We recently hosted our quarterly client conference call. You can read a full transcript HERE.

Below is an excerpt from the call discussing our investment in Broadridge Financial Solutions, Inc (BR).

Excerpt (Sean Stannard-Stockton speaking):

Another long-term holding in our portfolio is Broadridge Financial Solutions, a company we’ve been invested in since 2012. Over the last five years, this quiet, under the radar company has been one of our best performing and largest holdings. But it isn’t a company we talk all that much about simply because there isn’t much news flow in this industry and the news that is relevant isn’t typically particularly exciting.

Broadridge is the most important financial services company you’ve never heard of. They are the plumbing behind the financial markets. Their business has two core parts; Investor Communications, which delivers information from their broker-dealer, asset management, corporate issuers and wealth management customers to investors, and Global Technology and Operations, which provides trade processing services to manage the life cycle of a stock or bond transaction.

The crown jewel of their business is their near total control of the process by which companies and investment products complete the process of shareholder voting. When you are a shareholder of a company, or mutual fund, you have the right to vote on key decisions. Companies and funds are required to solicit votes from their shareholders and the SEC has made clear that they view engaging shareholders in the voting process is a key regulatory goal.

The vast majority of clients of Ensemble Capital have given us the authority to place these votes on their behalf. In doing so, we use a Broadridge service called ProxyEdge, which organizes and aggregates all of the ballots across all of our holdings and streamlines the process of voting them. It also provides us with information from third parties who offer advice on the various ballot measures. These votes are important to good corporate governance and a responsibility we take very seriously. What’s fascinating about this segment of the business is that Broadridge essentially has a legal monopoly providing this service with no material competition of any note. And it is a regulatory obligation for investment advisors to vote these proxies. Since the company counts 95% of brokerage companies as a client, it is almost as if there is an SEC mandated regulatory obligation for brokers and advisors to pay Broadridge for their services.

This dynamic, where Broadridge enables their clients to meet SEC regulatory obligations, is a key part of the story. From time to time, some investors have worried that regulation might hurt Broadridge. But while there is no doubt that they operate within a highly regulated industry, we believe that they are not the target of the regulation so much as they are a services provider that enables firms to comply with regulation. Indeed, the company’s management has routinely stated on investor calls that there has never been a new regulation that has materially hurt their business. Some investors seem to doubt these claims, but if you understand that regulation is what drives their business the idea that regulation is a risk doesn’t make much sense.

The investor communication segment isn’t only about voting. It also includes services that help their clients communicate with investor such as the distribution of marketing, regulatory and transaction related information. The SEC is very focused on increasing investor knowledge, engagement and transparency. So we believe there is a very long term tailwind supporting Broadridge’s business as the expectations for minimum investor transparency keeps increasing.

The Global Technology and Operations part of what they do is not as unique in the sense that there are meaningful competitors in this segment. However, these services are mission critical to the functioning of their clients. More recently, the company has been building out a set of services for wealth management firms. It might seem odd, but the fact is the wealth management industry is actually relatively young. Prior to 30 years ago, most investors worked with brokers who charged commissions for transacting in stocks and bonds. Today, the industry is moving rapidly towards advisory services such as what we provide at Ensemble Capital to our private wealth clients, where we offer holistic services and advice for a fee without receiving any transaction based commissions.

Because the industry is relatively young, so are the service providers. So one of the large opportunities ahead of Broadridge is building out a complete set of services and software for wealth managers. Unlike most of the newer firms in this space that have mostly built best of breed solutions for discreet elements of wealth managers’ workflows, Broadridge has done that but also is developing a comprehensive wealth management platform which they hope will streamline all aspects of the wealth management service offering.

And unlike the vast majority of financial software startups, Broadridge has deep, long term relationships with all of the major brokerage firms that are transitioning to wealth management business models. This is a big part of why they were able to win UBS, the largest wealth management firm in the world, as their initial client for their comprehensive platform.

Every company in our portfolio is unique. But even companies from different industries often benefit from similar dynamics. In the case of Broadridge, the key driver of their long-term competitive advantages is that they provide a mission critical service to clients, but the cost of those services makes up a tiny part of their clients’ overall cost structures.

Imagine you are an executive at a large broker and one of your managers suggests switching from Broadridge to a competitor for the service of delivering monthly statements and trade confirms. The first question you might ask is whether the change will make client happier. The answer is likely to be no. It is important to deliver statements and trade confirms and indeed it is a mission critical regulatory obligation. But investors are never going to pick a brokerage firm because they get monthly statements out more effectively. In fact, it isn’t even that clear what that would look like. It is just something that needs to get done without errors. There is no such thing as a premium statement delivery system.

So as the executive at a large brokerage firm, you might wonder why the manager is even wasting your time bringing up the idea of switching. So you ask a simple questions: “If the new service provider was free, would it save us enough to make a difference?” The answer would be no. These costs are so small relative to the huge cost structure of a broker, that the savings would be rounding error for the overall business.

So faced with a situation where changing to a competitor would provide no better of a service to investors and not save any material amount of money, but doing so would run the risk of errors occurring during the transition process and in fact could even cause regulatory issues, there is simply no reason to even consider moving to a competitor. And this is why Broadridge reports around 98% revenue retention meaning that every year, 98% of their customer base by revenue renews their contract for another year.

Providing mission critical services at a low-cost point in a business to business environment is one of our favorite dynamics. It creates a structural competitive advantage that keeps customers from leaving and allows for solid pricing power and stable long-term planning. With Broadridge, we think this dynamic will stay well intact for years to come and so long as the share price remains undervalued in our opinion, we expect to be shareholders for years to come as well.

You can read the full transcript HERE.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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