Broadridge Financial Solutions, Inc. (BR) Earnings Call Transcript & Summary

Welcome back to Evercore ISI's Payments and Fintech Innovators Forum. I'm David Togut. I research the payments and processor stock at Evercore ISI. Delighted to introduce Edmund Reese, Chief Financial Officer of Broadridge Financial. Edmund, thanks so much for being with us here today.

Thank you, David. Thanks for having me.

So we're pretty close on the heels of your recent Triennial Investor Day, so I'd like to start there.

David, before we jump into the questions, can I just take a moment to give a brief description of who we are and what we do and provide a quick overview of our model? And then I'd love to jump into the questions, if that's okay with you.

Please.

So thank you. And Broadridge is a $17 billion market cap global fintech leader. We provide solutions for mission-critical but nondifferentiating functions across the financial services industry. We leverage our next-gen technology to position us as a key business transformation partner within financial services. And our goal is to make our clients stronger. And through them, we enable better financial lives for millions of investors around the world. We'll talk a little bit about what, David, our 2 strong and growing franchise businesses in governance and in capital markets. And you'll hear about us building our third pillar in wealth and investment management. We're a scale business. We clear over 2/3 of fixed income trades, $10 trillion equity in fixed income trades per day. In our proxy business, we cover 80 -- over 80% of U.S. companies' shares, and we deliver over 6 billion critical communications annually. We're in a growth industry. Currently, banks are spending over $190 billion on tech in operations. And when you look at Broadridge's solutions, our addressable market is about $46 billion and compare that to the $3 billion of recurring revenue that we have, and you see that there's a strong opportunity ahead of us. Our underlying business really sits on the back of a simple financial model that has steady and consistent earnings per share growth. The foundation of our model is sustainable recurring revenue growth that benefits from underlying volume trends, from new sales, from high revenue retention from our existing clients. The second key component of our business model is our consistent investment, and I've talked a lot about that in Q2. The company has been committed to investing for the long term. That helps us move from a service provider into an equally trusted innovation partner because we invest in our new platforms, in our new products and in our people, such as sales force and technology teams across the globe. And then finally, the margin expansion, we have a long track record of expanding margins since 2017. I showed at Investor Day that our average margin has expanded over 80 basis points, well above our 3-year objectives. And finally, David, I would say, a strong free cash flow model that allows us to be able to execute on the balanced capital allocation plan, investing in our business, staying committed to a growing dividend and repurchasing shares, all of that while maintaining an investment-grade credit rating. I'm excited about the next 3 years. Our model suggests that our objectives will be 5% to 7% organic recurring revenue growth, and I know we'll talk a little bit about that; 7% to 9% recurring revenue growth; 50 basis points of margin expansion; and 8% to 12% adjusted EPS growth. And we're off to a strong start when I think about the second and first quarter, where recurring revenue in the second quarter increased 7%, and we're seeing double-digit gains across our different businesses. So healthy trends to help support our business, and I think that puts Broadridge on the track to deliver on our growth algorithm. We've seen recurring revenues double since 2014, now up to $3 billion. We've consistently grown the top line. We've reinvested for growth, invested in our platforms and new innovation. That's enabled us to generate consistent double-digit EPS growth and top quartile total shareholder returns. So I look ahead and I think we remain well positioned to continue to deliver on that financial model and hopefully top quarter returns over any multiyear period for a long time to come. So David, thank you for just giving me a quick opportunity to give an overview there. I'm happy to jump into your questions.

Great. Edmund, I appreciate that. Starting with the new 3-year guidance that you've laid out and which you discussed at Investor Day, what do you see as the major tailwinds driving your growth in your 3 major franchises: investor communication solutions, GTO and wealth? And conversely, what are the largest headwinds that present a risk to your guidance?

Yes. So I mean, I just talked a little bit about the strong financial model. That model benefits from, no doubt, tailwinds in investing volumes that drive position growth in our ICS business and volumes that drive trading growth in our GTO business that you saw over the past couple of quarters, in both components of our business, that's a benefit, a tailwind for us. We continue to have strong sales that create a backlog of revenue for us and help drive the growth that I mentioned earlier. I mentioned during Investor Day that we have a revenue backlog, the next 12 months of revenue. That's 12% of our recurring revenue. And event-driven revenue has continued to perform well as funds have had organizational activity and help drive that growth there as well. And we continue to take advantage of scale in our business. So margin expansion, long track record of that. I think that is something that we continue to see come through and give us opportunity to be able to invest and deliver on our guidance. Stepping back a little bit, David, though, thinking from a macro level, this environment has accelerated the trends that were happening pre-COVID. Companies' plans to increase their investments in interactive digital technologies has only continued in this environment. And you see the way that we're interacting today, investors and companies are also interacting. So you've seen us benefit from growth in our virtual shareholder meetings in our issuer business. You've seen the way that companies want to communicate across multichannels increase. That's a tailwind in our customer communications business, where digital has been growing in the high teens. And obviously, the democratization of investments gives us an additional boost as more retail investors come into the market. Finally, I'd say, David, in terms of headwinds you asked about, there's always volatility in the market, so a portion of these growth may not be as stable as other components. We'll continue to look at that. A small part of our business is also -- in our data solutions business, we custody assets that are impacted by interest rates, a small component of our business. That should dissipate as we move forward into the next 3 years. And obviously, event-driven revenue, that's 4% of our business, but it is more cyclical and a little harder to predict. So that's what I'd say from a tailwind/headwind standpoint.

Yes, on your recent December 2020 earnings call, you guided to the higher end of your fiscal '21 ranges. It's 3% to 6% recurring revenue growth and 6% to 10% adjusted EPS growth, and the December quarter clearly was well above those ranges. What are the factors that might be keeping you more conservative in your outlook, especially given the 24% stock record growth and the 24% trade revenue growth in the December quarter?

Good question. I mean, undoubtedly, we have had a strong Q1 and strong Q2. I think those results that we've seen there emphasize the resiliency of this business and the strength of the financial model that I was just referencing. And yes, you're right, the stock record growth has been strong and above historical levels. It was 11% in Q4, our heaviest quarter last year. But this year, Q1 and Q2 is when you saw what I would say are deceptively large growth percentages, 16% in Q1 and 24% in Q2. And I sort of frame it that way because Q2, as you know, has historically been 10% of our full year volumes, and that 24% that you saw in Q2 is impacted by a few large issuers. We sample our clients' stock record position, so we have strong insight into the near term. And I've said -- in Q2, we said that we expect low double-digit growth for the rest of our fiscal year '21, in line with the growth that you saw in Q4, our heaviest quarter last year, so in line with that quarter. Beyond that, I would say the equity trading volumes are coming off of record levels last spring. You all know it was 28% January to March and 27% in April through December. So growth on top of that, I think, will be challenging. It's important to point out, though, David, that we have a very balanced business, not simply driven by position growth and trading volumes once you think about our wealth management business, once you think about our issuer solutions, customer communications, and data-driven business as well. So while we've seen these percentages, it's important to note that they're on a smaller portion of our year and that we have a very balanced business across all of that. All of that said, I focus on our annual results and our 3-year objectives, and we feel really good about what we are able to accomplish and moving to the higher end of our guidance for fiscal year '21 and, more importantly, our ability to be able to invest for longer-term growth gives us great confidence going into '22 and '23.

Got it. Also in your updated 2021 guidance, you reduced your operating margin expansion target to 50 basis points from 100, and you called out your focus on making additional investments. And in particular, you highlighted the upcoming launch of your new AI-enabled fixed income trading platform, LTX. How big is the TAM for LTX? And when might it be material to Broadridge's revenue and earnings?

Yes. I mean, our initial focus with that on LTX is on the U.S. corporate bond market, and there's a large market with $10 trillion of outstanding debt. Of that $10 trillion, about $30 billion to $40 billion gets traded each day, and the amount that gets traded electronically is even smaller. Only about 70% of that -- or I should say, 70% of that is done on legacy channels, like voice or messaging. So LTX is our fixed income trading platform, and we believe that the future of FI is in AI given the millions of CUSIPs out there and also on digital platforms. And today, you think, currently, trades are larger size, they're executed manually, and they allow for a single buyer. LTX uses the AI to locate the right counterparty. And given that we have post-trade processing for 19 of 24 primary fixed income buyers or 2/3 of the industry post-trade processing on our platform, I think we're in a good position to use that data with this AI technology. That platform allows us to trade with more buyers, allows the trade to happen with more buyers and allows for price improvement. So we've had a soft launch. Trades have been executed. We talked about 10 dealers and 35 buy-side clients already on the platform already trading. I think the next time line and milestone is to continue to do some development on the platform, bring on some of the larger players and have some liquidity on the platform. If we see success there, I think it could be a tailwind to our '22 financials. So David, that's a little bit about the opportunity for us and where we are with that launch.

Yes. Also for 2022, you have the onboarding of your large wealth management technology contract with UBS.

Yes.

How long will it take for UBS revenue to reach its full run rate of approximately $70 million annually, by my estimate?

Yes. I mean, I think the key point in your estimates, I think, are largely a range with the run rate revenues that we expect there. I think the key point is that the development is going well from our perspective, from UBS' perspective. I'll let them deal with the launch and when we start to see the revenues come on. It's important, whether it's 6 months from now or 12 months from now, that -- it's a multiyear contract, so the important focus for us is completing that development and getting up and running multiyear contracts. So we'll start to see a pickup as we go into fiscal year '22 from that revenue.

Just building upon that, how do you see the TAM developing for Broadridge once you have the UBS contract up and running in terms of what are the other large wealth managers out there that you might pursue? And kind of what are the greatest technology needs relative to what their internal technology is today?

Yes. I mean, the short answer is that client #2 could be an existing client, and I think it is possible to see them on the platform within the next 12 months. New clients, I think, will be faster than the time period that we spent to develop the platform and bring UBS onboard, faster and with less investment, but I think it's still sort of multiyear. That's the short answer. I think we, as part of this build-out, are focused on the top 20 broker-dealers as prospects. Half of them have proprietary solutions where, I would say the systems are aging, and the other half stitch together an array of third-party point solutions. We're building an ecosystem where Broadridge provides a container, and on top of that allows for API connections. So applications from Broadridge, third-party solutions that we are able to integrate into the platform and assets from the proprietary bank themselves that they think put them in a competitive position, that's the advantage. And that's what I think UBS looks at when they think about us building this platform. There are components of that are live and in production today. Our cloud-based billing service has gone live, and you saw UBS talk about that recently. And we feel good about the prospects of bringing on additional clients as we move forward here.

When you look at the opportunity with top 20 broker-dealers, many of them clearly are also in-house on equity and fixed income trade processing. How do you think about the go-to-market strategy for Broadridge, both with trade processing and wealth in terms of addressing the opportunity with the biggest broker-dealers?

Yes, I mean, a large chunk -- look, first, our go-to-market strategy has been quite stable over the past couple of years. We've been growing closed sales at 11% over the last 6 years. That's a strong balance between our governance franchise and our capital markets franchise. And if you think about what's happening there, it is us going to market with existing clients and expanding them into multiple asset classes. If you think about our post-trade processing system across -- these are global companies in many cases, so across different geographies where we can help simplify their technology, drive down cost, drive down risk. And with wealth solutions that are across not just the back office where we've historically played, but with this build out across the front and middle office, acquiring and engaging customers, on-boarding customers, compensation management, et cetera. So I think this land-and-expand approach that we have to our closed sales with existing clients across capital market products, post-trade processing as well as wealth management is an opportunity for us. And I would say, we're already in discussion with many of these top brokers that we just discussed.

What do some of the sales cycles look like on some of these larger prospects?

Yes, I mean, on the larger ones, it -- first, I would back up and say that our sales has been -- a large chunk of it has been -- I'd say, 2/3 of it has been on some of the smaller type products. But these larger sales that we're talking about, I think you can think a year, 1.5 years-type cycle to be able to bring them on board.

What's your most recent gauge of the impact on Broadridge's revenue and earnings from Morgan Stanley's acquisition of E*TRADE since both are clients of Broadridge clearly on proxy and then E*TRADE also on trade processing? And how can we think about potential outcomes for Broadridge?

Yes. Maybe even stepping -- I'll answer the question specifically on Morgan Stanley and E*TRADE, but let's just step back for a moment and talk about consolidations in general and break it up between our 2 businesses. When -- you have the kind of consolidations that you just mentioned with Morgan Stanley and E*TRADE, I think in our ICS business, it's a smaller threat, right? The pricing is per account or per position, and those typically aren't reduced when there's mergers happening. And firms are less likely to in-source ICS services, so I feel that we're in a pretty solid position there. The larger threat, to the point that I think you're making, is in the GTO business where we price on trade volumes. And normally, when companies merge, that creates the opportunity for tiered volumes and, therefore, tiered savings when they merge. So that's one risk. The other risk is when one firm might have an in-house back-office solution and the other uses GTO, and then that could be a gain or a loss for us, right? That's the larger risk for us, and that's what we're facing in this Morgan Stanley and E*TRADE. I think we're still working to see how that pans out, but we feel good about our overall guidance and objectives with that in mind. The other thing I'd call out, David, that it's important to think about when these consolidations happen is the event-driven revenue. That's a modest uptick for us as the consolidation revenues happen as well.

Got it. What are your latest views about the current state of regulation of your industry? SEC and NYSE are suggesting that maybe the regulatory oversight should change. How should investors gauge potential impacts from regulation and maybe some change in oversight?

Yes. I mean, the first thing I would say is that we have a strong history of working with regulators and working with our fund and issuer partners, right? Regulators want disclosure to investors and our partners. We've been there focused on helping to drive down their cost, which is what we've been doing as we've moved to more digital-type solutions. And so look, I think with the new administration coming on, it's not yet clear what the agenda is or when an agenda that would impact our business directly, when we would start to see the impacts of that. The current sort of agenda items out there, ESG as an example, as you listen to some of the focus areas that the new head of the SEC has in mind, I think could be broadly a tailwind for Broadridge. Prior agenda items, pricing, notice and disclosure, those are items that aren't yet brought back to the forefront as a focus for this administration. And I don't see anything imminent to Broadridge from that. But again, I emphasize this track record of being able to work with regulators and with our funds and issuers and continue to have a diversified business to overcome any negative impacts that might happen there.

Got it. Where do you stand in terms of implementing blockchain or distributed ledger technology in international and U.S. proxy businesses? And can you help us dimension what impact we might see on EBIT margin from implementing some of these technologies?

Yes, yes. One -- I mean, one thing is the blockchain technology itself. The other is the use cases that are -- where our network gives us a distinct advantage. That's the power. That's sort of the benefit for us. And there are places where we have products that are live today. If you think about -- you asked about the international market, so SRD data hub. Today, there's massive infrastructure in the U.S. on communications between issuers and funds within investors. It's less so the case in the international market, and so you do have an opportunity to build a new network that can be serviced on blockchain. And we're in a strong position given our scale and domain expertise there to create a hub for corporates to be able to see their investors and communicate with their investors. So we're using it there. And if you look at the regulatory component of our ICS business, some of the benefit -- some of the growth that you see there is driven by that business. I would say, right now, it's not significant from an EBIT standpoint, not hugely significant. And we're working on how to scale other solutions like our DLT repo. Banks are internally trying to move collateral around the different legal entities that they have. A lot of that is going outside and bringing collateral in-house. Our blockchain technology there, again, using our expertise given that we are the back office booking records from many of the capital market banks in the system today allow us to have an advantage and help them move that collateral internally. There's an efficiency save there for them. There's modest capital gains there. The next step, I would say, though, is that they -- not just intrabank, but outside and is there any other opportunity that we can provide there. So we have solutions in place. I would say that they're not super significant from an investor standpoint at this space, but an opportunity for us to be able to utilize our network.

What are your broad capital allocation priorities among dividends, share repurchase and acquisitions? And what types of businesses are you most interested in acquiring at current prices?

Yes. I mean, first, just -- I'll take your question in 2 components. First, this is a very strong capital-light business, where we generate free cash flows that are nearly 100% or historically have been 100% of our adjusted net earnings. Recently, as we build out some platforms, like wealth management, you might -- you see that dip a little bit into the 85%, 90% range, but strong free cash flows in this business. We invest internally first and we stay committed to a dividend that has been roughly about 45% of prior earnings and growing in line with earnings as well. The third part of using those free cash flows and our capital allocation plan is really doing due diligence in the M&A space, and long track record of really doing the diligence on M&A opportunities that fit into our strategic initiatives. Over the last 3 years, I talked about $800 million in deployment on M&A activities in the $50 million to $60 million range. Occasionally, you'd see us go above that. But you look over the past couple of years and you see M&As across wealth management, across data solutions within our capital market space as well, and I look at the pipeline and I see opportunities, a strong pipeline across those areas as well. Of course, we're going to continue to have our high bar on what we expect, what is the accretion of Broadridge revenue and EPS going to be, where do we expect the IRRs to be. As we think about the current valuations today makes it a little bit tougher, so you haven't seen us do any M&A since February of '20, but that continues to be an area that is part of our capital allocation plan. I think we have a strong pipeline of opportunities. We'll continue to provide our diligence. And if not, we're not going to be overcapitalized. We'll return any excess cash to shareholders. We do all of that staying within our investment-grade credit rating. That's the objective. That's the policy, our interest. M&A has been an evergreen policy for a fintech company like ours, and so we'll continue to be focused on it as part of our capital allocation plan.

There's recently been management change at the top with Tim Gokey becoming CEO 2 years ago after Founder and CEO Rich Daly retired. Can you talk about your observations about what changes Tim might bring to the business versus what -- how Rich ran the business historically and kind of what that might mean for Broadridge going forward?

So I mean it -- I don't know if it's common to see what we see here at Broadridge, with such a strong transition period between Tim and Rich. And of course, Tim -- Rich continues to play a strong role as a member of our Board here. Rich has really had the organization focused on execution, helping us build the scale, and use our scale and domain expertise to have the reputation that we have and have the 80% coverage across our proxy business. I think Tim has the organization really focused on not just the near term, but really, if you think about the investments, if you think about the M&A and the acquisition that we have been doing, what I call and what he calls Horizon 2 and Horizon 3 growth opportunities. So driving, investing in our product innovation, looking at acquisition opportunities to really think about growth for the long term as well. So they both continue to be -- play a key role in the organization, both the history and going forward. It's been great for me to see not just the performance over the last 6 years; our next 3-year objectives, which are right in line with that performance; but the strategic initiatives that Tim and the team are progressing that give us strong confidence to be able to hit those objectives.

Terrific. Let me just pause there to see if there are any questions from investors. [Operator Instructions] Well, perhaps in closing, Edmund, just any thoughts that you would want to leave investors with, either kind of your impressions in your first few months as CFO of Broadridge or any like topics you think are not well understood by investors, either, let's say, newer investors who are coming to Broadridge.

I don't know if we have enough time to cover it all in the last few minutes. But I'll tell you, I'm super-excited to come over to Broadridge. I loved the company where I was before, American Express, no doubt. But Broadridge was attractive to me because many of the lessons that I learned over there, helping to grow share, helping to grow scale and relevance, and you know that well, having covered American Express, I bring to Broadridge and apply it to a global fintech leader who has a strong position in our franchise organizations and in a growth industry. So I feel good about that. I think it's part of my job to help to continue to drive that sustainable revenue, to be able to drive initiatives, to continue to get margin expansion and make sure that we invest in the right opportunities, both internally, externally. I have noticed that there aren't really any true peers of being able to explain this unique business, so that they can be evaluated, our performance can be evaluated well is a focus of mine. I do think that the quarterly metrics, you asked me a question about 24%, sometimes has a tendency to distract from the fact that we have solid annual performance, which is why we focus on annual guidance and the 3-year objectives that we have because our long-term growth drivers are quite stable. And look, I look forward to taking advantage of growing a business where 65% of the revenue is recurring, where we have diversity across 2 franchises and a growing third arm in wealth management; and where we're operating in over 100 countries backed by the strong financial model that has produced, over the last 6 years, 12% of adjusted EPS and this top quartile TSR. It's super-exciting to be a CFO for a company like that.

Well, thanks so much, Edmund. Greatly appreciate your time and insights and participation in our conference today.

Great. Thank you for having me, David. Looking forward to talking to you soon.

Likewise.