Qualiport

[ March 15, 2000 ]

Extracting Value From Experian

By Maynard Paton (TMFMayn)

Carburton Street, London -- The Qualiport has over £1,900 in the kitty at the moment, with another £2,000 on the way soon. Although we're in no real hurry to rush out and spend it, I am keen to look at any company that Fools think could be worthy of the Qualiport. Ideally, I would be looking to purchase just one company with the near £4,000 we will soon have in our hands. And if Unilever (LSE: ULVR) were to suddenly develop a share price spurt and reach to a fair value, another £1,200 or so could be reinvested as well. So, the next prospective purchase could be a significant one! Although I have to say, rather than one huge new investment, a combination of a new investment and a top-up is more likely.

Anyway, being open to any Qualiport suggestions, I'm going to have look at a recommendation from Qualiport discussion board regular Mark Lucas. I think his proposal warrants a wider audience.

Experian

Mark suggested Experian, a subsidiary of Great Universal Stores (LSE: GUS). Now, don't all jump and say "GUS is a retailer, have you not learned anything from holding M&S?" just yet. Indeed, GUS is a retailer, owner of the Argos chain, a catalogue home shopping operation, and a mixture of a few other retailing businesses as well.

But the Experian division isn't about retail. It's about IT, marketing and outsourcing. Primarily the company holds numerous databases containing public and proprietary information on consumers and businesses that allow clients to establish credit worthiness. And for the larger credit-checking customer, Experian also supplies software and IT consultancy. Direct mailing lists and provision of financial processing services are also undertaken by Experian. There's undoubtedly a lot of potential for Experian to benefit from e-commerce. And there is lots of repeat business too. All in all, Experian's business sounds a lot more enticing for a long-term investor than selling televisions from a catalogue store. Suffice to say, having had a brief look at the Experian business, I like it.

So, if we were to consider Experian, we would have to buy shares in its parent, GUS. Here's the theory. If we can buy GUS at a price that fairly values Experian, and throws in Argos and the rest for next to nothing, then GUS could look an attractive purchase. It's a "special situation" of sorts. Not a short-term "value" play, but a long-term investment camouflaged behind a rather dreary exterior. Of course, we have to determine whether Experian is a business that has any long-term investment merit in the first place. For this feature, I'll concentrate on giving an Experian overview. And I'm not interested at all in Argos and the rest -- apart from the profits that these additional divisions generate.

Experian within GUS

Here's how Experian fits into the whole GUS picture. As GUS has suffered a deterioration in its retail performance of late, I'm going to use the latest interim figures. Incidentally, it's this deterioration that has set the share price tumbling, from 800p to 400p in the last twelve months, to start prompting the calls of buying GUS for a cheap way into Experian.

                Six months to 30/09/1999 
              Turnover          Trading Profit 
               (£m)                  (£m) 
 
Experian        472.4                 95.4 
Other          2023.2                130.7 

Great 20% operating margins at Experian. Very nice. And now, a quick look at the historical record of Experian.

                   1995  1996  1997  1998  1999 
 
Sales (£m)          80    112   283   616   899 
Trading Profit (£m) 20     24    60   142   192 

I have to admit, I nearly fell off my chair when I saw these figures. A ten-fold increase in sales and profits over five years -- wow! I then realised that acquisitions must have helped things along. Indeed, Experian itself was bought by GUS in 1996 for £1b. The purchase of Direct Tech was performed a year after, and then Metromail a year after that. With a string of other smaller acquisitions as well, it's all given a mighty boost to the top line revenue figure.

With all the corporate additions, trying to determine the underlying rate of growth at Experian is tricky. Probably the best indication is to look at the latest interim results again.

                    Year to 31/03/1999 
Source                1999     1998      Increase 
 
North America        310.3    293.9        +6% 
United Kingdom        92.4     81.5       +12% 
Rest Of World         70.7     58.8       +20% 
 
Total                472.4    434.2        +9% 

Okay, so 9% growth isn't spectacular, but it's just about acceptable for an annual compound sales growth rate. In fact, Experian gives mitigating circumstances for the US slowdown. The integration of Metromail and the deferring of business due to Y2K issues caused the pedestrian US performance. But GUS do state that beyond those issues they anticipate revenue growth to "improve significantly", with the development of a new data warehouse that should provide a "significant competitive advantage". Reading between the lines of previous results as well, I suppose a forward annual sales growth rate of 10-15%, continuing the historic trend, isn't out of the question.

One worrying aspect of the US operation is the competitive pressures on supplying credit history reports, providing 25% of all US Experian revenues. In this respect, volume growth of 15% resulted in just a 5% increase in revenues during the year to March 1999. In the six months to September 1999, volume growth rose 10% but revenues "increased slightly". Hmmm... although the 20% operating margins give the impression of an overall business "franchise", it appears some parts of Experian are more of a "franchise" than others.

Valuation

A quick look at the valuation. At 400p, GUS are valued at £4b. Mark preferred to use the following approach to determine "fair value".

The annualised operating profit for Experian, using the latest interim results, is £191m. Now with Argos and the rest of the GUS businesses producing an annualised operating profit of £260m, it's fair to offset this against the expected combined GUS tax and interest bill of £180m. This allows quite a large margin of safety, of £80m, should the retail operation continue to fall apart. So with all the interest and tax paid for by the retail operations, owners of Experian are left with £191m each year. Put that on an undemanding multiple of 20, which is very understated for a growing IT business today, and we arrive at a group value of GUS of £3,820m. Just a shade under current £4b GUS price tag.

Alternatively, I like to look at GUS in a different way, a sort of a "sum of the parts", by calculating a conservative value of Experian, and then deducing a value of the GUS retail businesses. So, assuming all the interest is related to Argos, Experian's value can be calculated by taxing, at the current GUS tax rate (23%), Experian's annualised operating profits of £191m. That gives post-tax Experian profits of £147m. Putting that on the same cautious multiple as before, 20 times earnings, generates a standalone value of £2,941m for Experian.

Thus the rest of the retailing businesses are worth a total of £1,059m. Subtracting the total GUS interest bill of £100m from the £260m retail operating profit leaves £160m. After 23% tax, that gives retail earnings of £123m. So this implies a current price-to-earnings multiple for Argos of 8.6 (£1,059m/£123m). About right in the days of a very depressed retailing sector.

These are rough and ready figures. Certainly the low tax charge has an effect on valuations, with GUS stating that a "corporate reorganisation enabled the Group to adopt a more efficient financial structure". I suspect the recent loss-making Metromail Experian acquisition played its part here. I wouldn't like to put forward any estimates for the individual tax rates of Experian and the retail operations.

To summarise: I like businesses that have chunky margins and opportunities for material sales growth. Although there is no way of knowing from the latest GUS annual report, I assume Experian is asset light, operates without much recourse to debt and earns a high return on equity. I would be very surprised if this wasn't the case. But I don't know for sure. I guess putting a conservative-ish price to earnings ratio on any value for Experian offsets this uncertainty. Indeed there could be all sorts of underlying financial question marks at Experian, all shrouded by the consolidation with Argos. Unlikely, I know. But all the same, a factor to contemplate. Then there is the poor performing retail division. Will it get worse, and offset the good work done at Experian?

Certainly I'm interested in Experian and want to take it forward. I have no qualms in buying GUS as a way into Experian, just as long as the price-value equation takes into account all the uncertainties mentioned above. On the face of it, Experian exhibits a lot of the Qualiport criteria. On Monday, I'm going to look at another, but smaller, IT company that looks to fit the Qualiport criteria as well. In the meantime, I'm going to dig deeper into Experian.

Related Links
• Less is More
• Experian website
• GUS Discussion Board

Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.