London Stock Exchange Group: Worries About ASV Slowdown Not An Issue (OTCMKTS:LNSTY)

Overview

My recommendation for London Stock Exchange Group (OTCPK:LNSTY) stock is a buy rating, as I am not worried about the potential annual subscription value slowdown [ASV]. Instead, I remain bullish about the group’s fundamental performance, especially in the data and analytics segment. Note that I previously gave a buy rating to LNSTY due to my positive take on the acquisition of Refinitiv, as it made strategic sense, propelling LNSTY forward.

Recent results & updates

LNSTY 2Q23 revenues of GBP2.06 billion were in line with expectations. Data & Analytics has maintained its strong performance, with segment revenues increasing from GBP1.2 billion to GBP1.31 billion. This upward trend can be attributed to the segment’s increased momentum as a result of its higher rate of new mandate wins. Specifically, the segment’s deal size keeps growing as enterprise agreements expand, increasing LSEG’s wallet share with major customers. The growth of post-trade services also contributed, growing by 23% in 2Q23. Although revenue growth was steady in 1H23, EBITDA margin was 46.9%, 110 bps below the consensus estimate of 48.0%. I suspect this might have spooked some investors into selling after the results were released. However, upon adjusting for one-off non-cash items, the EBITDA margin is closer to 47.7%, which is in line with consensus expectations.

In sum, I am pleased with the outcome and continue to have a positive outlook for the company. For 2Q23, I believe the company’s ASV growth is the primary point of debate. Some investors are concerned that the 6.9% ASV growth seen in 2Q23 (a decrease of 70 basis points from 1Q23) will persist through the rest of the year. I would advise against linear extrapolation, however, because the acceleration in ASV growth seen in previous quarters was driven by positive retention patterns. While the incorporation of contracted sales had a greater effect on the company in 2Q23, when LSEG is replacing another vendor, this latter process can take up to nine months. Hence, I expect a shift in this pattern during the latter half of 2023. Management has explicitly stated that they are not encountering the prolonged sales cycles that have affected rival companies in recent quarters. Instead, they are witnessing encouraging developments, including the growth in average deal size and higher success rates in securing mandates.

In general, I believe LNSTY will continue its expansion, especially in the data and analytics segment and the enterprise data sub-category, which grew by 9.9 percent in constant currency terms. Successful cross-selling to FTSE Russell clients, strong real-time data trends, integrating the MayStreet acquisition, and ongoing investments in expanding its offerings and distribution channels are all contributing factors to this growth.

As the need for data to satisfy regulations and fuel advancements in AI grows, I anticipate sustained growth. Also, LNSTY has introduced its Design Partner Program, which facilitates joint demonstrations of new features and designs between LNSTY and Microsoft (MSFT) for the benefit of LNSTY’s major customers. With more high-quality customer feedback, LNSTY’s R&D capabilities and plans should advance rapidly. Management stresses the significance of the close partnership between the LNSTY and MSFT teams in their efforts to use AI to boost customer productivity and gain deeper insights through AI-driven proprietary analytics.

Valuation and risk

According to my model, LNSTY is valued at GBP9184 (pence) in FY24, representing a 12% increase. This target price is based on a rather conservative growth assumption, anchored against consensus FY23 estimates. My model aims to show that 5% top-line growth, coupled with minor margin expansion, is sufficient to give a decent upside over the next year. There might be debate surrounding the 23x forward PE that I used, but I have compared it against other players in the industry globally. These peers trade at a median of 20x forward PE and have grown much slower than LNSTY in general. As such, LNSTY deserves to trade at a premium, in my opinion.

Summary

I maintain a strong buy rating for LNSTY with confidence in its fundamental performance, particularly in the data and analytics sector. 2Q23 revenues met expectations, with Data & Analytics segment revenues showing strength due to increased mandate wins and expanding deal sizes. Although EBITDA margin initially raised questions, adjusting for one-off non-cash items reveals alignment with consensus expectations. ASV growth in 2Q23 has sparked debates, but linear extrapolation is cautioned against. Management’s affirmation of shorter sales cycles and the growth in average deal size instills optimism. Overall, LNSTY’s prospects appear promising, driven by data and analytics expansion, sustained growth in enterprise data, and the strategic partnership with Microsoft.

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