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Computershare Limited (ASX:CPU) is the world’s largest and only global share registry (also known in the US as a stock transfer agent) and employee management service provider, with over 100 million shareholder accounts for over 14,000 companies.

Founded in Australia in 1978, it has grown to be the leading provider of financial market services and technology to the global securities industry, operating in 17 countries across five continents.

Services and solutions are provided to listed companies, investors, employees, exchanges and other financial institutions.

CPU is run by founder, 10 percent shareholder and chief executive Chris Morris.

In addition to the remainder of the board he is assisted by his sister Penny Maclagan, who is technology services director and a circa three percent shareholder.

Through its US company Georgeson, CPU contacts shareholders when action is required during proxy voting.

The company also owns businesses involved in commercial printing, direct mail, tenancy administration, cheque mailing and the provision of trust and securitisation services.

CPU earns further interest income from holding client funds (effectively funds held in trust). In 2007 (market peak), client funds amounted to almost US$7 billion.

CPU’s business has a high fixed cost component, thus the scale of the business is important, with CPU being an aggressive acquirer of its competitors. Having purchased these businesses, the company installs its own technology and benefits from the leveraging of this technology across more accounts. Over the past two years, CPU have acquired Restricted Stock Systems, Administar Services Group LLC, QM Technologies Limited, Strand Business Systems, it’s sister company Strand Enterprises and has a controlling stake of 30.2% in VEM Aktienbank AG located in Germany. The acquisitions are intended to enhance CPU’s operations in varying markets across the world, providing access to a wider technological and service base and solid entry into the European market.

The group’s principal activities are carried out through the following business segments:

Discussion

CPU’s numbers reveal some interesting facts and at the same time pose a dilemma for investors.

CPU enjoys a large recurring revenue base however, the profit declines in 2003 and 2009 shown in the table above are a reminder that the company’s underlying business is a cyclical one. When markets slump, declines in the number of new floats, takeovers and other capital raisings such as rights issues and entitlement offers, reduces demand for CPU’s services and new business recedes. At the same time the level of existing activity also declines, albeit less dramatically. Partially offsetting this is the fact that declining share prices usually occur amid a reassessment of the activity that resulted in the previous boom, which in turn produces a higher level of contested proxy votes. Whilst this activity benefits CPU, investors ultimately need to be mindful of the key factors that influence the number of deals such as mergers and takeovers and – with some lag to CPU’s business – private equity deals that eventually result in IPO’s. Higher interest rates and the current global trend towards more market regulation will dampen the frequency of deals.

With the global financial crisis, markets have fallen considerably over the last two years. This fall has shown the cyclicality in CPU’s business. NPAT fell 11.45% in FY09 on the back of much lower corporate activity whilst the share price has suffered having fallen 22% over the last two years. Since June 30 2009 global markets have risen and corporate activity appears to be back on the agenda, investors are now piling back into CPU shares as they expect earnings to recover with the market, this has seen the stock trade up above $10.50.

One headwind CPU faces in the short term is the interest rates it is receiving on its clients funds. Currently global interest rates are at historic lows, which will affect CPUs profit over the next 12 months. However, the upside for CPU is when global growth does return and interest rates do rise, this will go straight to the bottom line. For every 25bp change in interest rates in the northern hemisphere, this equates to approximately US$4 million profit before tax for CPU.

The last few years have shown that with shares highly correlated to activity in the stock market, the best time to buy a business so exposed to its swings and ancillary activity is when sentiment is negative towards equities and the prospects for corporate activity. Inevitably however the market turns (as it has earlier this year) and if CPU’s track record of acquisitions is anything to go by, the company will emerge in a recovery with a stronger business and larger market share.

Acquisitions

CPU’s growth can be largely attributed to acquisitions. Between August 1995 and March 2009 and driven by founding and circa 10 percent shareholder Chris Morris, the company made almost 80 meaningful purchases. This growth by acquisition strategy has seen CPU grow nearly 100-fold since the company listed in 1994.

Putting aside our frequently-stated preference for non-acquisitive growth, CPU’s size in global share registry services also reduces the number of meaningful acquisitions available. In response, recent acquisitions have been in less cyclical markets such as bankruptcy administration and recently in childcare voucher services and Kurtzman Carson Consultants (KCC), a company that provides administrative support services to companies undergoing corporate restructuring or Chapter 11 bankruptcy proceedings.

These non-share registry acquisitions have been described by sometimes enamoured analysts as EPS accretive and diversifying the company’s revenue streams and cyclicality, however they are also a signal that the business will inevitably venture away from its core operations or become more cyclical if it does not. This latter risk is also accentuated by the company’s size.

Management have indicated that CPU would not hesitate to tap equity markets to fund the right acquisition rather than risk over-gearing. It remains to be seen whether any forthcoming purchase and associated raisings structure is not only EPS accretive, but non ROE and Equity Per Share dilutive.

Figure 3 – StockVal Valuation: Computershare Limited (ASX:CPU)

CPU over its history has shown an ability to produce a high ROE in both bull and bear markets. Due to its cyclical nature the company’s profitability does however rise and fall with the market. FY09 saw profit drop 9% from FY08 and return on equity dropped from 42.7% to 36.3%.

Gearing on a historical basis is currently high. Net Debt stands at US$794 million. The company uses a measure of Net Debt to EBITDA to measure the strength of its balance sheet. This ratio currently stands at 1.67x  which is well below the company’s comfort level of 2.5x. However, if markets continue to rise CPUs profit should increase which will push this ratio towards the comfort level. Due to this we don’t see any need for CPU to raise capital unless a suitable acquisition is found.

We have forecasted ROE going forward to be 32%. This is based on a two to three year view. Potentially there is upside to this number if 1) interest rates rise globally 2) corporate activity returns towards the 2007 levels or 3) CPU makes accretive acquisitions. Whatever happens we believe CPU is well positioned to profit from further recovery in global equity markets. We see good value below $9.

Guy Carson uses StockVal. Exclusively for The Bull subscribers, StockVal is offering a free two-week test drive. Click here

 

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