Karnov Group (STO: KAR)
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In this write-up, I look into Karnov Group, a Swedish-based company that provides niche legal and regulatory information solutions. Although I have been familiar with the company for a while, I had not taken the time to research it further, until the two charts below caught my attention.
While there are many things to like, I believe the negatives outweighs the positive at this point in time. As a result, I struggle to get comfortable enough to invest, but have added the company to my watchlist to see the equity story improves. Here are the key highlights and concerns:
Highlights:
Unrivaled market position
Loyal customer base
Non-cyclical
Highly cash-generative
Concerns:
Limited upside left in core-market
Stepping into unchartered territory (Region South) through a huge acquisition
Material AI disruption risk
Introduction
Karnov Group, founded in 1862 and headquartered in Stockholm, provide mission critical knowledge and workflow solutions to legal, tax and accounting professionals on a subscription basis, paid annually in advance (88% of FY22A sales), with ~95% of customers renewing their subscription. Through its 13 brands and non-imitable platform, Karnov empowers professionals to perform their duties with a higher degree of efficiency and certainty as they can swiftly access relevant information. This exact value proposition is captured in the company’s slogan; “Make Better Decisions, Faster”. In many ways, particularly in Denmark, Karnov holds an unrivaled market position and has positioned itself as the industry standard.
Up until recently, the company solely operated in the Nordics (Denmark, Norway and Sweden) but in November 2022, Karnov officially expanded its presence to France, Spain, and Portugal by acquiring carved-out assets from Thomas Reuters and Wolters Kluwer. As such, the company’s geographic footprint is divided into Region North (90% of FY22A sales) and Region South (10%). Region North have ~80,000 active users and a market share of ~45%, whereas Region South have ~480,000 users and a market share of 25% and 8% in Spain and France, respectively. I was unable to locate the market share in Portugal. While the expansion to Southern Europe is certainly unchartered territory - and will likely prove to be challenging - the art of conducting M&A is nothing new for Karnov Group who has successfully completed >10 bolt-on acquisitions since 2013.
Here is a high-level overview of the company’s business model. Content (left) is provided by >7,000 well-renowned authors and experts whose reason to write with Karnov Group rests on the company’s prestigious reputation and the legitimacy it adds to their respective career. In addition, the group’s in-house personnel closely monitors changes to the legal landscape and updates the content accordingly. Content is distributed Online (~80% of FY22A sales) and Offline (~20%). Aside from this, Karnov Group also offers adjacent services, such as Legal training/courses and Compliance/Workflow Guides. Customers consist of the big consultancy and law firms, banks, corporates, and public institutions.
Financials/Historical Trading
Karnov Group became a listed company in 2019, hence availability of historical data is not ideal. Nonetheless, financials dating back to 2017 is readily available on the company’s website. With some more digging, it would be relatively straight forward to retrieve additional financials, i.e. through the Danish registry, CVR.dk. Below is an overview of the revenue development, split geographically, from 2017 through 2022. Note how growth in Denmark has been more subtle (6% CAGR) compared to that of Sweden/Norway (CAGR 38.9%). Generally speaking, the Danish market is quite penetrated with Karnov Group being a monopoly - more on that in the subsequent section. On a group level, top-line has grown at a 19.8% CAGR. Excluding Region South, CAGR stands at 17.2% which is quite remarkable considering that the number of customers have only grown from ~60,000 to ~80,000 during 2017-2022 (excl. Region South).
*If the acquired entities (Region South) had been consolidated for the full year the revenue for the Group would have been TSEK 2,281,907
Lets take a look at the annual growth contributors, which is particularly relevant in light of the company’s active M&A approach:
Clearly, M&A has been a primary growth driver in FY18, FY21, and FY22. However, there has also been consistent mid-single-digit organic growth, which is reassuring. Considering the modest growth in the number of users during the captured period, I suspect much of the organic growth comes from up- and cross-selling to existing customers. While this is a testimony to the company's pricing power, it also suggests that growth opportunities may be limited, leaving the company with only two levers left to create additional value; improve profitability and/or expand the TAM. With the expansion to Region South, Karnov chose the latter. Hard to improve already stellar margins, albeit coming down a little since FY20A:
As noted in the previous section, the vast majority of Karnov Group’s sales are online, hovering around 80%. Naturally, moving more customers online provides a nice margin uplift, however, I do not think a >90% conversion is realistic in the near future. In fact, the recent expansion to Region North is expected to put a bit of temporary pressure on the proportionate relationship between on-and off-line sales:
Here is an overview of online/offline and sub/non-subscription sales split:
Sales are recognized on a straight-line basis over the contract period which makes it difficult to reconcile the true (cash) EBITDA. Would be nice if the company included “invoicing” as a separate metric in reports/presentation for reconciliation purposes/identifying trends. Since this is not possible, keeping a close eye on cash flows and reading/listening to supplemental information is crucial. Also, most subscriptions are due for renewal in Q1 and Q4, leaving a bit of swings in the financials. Normally, seasonality would make me extra concerned about the working capital swings, and its effect on liquidity during low-activity months. However, given the nature of the business (asset light and highly cash generative), this is not something I worry too much about. Karnov Group operates with a negative working capital, low maintenance CapEx (mainly relates to content (software, etc.)), and excellent cash conversion:
That said, Karnov periodically conduct large M&A transactions, which might put a pressure on liquidity. Most transactions are financed via debt, however, for the most recent (and largest) acquisition and expansion into Region South, new equity was also issued. Let’s look at the leverage development:
Quite a jump in FY22. Management has been explicit about its objective to bring it back down to 3.0x:
Looking at ROIC, I must admit I am quite disappointed to see low-to-mid-single-digits. While goodwill is a significant drag, it cannot be fully ignored as M&A has been a core element of the strategy. In light of this, coupled with the mega-M&A transaction, I already know at this point that I will not include Karnov Group as part of the portfolio. With that, lets go to the next section.
Market
The professional information industry is a significant and growing market, and Karnov Group operates in an attractive niche within this industry. Demand for the products is stable and mature, driven by the indispensable nature of the information and its affordability relative to other operational expenses. However, there is still potential for growth, as the market benefits from ever-increasing legal complexity, partly driven by cross-border regulations and the EU. Question remains if Karnov can replicate its Nordic approach to the rest of Europe, let alone Region South.
In the FY22A annual report, management gives a picture of the total addressable market. The TAM for the Nordic region stands at SEK 2.1 billion, out of which about 81% is estimated to be generated online and roughly 18% offline. Over the medium term, the market is projected to grow at a rate of 2.4 percent. The Nordic market is known for its high level of consolidation, which translates to fewer players in the industry. On the other hand, the TAM for the South is a whopping SEK 15.3 billion and is expected to increase at an annual rate of almost 2.0 percent over the medium term. As such, Karnov’s TAM grows from roughly SEK 2.0 billion to approximately SEK 17.3 billion, a 9x expansion.
Apart from smaller local competitors, such as Schultz (Denmark) or InfoTorg (Sweden), Karnov also competes with larger ISPs, including Thomson Reuters. However, their offerings are more generalized.
Admittedly, I had a tough time mapping the industry dynamics. However, a unique opportunity to understand the sustainability of Karnov Group’s moat presented itself; a networking event at one of the major law-firms in Scandinavia. Even better, a central theme to the event - apart from the usual networking, food, and cocktails - was the role of artificial intelligence. The potential risk of disruption from AI is something I had thought about all throughout analyzing Karnov Group, hence attending this event was a great opportunity to scuttlebutt. Almost everyone I spoke to have actively implemented ChatGPT in as part of their work, however, they also reassured me that they did not have enough confidence to rely on the information without validating the information. Also, ChatGPT does not offer the legal commentaries which I came to understand is highly valued among Karnov users. That said, considering the outrageous speed with which language models have developed already, I don’t see why it shouldn’t be able to implement commentaries, and more, in the coming years. Then again, Karnov definitely have a data-advantage and may be able to use the AI to distance themselves even further from competitors.
At this point, I have a multitude of unanswered questions, insufficient visibility, and subsequently, a low level of conviction. Therefore, I plan to monitor the company and observe how the situation unfolds.
An abrupt ending, I know, but I think time is better spent looking for other opportunities while seeing how this one plays out.
Thank you for reading!