Description

Executive Summary:  Clarivate is a leading information services company offering mission-critical content and analytics to organizations in the academic and government, life sciences and healthcare, and corporate verticals. It’s product portfolio includes market-leading brands such as Web of Science, Cortellis, DRG, Derwent, CPA Global, and ProQuest (assuming 4Q21 close). Previously the IP & Science division of Thomson Reuters, Clarivate was sold to Onex Corp and Baring PE Asia in 2016 who then completed a reverse merger with SPAC Churchill Capital two years later to bring the company public.

Like many other information services companies, Clarivate has an attractive business model. Its key assets are highly valuable - Management believes it is the #1 or #2 player in nearly every market that it operates. It’s proprietary data and analytics solutions are embedded in its end users’ daily workflows, creating a sticky business with a high level of subscription and recurring revenues.  Because most of the costs are incurred collecting the underlying data and creating the analytical tools, Clarivate has a high degree of operating leverage that translates into strong incremental profits on each dollar of growth. The business also has low capital requirements and thus tends to generate high levels of free cash flow.

In many ways, Clarivate’s current CEO Jerre Stead is executing on the same playbook he used as Chairman and CEO of IHS Markit to great success. The company has spent the past 5 years building out its core infrastructure to address technical debt accumulated while owned by Thomson Reuters, move its data sets to the cloud, and accelerate new product development. Moreover, it has dramatically improved its profitability by implementing various self-help measures. Lastly, the company has embarked on an M&A growth strategy that has structurally improved the organic growth and margin profile of the company.

In the Information Services sector, organic growth tends to have the greatest impact on valuation multiples. Based on the initiatives CLVT has undertaken and the portfolio restructuring via M&A, we expect organic growth to accelerate from the +LSD range of the last several years towards the mid-to-high single digits. This would place Clarivate towards the high end of its peer group.

At ~$22, we estimate that Clarivate is trading at less than 15x FY23 FCF (Pro Forma for its pending ProQuest acquisition). This compares to an average of 29x for peers (median 26x). Should CLVT close the gap like we expect, we see substantial upside in the near-term. Longer-term, performance should correlate to profit growth which we peg comfortably at double digits organic with M&A upside.

Company Overview:  Clarivate (CLVT) is a leading global information services and analytics company serving the scientific research, intellectual property, and life sciences end markets. It provides structured information and analytics to allow its customers to discover and commercial new ideas while also helping to protect content, patents, and brands. The company operates several leading (i.e. #1 or #2 in their global market) brands that are well known in the broad scientific community, including Web of Science (scientific and academic research), Cortellis and DRG (pharma and biotech intelligence), CPA Global (IP management), Derwent Innovation (patent analytics), CompuMark (trademark protection), and MarkMonitor (domain brand protection). The company was originally a division of Thomson Reuters before being sold to Onex Corporation and Baring Private Equity Asia in 2016 for $3.55bn. It ultimately went public in 2019 via a reverse merger with Churchill Capital Corp, a SPAC led by information services industry veteran (and current CLVT CEO) Jerre Stead.

In 2020, the company generated ~$1.25bn in revenue split between two reporting segments – Science Group and Intellectual Property. The business has a high degree of visibility in revenue with ~3/4 of sales either subscription-based or reoccurring in nature. Geographically, ~50% of sales are in the Americas, 29% in EMEA, and the balance in the APAC region.

Pro forma for the pending acquisition of ProQuest, we estimate Clarivate generates over $2.6bn in revenues (almost 3x 2019 sales) with an adjusted EBITDA margin of ~45%, more than 1,500bps higher than 2019 levels.

PRIMARY DATA SETS - SCIENCE GROUP

Web of Science ($380mn in FY19 revenues – last time disclosed): Web of Science (WOS) is Clarivate’s flagship product. It is embedded in the infrastructure of R&D, and is utilized as the reference standard in academic, institutional, and corporate sectors. Known as the arbiter of science, WOS finds the most important journals that publish in various spaces within science and identifies the most noteworthy researchers in the world in each of the scientific disciplines. It is particularly strong in biology, life sciences, and the medical sciences space. Notably, WOS does not contain any underlying content. Its purpose is to allow the researcher to find the most relevant literature on a given topic and then it hooks up into your library’s systems.

It’s primary competitor in the field is Scopus (Owned by publisher Reed Elsevier), though WOS is differentiated by being the only independent, truly unbiased source of scientific literature because it does not own any content. It also has an unmatched level of peer review which allows researchers to really trust the information. WOS has >1.9bn tracked citations from over 176mn index records going as far back as 1864. Another key product WOS provides is a ‘Journal Impact Factor’ metric used by universities and funding organizations to inform their evaluation of research excellence when assessing faculty or selecting funding grantees.

WOS’s primary end market is academia and government institutions where research spending has increased ~8% from FY17-19 (U.S. large academic institutions +MSDs over same timeframe). The product has a reasonably large presence in China. Management told us that WOS’s renewal rates were ~95% annually and that pricing power in this business was meaningful.

ProQuest ($876mn in FY20 revenues – acquisition has not yet closed!): ProQuest provides leading content and software solutions for Academic and Research institutions.  It serves 25,000 customers, has minimal customer concentration (no customer >1% of sales), and very strong (100%) retention in its largest customers.

Its largest business is content (~60% of revenues) where the business helps libraries acquire, manage, and search for content from a single point of access. It provides access to >5mn dissertations, 20mn pages of new papers going back 3 centuries, 6bn digital pages, 285mn journal articles, and >450K eBooks. It is a duopoly with EBSCO where PQ is known for its strength in e-Books and the softer sciences and EBSCO is known for its strength in physical books and harder sciences.

It’s other business is software (~35% of revenues) which provides integrated library systems (ILS) to libraries globally. An ILS is an ERP system for libraries and is the backbone of the library. ProQuest’s Alma product is the dominant platform within top tier libraries with over 2,000 installs globally, while the #2 competitor is OCLC with 1/5 the footprint, and the #3 competitor only has ~20 installations. A key point of differentiation for Alma is its ability to manage both digital and physical assets on one platform as digital is more complicated due to various licensing agreements. Over time Alma has taken share primarily from older systems that lack the capabilities. It does not have a scaled competitor.

Our sense is that library budgets tend to grow 2-4% annually which is around where we’d expect content to grow, while we expect double-digit software business growth  from continued replacement of legacy systems and the sale of additional modules. ProQuest increased revenues 5% organic in 2020 and was +7% in 1H2021. Longer-term, management sees this business growing in-line with its overall portfolio at ~6-8% organically.

Cortellis ($167mn in FY19 revenues – last time disclosed): Cortellis is a collection of products and services catering to pharma, healthcare, and biotech industries. Its product are used by strategy, business development, drug development, medical affairs, and clinical professionals to support research, market intelligence, and competitive monitoring in connection with the development and commercialization of new drugs. Originally a collection of businesses acquired by Thomson Reuters and run separately as brands IDDB (drug pipeline intelligence), IDRAC (regulatory intelligence in life sciences), Newport (generics intelligence), and Integrity (early-stage drug discovery intelligence), the products were rebranded as Cortellis post-Thomson Reuters and the data sets were moved to the cloud and integrated.

Customers use its database, which contains >80,000 drug program records and >435,000 clinical trial records, to access and evaluate scientific data, drug pipeline data, clinical trial info, and regulatory information. The data is used by hundreds of research outfits and 100% of the Top 30 pharma companies.

Decision Resource Group ($207mn in FY19 revenues): DRG is a provider of data, analytics, and insight solutions for the life sciences industry. DRG is a complementary asset to Cortellis in that its data is focused on the commercial side of the pharma industry vs. Cortellis on the development side. Essentially DRG’s value add is it supports patient identification – i.e. how many people are suffering from a particular disease… what is the prevalence – and market access – i.e. targeting and strategy, segmentation, and reimbursement insights. It works with 100% of the top 50 life sciences companies, 19 of the top 20 medical device companies, and 8 of the top 10 U.S. payers and U.S. health systems.

PRIMARY DATA SETS – INTELLECTUAL PROPERTY

Derwent Innovation ($180mn in FY19 revenues – last time disclosed): Derwent is the flagship product used by R&D professionals and lawyers to monitor patent filings, search existing patents, and analyze data to support R&D decision market. The data is critical for customers seeking to secure patent protection and address infringement litigation. The database has >93mn patent publications from 59 patent offices accounting for 90% of all patents published globally in 2020, and its data has been developed and curated for >50 years. Note -this business also included a standards measurement business that was ~1/3 of 2019 revenue but was divested in 2020.

CompuMark ($120mn in FY19 revenue – last time disclosed): CompuMark provides trademark research and protection services for businesses and law firms globally. Its offerings span the entire life cycle of a trademark from determining availability to monitoring for infringement. It provides curated content from >180 patent and trademark offices with data going back over 30 years, in addition to 65+ industrial design databases and 70 pharma in-use databases.

MarkMonitor ($120mn in FY19 revenue – last time disclosed): MarkMonitor helps enterprises establish, manage, optimize, and protect their online presence, providing a suite of technology services for customers to register and manage their portfolios of domain names. It also provides insights that help maximize the power of a company’s domain portfolio and mitigate cyber squatters’ attempts to defraud consumers.

CPA Global ($560mn in FY19 revenue): CPA Global offers patents and trademark management and technology solutions to corporate customers and law firms globally. It has ~12,000 customers, including 9 of the top 10 patent filers in North America, 8 of the top 10 in EMEA, and 10/10 in Asia Pacific, as well as 47 of the top 50 R&D spenders globally. The company enjoys very strong 97% customer retention and >90% of revenues are subscription or reoccurring in nature.

The largest business line CPA offers is Patent & Trademark Processing Solutions (77% of revenues) where CPA automatically processes, renews, and files patents and trademarks on behalf of its customers. In 2020, the company processed ~3.4mn patent and trademark renewals. This is particularly useful in managing renewals as most IP needs to be renewed annually or on some set schedule, and the cost of missing a deadline could be extremely material to customer.

It’s other 2 businesses, Lifecycle Management Technology (12% of revenues) and Information Services (11% of revenues) offer additional solutions to automate workflows and adhere to legal requirements, as well as provide additional data and analytic tools to help companies manage their IP.

Combined IP Group – Sum is Greater than Its Parts: Historically, CLVT managed its patent, trademark, and domains businesses separately despite the obvious fact that companies often are looking for these solutions around the same time. With the integration of the three legacy businesses plus the addition of CPA Global, CLVT can connect the entire lifecycle of a company’s intellectual property, and the company is in great position to cross sell its offerings to customers. It is more than 4x larger than the number 2 competitor (Questel) and management believes it can steadily convert businesses who self-manage their IP because of the significant cost savings it can offer. We estimate the market is growing ~5% annually, over-indexed to China, and note that there can be some cyclicality to patent filings.

Investment Highlights:

Information Services tend to be attractive business models and CLVT is no different: Information Services companies tend to be high quality businesses that have higher barriers to entry due to the uniqueness of the content and the costs necessary to replicate. These businesses have strong top-line visibility due to a high level of recurring revenues in their models and high retention rates, and pricing power in these businesses tends to be very high. Information Services businesses are also very profitable. With limited costs to acquire new customers besides sales expense, incremental margins are very high. The companies also tend to be capital-light and thus generate very high levels of free cash flow.

Clarivate is no different from its peers. It generates ~75% of revenues from subscription and reoccurring revenue and enjoys 90%+ renewal rates. And after several restructuring actions post merger with Churchill Capital, CLVT has meaningfully improved its profitability. In 2021, management expects adj EBITDA margins of ~44.5%, +1500bps vs. 2018 and above the peer average of ~40%. Going forward the company sees further improvements with the natural operating leverage in the business as incremental margins are ~85%. In terms of FCF conversion, the company is converting just 55% of adjusted EBITDA into FCF, below peers, but this should improve as deal-related integration costs abate and the company de-levers after a period of heavy M&A. Longer-term, management believes ~70-75% conversion is appropriate for its business.

Clarivate is improving the organic growth of its businesses via blocking & tacking and portfolio optimization: Information Services valuation multiples are correlated to organic growth, and this is one area where CLVT has lagged peers. Organic growth was just 3% from 2011-2015 while the business was owned by Thomson Reuters, as its parent company failed to integrate the businesses and allowed a large amount of technical debt to be accumulate. When the business was sold to Onex and Baring in 2016, the new owners set to work on modernizing systems and upgrading content, function, analytical tools, and user interfaces. Early on, most of the work was inward focused, with modernizing its tech stack and carving the business out of TRI’s systems the key priorities, and as a result organic growth was just 2% in 2018 and 2019.

Since the Churchill Capital reverse merger in 2019, CLVT shifted its focus towards growth and we see signs of improvement. Importantly, Churchill Capital provided the company with an experienced CEO in Jerre Stead, formerly the Chairman and CEO of IHS Markit during a 15 years period marked by exceptional share price performance. In addition, being publicly traded gave the company share capital to structurally improve the portfolio’s growth rate via M&A. Jerre wasted no time executing on the same playbook employed at IHS – optimize margins, invest in innovation, restructure go to market, and use M&A to improve the product offering.

At the time of the Churchill merger, CLVT believed it could reach 4-6% organic growth over time, but management has since upgraded its longer-term targets to 8-10% organic. The key drivers are as follows:

• Pricing supported by new product development: While owned by Thomson Reuters, new product development suffered from a lack of investment and an over-reliance on external contractors in R&D. The company also lacked the infrastructure to measure product usage and cross-pollinate data sets to generate incremental value-added analytics. As a result, pricing had historically been under-utilized despite many of the data sets being mission-critical and embedded into customer workflows.
  
  Since separating from TRI, Clarivate has developed the necessary infrastructure and dramatically lowered its reliance on outside contractors for development while investing 5-6% of sales in both capital expenditures and R&D. The result has been an acceleration in new product development that has allowed management to steadily increase pricing. Management implemented pricing of 2% in 2019, 3% in 2020, and expects to achieve pricing of 4%+ annually looking ahead. 

• Inside sales buildout driving cross-selling, better retention: Clarivate has a long tail of customers (~13,000 from its legacy operations accounting for 20% of revenue) that historically were inadequately served by a field sales organization, which lead to naturally higher attrition and a rightfully deserved reputation of being hard to do business with.

To better serve this customer base, management is in the process of building out an inside sales force and expects an improvement in customer satisfaction and cross-selling of complementary products. As customers that use 2 or more products tend to be far more ‘sticky,’ management believes this effort can improve retention from ~91% to ~94-95%.

• M&A: Since the SPAC transaction, CLVT has been very active, announcing 3 large deals that account for >60% of pro forma revenues, each of which are accretive to organic growth (we estimate ~7% organic growth for the acquired businesses).  The company has also enhanced its core portfolio by completing 5 tuck-in deals and divesting 2 businesses. The acquisitions naturally enhance the portfolio’s organic growth rate as deals anniversary while also providing cross-sell opportunities for both the core business and recent acquisitions.

M&A is highly synergistic and accretive: With >200 deals completed in his career including 124 deals while at IHS Markit, M&A is a core competency of their CEO. Unsurprisingly, since going public, Clarivate has been an active acquiror, completing 5 bolt-on deals (divesting 2 non-core businesses) as well as two transformational deals (DRG for $950mn in February 2020 and CPA Global for $6.8bn in October 2020) in addition to a third (ProQuest for $5.3bn that is expected to close in 4Q21) that has yet to close. 

We view this activity as a positive for several reasons: (1) accretion - Financially, acquisitions tend to be materially accretive with CLVT instituting a >10% EPS accretion hurdle rate in year one to proceed. (2) growth - The deals are accretive to organic growth – a key consideration for industry valuation multiples. The three large deals CLVT has announced are growing an estimated 7% organically vs. CLVT at ~+2% prior to 2021. Moreover, management noted that bolt-ons plus divesting non-core businesses added a ~1% to organic revenue growth; (3) synergies – Information Services deals have historically generated material revenue and cost synergies. Morgan Stanley noted that cost synergies in Information Services deals = ~17% of a target’s expense base while revenue synergies = ~18% of a target’s revenue base; and (4) competitive positioning – Deals can widen the gap vs. competition by adding additional capabilities in a market or providing a business with a new market opportunity entirely.

ProQuest deal checks all the boxes. CLVT’s pending acquisition of ProQuest for ~$5.3bn checks all the boxes above. Management expects it to be >10% accretive to earnings in 2022 and 15% accretive to 2023. There are meaningful cost synergy opportunities – CLVT is calling for ~$100mn or 16% of ProQuest expenses and it is worth noting that it’s recent acquisition of CPA Global is delivering 33% more savings than initially projected.

Moreover, the deal is extremely complementary and should result in material revenue synergies over time. ProQuest has content and software offerings geared towards academic libraries that are collectively growing mid-single digits plus organically, but the business is relatively under-penetrated in China where CLVT’s Web of Science offering holds a dominant market position. Moreover, ProQuest’s content competes against EBSCO, and EBSCO has historically done better in harder sciences. The combination of ProQuest and Web of Science has potential to improve ProQuest share in harder sciences.  

2023 outlook appears very attractive. On our numbers, pro forma CLVT could deliver upwards of $1.5bn in adjusted EBITDA even if organic growth for the business is below target at 5%, which would amount ~$1.1bn in FCF or ~$1.50 share (based on estimated 760mn shares outstanding).

** note that management is guiding for 6-8% organic revenue growth exiting 2021 and believes longer term organic growth is in the 8-10% range. Management is also guiding for 85% incremental margins vs. our 75%**

Valuation: At ~$22, CLVT is trading at ~15x our 2023 estimated FCF, which we believe to be conservative. This is a meaningful discount vs. information services peers that we suspect is due to (1) skepticism around its organic growth potential, and (2) heavier debt levels with the business at ~4.5x net leverage once the ProQuest deal is closed.

• Organic growth concerns: Our sense is that the business will show an improvement in organic growth as the higher growth deals anniversary into the numbers. We also think that the initiatives management is undertaking will be accretive over time. We are comfortable that CLVT can reach the group average of ~6% organic even if its longer-term target may prove ambitious.

• Debt levels: Information Services companies print cash flow and CLVT is no different. As the current acquisitions are integrated, deal-related costs should wind-down and cash flows will improve. This will allow CLVT to pay-down debt and de-lever. On our estimates, CLVT will be generate >$2bn in 2021-2023 FCF which it can use to bring leverage down close to 2x by the end of 2023.

As growth accelerates and debt levels come down, we see no reason the company can’t enjoy a multiple like the broader group. At 25x our 2023 FCF estimates, CLVT would be worth $38 (+78% vs. today’s levels). And beyond that, a 5% organic grower with 85% incrementals should be able to increase FCF at a double-digit clip organically, with M&A as a very real lever in addition.

Catalyst

-Reacceleration of organic growth

-Closing of ProQuest acquisition

-Upcoming analyst day and provision of 2022 guidance