We Initiate Clarivate (NYSE:CLVT) with a Neutral rating as we remain concerned about the company’s high leverage and preferred stock along with insufficient cash flows which would force them to refinance. The company’s growth had largely been through several large deals including Proquest, CPA, and DRG, however, organic growth had largely lagged behind the market growth rates. While the new management team refocuses on driving organic growth, we remain skeptical as a result of limited potential for margin expansion and challenging macro backdrop amid a softening outlook for IP as well as a potential slowdown in Life sciences going forward as a result of slowing approvals.
Clarivate is a leading information and analytics player with a focus on Academia and government, scientific research and IP, and Life Sciences end markets. The company serves about 50,000+ customers across more than 180 countries worldwide. It generates about half of its revenue from Academia and Government while Intellectual Property contributes about a third of revenue with life sciences contributing the rest. In addition, it has a diversified revenue base geographically with about 55% of revenues generated from Americas while EMEA and APAC contribute about 26% and 19% respectively.
CLVT has primarily grown via acquisitions with revenues growing at a CAGR of 29.3% during the 2018-2022 period. It has a successful track record of acquisitions which has been margin accretive as a result of focused acquisitions as well as significant cost synergies realized which enabled the EBITDA margins to jump by over 12 percentage points during the period. However, Adj. EPS grew at just 10% CAGR primarily due to higher leverage to fund the acquisitive growth.
In addition, organic growth across its end markets has been lagging the market since the pandemic which points to the continued challenges for the company in growing organically. During FY20-22 period, the organic growth rate for CLVT has just been ~3% compared to about 6% market growth rate which demonstrates significant underperformance compared to market.
Management noted that research and analytics function within academia and government, patent and trademark intelligence within IP, and commercialization solutions within Life sciences and healthcare had largely been the underperforming categories.
In Line Q3 Results
CLVT reported an in line Q3 results with revenues up 1.8% driven by a 1.7% organic growth along with favorable Fx, slightly ahead of the consensus estimates. Academia and Government segment reported a 3.4% growth driven by continued momentum in its content aggregation category which had been a key growth driver for the segment. Life Sciences and Health segment reported a 1.7% growth driven by an increase in FDA approvals through the year compared to last year. In 2022, the total number of drugs approved was 37 while total drugs approved till YTD October were 46 which aided in driving positive organic growth.
IP segment declined 0.9% which continues to be challenged by macro pressures as well as the ongoing strike of US Actors strike. Adj. EBITDA margins expanded by 80 bps YoY to 43.5% on the back of operating efficiencies driving higher profit conversion and carryover cost synergies from ProQuest acquisition partially offset by divestiture of its MarkMonitor business. The company reported a non-GAAP EPS of $0.21, ahead of the consensus estimates at $0.18.
The company reiterated its full year guidance expecting revenue of $2.63 bn with Adj. EBITDA of $1.12 bn and an EPS of $0.80. This implies a flat EPS of $0.21 in Q4 2023 vs $0.22 last year despite a slight beat in Q3 reflecting a weak follow through. USPTO delayed its large contract and is now expected in Q1 2024 which continues to be an overhang. Estimates have consistently declined as a result of tepid operational performance and slowing organic growth dragged by its IP segment.
We believe the company is likely to post about 1.5% organic growth in 2024 as the pricing benefit wanes driven by strength in academia and government segment within its content aggregation category and timing benefits of USPTO order partially offset by decline in life sciences segment due to potential lower approvals in 2024 on YoY basis. We further expect EBITDA margins to plateau at 42% as the company realized the full benefits from cost synergies arising from the acquisition and an implied EPS of $0.85, up 6% YoY due to slightly lower interest expenses as a result of partial prepayment of term loan expected in Q4 2023.
Stretched Balance Sheet
The company has a debt outstanding of about $4.9 bn with total cash in hand of ~$400 mn implying a significantly higher net leverage ratio of 4.7x. In addition, the company has a 5.25% preferred stock worth $1.4 bn. The company has historically a capex to revenue of 6% – 9% with 2023 projected capex to be ~9% of revenues.
The company does not have any near-term maturities with debt repayments worth $3.2 bn (including $2.5 bn term loan and $0.7 bn in senior notes) scheduled in 2026. While the company is preparing to prepay term loan of $300 mn, it would still have a debt outstanding liability of $2.9 bn by the end of 2026. Assuming an organic growth of 1.5% and stable EBITDA margins of 42%, the company is unlikely to drive higher cash generation to make scheduled debt repayment by 2026, even considering the existing cash balance. Even in the most aggressive assumptions, the company is unlikely to generate sufficient cash which would necessitate refinancing, likely at unfavorable terms.
Clarivate trades at 9.4x EV/ EBITDA which appears to be at the bottom quartile compared to its peers and at a discount to the peer average of 13.2x. The company also trades at a significant discount compared to its long-term average where the growth had largely been through transformative acquisitions. We believe the stretched balance sheet provides little flexibility of any meaningful acquisition to drive growth with the company’s focus back on driving organic growth under the new management in an otherwise challenged macroeconomic backdrop that has historically lagged market growth rates. We believe the discount is warranted as a result of significant leverage and debt overhang and the expectations of continued capex and investments to drive growth. We remain on the sidelines and Initiate at Neutral and await any tangible progress on the organic growth.
Risks to Rating
Risks to rating include
1) Its inability to drive higher organic growth which had historically lagged market growth rates
2) Slower approval process by the US FDA which can lead to further weakness in its Life sciences and Health segment
3) Its acquisitive model could be prone to execution risks which could lead to a significant impact on its operations
4) Upside risks include R&D spends by academia, government and healthcare is relatively less sensitive to macro which could have strong tailwinds, cost initiatives to drive margin expansion and share repurchases
CLVT has engaged in a number of transformation deals in order to boost revenue growth and drive higher margins, however, it has consistently lagged market growth rate. The newly seated executive management team is tasked with integrating the acquisitions and driving organic growth and cash generation amidst a challenging backdrop. While the valuation looks attractive on paper, a highly leveraged balance sheet and limited visibility on organic growth keep us on the sidelines. Initiate at Neutral.