With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Gartner Inc. (NYSE: IT). Firms such as Wellington Management, Citadel, and Winslow Capital Management have all added to their IT positions recently. Most notably, Wellington Management increased shares held by 12.91% (as filed on 6/30), bringing their total IT holdings to 1,818,820 shares worth around $644 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Gartner Inc. (NYSE: IT).
In August, Gartner Inc. posted strong earnings results for the second quarter of fiscal year 2023. In the quarter, revenues were $1.5 billion dollars, a 9.2% YoY increase. Total contract value came in at $4.6 billion dollars, a 8.9% YoY increase. Additionally, free cash flow was up 4% YoY to $410 million dollars, with net income coming in at $436 million dollars during the quarter. With these strong earnings results, management increased free cash flow, adjusted EBITDA, and diluted EPS guidance for 2023, showcasing the business’ strong outlook going into the last few months of the year. In addition to solid financial metric growth, management repurchased 400,000 shares in the quarter for $132 million dollars. With these solid earnings results in mind, we believe that Gartner Inc. is a compelling investment opportunity and a high quality business.
Gartner Inc. delivers actionable, objective insight to executives and their teams. Gartner’s tools and expert guidance enable faster, smarter decisions and stronger performance on an organization’s mission critical priorities. Gartner is a trusted advisor for more than 15,000 enterprises in approximately 90 countries and territories in every industry and enterprise size. The business delivers its products and services through three segments that include research, conferences, and consulting. The research segment provides executives and their teams with guidance and tools to help them meet their mission critical priorities, with Gartner’s experienced experts delivering practitioner-sourced and data-driven research to their clients. The conferences business segment provides executives and teams with the opportunity to learn, share, and network through Gartner’s industry-leading business conferences. Lastly, the consulting business segment serves senior executives leading technology-driven strategic initiatives. Gartner’s consulting segment enables optimized technology investments and strong performance of their clients mission critical priorities through on-the-ground support and customized analysis.
Gartner faces competition from a significant number of independent providers of information products and services. Gartner also indirectly competes with consulting firms and other data and information providers, which includes electronic and print media companies. Management believes that Gartner is very competitive within the information products and services industry. Management believes there are an array of principal factors that differentiate them from their competitors. These factors include superior research content, leading brand name, Gartner’s large global footprint and established customer base, experienced management team, vast network of research experts and consultants, and substantial operating leverage within Gartner’s business model (Gartner can distribute intellectual property and expertise across various platforms and business segments to derive incremental revenue and profitability).
Management is solid and their capital allocation priorities do a great job of creating shareholder value. Management likes to repurchase shares, directly creating shareholder value. In 2020, management repurchased $200 million dollars worth of shares. In 2021 and 2022, management repurchased $1.7 billion and $1 billion dollars worth of shares, showcasing management’s aggressive share repurchase initiatives within the last few years. As of December 31st, 2022, there was still around $600 million dollars for further share repurchases of Gartner’s common stock. While management likes to return excess cash to shareholders via share repurchases (thereby creating shareholder value), the company does not currently plan to issue cash dividends on the business’ common stock.
In terms of management incentives, Gartner’s management incentives are solid, doing a good job of aligning shareholder and management interests. NEO and CEO compensation structures put a large amount of pay “at risk” (85% for the CEO and 69% for all other NEOs) with long-term incentives that put priority on long-term performance of the business. Additionally, only 7% of the CEO’s total compensation comes from a base salary, whereas all other NEOs earn 16% of their total compensation in the form of a base salary. Long-term incentive rewards are rewarded based on a multitude of factors, including external market practices, individual performance, the value of awards granted in previous years, and succession considerations. Long-term incentive rewards are paid out in equity via PSUs (performance-based restricted stock units) and SARs (stock-settled stock appreciation rights). With a large portion of NEO and CEO total compensations coming from long-term incentive rewards (which are paid out via equity), shareholder and management interests are well aligned. Additionally, equity rewards vested over a period of time do a great job of retaining executive talent over the long-term. We believe the best businesses are those that treat shareholders like a partner in the business, and we believe that Gartner’s shareholder friendly management incentives do a great job of this.
Gartner Inc. is a very efficient business. The business operates at a LTM ROE of 416.6% and a LTM ROIC of 32%. With a WACC of 10.5%, Gartner Inc. operates at a ROIC to WACC ratio of 3.05x, showcasing the business’ ability to generate returns on cash reinvest back into the business at rates of return far higher than its weighted average cost of capital. Businesses that are able to efficiently reinvest cash back into the business, like Gartner, are considered to be compounders, businesses that are able to rapidly compound intrinsic value over the long-term. Looking further at efficiency metrics, we can see that ROIC has expanded rapidly since 2017. In 2017, ROIC dropped from 44.7% to 3.4%. Since that large drop off, ROIC has expanded from 3.4% to a LTM ROIC of 32%. This may possibly show a strengthening moat or competitive advantage within the industry that Gartner operates in.
Analyzing Gartner’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Gartner has grown revenue at a CAGR of 11.2%, with gross profit growing at a CAGR of around 12.6% in that same time frame. This growth in gross profit can largely be attributed to expanding gross margins. In 2013, Gartner operated at a gross margin of 60%, compared to today where the business operates at a LTM gross margin of 68.4%. As you can see, Gartner is a high margin business, and is able to generate a large profit from revenue. In terms of earnings, Gartner has grown EBITDA at a CAGR of 14.5% since 2013, with EPS growing at a CAGR of 17.5% in that same time frame. This growth in EPS can largely be attributed to share repurchases. Gartner is a cannibal, decreasing shares outstanding by 14.3% since 2013.
Looking at Gartner’s balance sheet, we can see that the business operates in good financial health. Gartner currently has around $1.17 billion dollars worth of cash and equivalents on hand, with $2.45 billion dollars of long-term debt and no short term borrowings. While we would like to see a business have more cash on hand than debt, Gartner operates at a very manageable cash to long-term debt ratio. Adding credence to this point, Gartner operates at an interest coverage ratio of 11.84x, signifying that the business generates $11.84 of EBIT for every dollar of interest expense that the business incurs, showing the large runway Gartner has to pay off its debt obligations.
Looking at Gartner’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ operational efficiency. Since 2013, Gartner has grown net income at a CAGR of around 16%, with free cash flow growing at a CAGR of 12.3% in that same time period. Free cash flow margins have stayed relatively flat over the last decade, with the business currently operating at a free cash flow margin of 17.4% of revenue.
After conducting a reverse discounted cash flow analysis, we can see that Gartner Inc. is trading at share prices that imply a 13.14% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. While Gartner is a very high quality business, we believe that this is a high valuation above fair value for Gartner. At a more reasonable growth rate (7%), Gartner has an intrinsic value of $235 dollar per share (according to our models), implying a 33% decrease from current share prices. While Gartner is a very high quality business, like mentioned above, we believe that it is fetching a valuation that is too high for our liking. It may be beneficial to wait for a correction before entering into a position. As always, these figures are all based on our models, and we encourage every investor to do their own due diligence before entering a position into Gartner Inc.