Verisk: There are many positives, but the valuation is a bit high (NASDAQ:VRSK).

Information services companies

I am attracted by leading information service providers because of their long-term success driven by the secular rise in data demand and the large & expanding margins that are a result of the economic model’s operating leverage. The strong will be able to grow stronger due to their well-respected brand names and the economies that scale from their extensive distribution and wide coverage.

Verisk: A brief history and overview

Verisk (VRSK), which is a leader in data analytics and provides service customers in the insurance and energy & special markets (it recently announced that it was selling its financial assets), has these attractive characteristics of information companies. Verisk’s role as the trusted “hub”, for client data, is what makes it truly special.

The company was originally called ISO (Insurance Services Office), and was a non profit advisory and rating organization. It was created by an association of insurance companies who sent their data (e.g., claims, premiums, losses, etc.) to ISO. ISO would then combine, process and report the information to regulators, as required by law. The data would also be provided back to the insurers anonymously to enable them to determine their premium rates. This gave ISO a unique opportunity to access industry-wide information. It continues to do so today.

In the late 1990s ISO increased its insurance data assets by acquiring American Insurance Services Group, assets from National Insurance Crime Bureau and assets from American Insurance Services Group. These assets help to prevent fraudulent claims. It entered catastrophic modeling in 2002 with the acquisition by AIR Worldwide. In 2006, it expanded into the insurance claims industry with the acquisition by Xactware Solutions.

In 2009, ISO was renamed Verisk.

Verisk bought Wood Mackenzie Limited at a cost of $2.8 billion in 2016, to expand its reach into the global energy, natural resources, and power space. It also exited healthcare in 2016. Verisk also acquired Wood Mackenzie Limited for $2.8 billion in 2016 to expand into the global energy, power, and natural resources space. In 2016, it exited the healthcare segment.

The company also purchased Sequel in 2017, which offers an integrated suite software that allows for the management of all insurance and other reinsurance businesses. The acquisition also integrated the company into the workflows of its clients.

The company’s organic growth and acquisition strategy has made it a provider of rich data and analytical tools that can be used to assist clients in product development, strategy, capital allocation, underwriting, strategy and product development. Verisk allows clients to use state-of-the-art artificial intelligence and predictive analysis to access its unique dataset, public data, and client data. This allows clients to better price risk, reduce fraud and make better real time decisions.

Verisk plays a key role in helping the invisible hand of the market to maximize use of scarce resources and reduce wastage due to mis-allocation of risk. As with other top information services companies, the incremental cost of providing data Verisk already has to a client is virtually zero. The incremental gross profit on each additional unit is high, which results in extraordinary operating leverage.

Portfolio streamlining and management changes

Verisk announced on February 18, 2022 that Scott Stephenson, CEO, will be retiring after the 2022 Annual Meeting. Lee Shavel, the company’s CFO and group President of the energy & finance segments, was appointed CEO. Mark Anquillare, the COO of Verisk, will assume the role of Verisk’s Group President.

The company also announced the sale of its 3E compliance solution business to New Mountain Capital for up $950 million. This includes an upfront payment of $630million and an additional $320million if 3E or New Mountain reach certain earnings targets. The company also announced that Verisk’s financial service business was sold to Transunion (TRU), for $515 million. The proceeds of transactions amounting to 3.5-4% or less of the company’s total market cap will be returned to shareholders via share buybacks in the near future.

Verisk will become a company that focuses exclusively on insurance and energy markets after these divestments. Verisk also stated at the 4Q-2021 earnings call that it is currently studying the possibility of a spin-off its energy & specialty markets division. If this occurs, existing investors will still be able to hold two pure-play information services companies.

Insurance segment

Verisk provides data to its customers in insurance. It focuses on the prediction and pricing of loss, as well as compliance with reporting requirements in each state. It includes all 100 top US P&C (property & casualty) insurance companies among its clients.

The company has more than 22.9 million statistical records. These include approximately 9.9 Billion commercial lines records and around 13.0 Billion personal lines records. The company verifies the accuracy, reliability, and validity of these records. Verisk received around 3.1 billion individual records from insurance companies in 2020, including details about insurance premiums collected and losses incurred.

Verisk provides predictive analytics and statistical data that allow for better real-time pricing information to property and casualty insurers. This helps to ensure that premiums are set at a level that is appropriate for the risk. Incentives to those who are not in high-risk areas, such as beaches and factories in earthquake zones, to move to safer and more cost-effective locations encourages policyholders to pay higher premiums.

The company provides fraud-detection tools and claims processing for P&C insurance. This helps to increase the profitability of insurers as it lowers fraud and over-payments of claims that are eventually borne by other insured party in the form higher premiums and society in the form misallocated funds.

Segment Energy & Specialized Markets

The company is also a leader in data analytics for the natural resources value chain, which includes the global energy, chemicals and metals, mining, power and renewables, and power and other sectors. It has nine clients that include the top ten global energy producers.

The company provides better information to natural resource companies throughout the production and supply chains and in ESG (environmental. social. and governance) issues. It gathers and analyzes proprietary data on thousands of oil and natural gas assets, solar assets, wind turbines, and mines. Additionally, it provides detailed market assessments across each value chain. This helps firms increase profitability and reduce wastage.

Competitive moats for sticky clients

The company is a trusted party that insurers and others can access for detailed records of insurance transactions and production data. These data assets can be expensive to acquire and hard to duplicate.

The company’s revenues, which amount to about 85%, are subscription-based, with agreements that last between one and five year. This reduces the company’s financial volatility. The company survived the COVID-19 epidemic well. Both the insurance and energy segments continued to grow well through the downturn (see figure 5 below).

Resilience in times of inflation

Valueline wrote the following in its February 22, 2022 report:

[Verisk’s]Insurance products are more important during inflationary periods like today. Its real-time data collection allows customers to accurately price their policies to reflect changes in the environment. Insurers are at risk of underpricing or over-compensating their products, which could make them less competitive. We wouldn’t be surprised to see the management being more aggressive in pricing this year.

Similar to the inflation-related rise in commodity prices, energy and natural resource companies will likely increase their exploration, production and sales activities. This could lead to increased demand for their products.

Stock price

Verisk stock has been a solid five-bagger over the past decade (figure 1, red lines). It beat the S&P 500 index (green lines), but it was still a significant underperformer compared to other information services companies like Moody’s (MCO), and S&P Global(SPGI) (blue, orange lines).

Figure 1: Verisk’s stock prices compared to its information services peers

Revenue Growth

Overall growth

Verisk’s strategy to grow organically and through acquisitions is similar to its information service peers. The company’s revenues are smaller than those of its peers S&P Global (red line), Moody’s (green and orange lines) and IHS Markit(INFO) (blue, green, and blue lines). All four have fairly similar growth rates. However, Verisk (figure 3, blue line) appears to be more resilient than S&P Global or Moody’s (green- and orange-line) and the 2020 COVID-19 pandemic better than IHS Markit.

Figure 2: Actual TTM revenues

Figure 3: Actual TTM revenue, index to 2017-12-30

Segment Growth

Verisk’s insurance business is its largest and has been the main driver behind growth (figure 4: green line). It grew at an average annual rate of just under 9 percent over the past five years. It grew 9.9% in 2020-2021 based on price increases and acquisitions (or 7.3% when excluding acquisitions, dispositions and businesses held for purchase).

The revenues of the insurance sector are less than half that of the energy & specialty markets segment (blue). It grew at a rate of 8% per annum over the past five years, which is less than the insurance segment. The segment’s growth accelerated from 2018-2021. It was disappointing to see 2021’s growth stop (blue line). The core research subscriptions increased and the subscriptions for safety and environmental services increased. The growth in 2020-21 was mainly due.

Figure 4: Segment TTM revenues

Figure 5: Segment TTM revenues indexed to 2016-12-31.

Margins

Consolidated Margins

Verisk’s EBITDA margins have increased from 45% up to 49% (figure 6 red line) over ten years. Comparatively, the EBITDA margins at S&P Global and Moody’s have increased by almost 1000bps or twice as much as Verisk’s.

Figure 6: EBITDA margins at Verisk and peers

Note: In my calculations, I used actual EBITDA and NOT adjusted EBITDA.

Verisk has not displayed the operating leverage that I would have expected from its best-in-class peers (S&P Global, Moody’s), and its EBITDA growth is not as high as its revenue growth over 5 years (figure 7)

Figure 7: Verisk revenue growth vs EBITDA growth

Management at Verisk expects increased margins as it reduces its expenses by focusing on productivity, modernization of technology, and better utilization of employee talent. The company has moved away from its mainframe hardware and is now using the Amazon Web Services platformIt will be closing down its own datacenters as a matter of course. This is expected to improve its technological capabilities and lower costs.

Segment gross margins

One step further, the gross margins in the energy and specialty markets segment (figure 8. blue line) is over 1000 bps less than that of the insurance sector (green line). The gross margins for financial services, which are in the process to be sold to Transunion (orange line) is even lower.

Figure 8: Verisk segment gross margins

Segment EBITDA margins

Figure 9, blue line, shows that the EBITDA margin of energy & specialties segment is over 2000bps lower than that of insurance segment (green line). Despite the fact that the insurance segment’s EBITDA margin grew by 300bps over the past five years, Verisk’s overall EBITDA margin was down (red line). This was due to the flat margin in the energy & special markets and sharp contractions in the financial services segments.

The EBITDA margin for the insurance segment was 110 bps higher in 2020-21 due to an increase in compensation and hiring. This signals management’s confidence about the company’s future prospects. EBITDA in the energy and specialty markets segment also increased due to cost discipline, lower earnings, and lower travel expenses due to COVID.

Figure 9: Verisk segment EBITDA

Outlook

Verisk’s “cost of goods to be sold” is primarily composed of data and labor. Data is IP (intellectual Property) and therefore the incremental cost for each additional sale should be very low. This will result in high incremental EBITDA margins. Verisk will therefore be able to create new uses for its data that can be sold to customers. The Company has been hard at work to re-imagine the potential uses of its data that were central themes in several of its previous annual reports. It has created innovative solutions for clients, including software voice analysis to help life insurance companies detect tobacco use and price policies accordingly. Recently, the company acquired an exchange that allows auto insurers track customers’ driving habits.

I expect insurance revenues growth to continue at a steady pace in the future. However, it is unlikely to accelerate given the size and high penetration of its customer base. Management said that the SGA costs for the insurance segment rose in 2021 due to an increase in hiring and headcount. If management’s optimism holds true, the increased sales in 2022 would more than offset the higher salaries. This should lead to higher EBITDA.

The growth rate in the energy and specialized markets segment should increase, especially if commodities price inflationary incentivizes consumers to spend more. This segment is facing more competition from IHS Markit’s Natural Resources segment, Bloomberg (privately owned), News Corp (NWS), among others.

Valuation

Despite the market pullback, Verisk trades at a free flow yield of about 3%. This is higher than historical levels (figure 10), and its information service peers (S&P Global, Moody’s), which have higher EBITDA growth rates.

Figure 10: Verisk valuation

Figure 11: Verisk’s free cash flow valuation compared with peers

My concerns

(1) Verisk’s energy and specialized markets segment revenue isn’t growing as fast than expected. I am concerned that Verisk may lose market share to larger competitors due to the merger of IHS Markit’s business intelligence unit with S&P Global. This is a very serious concern for me because I am not a user of these products and have not been in a position to find positive reviews. It makes it difficult for me assess the relative merits each company’s offerings.

(2) High valuation: Despite the recent market pullback Verisk trades at a free flow yield of about 3%. This is higher than historical levels and its information service peers (S&P Global, Moody’s), which have higher EBITDA growth rates.

I believe Verisk’s high subscription revenue, wide moats and stability within its insurance segment may be mitigations that could justify its higher valuation.

(3) Cybersecurity threat – Verisk is trusted by clients to manage their highly confidential and sensitive data. Verisk is migrating its operations from company-owned, operated mainframes to Amazon Web Services cloud. This increases the “attack surface” of cybercriminals. Even though Verisk invests significant resources in security measures, clients could be skeptical about Verisk’s ability protect their data.

(4) The company doesn’t provide key performance indicators other than segment revenue and EBITDA increase, making it difficult to get a quantitative understanding of the “real life”, factors that drive the business.

In closing

I am attracted by the long-term growth potential and the expanding margins that are inherent in the business model. The strong will be made even stronger by their well-recognized brands and the economies created by scale.

These attractive traits are what Verisk has and it also has unusually large moats due to its position as the trusted “hub”, for clients’ proprietary information.

The company is likely be benefited by secular growth in data demand, inflationary conditions, and management’s renewed focus to the insurance and energy and specialized markets segments.

Although the market pullback has caused a decline in valuation, it remains high. I intend to keep my current position and increase it upon sharp pullbacks.