I often read about excellent companies such as Motley Fool Stock Advisor pick Corporate Executive Board
This is a consulting and research company like Booz Allen Hamilton, Boston Consulting Group, and McKinsey, but unlike its competitors, CEB has a subscriber model. For a fixed fee (averaging $35,229 per program last year), clients can subscribe to one or several research packages or programs. These programs provide the client (or "member," as the company prefers to say) with research publications based on peers' and competitors' best practices, interaction with in-house industry experts, conference attendance, and website membership for updates and data retrieval. CEB's primary goal is to provide executives with research on processes practiced at peer organizations regarding financial services, human resources, sales and marketing, and IT. Clients represent a diverse group including eBay
Let's look at CEB's three key strengths.
Ability to cross-sell programs. For CEB to make money, it has to cross-sell many programs to the same customer. Since it doesn't have to customize its programs for each client, the cost of selling the additional program is restricted to selling and marketing. Here it's been brilliant. From cross-selling 2.42 programs per client in 2001, it has managed to increase it by 12% each year to 3.82 in 2005.
Client loyalty. The client renewal rate has never flagged below 90% in the last four years. This has been crucial to CEB's business model of cross-selling and a major vindication that selling non-customized research is a good business model.
- Lack of direct competition. CEB successfully occupied a space not identified or followed by competitors. I'd believe that it would take competitors years to reach close to CEB's business -- building the 37 programs it already has, putting in the infrastructure to service clients, and providing it at the scale and price CEB does.
Corporate's valuation demands that I get a little nit-picky -- after seeing so many years of growth, I would rather be cautious than regret it later. Here are the problems that I see for CEB.
Operating leverage is not that great. With 30% annual revenue growth between 2001 and 2005, cost of sales also grew 30% annually during the same period, suggesting that to cross-sell, you do need to build a large research portfolio. Program development costs haven't flagged, and the cost of sales increases commensurately with sales -- each year, there's a commitment to adding five to six programs, and that's obviously costing money. Secondly, marketing's also been taking a bite out of operating profits, having grown at 33% over the past five years -- faster than sales. A 33% operating profit growth on a 30% revenue increase suggests that the operating leverage in the subscription model isn't that great.
Foraying into the middle market will put pressure on margins. Having penetrated more than 80% of the Fortune 1000, perhaps suggesting saturation, CEB forayed into the middle market segment, targeting companies with revenues between $100 million and $750 million. But that means lower pricing ($7,000 to $10,000 per program), higher development and marketing costs, and fewer opportunities for cross-selling since it'll have fewer programs to sell. The good thing is that this is supposed to be a $1 billion opportunity, and CEB's cheaper price tag and "all you can eat at a fixed price" model are likely to win more converts and maybe even expand the research category.
Pricing has been weak. Management claims that with larger clients who don't get discounts, it can manage 3%-4% higher prices per year, but the longer-term trend has been close to 1%-2% on average. The shift to middle market is unlikely to be better, especially when it's reaching out to a market that doesn't have the strong research budgets of the Fortune 1000 companies.
- Expensing options takes a big bite out of earnings. Last but not least . After expensing options -- a result of better practices forced by FASB no less, '06 and '07 earnings drop 21% to $1.87 and 18% to 2.35 from consensus estimates. At $100 per share, it gives CEB forward P/E ratios of 54 and 42 for the next two years.
CEB can't be faulted on execution and its business model. My big beef is that even with consistent 30% revenue growth, CEB hasn't grown net income more than 37%, and with saturation in its prime segment and uncertainty over the new one, agreeing to pay Mr. Market 56 times options adjusted 2006 earnings is a bit much. I'd hold on for a better price.
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