Thoughts on the S&P Global / IHS Markit merger

On the surface, the combination of S&P Global and IHS Markit appears both inevitable, given the frenzied consolidation of financial market infrastructure in recent years; and straightforward, given that both companies are built on data.  Smash the companies together, cut duplicative costs, cross-sell datasets, and combine the datasets into new products.  Easy.  But the deal’s strategic logic is complicated by the mishmash of financial and industrial datasets across both companies, and its enormous size belies its modest contribution to the returns that S&P’s shareholders are likely to realize.

IHS Markit (INFO) came about through the 2016 merger between industrial data vendor IHS Inc. and financial data vendor Markit. IHS Inc. was founded as an aggregator of third-party engineering content, which it gather over the next 60 years from 400+ technical organizations¹ that developed operational performance, safety and other standards across various industries.  It maintains a vast library of diagrams, product change notifications, and other data on 500mn different components from over 10k technical books, which engineers reference to design, test, and repair structures that go into cars and planes. 

From its origins in technical standards data, IHS built a presence in upstream oil and gas data, one small acquisition after the next.  IHS has, according to management, the most comprehensive energy database in the world and counts nearly every major E&P, refiner, and national oil company as a customer.  It has 140 employees and independent contractors who communicate with government agencies and oil & gas operators; collect seismic surveys and the drilling results of 700k wells; assess the hydrocarbon potential of hundreds of basins; and evaluate the infrastructure and geological context – airports, roads, distance to land, water depth – surrounding areas of interest.  This is mission critical stuff for an E&P looking to spend billions developing reserves. 

IHS then reached downstream from oil and gas, acquiring data relevant to refiners and liquified natural gas (LNG) producers, and then migrated further downstream still to cover chemicals and chemical byproducts related to agriculture (fertilizers, crop protection, biofuels)².  By the time it went public in 2005, IHS derived as much revenue from Energy, which at the time was growing ~12%-13% organically, as it did from Engineering, whose growth had slowed to 2%-3%. 

In selling technical standards data to parts suppliers, IHS already had tentacles into the automotive supply chain.  Why not build on that?  So starting in 2008 it began rolling up auto assets, launching IHS Automotive as a separate business line in 2011 and catapulting itself to scale in 2013 with its $1.4bn acquisition of RL Polk³, which more than doubled the size of IHS’ automotive segment.  Through that acquisition, IHS picked up CARFAX, the larger (60% of Polk’s revenue) and faster growing (double-digits vs. low-single digits) part of Polk that extended IHS’ capabilities to car dealers (CARFAX, as you likely know, provides detailed vehicle history reports that dealers use to assure customers that the car they are buying isn’t a lemon).  

IHS leveraged CARFAX’s consumer brand resonance to build a used car listing service similar to cars.com and Autotrader, and later rolled out an after-market loyalty product, CARFAX for Life, that directs car buyers to dealers for maintenance and repairs.  Rounding out its dealer offering, in September 2017 IHS purchased automotiveMastermind, a fast-growing marketing application⁴ that could ingest Polk and CARFAX data to build relevant audiences (testament to the profitable nature of its growth, the auto business expanded its margins even as AMM’s 8% margins rolled into the income statement)⁵. 

IHS’ auto database includes the year, make, model, and VIN of nearly every vehicle on the road in the US.  OEMs and dealers, who would otherwise only have access to internal data representing just a sliver of the overall market, rely on IHS’ market coverage to gauge consumer tastes in different markets; develop sales and production forecasts; and benchmark their unit sales volumes in different markets.  Dealers combine IHS content with demographic data to market new models to existing car owners.  OEMs can draw on IHS’ product design, chemicals, and electronics components market research and cost data to inform their manufacturing operations.  In short, from suppliers to dealers, from product planning to the aftermarket, IHS now has the entire automotive value chain covered.  All the major auto OEMs, 95 of the largest auto parts suppliers, and 20k auto dealers count themselves among IHS’ customers.  

In 2015, after hundreds of acquisitions over 60 years, IHS looked something like this:

Indicative of the hard-to-replicate, mission critical product it sells, the Resources segment commands pricing power (2%-4%/year) and a low-90s retention rate (retention is more like high-90s for IHS’ large enterprise customers).  But with 60% of the business anchored to upstream oil & gas capex, the business has also proven volatile.  Revenue went from growing organically by low-teens in the mid-2000s to contracting by low-teens when upstream capex was cut in half from 2014 to 2016, to growing by 4%-5% in 2018 and 2019, and then shrinking by 9% in 2020.  Despite its sophisticated understanding of oil & gas supply and demand dynamics, IHS has more or less developed Resources revenue guidance by extrapolating current trends, repeatedly underestimating the swings.

85% of the Transportation is made up of autos (1/3 of which is tied to new car sales and parts suppliers), the growthiest and highest margin of IHS’ verticals.  The balance comes from maritime and trade information like the origin, destination, owner, cargo, and engine data of oceangoing vessels⁶. 

Consolidated Markets & Solutions (CMS) includes the legacy product engineering data and, through its $200mn acquisition of Global Insights in 2008, Economic and Country Risk (ECR), which evaluates the political, legal, regulatory, and economic risks across countries.  CMS’ mid-20s margins are substantially below the 40%-45% margins of Resources and Transportation due to royalties paid on third-party content.  This is a slow but consistent business, with revenue growing by 0%-2% and margins expanding a bit along the way.

Markit

Markit was founded in 2003 to provide reference and pricing data for credit derivatives, but over the years expanded to other illiquid and hard to price assets like loans, CLOs, and corporate and muni bonds.  The way this business works is brokers and asset managers give Markit their trading data and Markit sells the aggregated trading data back to them⁷, feeding it through internal systems, Bloomberg workstations, and analytic platforms like Aladdin and RiskMetrics⁸.

As discussed in [MKTX, TW] Market infrastructure: part 3, electronic trading networks like MarketAxess and Trumid are growing their share of fixed income trading volumes as broker-dealers, hamstrung by post-GFC liquidity and capital regulations, have been forced to downsize their balance sheets.  They may get more serious about selling corporate bond trading data, which could represent a competitive threat at some point.  But so long as there is some fragmentation among trading venues, asset managers will always want an independent third-party to aggregate data across them. Markit also uses its derivatives and credit data to value complex illiquid securities – including private equity positions, where it has been taking share from Duff & Phelps and Houlihan Lokey – and to price popular fixed income and credit derivatives index families like iBoxx, iTraxx⁹, and CDX, which were acquired by Markit in 2007¹⁰. 

Indices are a great business for all the reasons I’ve discussed in previous posts.   They spur adoption in a reflexive fashion and are pegged to secular trends like passive investing and the disaggregation of portfolios into factors.  Equity indices are especially profitable because much of their value comes from consensus.  S&P Global and MSCI, whose equity index segments command ~70% EBITDA margins, can use their trusted brands to create new products out of thin air. As I wrote in a previous post, that the Dow Jones remains a ubiquitously quoted benchmark despite the absurdity of its methodology, which weights constituents on their share price, is more feature than bug as it suggests that a more reasonable index couldn’t just come along and replace it the same way a vastly superior technology might in theory replace the entrenched network effects of, say, Google. 

Fixed income indices are less brand oriented.  I mean, yes, brand still matters and anyone who works in fixed income recognizes Markit’s iBoxx, iTraxx, CDX, ABX family of indices.  But corporate bonds, which often trade by appointment, can be far less liquid than their equity counterparts, so an index IP owner can differentiate by providing high resolution pricing and reference data on underlying constituents.

IHS Inc. also converts data into widely referenced commercial benchmarks – for example, nearly every gallon of refined fuel in North America is priced to IHS’ OPIS cost benchmark.  But creating a cost benchmark for automotive or wearable device components or other industrial use products isn’t as straightforward as slapping a logo onto a market-cap weighted portfolio of ESG stocks or whatever.  IHS hires geologists, oil & gas experts, analysts, and researchers to acquire and scrub the underlying data.  It has more economists on staff than any organization in the world apart from the World Bank and the IMF and more analysts tracking the energy markets than any major broker-dealer.  And so while IHS’ content can be repackaged and monetized many times over, that content is also burdened with significant costs.