TransUnion (TRU) Earnings Call Transcript & Summary

We'll get going. I'm Jeff Meuler, Baird's information solutions analyst. Thanks for joining us. Pleased to introduce TransUnion as the next presenting company at the conference. TransUnion is a global consumer information solution company and credit bureau. With us from the company, Chris Cartwright, CEO since 2019, prior to which he headed the company's largest segment and has a long history of running information solutions businesses. Also with me onstage, Todd Cello. CFO since 2017, been with the company since '97, has pretty much run all of their major finance leadership roles. And then Aaron Hoffman from the IR team on stage and Greg Bardi from the IR team joining us from the conference.

So thank you for being here. It's your first, I think, investor conference or webcast since a tough quarter and some reduced Q4 guidance. There's been a pullback in your stock. So I just wanted to see if there's anything that you thought from your follow-up investor conversations messages from the Q3 call that you think did not resonate in the way that you thought they would with investors or anything that you think investors might be overlooking?

Yes. Well, listen, thanks, Jeff, and good to be here. Yes, certainly, it was a difficult and surprising third quarter, as many of you know, and it's good to have an opportunity to kind of talk it through holistically. So I think the downturn that we experienced in the third quarter reflects the macroeconomic pressures that have been building on U.S. consumers for really ever since inflation showed up and the Fed started to aggressively increase interest rates, which have increased borrowing costs, which are pension consumer households. And we guided in the middle of the year after 2 successful quarters where we beat, but didn't raise, trying to prudently derisk the second half. But then in September, there was a sharp slowdown in the near prime and the subprime segments of consumer lending, but also card issuance and a slowdown in fintech, which covers -- which spans across the segments. Additionally, the mix of what we sold in the quarter was more weighted toward noncredit products, which, while still extremely profitable, are lower margin than the credit products, which declined because there was less marketing and origination activities by the banks, again, kind of isolated in those 2 segments. So that was surprising. And then from that, the fourth quarter guide, we wanted to be conservative and derisk the fourth quarter. The thinking was, look, we'd rather be here in February apologizing for beating those numbers than for a second miss. And then I think the market extrapolated to the full year '24 in a way -- well, frankly, it's much more negative than we think this environment reflects, right? We'll talk through some of that in detail. I think pulling back from the third quarter and just considering TransUnion as a whole, we continue to grow. We believe our portfolio is engineered to grow and to stay positive regardless of market conditions. I look to our performance around the world. We have achieved considerable diversification and that's borne out as the U.S. financial services market has slowed, really since the second half of '21. But our emerging verticals in the U.S. have compensated for that decline. Our International portfolio continues to compound at low double digits. And the direct-to-consumer business, which has been undergoing a reset is becoming less of a drag on the portfolio in total and we expect will become a positive contributor as we go into next year, right? The level of innovation. I mean, strictly the number of new products that we have to sell, both as a result of what we've built, but also what we acquired is unmatched in our history. And we have been integrating these acquisitions and digesting them, and we're doing a great job of cross-selling. We are really connecting well through our go-to-market efforts with our clients in multiple markets. We still see share gains globally. I mean, if I look at Canada, which has similar economic circumstances to the U.S., we've been able to grow share rapidly there in recent years, but it's really a decade-long share expansion there. In the U.S., our share has grown dramatically over the past 10 years. We've gone from a third player to what we believe is kind of tied for first in U.S. financial services market share. And there are still examples of that in the current year where at the upper end of the market, we're increasing our position with certain card issuers. We're competing extremely effectively. So what we saw in the third quarter has nothing to do. Our share is strong. Our share is stable. And even in the U.K., I mean, the U.K. was a difficult quarter. We took a very material write-down. But if you separate the declining elements of the U.K. portfolio, which has been short-term small-dollar lending, which the regulators have tried to stamp out of that market, and fintech, we've been gaining share in core mainstream banking since we acquired our way into the U.K. market in 2018. I spent a good deal of time in that market recently. I'm confident that we are a strong and disruptive player, and we're going to continue to do well there. We're going to grow through this period. So there's a lot of positives on the revenue side. But again, the third quarter was a surprise. We look to derisk the fourth quarter as best we can. As we sit here today, having closed the books in October, we still feel positive about the fourth quarter and where we stand against the guide. And again, as we look to '24, while we can't formally provide '24 guidance, just taking the fourth quarter times 4 gets you to a much more negative place than where we believe the markets are and certainly our business. That approach doesn't account for the next layer of revenue through all of the selling that we've done this year. It doesn't require -- include the growth momentum from the portfolio, the pricing actions, any of the variety of things that are going to be additive to the fourth quarter revenue run rate, right? And then I would say the other part is just on the cost side. We saw our business begin slowing down in the second quarter of '22. We began curtailing our costs in a variety of areas, certainly personnel. That has continued as the U.S. markets have slowed. Even early in the first quarter, kind of unrelated to earnings, we had a personnel action designed to tighten the structure and drive productivity. You can expect that we'll continue to do so as is appropriate for the revenue the business is getting, and we'll share more details with you as those actions take place. But I think more importantly, we believe that we are positioned to structurally improve the cost side of our business and drive margin and productivity going forward. We're going to do it in 2 areas. We're going to fully leverage the centers of excellence globally that we've been investing in and staffing up for several years now. About 30% of our workforce is there. We think there's a final step to take to achieve the right balance between our employees that are in local markets focused on customer needs and revenue generation and in the more centralized efficiency-oriented processing parts of the business. And then secondly, we believe that on the technology side, the combination of our Project Rise migration to the cloud plus the investment in Neustar and their next-generation technology is going to allow us to take a material chunk out of our technology costs. Now we're going to communicate this to the market in the relatively near future. We've got to wait for the appropriate time, but it won't be long and we will provide full details. And it is additive to the current margin trajectory of the business. Capital allocation is probably the last thing I would say. We remain committed to paying down our debt. $75 million in prepayment in Q3, aiming for the same in Q4. We hope to continue that momentum of paydown over '24 and going forward. And we're committed to getting to 3.5x and ultimately 3x leverage in the near future.

And when you say you're going to communicate the structural expense takeouts and the opportunity from them in the relatively near future, does that mean in conjunction with reporting Q4 or potentially ahead of it?

Likely ahead of it.

Okay. And then when you say you derisk the guidance, as you said, you also said that you beat Q1 and Q2 and you held the guidance and you thought that would derisk the back half guidance and that did not prove to be the case. So can you just be any more clear on what the Q4 guidance is assuming when you say that it's derisked?

Sure. I'll take that question, Jeff. So what we factored into our Q4 guide were the conditions that we saw in September that we articulated, Chris just went through the drivers of that. And then we took a more conservative approach, meaning we assume that things would get worse from what we saw in September. And again, that is all just in the spirit of, first, we only saw about 3 weeks of that in September, right? I mean things were tracking for the most part through July and August. So we were faced with the situation of how do you guide the quarter when you really didn't see too much of the impact. So that was why we took what we would consider an overly conservative perspective for the fourth quarter. Like Chris said, we would much rather be in a situation to talk about beating and apologizing for that as opposed to dealing with another miss like we had in the third quarter. And just to touch on October, Chris mentioned this, but just to put a finer point on it. We closed the books on October and I would just say that we are pleased with how the results came in relative to the guide that we provided.

And I think one of the things the market is wrestling with is there's 3 credit bureau-centric information solutions companies. One has reported -- or two have reported, you and one of your peers, one has not. And we didn't hear as much messaging about a softer September, October from the one that has reported. Can you just talk about what markets maybe you over-index to or why you think you might be seeing something different from the one peer that has reported thus far?

Yes. And so what I'd say on that is the areas of additional softness that we experienced mainly in September, because 80% of the third quarter revenue miss occurred in September, is in the U.S. and it was in consumer lending and card issuance. Now as for our share, we believe that we've got a very large share of the U.S. market, probably at the top of the market or tied for that, right? And most of you who follow TransUnion know that share gain story has been a part of our recent history. So we think we are broadly reflective of the market in total. There's no material overweight in any particular segment. It's very well balanced, high, medium, small banks, if you will. With the exception of fintech. As most of you know, we have a very large share of the fintech industry. We've pegged that at about $175 million of our global revenues. Fintechs have been materially impacted in this downturn. So if there was any disproportionate impact, it would be there. However, generally, we are reflective of the entirety of the U.S. financial services market and our share is very stable to increasing at this point. Now it's always difficult to compare portfolios, right? If you look at the 3 bureaus, we each have certain unique lines of business that have to be removed before making the comparison. Additionally, the different bureaus have different approaches to reporting what is in common. We report everything in financial services or emerging. And within financial services, we're clearly breaking out consumer lending, card, auto, mortgage, et cetera. And we're including the online polls, the batch, the score [ sales ], it's holistic. When you compare to other providers, those piece parts can be in different areas, making it a little bit more difficult to compare. When we unbundle that internally, which obviously we do to benchmark ourselves, we are very comfortable and confident with where we stand in the market and we see a much less material gap than may be clear from the top [ level ] reporting.

And when you say that the revenue that you give us is holistic for those big 4 categories within U.S. financial services, does it also include marketing and prescreen revenue? And do you overweight within marketing revenue at all relative to others in the market?

Well, I don't think we overweight. And again, I just spoke to that, so I won't belabor the point, right? I think we represent the market quite well.

For marketing solutions within financial services?

Yes. Just to be clear, when you talk about marketing within TransUnion, there's our heritage credit-oriented marketing, which is in financial services. It's all in financial services. And then there will be -- the Neustar market spend planning and evaluation, and of course, audience generation components, which is something unique to TransUnion, right? But what we report in financial services would be the online business and the batch business. And batch is marketing prescreen, it's portfolio reviews, it's collection scoring. It's all of those batch equities and that's in our financial services revenue.

Okay. And I know you said that you've been moving up among some large U.S. financial services clients and just for like the investors in the room that may not be as familiar, a lot of large financial services companies have a primary, a secondary and maybe a tertiary bureau. So when you say that, you could be moving up from secondary to primary, right?

Yes.

And Equifax did note that there was, what they call, the large financial institution that onboarded on to, I guess, the EFX Cloud In Q3. Did you have any financial services customers that you've recently lost as a customer?

We did not. And look, share is something that we monitor very closely in our monthly business reviews. Obviously, there's always some movement between competitors and you're always looking for net measures of progress. And I did hear that comment that they made, I'm not clear which service they're speaking of. They've got a broad portfolio of services, obviously. But we definitely looked back and looked hard at our market positions and we see no evidence of that in our portfolio.

In the fintech space where that's one of the markets where you said you do over-index to, that was a market that the other bureaus, to some extent, wanted to compete for and you won it. And so talk about why you won it? And do you think it's still a structurally attractive market for you?

Well, look, we definitely think it's a structurally attractive market. But what you've seen with fintech because lots of consumer -- almost half of the consumer lending in the U.S. is done by nondepositories. Whenever there is a change in the cost of funds flowing into those depositories or there's deterioration in the lendability of consumers, you're going to get a pause. And so whether it's fintech or smaller lenders in that space, they'll stop and evaluate what's going on before they deploy additional capital. So far in the second half, rates went up 50 bps already after going up 20 in the first half. So something has changed. Their cost of funds have increased. There is clear stress in the subprime space where delinquencies have risen beyond pandemics. And so there's been a pause in that marketplace. Now, look, we serve that market well. We serve all of our clients well. It was hard-won share. It is long-term growth-ful share even if there's a pause right now, even if it's going to take some time for rates to reach an equilibrium where they can continue to then find pockets for growth, opportunities to convert, increasing card balances and revolving debt into refinanced loans, those opportunities are going to return and that's going to provide us growth upside once we get through this stall.

And help us understand how bookings or new product sales are going within financial services to maybe kind of reinforce the point that it's macro headwinds and the structural growth that we've come to expect from TransUnion is still there?

Yes, absolutely. So in '21 and in '22 on both the heritage credit product side of the house and in the newer product side of the house, things like Neustar and Sontiq, et cetera, we set 2 records for bookings in those years and we have benefited from the realization of that revenue in the following calendar year, but that's not enough to offset a receding tide from the entirety of your customer base. And as I've spoken to, there are some areas where volume has been going down for a couple of -- probably a couple of years now. I expect this year we'll have another strong bookings year. As I sit here, I can't say whether we're going to break new records. But I think in absolute terms on both credit and noncredit, it's already a solid year for bookings and I think we're going to close strong. And I think it's for 2 reasons. One, a lot of innovation. The product line is more attractive now than it's ever been, so is our selling effectiveness. We can always do better, we'll continue to do better, but it's strong right now. But then if you look across financial services, particularly at the upper end of the market, their net interest income is still very strong, right? And so they're interested in investing in solutions that make them more efficient as they look toward the future and they worry about a slowdown.

So we're talking about a lot of macro headwinds. But at the end of the day, you grew 3% organic constant currency in Q3. Q4 guidance is still for 2% to 3% organic constant currency growth. But we've been getting kind of questions like what is the overall cyclicality of TransUnion? Has it increased with some of the transactions that you've done? Maybe if you can just comment on that, please?

Yes, sure. The short answer is greatly diminished from where we were when we started this journey. Coming out of the great financial crisis, we were very much U.S.-focused B2B credit, if you will. And peak to trough there, there was a 10% decline in revenue. Now the GFC, those were extremely difficult circumstances. That's not what we're dealing with now. We've had this broad-based slowdown, but employment is still high. There's wage growth. There's a labor shortage. And even if layoffs increase and unemployment goes up, there are still going to be a lot of dollars flowing through consumers and households and the like, right? So it's a much more stable situation. Since then, we've achieved a lot of diversification. Part of that is global, which is over 20% of our portfolio now. Part of that's in the U.S., where 45% of our U.S. revenue is coming from nonfinancial services accounts. So we've achieved a lot of geographic, vertical and product-based diversification, which is why we've continued to grow as the market has slowed from peak levels in the second half of '21 through now. So I expect that we will remain positive and growth-ful as we look to the intermediate future.

And I know you withdrew the 2025 guidance for now, but you were calling for 8% to 10% CAGR growth. Is that still the right way to think of a growth framework for TransUnion? And are there like a handful of -- and it's a diversified growth model, but are there a handful of particular markets or products that you would call out as being like meaningful growth drivers in coming years?

Sure. Look, we have -- look, so far, the acquisitions have been additive to our growth rate and to our stability because they're bringing more of -- and even more of a recurring nature. And that's particularly true with Neustar and 75% of Sontiq's revenues approximately are highly recurring as well, and of course, Argus is more of a subscription model. So Neustar has been additive to our growth, and this really goes to your prior question, where, upon acquisition, there were some concerns that we'd increased the cyclical exposure. But only 20% of Neustar's revenues vary with market cycles and that's the audience generation and the campaign planning and we've seen that go negative as the economy has slowed down. But the rest of the portfolio is holding up well. And overall, it makes us more diversified and stable. But we still think the new marketing solutions, our analytics solutions, moving into prospect databases, et cetera and, of course, the International portfolio, those will drive our growth going forward in addition to our great credit and trended and alternative data. And we think consumer business is troughing and is going to become positive as we grow through this change in marketing practices and spend.

And I know you referenced kind of like the mix dynamic of selling less very high-margin credit products and selling some more of some other products that are currently lower margin. I think a lot of investors are still struggling with like the math behind it because the EBITDA dollar guidance came down quite a bit more than the revenue guidance. Just anything further you can say on that?

Yes, absolutely. And I think it's important that we spend a minute on that. So in February of 2023, we provided our full year guidance. And as Chris has already alluded to, our first quarter results and our second quarter results were ahead of the high end of guidance. So through the first half of 2023, TransUnion was about $33 million ahead on revenue, but only $10 million ahead on adjusted EBITDA, again, compared to the high end of the guidance that we provided for Q1 and Q2. The margin on that overage, $33 million of revenue, $10 million of EBITDA, is about 30%. If you think about the full year guide for adjusted EBITDA, we were guiding at the beginning of the year and the guidance that we have provided to be around 36.3% to 36.6%. So clearly, the beats that we had in the first half of the year were below the guidance for the full year. So what that spoke to was the issue that we faced and that we talked about on our first quarter call with the margin on the price increase from a third-party score provider and the impact that, that had. It also had to do with the mix of the business that we were selling. So selling a little bit less credit, which is more profitable, probably no surprise because that's our heritage, and that we've scaled it up. So that gets you to the first half. If you then look at the third quarter guidance and you look at it compared to the high end, again, we missed revenue by $19 million and we missed adjusted EBITDA at the high end by $14 million. So if you take the revenue, which I said was $33 million to the first half favorable, $19 million unfavorable, you're ending up with a positive $14 million. Now this is the important part on the adjusted EBITDA. So if we were $10 million ahead through the first half, but $14 million off in Q3, that's a negative $4 million on the adjusted EBITDA. So you can see the dynamic that happened where the adjusted EBITDA ended up being worse than the revenue just by simply looking at the high guide and our performance to it. Then you enter into the guidance that we provided for the fourth quarter, and what we did is we took down the credit-based products that carry a higher margin. So when you do that, that's how you end up with this disproportionate. Just thought it was important to walk through the pieces there, so you can appreciate and you could see based on the guidance.

Yes. And those are the financial steps along the way. I think, look, in the big, you guide to a certain revenue number, you assume a certain product mix and those products have differing levels of profitability. Credit at the margin is extremely profitable because the data has contributed. There's not a direct product licensing cost. When we sell more third-party scores, there is a direct cost. If we sell more trusted call solutions, we pay the carriers for that data. There's a cost associated with marketing audiences, for example. Now to be clear, everything we sell is nicely profitable. But if the mix shifts, we're going to have less contribution margin, if you will. Total revenues less direct cost to get to the contribution margin, that's what happened. If you look at our underlying costs, they've been flat quarter-to-quarter for some period now.

And then you volunteered that the EPS run rate from Q4, it's probably over punitive to extrapolate that as the right run rate into 2024. So let's maybe just go into more detail on like what the typical building blocks investors should think about when they like do their TransUnion models? Because I think there's also some like integration expense that falls away. There's the typical structural growth. So just anything further you can say on that because I think that's an important point that you're volunteering.

Yes. Look, that's a really good point and that, again, speaks to 2024. And look, we're not in a position to guide fully 2024. We want to finish '23. I think you can understand that. But that said, and I like your word over punitive, you can't take the fourth quarter estimates and times them by 4, as I already addressed, right? There's revenue momentum, there's new sales, there's pricing. There's a whole variety of things that influence to the positive. You can't take the EBITDA without the benefit of cost actions, both in the intermediate term, but also structural cost actions, right, that are going to influence that to the positive. And so as a result, EBITDA, EPS, et cetera, will most likely be better than where the market consensus is currently.

Better than where the market consensus is currently for...

When I say consensus, I don't mean like the average of all you guys guide because I'm not clear on what that is right now. I just mean general emotion and sentiment.

Okay. And then just long-term capital allocation. So why the new debt framework? Why not something potentially less? And how do you think about like long-term capital allocation once you get there?

So Jeff, I think you're referring to the refinance when you talk about the...

Well, you did a refinance, but a couple of quarters ago you also lowered your leverage target. So...

Sure. Let me talk about all of that then, yes. So just as a reminder, at the beginning of 2023, we committed to a target leverage ratio of 3.0x. Since TransUnion has been a public company going back to 2015, our stated target was 3.5x. So we're running towards that target at 3.0. Through the third quarter, we were at 3.7x. So we still have a ways to go. As Chris already said, from a capital allocation perspective, priority continues to be debt repayments, which we've made, $225 million worth thus far this year. On October 27, we closed a refinance of our Term Loan A as well as an upsize of our revolving credit facility. We were able to secure commitments for about $1.9 billion from our banking partners. And what we did with that $1.9 billion is, first of all, we had to refinance the Term Loan A, which was about $1 billion. And what we did is we upsized that to $1.3 billion. And the reason we did that is because the Term Loan A offers the lowest coupon. So what we did with that incremental $300 million is we prepaid our B6 loans, which is the debt that we incurred for the Neustar acquisition. It carries the highest coupon. So we were able to get some interest expense savings there. From a pricing perspective, we were able to maintain the same pricing on this facility that we had before, which we consider to be a win for us. The only change is at a higher leverage ratio. We'd have to be 4.5x on the leverage, and I just said we were at 3.7. So we're a ways away from that. At that point, it would be SOFR plus 200 as opposed to where today we're at SOFR plus 150. So overall, really positive outcome for TransUnion.

Excellent. And that's all the time we have for our questions in this room. Please join me in thanking Chris, Todd and Aaron. And management will be available for additional questions in a breakout session now, which is in Salon A towards the ballroom. The next presenting companies at the conference, Trimble, Dover Corp...