competitive advantage is something easily identified once a company has developed and created one, but virtually impossible to predict before one has been created. While Wall Street and Bay Street ponder a gloomy and dreary financial services recession and discount this stock with further pessimism I’ll continue to watch with excitement and anticipation for what I believe is happening. As this company continues to focus on its core competencies, works through the massive acquisition with Reuters and management continues their pursuit of a brilliant strategic focus; they are in fact creating one of the world’s premium electronic information companies that is able to span the globe with its portfolio of products.
The SCA that I perceive this company to be creating, in its infancy, is the sheer quantity and access to data and the ability to monetize this into information that can be sold through subscribership to companies around the world at margins well above today’s.
With Q4 & Fiscal 2007 results to be reported tomorrow at 8:30am (EST) I felt this post might be a useful insight for investors pondering a new position in this company or considering its current position within their portfolio. I won’t guarantee that the numbers will blow away market expectations, but I certainly expect to see a continuation of the strong results that have been reported by management in the subsequent two quarters.