Computershare (CPU) operates as a technology and administration company, largely servicing financial entities and corporates, helping streamline many of their business functions. Life started in 1978 initially to provide business process automation services, before specialising in share registry software, for which the company and product is most widely known. CPU has significantly grown both organically and inorganically to now comprise 7 separate divisions, effectively diversifying its revenue streams.
Recurring revenue. c.80% of CPU’s FY22 revenue was considered recurring in nature, providing valuable defensiveness throughout the cycle. The remaining revenue is split across transaction-based contracts which despite being lumpier, provide growth opportunities.
Margin income (MI) is printing cash, increasing with rising rates. CPU derives interest income on the cash balances that it holds on behalf of its clients. The recent acquisition of Corporate Trust Services has nearly doubled the total balances, with scope for this to grow as CPU win more clients. With interest rates normalising after the pandemic, CPU can now return to high levels of free cash flow, available to fund dividends and acquisitions and maintain a higher earnings profile.
History of accretive synergistic acquisitions. Cost control has been a key focus for CPU as many of its businesses face low-single digit organic growth, with disciplined cost management becoming engrained in the culture. Inorganic growth has been instrumental in CPU’s strategy, and the recent acquisition Corporate Trust Services is expected to deliver US$80m of pre-tax cost synergies by FY27, which could be >15% on an EPS level.
Investment View
We rate CPU a Buy. The company’s overall earnings are highly sensitive to global bond and cash rates, and therefore can be volatile. This however serves as a valuable inflation hedge, and CPU has strongly rallied as interest rates rapidly rose over the last year. The base business revenues are relatively defensive and stable throughout the cycle, providing a level of predictability.
CPU is currently trading on a FY24 PER of c.12.5x, with its 10-year historical average being closer to 17x. Whilst there is ample valuation upside from a multiple perspective, as we are nearing the end of the rate rising cycle, we note there are risks to the earnings outlook and there are likely no further significant upgrades from margin income, albeit if rates remain higher for longer, CPU will continue to benefit.
Business Overview
Computershare (CPU) was established in Melbourne in 1978, with the initial ambition to provide computer services to businesses that needed to automate processes. Eventually, CPU progressed to providing specialist computer bureau services to Australian share registrars. The company has since evolved through organic and inorganic growth into 7 separate business divisions, each providing a diversified revenue stream.
Issuer Services comprise register maintenance, corporate actions, stakeholder relationship management, corporate governance and related services.
Mortgage Services and Property Rental Services comprise mortgage servicing and related activities, together with tenancy bond protection services in the UK.
Employee Share Plans and Voucher Services comprise the provision of administration and related services for employee share and option plans, together with Childcare Voucher administration in the UK.
Business Services comprises the provision of bankruptcy and class actions administration services, and the legacy corporate trust operations in Canada and the US.
Computershare Corporate Trust comprise trust and agency services in connection with the administration of debt securities in the US.
Communication Services and Utilities operations comprise document composition and printing, intelligent mailing, inbound process automation, scanning and electronic delivery.
Technology Services comprise the provision of software specialising in share registry and financial services. Note that almost all of the revenue earned here is netted off as intersegment revenue.
Figure 1: FY22 Revenue by segment
Figure 2: FY22 Revenue by geography
CPU has continued to diversify its business streams with a significant focus towards higher quality recurring income, providing more stability throughout the cycle. EBIT margins have consistently been in the 20-25% range, albeit with some volatility due to lower interest rates, especially over the last 2 years. CPU are expecting margins to lift back towards historical norms as margin income improves with higher interest rates.
Figure 3: High quality core businesses driving consistent operating performance
Key Earnings Considerations
Margin income and interest rates have been the key driver of earnings expectations, leading to significant upgrades over the last 2 years, which we provide more detail on below. Expectations of interest rates in the US are for further rises above the 4.25%-4.50% current target, before paring back towards a more neutral rate of around 3.50%. CPU and the market forecast margin income based on the future interest rate expectations, where any significant changes can have outsized impacts on the earnings and therefore share price. Much of the interest rate upgrade cycle has played out already, where we do not expect any further material upgrades based on interest rates. However, if rates do remain higher for longer due to stubborn inflation, CPU’s earnings would continue to be upgraded. CPU also engages in hedging programs where it will seek to earn higher rates for longer. We note that if rates fall faster or further than anticipated by the market, CPU’s earnings will be at risk, and so too will the share price.
Underlying base business growth and acquisitions are other drivers of returns, although we note many of the divisions are relatively mature, with earnings growth largely being attributed to cost-outs and synergies to improve margins. Key acquisitions have been driving earnings accretion and overall growth of the company. The recent acquisition of Computershare Corporate Trust (CCT) is a particular bright spot, with CPU validating a US$80m synergy benefit by FY27, which may be a greater than >15% uplift to earnings per share. CPU has a history of finding more synergies and cost-out opportunities, with disciplined cost control potentially surprising market estimates. The remainder of the business units will likely grow at mid-single digits, driven by incremental market share gains and business efficiencies. CPU also operates a bankruptcy business, which provides a level of counter-cyclicality to its earnings if economic conditions worsen. We provide more detail on the below divisions and key opportunities and challenges for each.
Capital management opportunities will likely be ripe over the coming years, with CPU’s free cash flow improving with higher interest rates. CPU’s Net Debt/EBITDA ratio at 30 June 2022 was at 1.64x, well below its target range of 1.75x-2.25x, providing ample room for debt funded acquisitions, or capital management. We would expect the dividend yield of the stock to remain strong at around 4% whilst cash rates remain where they are, with further likelihood of buybacks or accretive acquisitions with the excess cash. Further, CPU has stated its intention to sell its UK mortgage business, providing other opportunities for cash returns to shareholders. A better sale outcome could surprise on the upside.
Margin Income and Leverage To Interest Rates
CPU is able to earn interest on balances that it holds on behalf of clients which are then exposed to short dated bond yields and other cash-like products. The balances are often with CPU for short time periods, with an example being a company paying a dividend, where it will first provide the money to CPU, which CPU will then distribute to the relevant shareholders (note there are a plethora of other scenarios where CPU will hold cash for a client). This process provides an invaluable source of relatively easy and relatively risk-free income for the business. The acquisition of Computershare Corporate Trust (CCT) from Wells Fargo in late 2021 has seen the average client balances significantly increase, providing a meaningful uplift in earnings potential.
Figure 4: Margin Income driven by higher balances and rates in 2H22
At the FY22 result in August, CPU guided for a meaningful uplift in FY23 for margin income of US$520m, up from US$178m in FY22. This was driven both by higher rates and higher average balances. CPU also guided for EPS to be up 55% as a result. Note that CPU does not earn the exact cash rate on the total balances, given that not all the balances are exposed and there is hedging within the portfolio, and CPU expect on average to achieve around 90% of the overnight cash rates. CPU are also anticipating an additional benefit of $50-75m in FY24 due to improved yield on exposed balances from the ending of CCT earning below market rates from Wells Fargo as part of the transaction agreement.
In November 2022 at the AGM, CPU provided a further update to its guidance on the back of faster than anticipated rate rises in the US, and significantly upgraded its margin income assumption from US$520m to US$800m. This demonstrates the substantial impact that interest rates can play on CPU’s overall earnings and its sensitivity to changes in rates. With cash and bond rates looking like they are near their peak, we expect the upgrade cycle from margin income to similarly reach its peak in due course. CPU however expect US$1,010m margin income in FY24 as a full year of higher rates is captured.
Figure 5: Margin Income guidance upgraded over FY23 ($USm)
Figure 6: Cash rate assumptions largely increased since August
Core Business Opportunities
CPU has a solid core business, with much of its income being recurring in nature. Each division has its own separate opportunities and challenges which we break down into more detail below.
Issuer Services (38% of FY22 revenue) is the largest overall segment, and is further broken down into Register Maintenance, Corporate Actions, Stakeholder Relationship Management and Governance Services. Register maintenance for which the company is most known is still the largest component of overall group revenue. Over FY23, CPU are expecting market share gains in register maintenance and organic growth in adjacent market segments, such as registered agents, company secretarial services and private markets. Margin Income is expected to increase as rates continue to rise but there are some challenges from inflationary cost pressures. CPU are also anticipating further weakness in Corporate Actions and M&A activity over the coming year.
For the segment, CPU expect organic growth (excluding margin income) over the medium term for revenue to be 0-3%pa and EBIT growth of between 0-5%pa, driven by ongoing investment in front office capabilities and digital innovations to improve margin efficiency.
Figure 7: FY22 Issuer Services revenue breakdown ($USm)
Figure 8: Continued net wins driving increased account numbers
Figure 9: M&A volumes likely to remain below FY21 levels through FY23
Mortgage Services (23% of FY22 revenue) comprises both a US and UK business, with the US business generating c.78% of segment revenue in FY22 with CPU stating its intention to sell the UK business in FY23. The segment primarily deals with Mortgage Servicing Rights (MSR) which refer to a contractual agreement in which the right to service an existing mortgage is sold by the original mortgage lender to another party (such as CPU) that specialises in the various functions involved in servicing the mortgage (such as the administration in collecting and distributing payments). A lender will often sell MSRs as a means of freeing up lines of credit for lending money to additional borrowers and for solving business complexities by being able to devote more resources to mortgage origination. The owner of the MSR can either service the loan itself or appoint a sub-servicer to do so. CPU has been moving away from owned MSR’s and focusing more on the sub-servicing component, as there is less upfront capital required and CPU can generate higher returns on invested capital (ROIC).
Over FY23 for US Mortgages, CPU expect to see improvement in underlying portfolio values (measured as UPB - Unpaid Principal Balances) as higher mortgage rates slow down prepayment speeds. There are also plans to execute on a cost-out program to increase digitisation and drive operational efficiencies, reducing cost per loan in fulfillment and servicing.
In UK Mortgages, CPU are actively managing the cost base and have extended the cost-out initiatives to FY26 which is expected to deliver incremental benefits of US$6.5m. It intends to complete the sale of the business in FY23.
Figure 10: Sub-servicing volumes driving UPB growth
Figure 11: Solid organic medium-term outlook
Employee Share Plans (13% of FY22 revenue) revenue is broken down into fee revenue, largely from customers utilising its platform for administration purposes, and from transactional revenue where a user will execute a trade on their stock holdings or options. CPU has focussed on its front office investment to leverage client relationships, leading to a 5% growth in fee revenue over FY22, driven by new client wins and upselling opportunities. Transactional revenues were impacted by market volatility, although this is expected to recover as markets normalise over the coming years.
CPU recently acquired the EquatePlus platform in 2018, which is a market leader in the segment. Growth for CPU will be driven by increased equitization of remuneration as clients issue more equity as compensation deeper into the organisation, as well as the increased globalisation of workforces and complex regulation, driving corporates to seek global service providers to provide compliant and consistent solutions. The organic medium-term outlook for revenue growth is between 3-6%pa, and for EBIT to grow 4-8%pa, driven by an improving margin and continued rollout of the EquatePlus platform globally.
Computershare Corporate Trust (13% of FY22 revenue) was acquired on 1 November 2021 from Wells Fargo, and it provides a wide variety of trust and agency services in connection with debt securities issued by public and private corporations, government entities and the banking and securities industries. The acquisition is exceeding initial expectations with cumulative synergies of US$10m in FY22 achieved, vs US$7m expected.
CPU expect to continue delivering and integrating the business and fully leverage opportunities from the increasing rate environment and in the management of client balances. Whilst rising interest rates may impact debt issuance volumes, margin income is expected to more than offset this. CPU expect to deliver US$15m in cumulative synergies by the end of FY23 and are targeting a total of US$80m by FY27.
The organic medium-term outlook is for revenue growth of between 5-7%pa, and EBIT growth of 15%+. This will be driven by a targeted ROIC of 15%+ and through strong integration synergies. In FY23, CPU expect the segment to generate US$450m of EBITDA, generating a ROIC of c.32%, more than double the target.
Figure 12: Trust Fees ($USm)
Figure 13: Cumulative Synergies ($USm)
Business Services (7% of FY22 revenue) includes legacy corporate trust revenue, as well as bankruptcy and class action administration. Over FY22, the legacy corporate trust business continued to add mandates albeit was impacted by the sale of Private Capital Solutions. The bankruptcy market was subdued with low case filing levels, although CPU expect a rebound in FY23 with a deteriorating economic environment and expect case wins to increase by 68%. CPU has continued its focus on global and large-scale class action opportunities and continues to manage several large projects. CPU also expect improved margins from a revised operating structure, process automation, and systems enhancements.
The organic medium-term outlook for revenue is growth between 4-7%pa and for EBIT growth of 3-5% as the segment invests into its front office skills and capabilities to ensure it is properly positioned to execute on market opportunities.
Valuation Considerations
In response to the rapid interest rate rises, CPU has rallied strongly over the last 2 calendar years, returning 43% in CY2021 and 34% in CY2022, compared to 17.0% and -1.3% for the ASX200 respectively. CPU has traditionally traded relatively in line with the US 10-year treasury bond yield (albeit not a perfect correlation at times) and currently the two are relatively in line, indicating that the stock is closer to being fully priced where current rates are. However, if inflation and rates continue to run above expectations, there is scope for additional earnings upgrades and shareholder returns, although the stellar performance of the previous 2 years is unlikely to be repeated.
Figure 14: Share price performance has largely tracked the US 10-year bond yield
If rate expectations were to remain the same, earnings would largely be driven by the base business which we would expect to track at mid-single digits. With interest rate expectations stabilising, the opportunity for further earnings upgrades remains subdued. CPU however is trading on relatively inexpensive multiples given the recent earnings upgrades in November. We believe the market is heavily discounting CPU and would expect some level of mean reversion towards its longer-term averages, providing significant valuation upside.
Figure 15: Trading below average P/E
Figure 16: Same for EV/EBITDA
Over the last few years, the base business contributed 60%, 76% and 65% over FY20-22 respectively to group EBIT, with the remainder being margin income. Growth in the base business has been relatively modest, growing just 1.4% in FY22. Whilst FY22 was largely an outlier year with runaway inflation, rapid interest rate rises and other deteriorating macro-economic conditions, CPU’s future growth is highly dependent on margin income. There is upside potential however with synergies and cost-out programs, improving margins, as well as growth drivers through market share gains.
Figure 17: Divisional EBIT ex-margin income growth is relatively modest. 65% of FY22 Group EBIT was from the base business, with 35% from margin income
The balance sheet is in impeccable shape, with the net debt/EBITDA ratio of 1.64x as at 30 June 2022 falling below CPU’s target (1.75x-2.25x) given the windfall from margin income. This provides additional optionality for debt funded acquisitions, without needing to tap the equity market. With CPU also looking for a sale of its UK mortgage business, there is a significant opportunity of increased capital management if there are no suitable acquisition targets present.
Investment Thesis
We rate CPU a buy. Trading on a FY24 PER multiple of c.12.5x, CPU is much cheaper than the market and when compared to its 10-year historical average of c.17x. The outperformance in 2021/22 was driven by the rising interest rate environment, with CPU’s margin income being highly leveraged to current interest rates. Whilst we believe the future upside on interest rates is capped given that we are nearing the peak of the interest rate cycle, CPU is still printing cash.
CPU returning to its long-term PER multiple of c.17x would see considerable upside. Consensus has FY24 eps rising c.20% on FY23, although the actual figure will be volatile and impacted by future rate assumptions. We would expect the market applies a lower multiple than its history given the macroeconomic volatility and likely slowing of upgrades from interest rate rises as bond yields begin to taper.
With 35% of FY22 EBIT being attributed to margin income and the split likely to be higher in FY24, the earnings figures are highly susceptible to changes in interest rates. We therefore caution that any significant change in the interest rate environment would have an outsized impact to CPU’s earnings and the stock will likely continue to be volatile over the coming year, largely trading on macro signals from the bond market. We also note that CPU reports in USD, with changes in currency also impacting the translated $A share price.
