This Is One of the Best Businesses in the World

Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I often find myself thinking about the perfect business: one that exhibits all the qualities that will ensure a highly profitable operation for years to come. It must have certain qualities to distinguish it from all the other businesses out there. It mustn't need a whole lot of assets to make money. That's because assets need maintenance, and a pricey overhead will certainly hurt the bottom-line. It must generate sufficient cash at all times - good and bad, alike. And most importantly, it must boast an exceptionally high operating margin. If it's able to support such a margin throughout its years of operation, I'll know that it has a wide enough a moat. Otherwise, other competing businesses would have eaten its lunch.

One of the best businesses in the world

I believe the business of selling unbiased research and consulting services is one of the better businesses I know. And that's for the following reasons:

  1. Turbo- charged market: The segment of information technology (IT) is expanding rapidly. It's probably no surprise to you that our world is awash with enormous amounts of computer data. And it just keeps growing and growing. An eBay study says the amount of business data worldwide doubles about every 1.2 years. The Gartner Group predicts the amount of business data will grow 800% over the next five years. This information needs to be collected, maintained, and analyzed. Large companies want professional advisory on how to handle this amount of data.
  2. Recession proof: Companies and governments need data and services when they are growing as well as when they are downsizing. This makes the business of selling data and services lucrative in good and bad times alike.
  3. Few assets: a research and consulting business isn't expensive to maintain. There isn't a whole lot of capital expenditures on a service oriented business. 

Who's the leader in the research business?

Gartner (NYSE: IT) is the world's largest information technology research shop, and a leading information technology and advisory consulting company. The company produces its own research on technology-related subjects, information technology in particular, and then goes and sells its services to executives in charge of making strategic IT decisions such as CIOs. You see, corporate budgets for IT are relatively very large, normally in the ballpark of tens of millions of dollars. A business executive usually won't think too much before commanding $70,000 (the average cost per customer) to pay for Gartner to assist him in handling IT within his organization. In a sense, Gartner gives corporate IT managers the same type of backstop Moody's gives corporate financial managers. If Gartner says do something and it goes wrong, the corporate manager can deflect blame. It's a win-win situation. 

Market dominance

Gartner, with a market cap of $5.7 billion is by the far the strongest rival out there with 60% of the total IT research market. Way after it, comes Forrester Research (NASDAQ: FORR), an $800 million market cap research company and Xerox (NYSE: XRX). Xerox and Forrester, combined, control about 10% of the market of IT research. In other words, Gartner's dominance in the IT market is equivalent to Wrigley's dominance in the market for chewing gum. That's a highly remarkable presence.

Financials

Gartner is a cash gushing machine. It increased its total revenue from only $96 million in 2010, to $196 million in 2012. During the same period, cash from operations increased from $98 million to $152 million, a remarkable 56% increase. During that same period of time, Forrester increase its total revenue from $250 million to $292 million. This vastly improved its cash position which ticked up from a negative $10.8 million in 2010, to a positive $17.8 million in 2012. Also notable is the company's large cash position. The company's cash-per-share currently stands at $12.8, that's roughly a third of the share price. In contrast to Gartner and Forrester, things aren't looking too good for Xerox. This ailing company saw its gross profits decline by 6% from 2010 to 2012, despite a 5% increase in total revenues. 

Valuation 

Currently, shares of Gartner trade at a high valuation. Its price-to-earnings ratio for 2013 is 27.8x, with 41.4x and 7.9x for Forrester and Xerox, respectively. Xerox's valuation is artificially suppressed from the company's printing business that is experiencing secular decline due to the switch from paper to digital. On a price-to-earnings-to-growth ratio, Gartner, Forrester and Xerox trade at 1.4x, 1.1x and 1.1x, respectively. While Gartner is slightly more expensive when accounting for expected growth, this is justified as the company has the best EBITDA margin among the three companies of 17% compared to 14.6% for Forrester and 13.4% for Xerox.

Looking ahead

Research and IT consulting is a great business. Margins are high, maintenance is low, and cash flow is very strong. I believe that due to its size and dominance, Gartner is uniquely positioned to benefit from the growing demand for IT services worldwide. Gartner not only helps companies solve their IT problems, but it's also at the cutting edge of IT related research that is bound to drive the future. 



Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Gartner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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