Risk lurks everywhere. And it can be incredibly profitable -- as long as it can be identified, forecast, and tracked. So decades ago, Warren Buffett joined a consortium of America's biggest insurers to create a risk lab that can do just that.
That number crunching consulting firm, Verisk Analytics (VRSK 0.49%), has proven vitally important to Buffett given that some of his biggest -- and most successful -- investments have been insurers that rely heavily on quantitative analysis to model pricing and profit.
Verisk remained behind-the-scenes for years, but as the walls separating insurance and banking were torn down (Glass Steagall) and increasingly complex financial instruments were developed and sold to insurers (CDOs/CMOs), Verisk grew big enough that the consortium was able to spin it off to raise cash to bolster sagging balance sheets during the great recession.
Today, Verisk's data mining solutions are used by all 100 of the country's largest property and casualty insurers and that means that Verisk has a hand in pricing as much as 85% of the $540 billion in P&C premiums written annually. But it's not just P&C insurers that are embracing Verisk's solutions, it also doing big business with banks and healthcare companies, too.
Risky business is booming
Buffett's deep pockets allowed him to hold onto his stake in Verisk following its IPO and that has -- unsurprisingly -- paid off for the Oracle of Omaha. Since going public, Verisk has generated an impressive 127% return for Warren and his partner Charlie Munger.
That return reflects growing post-recession demand for Verisk's solutions, including new, adjacent markets like healthcare, where reform and rising costs are leading to quantitative approaches displacing empirical (and often subjective) practices and processes.
That shift has led to Verisk inking contracts with nine of the top 10 largest health insurers -- Verisk competes with UnitedHealth's Optum unit -- and a variety of health care providers and employers, resulting in health care sales climbing from just $50 million in 2009 to $270 million in 2013.
As a result, Verisk's total sales have grown a compounded 12% annually since 2004, rising from $540 million to nearly $1.6 billion last year. An expanding client base has also (importantly) reduced the company's reliance on its legacy P&C clients, which represented 80% of its sales in 2004, but represent just 47% of sales today.
VRSK Revenue (TTM) data by YCharts
But it's not just growing demand for its products and services that's likely impressing Buffett. It's also a business model that allows Verisk to build-it-once and sell-it-many-times. That means that Verisk operates a highly scaleable, and profit-friendly, business that gets about 75% of its revenue from bottom-line boosting subscriptions.
As a result, even as the company's revenue has accelerated in the past five years, with annualized growth north of 15%, capital spending to revenue has remained south of 10% and EBITDA margin has remained solid, at roughly 47%.
Buffett is holding
Verisk's success has enabled the company to kick off more than $300 million in free cash flow in each of the past three years, contributing to shareholder friendly share buybacks, bolt-on acquisitions, and earnings growth.
Verisk has returned roughly $1.4 billion to investors through share repurchases since 2009, including $279 million last year. Additionally, the company has been able to finance more than $1.2 billion in acquisitions that expand its product line-up. Overall, Verisk's shareholder friendly behavior seems to be just what Buffett is looking for given that his stake remains unchanged at 1.5 million shares. If so, investors might want to warm up to Buffett's approach to risk and consider Verisk, too.
