EUR 850.00 For Business Accounts Only

Morningstar | Post Divestiture a New Thomson Reuters Emerges. See Updated Analyst Note from 26 Feb 2019

Narrow-moat Thomson Reuters’ fourth quarter marks the first period since the company shed 55% of its financial and risk business. Though the company’s balance sheet is coming into focus, its income statement remains quite blurry. For the quarter, the company generated $6.18 in earnings per share. However, $6.32 of this came from gains in its discontinued operations while Thomson Reuters’ continuing operations produced a GAAP loss of $0.14 per share. Adjusted EPS was $0.20, which we find reasonable. For the quarter, revenue on a constant currency basis was up 7.4%. However, we’ll remind investors a vast majority of this growth comes from the zero-margin revenue produced by the agreement between Refinitiv and Reuters News. Excluding this, revenue growth during the quarter was only 1.9%. We’ll be updating our model to reflect full-year 2018 results and management’s guidance. Given the impressive rally, Thomson Reuters was only able to repurchase 151 million shares, well below our expectation that shares would decrease by more than 200 million. The biggest source of uncertainty in our model was based on the share price at which management would repurchase shares and at what price. Given this, we’ll be decreasing our fair value estimate to $45 per share. Our updated fair value estimate is about 18 times our forecast for 2020 normalized earnings.

The company’s guidance for the next two years is about what we have been forecasting and implies 2020 sales of about $6.16 billion and adjusted EBITDA of $1.88 billion, slightly below our forecast for $6.23 billion in sales and $1.92 billion in EBITDA. None of management’s updated guidance should come as a huge surprise to the market, which is why we’re surprised to see shares react so favorably.

For the quarter, Thomson Reuters' legal professionals segment produced growth of 4%. We don't think investors should get too excited. While long term we view this business favorably, we think it will take time for the company's legal investments to result in accelerated growth. We think it's likely the company hasn't invested as much in this business as it would have liked in previous years. Meanwhile, the company's tax segment produced top-line growth of 6%. Some of this is attributable to acquisitions, but nevertheless represents good growth that was previously obscured by Thomson Reuters' F&R business.

It is interesting to look at the transformation in Thomson Reuters’ balance sheet. The company has gone from having $9.38 in net debt per share to having only $0.93 in net debt per share a quarter later. This liberated balance sheet should enable some acquisitions and share repurchases. During the quarter, Thomson Reuters got back to its old ways, acquiring Integration Point, which provides software enabling companies to meet the tax and reporting requirements of importing and exporting goods across multiple tax jurisdictions. Based on the company’s cash flow statement, it appears it paid around $418 million for the company. Though we’ll need to investigate further, Integration Point does appear to be a moaty business that could potentially integrate well into Thomson Reuters' existing tax offering. We don’t know how much the company is generating in sales or income, which makes valuing it difficult.

However, there were some balance sheet anomalies this quarter. We are puzzled by the large jump in receivables. Receivables grew by more than 50% from the third quarter while operating cash flow collapsed by 76%. This may just be noise related to the divestiture or timing differences, but we think it’s worth keeping an eye on, and we will be digging into the footnotes of Thomson Reuters’ forthcoming annual report to investigate further.

Though Thomson Reuters' financial and risk business, now called Refinitiv, was barely mentioned by analysts on the call, we think it’s worth some attention. In the fourth quarter, the company generated adjusted EBITDA of $486 million. We’ll point out that EBITDA is really meaningless to Thomson Reuters' shareholders since Refinitiv has $14 billion in debt and preferred equity and Thomson Reuters' share of income will be reported net of these items. Net of financing costs and the severance its paying after the deep cuts to headcount, Refinitiv didn’t make much this period. Thomson Reuters’ equity investment line item shows a $212 million accounting loss. However, that’s likely not as bad as it seems and reflects multiple nonrecurring items. Free cash flow was a positive $210 million. That may seem like a healthy level of cash generation, but it reflect deep reductions in spending and capital expenditures. We'll point out that during the quarter, Refinitiv had capital expenditures of just $70 million, translating to an annual run rate of $280 million. While not a perfect apples-to-apples comparison, in 2017, this segment had capital expenditures of $464 million. In addition, in 2017 Thomson Reuters had another $440 million in shared capital expenditures assigned to its corporate segment. This suggests that Refinitiv has cut capital spending by at least 40% though likely much more. Given Refinitiv isn’t investing in the business, we have to view Eikon as a slowly melting ice cube and expect the value of these assets to decline over time.

However, it’s not all bad news for Refinitiv. In January, Bloomberg reported that Tradeweb had confidentially filed for an IPO of which Refinitiv has a 58% ownership. We know that average daily trading volumes have skyrocketed by 20%-40% in each of the last few months. Based on this, we would estimate that Tradeweb has seen revenue growth of at least 20%. Despite this contribution from Tradeweb, Thomson Reuters reported that Refinitiv achieved year-over-year revenue growth of only 3%, suggesting Eikon’s revenue growth is lower and potentially negative.