Gartner: Compound Insights - [Business Breakdowns, EP.160]

0:03This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from. and we are here to bring them to you. To find more episodes of Breakdowns, check out joincolossus .com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers or affiliates may maintain positions in the securities discussed in this podcast.

0:45This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Welcome back to Business Breakdowns. Today, we're covering a behemoth in the research market, Gartner. Our guest is Alvise Pejion, Portfolio Manager at Fairlight Asset Management. Now, I don't know how many of our listeners make breakdowns a family listening experience, but earmuffs for the kiddos for a moment. The way I would present Gartner is very much in the cover your ass economy. Executives are willing to pay $20 ,000 to $30 ,000 for reports or $50 ,000 plus for full subscriptions so they can access the insights and data collected by Gartner to help them make business decisions, purchasing decisions, and pivoting decisions.

1:32Alvise helps us cover how Gartner grew into this at -scale player, how the research and sales model has been fine -tuned over time, and particularly over the last 20 years, and where the opportunity for growth is in the future. It's a very interesting business with a lot of interesting dynamics that I think investors think about a lot. So please enjoy this breakdown of Gartner. All right, Alvise, I am very excited to break down Gartner. It is a name that I have a personal interest in. I came from a research background. I also revolve around the world of expert networks and consulting. So all of this, it's very close to home.

2:13And I wanted to just start out with how you would define Gartner and the industry that they operate in, just to kick us off. They provide research for the executive large corporations, but that might feel a bit abstract. So I think one of the best ways to really understand what GARN is to do is to really put yourself in one of the customer's shoes. So let's imagine for a second that you are the chief technology officer of a Fortune 1000 company. And then the board asks you to provide them with a summary on some IT topic. For example, can you please provide us with a summary of how artificial intelligence would impact our business?

2:54What are the positive things that it can bring? What are the risks? And where is the industry going? And yes, you have a lot of experience, but you've only got two weeks to go and prepare for this. So despite you having an IT budget that is probably in the millions, by accessing Ghana, you can immediately have the ability to really read all the resources. They have an online portal where you can find everything you need. The problem is a lot of information is not always good. If you don't have the time to read it all, it's not really much useful. So what Garners offer you as well is the ability to talk to the people that have written those research.

3:32They are the experts. So you can even actually meet in person with them if you want. By doing this, you can really quickly have a feeling for what the industry is doing on a particular topic. You can understand what the vendors are offering in that particular aspect. You can also see, very importantly, what other companies that might be in a similar situation might be doing. So all this really cuts on time. And at the same time, it provides you with a very credible source for this information. And I think this is quite important. So when you get to present at the board meeting, you can really reference some brand name that has been in the market for a long time and is quite famous for their research.

4:10And just thinking about you, you work in the investment field. You have investment banks that are producing research. You have analysts that you can speak to when they write that research. Is it fair to say this is that version, that model of sell -side research, but applying it more to the corporate world where instead of having hedge funds, mutual funds, investors as the clients, you have the corporations as the clients? That's not a bad parallel, but I would make a key distinction here. So when Gartner writes something to you, they don't have ulterior motives. They really are providing you for something that you are paying very clearly for it.

4:47So the research tends to be maybe a bit academic to some extent, but then the ability of talking to somebody makes it quite easy. It's not like a broker report, a sell -side report, where yes, it might be very good, but there's always the feeling that there's a bit of fear of missing out. You've got to act now, you've got to trade. And that's one of the differences. The sell -side research conspiracy theories. I've worked in the field. I wouldn't say that's always the case, but I certainly hear it. I certainly hear that there's maybe less conflicts of interest or less concern, certainly, from all the publicity out there.

5:17Especially also because with that research, it might be available now, but there's no certainty that it's going to be a follow -up piece. Sometimes there's not much grounding in the assumptions behind what you said. With Ghana, you have decades of library content available there. you can be mostly assured that there's going to be more development on the existing library. And thinking about who they will compete against in this field, who are the competitors to Gartner? If you're not using Gartner, who would you use? Well, that's a very good question. Gartner is the only global player that can provide research at scale at the moment.

5:53So there aren't really many alternatives if you really wanted to find somebody that provides you with that research. What you could do perhaps is you could piece together a number of research from a different set of providers, but obviously then you would just have to hope that actually the answer is in there for what you're looking for. And definitely it's not a time -effective way of going about it. Alternatively as well, you could call in management consultants, so companies like McKinsey or perhaps even Deloitte. The problem is at that point in time, your thoughts are going to be relatively general.

6:27You won't have specific questions to ask them. You would just want to really understand first what's the environment like and then zoom in particular questions. Perhaps later on when you really have a good feel for what the problem I mentioned before was artificial intelligence, how it could affect your business. Once you understand the general environment, then you can ask specific questions to McKinsey. I think that's how I think it in my head anyway. And then at the same time, they would be quite costly. So a Garnet seat access would cost you about $50 ,000. You could also probably ask your team to help you out.

7:01The reality though is most people are time constrained in those roles and the outcome of the effort is likely to be quite below the quality of what Ghana can give you because they have 2 ,500 resources to do the reports, not 204. And at the same time, they give you that big brand name that you can reference during your board meetings. It's much more powerful to say, well, I think this is where the industry is going And I can back this by data that I source from Gartner, rather than saying, well, John from IT Googled this topic for two weeks, and this is why I think I should be doing this. And just putting Gartner at scale, just getting some sense of what they actually look like today from some type of metrics.

7:44You mentioned they're a global leader. They have a full offering of topics. What do you think the best metrics are just to bring that scale and size of the business alike? Garner at the moment has $5 billion in contract value. So that would be the metric management always refers to. And that's pretty much the goal of the business contract value. Obviously, you've got to grow that profitably. And that's what I've been doing for many decades. But if there is one metric to understand the business and put it into some context, is that contract value metric. And that 5 billion breaks down in think that they have 18 ,000 clients And on average, each of them has about four to five seats.

8:26And each of these seats costs around $50 ,000. So if you multiply these elements, you get roughly to where the contract value at the moment is. And if we want to frame the opportunity, where Ghana could be in a few years, there are thousands and thousands of chief technology officers and people in IT that don't have the experience of actually sitting down with a Ghana representative and really understand how the service can really improve their workflow. So there's a big number of these executives that haven't been reached yet. So to do so, Gana employs an army of salespeople. At the moment, I think they have about 4 ,500, if not even more.

9:04And the sole job of these people is to really nurture the existing customer base, but also to reach out to these executives that don't have much of an idea of how Gana can help them and really over time convert them. And so if you want to put some numbers around this. Ghana itself suggests that there is about 140 ,000 enterprise leaders in the addressable market, but at the moment, they only have 18 ,000 clients. So really they have penetrated less, well, about 10 % of this opportunity. And then the other way that Ghana can really expand its market is really to sell more seats to the existing customer base.

9:42And that I think is quite plausible that it could happen because not only IT is becoming more and more important, so there's more people working in IT, but also Ghana over the years and specifically in the last five years has really expanded a number of topics that it covers. So not only provides IT research, but at the moment also provides research about supply chain management, human resources, the legal function. So I don't think it's a stretch to think that just the number of customers could double, but also the number of seats sold per customer could double over time. And if you were to extrapolate their market share and sort of come up with an overall market, it's not too hard to get to a 50 billion potential market.

10:26And at the moment, given that they only have five and they are the leading player, we're not overly worried about the length of the growth runway. It feels just by doing simple mess to feel quite long. When you think about penetrating those additional customers that they don't have right now? Are there certain types of logos that aren't included in the business? Are they overly tilted towards Fortune 100 companies or overly tilted towards IT heavy businesses or certain geographies? They're definitely a service that is targeted to large corporations. So that's the first point. They could target as well, medium -sized corporations.

11:05The problem is that at $50 ,000, I know that I made it sound like it's the best bargain ever, but it's still $50 ,000. So you can't go to any company and suggest they should invest in that. But there are plenty that have that. So that would be the first thing to point out. Then in terms of geography, it's a global business, but given its origin, it's a center around the United States. And also because most of vendors in IT are American companies, But they also have very good presence in Europe and to an extent in developed Asia. So they are a global company. And I think their research will resonate very well with any of those markets around the world, which are English speaking, but also used to conduct business in English.

11:49The library is a very good asset, but it's very costly to translate in different languages. So you need the user to be well -versed in doing business in English. So all those developing markets at the moment either doesn't have the funding to buy the product or the language barrier is an issue. And I know there's some element of being a customer, inclusion in some of the reports, a bit of a pay -to -play angle as well. How would you frame that as just part of the sales proposition for Gartner to clients in addition to the research and expertise that they're getting? So here we need to make, I think, a distinction between the type of clients because most of the clients, the great majority are actually corporations in search of insight that they can actually implement.

12:38Then a smaller part of the business has as customers, the vendors. And so maybe that's where this conflict or maybe this perception has come about where you feel that, okay, if I'm researching this vendor and I'm getting paid by them to do the research, there might be a bit of a conflict. It's a smaller part of Gartner's business. And here, it is where they compete with a company called IDC. But in the scale of things, because Gartner is such a big business, it's hard to really... I wouldn't say it doesn't matter, but as a side, I'd say it's a smaller part of the opportunity for Gartner. Yeah.

13:12Just looking at my notes here, it looks like it represents about 25 % of revenue today. So maybe a small part of the business, to your point, a smaller part of the opportunity for growth for Gartner. I wanted to transition a bit in terms of pricing. You talked a little bit about these licenses. Is it a single tier license? Are there various pricing points based on access to reports versus access to analysts? Just talk us through the complexity in terms of how they price the bundle that they offer. The company itself doesn't really disclose too much about it, but my observations and my research suggests that it works a bit like that.

13:50there are different tiers, but they're not massively different between them. I think if you want to speak more with analysts, it costs a little bit more. Garners not only provides research, but it also has two ancillary businesses, which account for about 20 % of their sales, one being consulting and the other being conferences. So for consulting, you definitely pay outside and it's not part of it, but you have the option to include tickets to conference and bundle in your Garners seat. So I think that also can change the upfront cost. But I think in general, the average customer spends around $250 ,000 a year.

14:27Those five seats using a $50 ,000 average might be slightly different, but I wouldn't put too much stress about perhaps the company can grow a lot faster if they can move people from one tier to the next one or something similar. But in reality, I don't think it's yet one of the big drivers or the main drivers of Garners growth. I think it's more really just reaching all those executives that I haven't got in the network yet. You alluded a bit to the ancillary businesses, consulting and events, 20%. It's interesting, you go back in time, 15 years ago, those were closer to 40%. So maybe we could talk a bit about the history in general, and that mixed shift over time, bring us back to maybe we start at the beginning of Gartner, how this business was created and turned into the behemoth.

15:15And then we can get into the business mix ship because I think that's an interesting dynamic as well. Looking at the history of Ghana, I think we can segment it into four phases. So the first one is relating to the beginnings of the business. So it's a relatively young company. It was founded in the late 70s by Gideon Ghana, who was originally a consultant for IBM. So during the first years of Ghana, it made sense for the company to really specialize on advising customers on what IBM products they should be buying or what the features are. But then over time, as the company started growing, they really branched out into other parts of the vendor ecosystem.

15:56They also branched into marketing and supply chain research. So this is really the first phase of the company. Then moving to a second phase, I think we can trace this back to 2004, which was the year in which Eugene Ho became the CEO of Ghana. So Eugene came from ADP, automatic data processing. And in that job, before joining Ghana, he was in charge of about 2 billion worth of payroll services. And these sales were made to big corporations. and at the same time he was leading an army of 1 ,600 software developers. So you can see there are some similarities to Garner in the sense that he was in a job where he was serving a service to large corporations and he was in charge of a lot of people.

16:48So people had high expectations about the impact that he could make at Garner, but it did deliver way ahead of expectation, I'd say, because once he joined Garner, he started really to double down investment in the quality of the research, but also very specifically made the sale force a key focus for Ghana. As I alluded earlier, research is great, but it certainly needs to be sold. And so by doing this, it allowed Ghana to really start growing organically double digits. And they were able to do this for quite a number of years until they reached 2017. and a main event happened that year, which I think it's what can lead us to maybe a third phase of the company's history.

17:32So second phase, big organic growth. And then in 2017, they decided to acquire another business. So what they did, they acquired a company called Corporate Executive Board. And this was again, another research provider, but it was not centered around IT. It was selling research, particularly on human resources, supply chain, legal, finance. So other parts of the research universe where Garner wasn't as big. So it was quite a complementary deal, quite a strategic one. So the acquisition added about 600 million to sales and the combined group that 2018 had about 3 .4 billion in revenues. By then Garner was already a leading force in the industry, but by doing this deal, not only got bigger, but also it expanded and made its addressable market a lot bigger.

18:24So that was a very important deal. And then the last phase of Ghana's history is really from that deal onwards today. And during this period, organic growth remained the main goal and it resumed at 10 % plus until today. What I think is important to also notice is that acquisitions are always risky. So Ghana had struggled for a few months to integrate the business, but the strategic fit overall concept was so good that after a year of trying to tinker around and trying to really find the right formula, that business really started growing. And at the moment, it's outpacing the growth of the IT part of the business.

19:00Very interesting. Going all the way back to the beginning, there was a time where you never got fired for buying IBM and someone created a business around how you should buy IBM. And there's something absolutely brilliant about that and how that connects to that claim. Yeah, it's a funny story as well that after a few years that Gideon Garner started the business focusing on IBM, I think IBM actually sued them because they were worried that they were actually giving too much away to clients in terms of IP. Wow. I wonder if that was a positive press outcome for him in terms of the potential marketing on the back of that.

19:36I think the company never got convicted on anything that it was just probably just something that happened there. Clearly, it's worked out. I want to tap into the Salesforce and the sales function a little bit. I think you mentioned 18 ,000 customers against Salesforce of about 4 ,000. So you can do the math there just in terms of how many people they have working to manage those relationships, let's say, four to one in terms of existing clients to salesperson ratio, plus trying to bring in new business. Is there anything that they're doing beyond just hitting the ground hard and trying to sell these contracts?

20:10Because as you mentioned, 50 ,000, when you're talking about several licenses potentially per firm. It's not small necessarily, so it requires a decision maker's approval. Is there anything in the sales function that you would point to as a key strategic difference maker for Gartner? I think the main job of the salespeople is really to draw out why Gartner's product really adds value. And when they are able to do this, and usually it takes months and a lot of engagement, but the moment this sinks in with the executive, price becomes a very secondary issue. Usually the budgets are quite big. For instance, in Australia, one of the big banks definitely are most likely a Ghana user and the budget of the CTO is in the billion.

20:54So spending $100 ,000 to $500 ,000 on Ghana's seats, it really pays itself extremely quickly. In my example before, the chief technology officer had that task to do. He had in two weeks to come up with an answer on artificial intelligence, but probably just even that paid off by itself. And then you got the remaining 11 months that you can still use it and gain value out of it. So in terms of what other things salespeople do, I think they have one goal and that is to drive contract value growth. They also help a lot to, I wouldn't say cross -sell because I see the conference business as supporting the research business.

21:31The conference business is well and truly profitable on their own merits, but salespeople calling, inviting them to these conferences or make them attend. It all creates more point of context where the customer can really have a feel for what Ghana is all about. You alluded to the 12 -month nature of the contract. Are all contracts structured as annual contracts? Are there any multi -year and anything you could share on what churn looks like? Sounds like there's not much churn, but any type of data around that is useful as well. I think it's great to talk about the financial model. We have four key elements.

22:10The first one being organic growth, then the margin, then the cash flow, and finally capital allocation. So we can discuss one by one these ones, and I flesh out where the nature of the contracts really help. So starting with organic growth, about 90 % of Ghanai's research business is based on subscription contracts. These are annual contracts. Half of these are multi -year contracts, but we're not talking about five years or anything like that, usually I think it's two to three years. So when we look at contract value, Ghana has been growing at 10 % to 12 % per year. So how does this break down?

22:47So the current book of business tend to grow about 4 % per annum. So net retention is quite high at about 100%. And then on top of that, Ghana is able to implement a 3 % to 4 % price increase per year. And then the remaining 6 % to 7 % to get to that 10 % growth, it's coming from new customers. And then the other part, which I think is important in the financial model, is the understanding about the margin. The business has inherent operating leverage because content creation only needs to be done once. And so you get over time, small incremental margin expansion as the number of customers grows.

23:27And at the same time, the research business is growing faster than the consulting one and the conference sense one. So because the research business is a 70 % plus gross profit margin business, so higher than the other ones as well, this also adds to the profitability to the margin expansion that has been happening over time. But then if we really want to understand why the financial model is so good for Ghana and why it makes such a great business, it's really cash flow. So all the subscription contents that we talked about before, they all are paid upfront. So Gan gets the money straight away, but then needs to pay for his employees.

24:06And he can do that over the remaining 12 months. So he has all this cash that piles in. And if he were to think, then the obvious question becomes, well, because for each dollar of profit, they generate $1 .20 of free cash flow at least. What is that management going to do with all this cash? And this is where the fourth element of the financial model comes in, which is the capital allocation piece. So Ghana has been returning all this money back to shareholders. And the way they've done so has been through buybacks. And they have shown that they have a very good understanding of the value of their shares.

24:40So they're actually really being very good at speeding up the pace at which they've been buying back shares in relation to where the share price trades. And to give an example, in 2020, after the COVID -19 pandemic erupted and we had that big market collapse, they were able in the subsequent quarters to buy back 7 % of the company shares on quite attractive valuations. So that really helped shareholders to really get a lot of value. And it has been one of the ways that management's added value over time. So I guess this links well to shareholder returns. So you start with organic growth, top -line growth at around 10%.

25:17And then as we mentioned, you get as well that margin expansion, which adds a little bit to your growth of earnings. And then on top of that, you got this constant reduction of the share count. So while GAN has been growing top -line, it's been able to compound EPS at 25 % since 2004, when Eugene Hall joined the business and really refocused it around the research business. Those are special businesses that can grow earnings faster than revenue and free cash flow faster than earnings. They're hard to find, but when you do, they're special. I want to tap into each of those categories a little bit.

25:52On the organic revenue growth, you mentioned their 50 % multi -year contracts, but each year they're getting 3 % to 4 % pricing growth driving that 10%. So are they implementing that pricing on some of those multi -year contracts? Otherwise, it would imply that the pricing hikes on annual contracts would be much higher than 3 % to 4%. And I'm just trying to gauge how much pricing power they actually have. I'm not entirely sure how those contracts are structured because I think it goes case by case. But one thing I would say that has been apparent to me is that in order to get those multi -year contracts, God, it doesn't discount.