Verisk Analytics, Inc. (VRSK) Earnings Call Transcript & Summary

Okay. I'm Toni Kaplan, the Head of U.S. business services research at Morgan Stanley. And I'm pleased to have with me Lee Shavel, Chief Financial Officer of Verisk. And before I begin, I need to read the following disclosure. For important disclosures, please see the Morgan Stanley Research disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And please note, if you have a question during the presentation today, please click on the box to send me your question, and I will try to fit it in during the presentation. So before joining Verisk in 2017, Lee was Chief Financial Officer of Nasdaq, so I know that this is a very special conference for him.

Maybe just to kick it off Lee, could you talk about your 3 top priorities going into 2021?

Sure. Good morning, everyone. And Toni, thanks for hosting this chat. As you mentioned, it's really -- it's a delight for me to participate. Obviously, I would much rather, as I'm sure all of you would, much rather be in London at this conference, which from my experience, is one of the best in pulling together such a broad range of investors from across Europe into that venue. So also special thanks to Nasdaq and many of my former colleagues, which I'm always delighted to see at the conference. So with that, to then address, Toni, your question. In terms of priorities, looking ahead to 2021, the priorities are fundamentally, I think, not different than any of our prior years in that I would define them first as focusing on sustaining and expanding our underlying growth rates in the business. Secondly, looking for opportunities to improve the productivity, the profitability of our businesses, utilizing the operating leverage that we have inherently within our business. And finally, using both of those to generate very good returns on invested capital for our business, which is fundamentally the value driver that we use to deliver strong value to our customers. And all 3 of those elements are fundamentally supported by investments that we are making and how we are using our capital to take advantage of the extraordinary position that we're in to deliver -- to capture data, to deliver analytics to our customer bases. We're investing in new analytic objects. We're investing in new analytic platforms to support our growth rate. We're investing in new technologies of machine learning and migration to the cloud to improve our efficiency. And we are investing in new areas that will generate high returns. So all of that is kind of the core essence of what we do year in, year out to create value. I would say, looking at 2021, we're naturally dealing with a number of factors related to COVID-19 that have impacted in the short term, we believe, some of our more -- some of our revenue elements that have sensitivity to the COVID-19 causal impact, such as travel and driving and advertising and those elements. But we have begun to see recovery from some of those, which we hope will continue into 2021. And we've also had some expense impacts, largely positive in 2020, in terms of reduced T&E that we'll be managing ahead with some view of trying to sustain some of those advantages. So that would be kind of where I would describe our focus in 2021 from a priority standpoint and what some of the nuances are related to this hopefully continued positive transition out of the challenging 2020 pandemic experience.

That's great. And it's actually a perfect segue into my next question. I did want to ask about the 15% of your business impacted by COVID. Just for those maybe less familiar, can you talk about some examples of where you've had impacts? You mentioned the auto insurance already, but just give some additional examples. And then have you -- are you recovering? Have you fully recovered? How long is it going to take until you're back to 100%?

Well, that last question, nobody really knows. I certainly can't predict what's going to happen here. And there are a lot of factors that will influence that. But what we've tried to do is describe for our investors what portion of our revenues, we believe, have some exposure to COVID-19 causal impacts, as you've described. Driving levels are down because people aren't going into the office as often. International travel is down substantially. We have other impacts on our consulting businesses in the energy sector. As a function of some of the challenges that may not be wholly COVID-related, but certainly influenced by COVID-related. So we went through all of our product sets. We've identified those revenue sets, those products that have exposure to those causal impacts so that we could break that out and look at how are those businesses comparing to what we would describe as the non-COVID impact, largely our subscription businesses. As you know, Toni, approximately 80% of our revenue is subscription-, recurring-based businesses, so not as sensitive to those businesses. And then we look at those overall growth rates. And I think in discussing kind of the broader impact, something that we were very pleased to see in the second quarter where we had the full effect of the pandemic, the third quarter where we were beginning to see some of that abate, is in looking at this revenues, as we described in the second quarter, looking at those growth rates on a year-over-year basis, the COVID-sensitive revenues of about 15% were down 20% year-over-year on an organic constant currency basis. When we looked at it in the third quarter, those revenues were only down about 10% on a year-over-year basis. And it reflected a mix of differing impacts or recovery rates. We saw recovery in the driving side, which impacted a number of our claims businesses. We didn't see a material improvement in international travel. So our travel insurance, which is a relatively small business from a revenue perspective, did not see a recovery. In some of the consulting businesses at Wood Mackenzie and PowerAdvocate, we continue to see sustained weakness on a year-over-year basis. Within that, we think that, that will be a longer recovery. And in Financial Services, we saw sustained weakness in advertising. Now you might not immediately associate advertising with COVID-19, but because people are driving less, commuting less, there is less advertising because a lot of it is physical space advertising. Billboards, signs on subway cars and buses, that influence things. So I would say, try to summarize, is that across these different elements and these different businesses, of the more auto-related businesses, we're showing some recovery. The consulting businesses continue to see sustained weakness. And the advertising, I think, also had yet to see a demonstrable recovery yet at this stage. So those are some of the elements. We can go into more detail, if you like, but that's kind of the general flow. In terms of what happens, I think if we continue to see a recovery in the pandemic over the course of 2021, those causal impacts will continue to abate and we will continue to see a lessening impact and hopefully, a return to growth for those businesses. In some of those categories, we have seen a -- in the third quarter, year-over-year growth rates. So we have reacquired for some of those revenues an improvement. Part of that is what's contributing to overall the 10% decline year-over-year to the 20%. But I also -- I want to end with one key point, which is on those non-sensitive element, the 85% that we identified, we continue to see growth rates that were consistent with our long-term expected growth rates. So I think from that perspective, that's a real positive and an indicator of the strong resilience of our core business.

That's great. And you touched upon the margin side as well in terms of the savings on travel. I guess, how much of the COVID-related cost savings can continue going forward? How are you thinking about T&E and office infrastructure? How much work from home are you expecting to have in the future? How much of the COVID savings become permanent?

Yes. It's hard to estimate because it's going to depend, again, on a variety of factors. I'll try to answer the question by saying, I think that we will be able to capture some of that savings on a permanent basis, but not all. And I think it's too early to estimate what that's going to be. I think from a T&E perspective, certainly, this experience, and more specifically, the very strong productivity that we've seen in our sales force across the organization has been very encouraging. And you can't look at those numbers and say, "Well, do we necessarily need to sustain the same level of T&E expense relative to that sales?" It may be that our clients are more available and so easier to reach in virtual channels, just as we're experiencing here. It could be that our sales folks have more time because they're spending less time traveling and more time talking to clients, and so that can have a benefit. But the upshot of all of it is that I think we will look at that and try to evaluate what can we do more of in a virtual context in reducing some portion of our T&E. And with regard to occupancy, it's not a big element of our cost structure. But certainly, we are looking at the amount of space that we're going to need if a larger portion of our workforce is going to be working from home. Not entirely, but perhaps more frequently. And that will move us into, while requiring less space, we still will have to invest in more hoteling-oriented facilities as opposed to permanent offices. And with our portfolio of leases, over time, I think we will be looking at probably a smaller footprint. And certainly, our expectation we're experiencing right now is that, on renewals, our overall cost per square foot are going to go down because of the supply/demand imbalance. And we'll be looking to take advantage of that, but that's something that plays out over 5 to 10 years as those leases come up and you renegotiate it. So I think we -- there is a meaningful efficiency that we will be able to hold on to that will be permanent. But we will have to follow the lead of our clients and what they want in terms of physical interaction versus their comfort level in a virtual format.

Great. And how are you thinking about the medium to long-term margins for Verisk? How are you thinking about the trade-off between investment and margin expansion? And just basically, are there -- is there a limit to how high margins can go? How should investors be thinking about your sort of long-term margin opportunity?

Yes. So Toni, I think the important point that I would emphasize here is that as opposed to looking at it on a kind of a serial, static basis of where is the margin? What is the margin? Where was the margin last quarter? Where was the margin next quarter? When you are looking at a large organization, I know that it's tempting to focus on margin and using it as a proxy for what is presumed to be the business as a whole. But it really is a portfolio impact of a lot of incremental change in margin. And so the way we think about it is, we start with the core of our business has very strong operating leverage. Meaning that, for our businesses in the data business, and I think it's true for most information services businesses, that because an incremental sales doesn't require a commensurate increase in expense, you're going to have natural EBITDA growth ahead of your revenue growth element. And so as I've talked about in our quarterly results previously, I like to look at our core operating leverage for our business before investment. Now I can't pull out every element of investment, but what we do is we try to take the big, chunky elements of investment where we are investing in initiatives like telematics or our Lens platform that are either low margin or negative margin because there was support structure. And we hold those, we put those aside for a moment to see is the core business generating operating leverage? And I think what we have found very reassuringly, and hopefully is no surprise to anyone, that we see very strong, consistent operating leverage, so that margin expansion exists underneath. And then what we're trying to do is we're trying to balance our level of investment where we generate great returns on those incremental capital investments, to consume some, but not all of that operating margin expansion. So we think of it on that very dynamic basis with the objective of, over time, showing that margin expansion. But we don't want all of that margin expansion to occur because that would come at the cost of what we view as very attractive growth investment and return investment opportunities as we're seeing in the rest of the business. So that hopefully gives you some context in the way that we think about it. I will say also that in evaluating growth, return and margin, if I'm an investor, I would be much more focused on prioritizing growth and returns relative to margin as a value creation, while keeping an eye on margin to make sure that, that operating leverage still exists and is in a very healthy place, which I believe it is.

Great. And actually, as you were talking, we have a question that came in on your favorite topic, return on invested capital. And so basically, could you just talk about how you think about return on invested capital by segment? Like is there a hurdle rate that you're thinking of as, like, on a segment basis?

Yes. And it's a great question and a very relevant question. And I would say the segment is certainly an intermediary level between the enterprise level and the project level. And I would say that I am primarily focused on enterprise overall, to make certain that we are making good allocation decisions across the organization as a whole because that's where you're allocating the capital. And that has to be supported on good project-level analysis of where you are investing in that capital to make sure that you're putting it, the capital, where you see the best returns. And so the segment level is that intermediary level, and in a way, captures a variety of either technology investments or new platform investments. To answer the question directly, I would say I don't see a significant variation in our hurdle rate or weighted average cost of capital for those businesses different than our overall corporate level. And I think we view our cost of capital in the 7% to 8% range. You all can calculate that for yourselves, but I think that's generally the way that we look at it. And I think at the scale of those businesses, while certainly, we have a smaller business like Financial Services and an intermediate in the Energy and Specialized Markets relative to Insurance, we're not really differentiating at that level. We do look at the project level. And if it's a smaller project, and particularly kind of a smaller M&A or acquisition, we will apply a higher discount rate relative to those because of the higher level of risk in that smaller business. But at that segment level, I wouldn't say we're differentiating it there. We are differentiating it on a project-by-project basis, but that's true for all of the segments. Sorry, a complicated answer, but I wanted to acknowledge the importance and the relevance of that.

That's great. And also just on the topic of invested capital. Just following yesterday's announcement of S&P and IHS Markit combining, I was hoping you could discuss whether you think there will be more industry consolidation in the coming year.

So I can't say that I necessarily see anything that -- from this deal that would trigger a higher level of consolidation. And I want to use this as an opportunity to talk about the scale motivation. I think a lot of investors, when they think about scale, they're thinking about operating scale or processing scale. And what's interesting is that, ironically, scale in that regard, particularly with the advent of cloud computing, is becoming much less important in this context because the ability of that scale, we can all leverage the cloud provider's scale. And so new companies that are coming up and are dealing with large amounts of data or information can avail themselves of substantial scale through that technology. So in that dimension, I'm not sure that simply acquiring another business provides that operating scale advantage. Where we think about scale is in -- within our industry verticals. And so I think everyone would accept the fact that one of our advantages is that we have scale in the insurance sector. And that's almost a presence or a virtual presence that allows us to leverage a network of relationships across the insurance industry that allows us to take new ideas and monetize them very effectively. Now that's not -- in a way, you can think of that as operating scale, but I think of it as something much different than that. And I think -- and Toni, to your -- to the piece that you put out recently analyzing it and looking at, is this going to have an impact on the other players? I think in each of those cases, you said, "I don't really see this having an impact." And so in that regard, I don't think it creates a competitive threat where any individual entity is going to say, "Well boy, this is creating a competitive advantage for someone else that is a threat to the business." So in that regard, I don't see it as a catalyst to drive further consolidation in the business on the basis of that analysis. There are other elements of scale. There's distribution scale, there's data scale. But short answer, for those reasons, I would say no.

That's great. And also just on the topic of M&A. Can you talk about, are there any particular areas of interest for you at the moment? And related to the last question, I guess it makes sense that you would be focused on your existing verticals. But just talk about your level of appetite for M&A, tuck-ins versus large deals. How do you -- remind the audience how you evaluate M&A opportunities, et cetera?

Sure. Thanks, Toni. And I think it's -- the M&A discipline is a very important one in this environment, and for 2 primary reasons. I think anyone that looks at valuation levels within the market has to kind of recognize that we're at historical highs. And at the same time, we're also in one of the most uncertain environments that we've ever dealt with, whether it's the pandemic or technology change. And so I think it's very important that when we are looking at acquisitions, and we do look at acquisitions, we do make acquisitions, the focus has to be on how are we creating value? How are we generating returns out of this acquisition? And so we go through a very deliberate process of making certain that the acquisition is something that is sponsored by one of our core business units. And that's important because it -- if it isn't kind of founded on this is how it is additive and how we can either bring value by increasing the distribution or improving the efficiency or utilizing some of our technologies to enhance it, then really, all we're doing is making an investment on a portfolio basis and hoping that, that investment performs well. So we go at it from how are we creating value with this acquisition within our core businesses and then tracking that, both the integration and the future performance, to make certain that it is -- that we are accountable to ourselves for, did we create the value that we expected from this? Now to my earlier point, our ability to take an entity that has a great product that is relevant to our core clients, whether they're Insurance clients or Energy clients or Financial Services clients, I think, is exceptional. And you probably heard us talk in our third quarter earnings call about the very positive experience that we've had with our FAST acquisition, of taking a business that had a very strong product in the life insurance software business and being able to really accelerate that by leveraging our relationships in the industry, and as well as integrating a lot of our data and analytics specific to the life insurance business for that. That's a case study of how the business wanted to continue to develop our presence in life insurance. This was a platform that we felt could be additive. It's proved to be even more -- or impacted, I think, has been more additive off of the great work that, that team has done. And that's the model, in a lot of ways, of what we're trying to do. We're not looking for a fourth vertical. We think that the opportunities in each of our areas are very strong, but it is premised on how are we leveraging what we have to create value out of those deals? And I think that's a fundamentally very different approach than a purely portfolio approach or an approach that is driven by diversification.

Great. We've got a question of what your organic growth rate is. But maybe you could frame it as what is your sort of long-term model? How often do you evaluate that? What could get you to sort of say, okay, maybe revenue growth should be at a higher level than the long-term model that you've put out. So just how do you think about that?

So our long-term guidance for organic revenue growth, I think, as many of our investors are aware, is in the 7% to 8% organic revenue growth. And that's something that I think, particularly for a business of our scale, is a pretty exceptional growth rate. And it's naturally, again, a reflection of some core businesses that continue to grow well in the mid-single digits and new emerging businesses that are growing in the high single digits and even the low double-digit area. And all of those contribute to that growth rate. And so sustaining that growth rate is a function of sustaining, as I said at the outset, those core businesses where we are continuing to add value. And so as a consequence of that added value, we're able to capture increasing pricing over time because we're delivering value for our clients and they've demonstrated a willingness to pay for that value; as well as investing in new areas of new analytic objects, new platforms, particularly in this environment, that allow distributed personnel to interact and process a lot of the transactions that insurance companies have to process, analyze those, and those generate higher growth rates. That's why that investment element of finding new opportunities that provide us those abilities to grow revenues are so important. And the position that we sit in, with rapidly expanding data sets and rapidly expanding demand for new analytics, is fundamental to supporting that. Now if we were to see continued strong growth in both that supply of data and demand of data, then I think that tends to produce a higher level of growth because we have new opportunities to supplement those legacy businesses. But we're very excited we have more opportunities to invest in currently than we have bandwidth or even capital to pursue, which puts us in a great position of being able to identify where we want to focus our efforts.

Great. And I was going to ask about digitization, but you've basically just touched on that. And so I wanted to ask about, just as a follow-up to that, the insurtech opportunity. How much room is there still to go in that area? Are you seeing new competitors there? Or how is your position within insurtech?

Yes. So Toni, I wanted -- there are 2 dimensions of this. One, and I think it's a very important -- probably the more important dimension from our perspective, is the emergence of new insurtech players that are seeking to deliver insurance products to consumers or to small businesses that are competing with traditional insurance companies. And there, the opportunity is twofold. One, the immediate opportunities. Those new players are, in most cases, are new clients of ours. And so they are purchasing the data products and the services that we have to offer. And so that's been additive to the growth rate. But probably more importantly is it's provided a level of competitive pressure that has encouraged our traditional clients to utilize our data and analytics to make them more competitive in that space. And we've talked in the past about our LightSpeed suite of products, which is specifically designed to gather more data to present a bindable quote to a consumer on a much faster basis than would have been done traditionally before. And that's largely a data and software exercise that we can be helpful. So that provides part of that demand equation that I was discussing before for our product set. On the insurtech side that -- where we have companies that are creating new analytical objects or new platforms, that also provides a competitive spur for us to evaluate, are these things that we can be doing for our clients, given the data sets that we have, given the investment that we have in data science? Or are they potential acquisition opportunities, as with a FAST or other insurance company, where we can dramatically accelerate or improve the value of their business and expand it? So we recognize that they are new companies offering new products, which we will evaluate as an opportunity or a competitive threat, but also as M&A opportunities for us that we can expand on.

That's great. And we actually are out of time. So thank you so much, Lee, for doing this session, and thanks for being with us for the day.

Great. My pleasure. Thank you, Toni.

Thank you. Thanks, everyone, for joining.