IHS Inc.; market cap as of 15/04/2016: $8.33bn
Markit Ltd.; market cap as of 15/04/2016: $6.16bn

Introduction

On March 21, US-based market data provider IHS announced a merger of equals with London-headquartered financial information provider Markit in a $13bn stock deal. The new company, to be called IHS Markit, will challenge the industry dominance of Bloomberg and Thomson Reuters. After completion of the transaction, former shareholders of IHS will own about 57% of the new company. Investors in Markit will end up with about 43% of the firm. The deal will also give the new company the opportunity to benefit from UK’s lower corporate tax rate.

About IHS

IHS is a Colorado-headquartered financial data provider operating in over 33 countries with c. $2.2bn in yearly revenues as of the end of 2015. Its expertise lies on providing and analyzing energy (Resources Division) and transportation (Transportation Division) data for corporate customers. An additional division of the company is specialized in providing information for technical professionals across the product design, technology, and economic risk industries (CMS Division).   In the past years the company has reorganized itself, now by product segment, and is in a process of divesting non-core assets—such as the Operational Excellence and Risk Management (OE&RM) and the GlobalSpec product offerings—in order to determine and pursue the strategic fit, profitability, and growth potential of all its assets under the new product segment organization. Moreover, IHS raised its EBITDA margin and produced a substantial free cash flow in 2015, which was used in strategic acquisitions. The company was involved in two acquisitions in 2015, first acquiring CARPROOF, a Canada-based vehicle data provider, and then by acquiring Oil Price Information Service (OPIS), a US-based petroleum pricing data provider.

About Markit

Markit is a London-based financial information provider operating in 13 countries with c. $1.1bn in yearly revenues at the end of 2015. It was formed in 2001 by a group of former credit derivatives traders from TD Securities, and went public on NASDAQ in 2014. Markit aggregates information from major bond dealers and uses it for research, valuation, trading, and reporting. Its main clients are investment and trading clients. The company operates through three divisions: an Information division, which provides pricing, reference data, indices, valuation and trading services; a Processing division, which offers trade processing solutions for OTC derivatives, foreign exchange, and syndicated loans; and a Solutions division, which provides enterprise software platforms, managed services, and custom Web solutions. In 2015 Markit acquired the Halifax House Price Index, Information Mosaic, DealHub and CoreOne Technologies in order to keep the company’s position as leading service provider, although none of these acquisitions were large transactions.

Industry Overview

Outlook for the industry has been optimistic and high growth levels are expected. A driving factor behind the growth is market fragmentation caused by post-2008 financial crisis regulation. These regulations have shifted over-the-counter trading away from banks and onto electronic trading platforms making it harder to value and price things, which is good for data companies.

Moreover, market data vendors are becoming desirable assets given that increasing competition has made exchange-traded products less profitable. A sign of this desirability is the wave of mergers and acquisitions that have taken place in the market data space over the past year. Some of the largest acquisitions include Bloomberg’s purchase of Barclays’ index benchmarking business, Verisk Analytics’ agreement to buy Wood Mackenzie, and McGraw Hill Financial deal for SNL Financial.

Deal Structure

The transaction consists of a merger of equals giving birth to a new entity, headquartered in London, to be named IHS Markit.  IHS shareholders will own approximately 57% and Markit shareholders will own approximately 43% of the combined company on a fully diluted basis. IHS shareholders will receive 3.5566 common shares of IHS Markit for each share of IHS common stock, which based upon the IHS closing price of $110.71 on March 18, implies a per share price of Markit common shares of $31.13. The deal values Markit at roughly $5.5bn (around 11x EBITDA), and the combined company at around $13bn.

Mr. Jerre Stead, CEO of IHS, will be Chairman and CEO until the end of 2017, while Mr. Lance Uggla, founder and CEO of Markit, will be President and board member until the end of 2017, then he will become Chairman and CEO. The board will be composed of 11 members, 6 designated by IHS and 5 by Markit.

The transaction, which has unanimously been approved by both companies’ boards, still requires shareholder approval and is subject to customary closing conditions and regulatory approval. Closing is expected to take place in the second half of 2016.

Deal Rationale

As mentioned in the introduction, the new company is expected to become a key player in the financial market data industry, which has long been dominated by Bloomberg and Thomson Reuters, respectively with market shares of around 32% and 26%. According to the boards of both companies, which have unanimously approved the transaction, IHS Markit “will be a leader in critical information, analytics and solutions, and will have non-overlapping customers and products, a strong financial profile and an excellent management team”. The company is also going to be delivering next-generation information and analytics products to help customers in decision-making, a field that is expected to offer incredible growth opportunities as trading and investing decisions increasingly depend upon machine output. Both CEOs are convinced that the cultural fit between the two companies and the enhanced product innovation resulting from the merger will guarantee high and stable cash flows and a strong return on capital for shareholders, who will be able to cash-in some value through two $1bn share repurchases scheduled for 2017 and 2018.

The merger will create a global information powerhouse with leading positions in energy, transportation, and financial services. The sharing and flow of information within the new organization will improve innovation capabilities, while greater variety in product proposition coupled with a complementary and broader customer base (including more than 75% of Global Fortune 500 companies, governments, large oil & gas and automotive companies on one hand, and investment banks, asset managers, hedge funds on the other) will generate important cross selling opportunities, potentially delivering approximately $100m of additional revenue by 2019. In terms of future product development, management has in mind the creation of a single vast data pool for industry applications and analysis, as well as the creation of new energy indices and of smart beta indices and factors, leveraging on IHS’s industry, economic, and risk data. With respect to cross selling, there are effectively great profit opportunities. In fact, IHS’s primary customers, i.e. aerospace and defense, oil and gas, and automotive companies, will be able to benefit from Markit’s enterprise data management, web services, and tax solutions services (helping corporations comply with tax rules and cross-border payments). On the other hand, Markit’s customers will have access to IHS oil and gas information and research.

Recurring Revenue - Figure 1

Moreover, a stable and diversified revenue base combined with a strong balance sheet allowing for financial flexibility should be key drivers in terms of new product investment. The large portion of IHS’s subscription based revenue, together with Markit’s fixed and variable recurring revenue, should guarantee stability in future gross proceeds. Durability in revenues on a global scale will also be the result of a more diversified segment and geographic mix. Management is expecting strong future free cash flows ($900m expected for 2015) and has set a target gross leverage of 2.0-3.0x with a high non-investment grade rating.

Revenue Breakdown - Product & Geography - Figure 2

The new company expects to realize cost synergies of $125 million by the end of 2019. These will be driven by integration of corporate functions, reduction in technology spending resulting from improvement in IT infrastructure, establishment of centers of excellence in cost-competitive locations, and optimization of real estate and other costs. The transaction is expected to be immediately accretive to adjusted diluted EPS, and should result in approximately 20% adjusted diluted EPS growth in 2017.

One last point should be made with respect to the tax consequences of the transaction. In fact, IHS Markit will be incorporated the UK, rather than in the US (though it will keep some key operations in Colorado). While initially this deal might have seemed to be designed for the very purpose of a tax inversion (we have seen a lot of these happen recently, triggering temporary competitive advantages and thus further inversions) it is clear from what has been analyzed in this paragraph that the actual benefits go well beyond that of a lower tax rate, which is expected to be in the 20-25% range. It is indeed true, however, that the benefit is not negligible, especially when it comes to repatriation of foreign profits (which would be charged a 35% tax from US authorities). Moreover, for the sake of clarity, this is not technically a tax inversion, insofar as IHS’s shareholders will end up owning less than 60% of the new company.

Market Reaction

Upon announcement of the deal, on March 21, shares of Markit climbed to $32.26 (rising 9.4%), while those of IHS jumped 6.4% to $117.80. The same day, the two closed at $33.51 and $122.09, respectively. The movement in share prices reflects the good growth prospects from the deal, both in the short run, given the immediate EPS accretion and the share buyback programs scheduled for the next 2 years, and in the long run, considering the opportunities offered by the sector, the operational and cultural fit of the two companies, and the track record of top management.

Financial Advisors

IHS was advised by M. Klein & Co. and Goldman Sachs Group Inc., while Markit was advised by JP Morgan Chase & Co.

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