Broadridge Financial Solutions, LLC (BR)

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In FY 2008, Broadridge had net earnings of $192 million on $2.3 billion in sales.^[1] The company enters into long-term contracts with firms to provide outsourcing services. This strategy leads to significant customer concentration, as Broadridge’s top five clients accounted for 22% of FY 2008 revenue.^[2] Additional revenue comes from securities transactions, which accounted for 23% of 2008 revenues.^[3] This segment experienced a decline in earnings of $11 million year-over-year.^[4]

The decline in trading volumes and the reduction in market liquidity associated with the current financial crisis threatens Broadridge’s earnings. Moreover, as the company serves eight of the top 10 broker-dealers, ^[5] further consolidation in financial services poses a significant threat. However, Broadridge stands to benefit from the increased regulation brought on by recent government intervention in the financial markets.

[edit] Business Overview

Broadridge offers a complete portfolio of outsourcing services to the financial services industry. These solutions include investor communications such as proxy mailing and vote processing, automated security processing, and transaction services. The company’s clients include broker dealers (companies that trade securities for clients and internal profit), mutual funds, institutional investors, trading companies, and annuity companies. During the fiscal year ending June 30, 2008, the company operated in more than 50 countries and distributed more than one billion investor communications ^[6].

[edit] Spinoff

Until March 29, 2007, Broadridge formed the Brokerage Services division of ADP, a company that specializes in payroll processing. By spinning of Broadridge, ADP chose to focus on its core market and increase shareholder returns by saddling Broadridge with more than $600 million in debt^[7]. Despite the debt burden, Broadridge stands to benefit from the new arrangement. As a separate company, management has greater flexibility to allocate resources more effectively. Consequently, management has focused on shareholder returns by decreasing the company’s debt and increasing the dividend ratio. Broadridge decreased long-term debt from $617 million to $447.9 million and short-term borrowing from $109.2 million in $0 from FY 2007 to FY 2008.^[8] In addition, dividends paid have increased by $33.4 million, or four cents a share, in the same period. ^[9]

[edit] Business and Financial Metrics

Source: Broadridge 2008 10-K ^[10]

Source: Broadridge 2008 10-K^[11], 2007 Annual Report ^[12]

Broadridge grew revenues by 11% in FY 2007 and 3% in FY 2008.^[16] Yet, net income actually shrank nearly 2.5% in 2008, leading to a decline in diluted EPS of six cents, year-over-year.^[17] The firm contracts on a yearly basis, leading to stable revenue and profit growth. In particular, the investor communications segment has maintained healthy growth of 13% and 10% in FY 2008 and 2007 respectively.^[18] These solid results have offset weakness in securities processing, the segment most exposed to trading volumes, and declines in “other” income.

The company has decreased its reliance upon debt to finance operations. In 2008, assets grew by 6%, from $2.7 billion to $2.8 billion.^[19] Over the same period, liabilities shrank 3% from $2.1 billion to $2.0 billion.^[20] Thus, shareholder’s equity, the assets that shareholder’s control, increased by $215 million dollars^[21]. Similarly, the company’s cash balance grew $110 million.^[22]

Since Broadridge generates a majority of its revenues in the United States, the company’s ability to earn $6.1 million in foreign exchange despite the dollar’s weakness stands out.^[23] This net gain comes after two years of $6 million losses in exchange income.^[24] In addition, the company’s geographically concentrated revenue base presents a problem for the near future. While Broadridge services equity markets in more than 50 countries, it generates little income in a majority of these nations. Further geographic diversification would protect the company from sustained downturns in its main markets.

Despite this weakness, Broadridge’s growth in continuing operations (a company’s recurring stream of income) has been consistently positive. From 2003-2008, the company has a 7% CAGR (Compound Annual Growth Rate, the rate by which continuing operations has grown each year, on average) in this category.^[25]

[edit] Business Segments

[edit] Investor Communication Solutions - 71% of revenues ^[26]

The Investor Communications Segment processes and distributes proxy materials, documents mandated by the SEC to inform shareholders about important events, to equity owners and mutual funds. These materials are provided in both electronic and paper formats. In addition, Broadridge supplies other regulatory documents, including tax information and important event disclosure documents, as well as account statements and trade records.

Due to the necessity and consistent flow of these documents, this segment provides consistent returns. During market downturns, companies file reorganization documents, implement institutional changes, and come under increased scrutiny from regulatory agencies. All of these factors positively impact the Investor Communications segment.

In FY 2008, Investor Communications had net earnings from continuing operations before taxes of $253.3 million on revenues of $1.58 billion.^[27] Thus, this segment had an operating margin of 16.1%.

[edit] Securities Processing Solutions – 23% of revenues ^[28]

The Securities Processing segment lets financial service companies to record, manage, and archive the trading of stocks, options, mutual funds, and fixed income securities. Accordingly, segment revenues and profits are highly correlated with market volume. In recessionary environments, increased uncertainty leads to volume decreases. Thus, the Securities Processing segment saw a decrease in earnings from continuing operations before income taxes in FY 2008. Earnings totaled $137.5 million (compared to $148.4 last year) on revenues of $514.4 million.^[29] This led to an operating margin of 26.7%.

[edit] Clearing and Outsourcing Solutions – 4% of revenues ^[30]

The Clearing and Outsourcing segment organizes the purchasing of securities by arranging buyers and sellers, processing the transaction, and recording the results. These transactions are carried out on either a cash or a margin basis. In a simple cash transaction, Broadridge executes a trade between the buyer and seller of a security. In a margin transaction, the company offers credit to clients for a specified percentage of the purchase price, charging a rate of interest on the credit extended. Consequently, Broadridge assumes significantly more risk executing margin trades. While the borrowing firm must have sufficient collateral, or other securities that Broadridge will assume ownership of in case of default, the recent failure of lending institutions illustrates the real risk involved in these transactions. Due to these failures, firms have significantly decreased lending practices.

In FY 2008, the company earned $-5.0 million on sales of $95.8 million.^[31] This compares favorable to a loss of $-11.9 million a year ago.^[32]

[edit] Key Trends & Forces

[edit] Further consolidation in the financial services industry threatens to further diminish Broadridge's core customer base

In FY 2008, Broadridge earned 22% ^[33] of its revenues from five clients. The largest single account produced 5-6% ^[34] of total revenues. Moreover, the company services eight of the top 10 broker dealers, the companies most affected by the current financial crisis. The failure of Lehman Brothers, a confirmed Broadridge client ^[35] , demonstrates the company’s exposure to continued consolidation in financial services. Despite the risk of losing large accounts, Broadridge has the potential to benefit from consolidation. For example, Barclays, a confirmed customer ^[36], could potentially acquire another bank that is not a client. If Barclays retains Broadridge’s services, BR would effectively gain an additional customer.

[edit] Broadridge stands to benefit from increased regulatory scrutiny in the era of government bailouts

As an outsourcing company for the financial services industry, Broadridge deals heavily with regulatory agencies. These agencies dictate the necessary documents, such as proxy materials and notifications of important events, that a publicly trade company must disclose. Since Broadridge handles these documents, the company’s revenues can be significantly altered by fluctuations in regulatory demands.

With the passage of a $700 billion bailout of financial services on October 3rd, 2008, the US government has assumed a new importance in the financial markets. Moreover, European governments seem to be following suit, as the British passed a $250 billion bailout on October 8th, 2008. In the past, increased government involvement has led to greater regulation. For example, after the accounting scandals in 2002 involving Enron and Tyco, the government intervened by way of the Sarbanes-Oxley Act. The Act significantly increased regulatory disclosures and compliance costs for public companies. Broadridge stands to gain from the additional documentation and regulatory demands implemented by government agencies. However, should regulatory demands become a burdensome cost to public companies, Broadridge could suffer for two main reasons: increased entry into the outsourcing business and companies’ attempts to actually perform these duties for themselves.

[edit] Broadridge faces a decline in revenues due to decreases in trading volume and low market liquidty

All three of Broadridge’s segments generate transaction processing fees. In addition, interest earned from margin lending also generates substantial revenue. These revenue sources depend heavily on trading volume, average market prices, and the liquidity of the financial markets. Currently, increased anxiety has led to lower trading volumes, share prices have plummeted, and liquidity is drained from the market. These features are the hallmarks of a recession.

A recession impacts Broadridge in the following ways:

• Reduced one-time revenues from mergers and acquisitions, investor communications, and mutual fund disclosures
• Less margin lending
• Lower trading activity and processing fees
• Increased litigation claims due to failure of buyers and sellers to fulfill contracts
• Fewer security purchases

[edit] Competition

Broadridge operates in a stable, but competitive industry. The company competes against other outsourcing firms as well as client’s in-house capacities. Despite the presence of well-entrenched competition, barriers to entry remain formidable. First, new entrants lack the skill and experience necessary to deal with complex requirements of regulatory agencies. Second, outsourcing firms provide sensitive information and services. Due to the importance of these products, firms need a long record of trusted service. This leads to lengthy relationships between firms and clients. The following firms compete with Broadridge:

[edit] DST Systems ^[37]

DST competes with Broadridge in information processing and computer software services. DST also provides statement and billing solutions, similar to Broadridge’s investor communications segment. In FY 2007, DST earned $1.7 billion in revenue and $874 million in net income.

[edit] State Street ^[38]

State Street offers investment operations outsourcing, recordkeeping, and transfer agency services that directly compete with Broadridge. In FY 2007, State Street earned $8.3 billion in revenue and $1.3 billion in net income.

[edit] Fiserv ^[39]

Fiserv also competes in the processing of financial transactions. In FY 2007, Fiserv earned $2.7 billion in revenue and $439 million in net income.

[edit] Fidelity National Information Services^[40]

FIS and Broadridge compete in the financial institution processing and outsourcing market. In FY 2007, FIS earned $4.8 billion in revenue and $561 million in net income.

[edit] References

1. ↑ Broadridge 10-K
2. ↑ Broadridge 10-K
3. ↑ Broadridge 10-K
4. ↑ Broadridge 10-K
5. ↑ Broadridge 10-K
6. ↑ Broadridge 10-K
7. ↑ Broadridge 10-K
8. ↑ Broadridge 10-K
9. ↑ Broadridge 10-K
10. ↑ Broadridge 10-K
11. ↑ Broadridge 10-K
12. ↑ Broadridge 2007 Annual Report
13. ↑ Broadridge 10-K Broadridge 2007 10-K
14. ↑ Broadridge 10-K Broadridge 2007 10-K
15. ↑ Broadridge 10-K Broadridge 2007 10-K
16. ↑ Broadridge 10-K
17. ↑ Broadridge 10-K
18. ↑ Broadridge 10-K
19. ↑ Broadridge 10-K
20. ↑ Broadridge 10-K
21. ↑ Broadridge 10-K
22. ↑ Broadridge 10-K
23. ↑ Broadridge 10-K
24. ↑ Broadridge 10-K
25. ↑ Broadridge 10-K
26. ↑ Broadridge 10-K
27. ↑ Broadridge 10-K
28. ↑ Broadridge 10-K
29. ↑ Broadridge 10-K
30. ↑ Broadridge 10-K
31. ↑ Broadridge 10-K
32. ↑ Broadridge 10-K
33. ↑ Broadridge 10-K
34. ↑ Broadridge 10-K
35. ↑ Barclays and Lehman client confirmation
36. ↑ Barclays and Lehman client confirmation
37. ↑ DST 2007 10-K
38. ↑ State Street 2007 10-K
39. ↑ Fiserv 2007 10-K
40. ↑ FIS 2007 10-K
41. ↑ DST 2007 10-K
42. ↑ State Street 2007 10-K
43. ↑ Fiserv 2007 10-K
44. ↑ FIS 2007 10-K
45. ↑ Broadridge 2007 Annual Report