Clarivate: Attractive Upside Even With Conservative Assumptions (CLVT)

Investment action

I recommended a buy rating for Clarivate Plc (NYSE:CLVT) when I wrote about it in May, as I expected organic growth to improve when the macro climate gets better, and I did not see any structural weakness in the business given the strong customer retention metric. Based on my current outlook and analysis, I recommend a buy rating. My key update to my thesis is that the organic growth recovery story remains intact, and the two largest segments have shown good improvements in this front. As the macro environment gets better, the laggard segment (LS&H) should recover.

Review

CLVT reported 2Q24 earnings on August 6, 2024, which saw a revenue decline of 2.8% on a reported basis and 0.6% on an organic basis. The organic decline was mainly due to transactional revenue still being down 4.1% in the quarter, while subscription revenue stayed positive at 0.7% y/y. Re-occurring revenue was still down at -0.7% y/y. By segment, Academia & Government (A&G) revenue grew 1.3% y/y organically, Intellectual Property [IP] revenue fell 1.8% organically, and Life Sciences & Healthcare (LS&H) fell 3.9% organically. Negative organic growth led to EBITDA margin contracting by 40bps to 42.2%. That said, EPS did better than consensus expectations, where CLVT reported $0.20 vs. consensus of $0.18.

I will start by saying that 2Q24 results were within my expectations, in that organic growth is going to recover, but at a slower pace. The big fall in share prices is probably due to the market expecting a better organic growth outlook. For what it’s worth, the stock went above my price target a few days ago. Putting aside the share price dropping, I believe the 2Q24 results were quite positive, in that organic growth has improved 1Q24 from -1.7% to -0.6%, and it was driven by CLVT’s two largest segments: A&G and IP.

For A&G, organic growth accelerated from 0.6% in 1Q24 to 1.3% in 2Q24, with subscription revenue in this segment growing by more than 3% and renewal rates improving to > 96%. CLVT has also started to get back its momentum in winning large contract wins that included: (1) a 7-figure US multi-year content aggregation deal; (2) an EU library software deal; and (3) and also AI product enhancements to Web of Science Research Intelligence, ExLibris Specto, and ExLibris Collecto. For the IP segment, a similar improvement trend was seen. While still negative, organic growth improved by 270bps, from -4.5% in 1Q24 to -1.8% in 2Q24, indicating stabilizing trends with regards to trademark search volumes. Notably, CLVT has managed to improve its win rate on IPMS (IP management system) from a losing share position to a winning one today. This is a strong leading indicator of growth for this segment, as it takes 1 to 1.5 years before revenue starts to show up in the P&L.

I talked about our improved win rate on IPMS, the 80% competitive win rate in Japan. Frankly, two years ago we were on our back heels, now we’re on our toes. And that is a critical early indicator for us in IP, because when you win an IPMS system, you implement that for 12 months, you get that revenue, but then it gives you a far greater likelihood of winning the much larger annuities on back of that – 2Q24 call

The laggard that is preventing CLVT from accelerating its organic growth is the LS&H segment, which saw organic growth decelerate from 2.8% to 3.9%. This is frustrating, but I believe the decline is mostly due to the weak macro environment that continues to put pressure on large pharma companies to be tight on their budgets, as seen from the increasing number of layoffs. I wouldn’t want to speculate when the macro environment will get better, but I think readers should note two important things. Firstly, the long-term trend so far is that R&D expenditure goes up overtime, and any decline caused by a weak macro environment is subsequently followed by a strong recovery. Secondly, it seems like we are nearing the end of this macro downturn as inflation has tapered, US job data has softened, and the Fed seems confident enough to cut rates in September. Assuming the start of a rate cut is in September, I would expect this segment to see a strong recovery in FY25 as pharma companies restart their R&D initiatives.

All in all, I don’t think CLVT deserves to be punished as hard as it did over the past two days. I continue to think that organic growth will recover to low single-digits easily over the coming quarters as the macro backdrop gets better. One important thing to add is that management has noted they will look to opportunistically repurchase shares as the leverage ratio has stayed below 4x.

Valuation

The good news for investors is that valuation is cheap at the current level of 6.5x forward PE. At this level, there is no need to make aggressive assumptions to get an attractive upside. All we need is for CLVT to accelerate growth back to 3% by FY26, margins to inflect back to 22%, and multiples to trade back up to 8x forward PE. This is definitely plausible, in my opinion, as the macro environment recovers over the next two years.

1. The A&G segment is already growing at 1.3%, with subscriptions growing at >3%. Once the macro gets better, transactional revenue should improve, and the A&G segment should easily go back to its historical growth rate of low single-digits.
2. The IP segment should continue to see organic growth improvement as CLVT continues to win share and as past deals start contributing to topline growth.
3. LS&H segment timing of recovery is dependent on macro-recovery, and my base assumption is that it will happen by FY25.

With organic growth accelerating, I don’t see a strong case for margins to stay depressed at ~21% levels. Historically, the business generated a 23-25% adj. net margin between FY20 and FY23. For my model, I assumed the margin would hit 22% in FY26. Multiples should improve as organic growth and margins get better. My assumption is for multiples to go back to 8x forward PE, which is a very conservative multiple considering that the market valued the stock at 9x forward PE two weeks ago.

Risk

The stock may trade down even further if the next quarter’s performance does not show any signs of organic growth improvement, even if the reason is due to the macro environment. CLVT has announced a new CEO will be taking charge, and this brings a new layer of uncertainty to the business and stock. If there are major strategy changes, it may further delay the timing of organic growth.

Final thoughts

My recommendation is a buy rating for CLVT. The recent earnings, while not spectacular, demonstrate a path to organic growth recovery. The stabilization of its two largest segments, A&G and IP, is particularly encouraging. While the LS&H segment remains a drag, I believe performance is largely dragged down by macroeconomic headwinds and should recover eventually. Given the cheap valuation today, I think it is an attractive entry point.