LumiNola
Investment action
I recommended a buy rating for Clarivate Plc (NYSE:CLVT) when I wrote about it the last time, as the business has turned its organic growth around to positive territory, and there are tailwinds that I expected would drive organic growth even higher. Based on my current outlook and analysis, I recommend a buy rating. While 4Q23 performance has disappointed my investors, I believe it was mainly due to the weak macrocycle that CLVT could not have done anything to make it better. If we look beneath the headline figures, parts of the CLVT business are actually improving, and management has put in place certain strategies that, I believe, will drive organic growth upward. Lastly, there is little expectation baked into the share price, such that even a modest improvement in valuation could yield attractive upside.
Review
CLVT 4Q23 revenue of $683.7 million represented 1.2% growth vs. 4Q22 y/y, coming in 20bps below the consensus estimate of 1.4%. On an organic basis, revenue grew 0.1% y/y, comprising subscription revenue growth of 2.6%, re-occurring revenue growth of 3.8%, and a transactional revenue decline of 8.3%. While revenue growth was lower than expected, margins did better than expected. EBITDA margins came in at 43.6%, beating consensus by 70bps. The better-than-expected EBITDA margin led, too, and EPS beat $0.23 vs. $0.21.
Given the disappointing share price action, I will start off with why I think the market dislikes CLVT’s recent performance and why I believe it remains an interesting buy. I think the obvious reason for the share price fall is that 4Q23 organic revenue growth decelerated from 1.7% y/y in 3Q to 0.1% in 4Q, which basically killed the thesis that organic growth has a turnaround and should continue accelerating. The deceleration was due to declining transactional revenue against an uncertain macro backdrop. Amidst macro headwinds, real-world data demand in LS&H decreased, trademark volumes in IP fell, and sales in the A&G books business fell, leading to an 8% y/y decline in transactional organic revenue in 4Q, which offset the acceleration of subscription and recurring organic revenue growth. The weak top-line performance led to an EBITDA margin contraction of 150 bps to 43.6% (although this beat expectations), and the FY24 guide points to 100 bps of additional margin contraction at the midpoint to 41.5% in 2024. Management also did not leave any room for investors to “hope for,” as they made the decision not to engage in additional cost cuts. Lastly, I believe investors got very disappointed with the fact that management pushed out its medium-term financial targets by one year and now effectively revised guidance downwards. They now expect organic revenue growth of 4-6% vs. an absolute 6% previously, EBITDA margins of >42% vs. the stated 43% prior, and EPS of ~$0.90, which is 10% lower than the $1 expected EPS previously, and all of these are expected to be achieved in FY26 instead of FY25 (1-year push out).
I believe these reasons are fair points that have some merit. However, it appears to me that the weak performance was more macro-driven than a structural weakness in demand. In fact, I think the operating data beneath the headline figures is quite encouraging. Subscription organic revenue growth actually accelerated to 2.6% y/y in 4Q from 1.3% in 3Q (full 130bps), while re-occurring revenue growth accelerated to 3.8% in 4Q from 0.5% in 3Q, pointing to incremental progress in the company’s organic revenue growth turnaround. Note that subscription and re-occurring revenue growth comprise 78% of total revenue, which is a massive portion of the business. In addition, management expects recurring and subscription revenue to continue growing in 2024. Although A&G’s book business saw lower revenue (caused more by macro headwinds than structural weakness), the A&G segment’s Web of Science product is seeing increased usage and renewal rates, a testament to management’s wise investments in the past. For the benefit of readers that did not follow CLVT, management previously made investments to include additional product enhancements centered on content aggregation and analytical tools, and I expect this to continue driving further A&G organic revenue growth acceleration in 2024.
On the weakness that LS&H is seeing, again, I believe a large part is actually due to the macro headwinds, which CLVT is at the mercy of. What I think investors should pay attention to is that management is refining its LS&H Real-World Data strategy, which is led by a new segment president. The plan is to transition from selling to competitors or data aggregators as a source of revenue to selling subscriptions instead. If executed properly, this makes a huge difference as it essentially reduces the macrocycle impact given that there is more visibility to demand, and it is a lot less volatile, both of which should improve the organic growth profile.
Management is also stepping up its efforts to restructure its product portfolio to remove non-core and growth-dilutive assets, which, I believe, should help elevate CLVT’s overall organic growth profile, pushing it closer to its medium-term organic revenue growth target. In particular, by 1Q24, they plan to sell off a small business in their IP segment that is making $30 million in revenue. They also intend to look for opportunities to divest similar-sized businesses in other segments.
Some investors would also point to the step-up in CAPEX spend of $20 million in 2024 (pushing total CAPEX to ~10% of revenue), and this would lower FCF in FY24. I argue that these investors are too shortsighted, as I see CAPEX as a vital component driving organic growth (investments are going into product innovation and generative AI efforts). Management plans to reduce debt by $400 million in 2024 and lower net leverage from 3.9x currently to ~3x by 2025, so there should be no incremental pressure on the balance sheet.
Valuation
Author’s work
Upon reviewing the latest performance, I believe CLVT can grow at 1% in FY24 and 3% in FY25. This is in contrast to my previous assumptions of 2% and 4%, respectively. The key reason for the downgrade is that the macro tailwinds have clearly impacted the business. However, I believe CLVT will be able to come in at the high end of its guidance as I expect: (1) a macro recovery in 2H24 (mainly due to the pending rate cut); (2) subscription and re-occurring revenue are actually accelerating and are expected to continue; (3) a continued uptake rate of the A&G Web of Science product; and (4) adjustments to the LS&H revenue model. That said, I do agree that FY24 margins are going to be lower because of the step-up in investments; hence, I lower margin expectations to 20.5% (management implied guidance). However, margins should recover in FY25 as revenue recovers.
Although valuation has come down to just 9x forward PE today, the beauty of this is that expectations are so low that even if we expect a modest improvement to 10x forward PE (as CLVT shows that growth can recover and accelerate), the upside is very attractive. If it sees more mean reversion, the upside could be higher.
Risk and final thoughts
CLVT has essentially reverted back to a ‘show-me’ story, and if CLVT continues to disappoint in organic growth, the stock is going to see more pressure as more investors step onto the sidelines and adopt a wait-and-see approach.
My recommendation is a buy rating for CLVT. While the recent quarter disappointed, I believe the weakness was largely macro-driven. Encouragingly, subscription and recurring revenue growth are accelerating, which forms a significant portion of the business. Management is also taking steps to improve organic growth through product portfolio restructuring and a strategic shift in the LS&H segment. With a low valuation and modest expectations baked in, even a slight improvement in growth could unlock significant upside potential for CLVT.
