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Fairly stable, predictable free cash flow streams in low to modest growth businesses Asset rich balance sheet with an abundance of hidden assets that are unappreciated by the market
DST owns an investment portfolio worth up to 93% of the companys total market capitalization
Materially undervalued on a sum-of-the-parts basis with numerous strategic transactions available to unlock shareholder value
Spin-off or sale of non-core businesses or assets Sale or auction of entire company to strategic or financial buyer
(1) (2)
EPS excludes affiliate income; adjusted for net debt and non-core investment portfolio EBITDA excludes affiliate income; Adjusted for non-core investment portfolio Source: Consensus Wall Street estimates
Company History
DST was founded in 1969 as the mutual fund processing subsidiary of Kansas City Southern (KSU), a railroad company DST grew rapidly over the next few decades, mirroring the growth of the broader mutual fund industry in general In 1995, DST was brought public as a separate entity One of the most distinguishing and unique features about DST is that since its inception, it has been run using a portfolio management approach. That is, aside from focusing on growing DSTs core business, management has shown a tendency to acquire and divest various related and unrelated businesses, acquire and sell equity securities of other companies, etc. Management has demonstrated excellent capital allocation skills over the years with this approach and has often used gains to buy back shares, retiring over 60% of DSTs outstanding shares since 2000
Financial Services
Provides technology based software and automation solutions to the mutual fund/investment management, life and P&C insurance and healthcare payer industries
Output Solutions
Provides integrated print and electronic statement and billing output solutions for customers in various industries
DST also operates an Investment & Other segment which houses the companys valuable but non-core investment portfolio consisting of publicly listed equity securities, private equity investments, real estate holdings and various joint ventures 4
(1) Adjusted for out-of-pocket reimbursement revenue, excludes intersegment revenues
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(1) Source: 2010 Investment Company Factbook
Maintain records of account ownership, shareholder transactions and other activities Calculate and distribute dividends and capital gains Prepare and mail account statements, federal income tax information and shareholder notices
Business Dynamics
DST is compensated primarily on a per account basis Revenue differs based on level of complexity and who ultimately performs the underlying work
Most common account is remote service, which generates ~$4-$5 in annual revenue per account
DST is the market leader with ~36% market share of all mutual fund accounts, ~65% of outsourced market(1) Potential to earn float from client balances held (~$400mm of client funds held(2)) ~100 million US registered accounts on platform BNY nearest competitor with an estimated 30 million accounts
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(1) (2) Source: Avondale Partners estimate Includes funds held on behalf of transfer agency and pharmacy processing clients
Financial Performance
Over time, DST has demonstrated consistent and predictable revenues, EBITDA and Free Cash Flow in its Financial Services segment
(in mm's)
Revenue Costs and Expenses Depreciation & Amortization Capital Expenditures EBIT
(1)
2006
2007
2008
2009
2010
(1) (2)
Reflects operating revenue from core businesses only EBTIDA-Capex Source: DST 2010 10-K
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~45% of industry total 275 million mutual funds are currently on subaccounting platforms Sub-accounting could reach 60-70% of total mutual fund accounts Sub-accounting is an inherently lower margin businesses, with annual revenues of $2-3 per account DST could lose up 20-25% of its registered accounts over the coming 2 years; management forecasts losses of 12mm accounts in 2011
Industry trends have led to an increasing amount of mutual funds investments being held by financial intermediaries (broker-dealers, other financial institutions) as opposed to a direct relationships between the fund company and the investor As a result, broker-dealers have invested in sub-accounting or omnibus platforms that allow them to provide transfer agency services in house, for a lower fee than that charged by DST and other transfer agents
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Analysts estimate that 10-20% of broker-dealers lack the scale necessary to offer sub-accounting services(1) 10-15% of mutual fund accounts are still held directly by investors, not by financial intermediaries(1) Additionally, certain types of mutual fund accounts are less susceptible to sub-accounting conversion due to features on these accounts that require shareholder consent, etc. Tax-advantaged plans Other retirement plans
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(1) Source: Avondale Partners estimate
Inherent in DSTs business mix are many mitigates which should serve to soften the shift towards sub accounting including:
Converting fleeing accounts to DSTs internal sub-accounting platform, international account growth, growth in the 401k/retirement plan record keeping business
In addition, DST has a more diversified revenue stream than investors typically give it credit for, allowing growth in other areas of its business mix to cushion the revenue blow from sub-accounting At less than 4x 2011e EBITDA, DST shares fully reflect most conceivable account loss scenarios Account losses from sub-accounting should see stabilization after 2012
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Management Gets It
DSTs high-quality management team has been operating in the business for decades and has demonstrated that they appreciate the sub-accounting threat and are attacking it head on
Started to develop sub-accounting business in 2005 Acquired TASS LLC in 2007, a sub-accounting service provider, which allows DST to recapture some of the lost revenue While DST is a distant second to BNY which has ~65mm accounts, its subaccounting business is growing rapidly
With CEO Thomas McDonnell owning ~3% of shares outstanding on a fully diluted basis, management is properly incentivized and has its interests aligned with shareholders
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Scenario Analysis
As mentioned earlier, the number of DSTs registered accounts(1) have been declining somewhat
2006 64.2 23.3 10.3 6.9 40.5 104.7 1.1 105.8 2007 71 27.5 10 8.7 46.2 117.2 1.9 119.1 2008 65.4 27 9.9 8.9 45.8 111.2 8.9 120.1 2009 63.6 26.8 10 9.5 46.3 109.9 11.2 121.1 2010 54.8 25.5 9.7 9.4 44.6 99.4 14.3 113.7
(in mm's)
Registered Accounts Non-tax advantaged Tax-advantaged IRA mutual fund accounts Other Retirement Accounts Section 529 and Educational IRAs
Total Registered Accounts Subaccounts Total Accounts Serviced International United Kingdom Canada
5.6 7.1
5.8 7.5
5.9 10.6
6.6 10.2
7.1 10.7
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(1) Registered accounts refer to those accounts serviced directly with the fund sponsor Source: DST 2010 10-K
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Source: DST 2010 10-K
Accounts Lost (in mm) % of Registered Accounts Lost Revenue Lost (in mm) % of Financial Services segment revenue EBITDA Margin EBITDA Loss (in mm) Pro-Forma Multiple EBITDA Multiple
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Adding in reasonable growth rates in other areas of DSTs business, it looks as though the market is pricing in a losses of up over 40% of DSTs accounts. Clearly, the threat DST faces from sub-accounting is being vastly overstated in the marketplace
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DST Health Solutions offers significantly better growth potential than DSTs transfer agency business and should be rewarded commensurately with a higher multiple
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(1) Source: Avondale Partners estimate
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Output Solutions
Financial Performance
Over time, DST has demonstrated fairly consistent and predictable revenues , EBITDA and Free Cash Flow in its Output Solutions segment
(in mm's)
Revenue Costs and Expenses Depreciation & Amortization Cap-Ex EBIT EBIT Margin EBITDA Margin FCF
2006
2007
2008
2009
2010(1)
491.7 437.5 47.8 24.1 6.4
However, there is operational improvement potential within the segment and management thinks it can reach consistent double digit operating margins as the business gains further scale
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(1) Excludes one-time $64.3mm termination payout in 2010 Source: DST 2010 10-K
Over the years, DST has accumulated a vast investment portfolio (housed entirely in the Investment & Other segment) that has gone unappreciated by the investment community. This investment portfolio offers substantial embedded value and downside support, as well as collateral for a potential take-private transaction
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Company Shares Owned (mm) Value (mm) Origin of Investment State Street Corporation 10.3 439.91 Sale of JV with Kemper Financial to State Street in exchange for shares, 1994 Computershare Ltd. 15 145.61 Sale of stake in Equiserve to Computershare in exchange for shares, 2005 Euronet Worldwide 1.9 30.55 DST was an original investor in Euronet and maintained an equiy stake Undisclosed 214.4 830.48
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Source: DST 2011 Q1 10-Q Data based on 6/10/11 closing prices
Dominant player in high-margin business with 20% share of total cell phone subscribers as users Customers include virtually all wireless cell phone service providers including AT&T, Verizon, T-Mobile and Sprint Insures over 100 million handsets Estimated ~$4bn revenue business(1)
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(1) Source: BusinessWeek
2007 Sale Price % Sold Implied Value of Asurion % Retained by DST Implied Value of DST's Stake 65% of purchase price 85% of purchase price
The value of DSTs 6% stake in Asurion may be worth considerably more than these conservative estimates given Asurions dominant market position, strong growth profile and recession resistant revenues, as consumers are more likely to insure their high-priced smart phones against damage, loss, etc. in a weaker economy
Source: DST 2008, 2010 10-K
DST Systems owns numerous real estate assets of varying types, locations and ownership structures. The company owns apartment buildings, parking lots, raw land, office buildings, (some of which are leased back to the company), and retail and industrial properties. While it is hard to determine exactly what real estate DST owns given the companys poor disclosure practices, a reasonable estimate can be made using the limited amount of information the company does provide
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Location
Bristol, UK El Dorado Hills, CA Hartford, CT Kansas City Kansas City Toronto, Canada Office Buildings
Sq Footage
126,000 580,000 302,000 305,000 177,000 113,000 1,603,000
Rent/ Sq Ft
? 10 10 3.75 3.75 ?
Rental Value(1)
Price/ Sq Ft
? 100 100 50 50 ?
Sale Value
? 58,000,000 30,200,000 15,250,000 8,850,000 ? 112,300,000
Source
Loopnet Loopnet Costar Costar
Location
El Dorado Hills, CA Johannesburg, South Africa Kansas City Kansas City Kansas City Kansas City Lawrence, MO London, UK Rochester, UK
Sq Footage
65,000 8,000 7,000 510,000 66,000 493,000 49,000 56,000 19,000 1,273,000
Rent/ Sq Ft
15 ? 15 15 15 15 10 ? ?
Rental Value(2)
8,531,250 ? 918,750 66,937,500 8,662,500 64,706,250 4,287,500 ? ? 154,043,750
Price/ Sq Ft
150 ? 110 110 110 110 70 ? ?
Sale Value
9,750,000 ? 770,000 56,100,000 7,260,000 54,230,000 3,430,000 ? ? 131,540,000
Source
Loopnet Loopnet Loopnet Loopnet Loopnet Loopnet
(1) NOI approach assumes 20% expense ratio, 8% cap rate (2) NOI approach assumes 30% expense ratio, 8% cap rate
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Location
Kansas City Kansas City
Sq Footage
163,000 108,000 271,000
Rent/ Sq Ft
3.75 3.75
Rental Value(1)
6,112,500 4,050,000 10,162,500
Price/ Sq Ft
50 50
Sale Value
8,150,000 5,400,000 13,550,000
Source
Costar Costar
Retail Space
Location
Kansas City Other Properties
Sq Footage
46,000
Rent/ Sq Ft
12
Rental Value(2)
4,025,000
Price/ Sq Ft
60
Sale Value
2,760,000
Source
Costar
Location
Numerous Surface Parking Lots 120 Unit Apartment Building Underground Facility Various Developed and Undeveloped Land Undeveloped Land, El Dorado, CA JV Office Building, Leased to IRS
Size
536k sq feet kansas city 200 acres 1.1m Sq Ft
Price/Sq Ft
$25-30 $20k-$40k (acre) $15.4m/Yr
Low Value
5,000,000 3,000,000 10,720,000 ? 4,000,000 63,720,000 22,720,000 $297,226,250
High Value
7,000,000.00 9,000,000.00 16,080,000.00 ? 8,000,000.00 63,720,000.00 40080000 $300,230,000
Source
Estimate 25k-75k per apt Costar Estimate Ongo.com article
Total Value
In total, DST owns an estimated $300mm worth of real estate assets, excluding 200k+ sq feet of production facilities in the UK, 75k sq ft of office space in the UK, 8k sq ft of office space in Johannesburg and an unknown amount of developed and undeveloped land in the Kansas City area, which were omitted from the calculations due to difficulty in obtaining estimated values
(1) NOI approach assumes 20% expense ratio, 8% cap rate (2) NOI approach assumes 30% expense ratio, 8% cap rate
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Boston Financial Data Services (BFDS) (1) International Financial Data Services, LP (IFDS LP) International Financial Data Services, UK (IFDS UK)
Joint Venture 2010 Share of Earnings (mm) Low Multiple (10x) High Multiple (15x) BDFS 14.8 148 222 IFDS LP 15.9 159 238.5 IFDS UK 6.2 62 93 369 553.5
(1) Holds $1.5bn+ in client balances with significant income potential from float Source: DST 2010 10-K
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Source: DST 2008, 2010 10-K
Adding it all up
Taking into account all of DSTs various non-core assets leads to an estimated portfolio value of between $1.9bn-or ~83%-93% of DSTs total market capitalization
DST Non-Core Investment Portfolio Valuation, values in $mm's
Asset Asurion Publically Listed Equities Real Estate Join Ventures Other
Pri va te Equi ty Tra di ng Securi ti es Hel d To Ma turi ty Securi ti es
Value (low) Value (high) $120.23 $157.22 $830.48 $830.48 $297.00 $300.00 $369.00 $553.50 $148.90 $50.30 $11.30 $1,827.20 39.2 83% $148.90 $50.30 $11.30 $2,051.70 44.0 93%
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As currently structured, DST Systems is not well suited to be a public company. The company has a complicated corporate structure, is comprised of various operating subsidiaries and has financial interests in real estate, equities and other private ventures that cause further confusion. In order to realize fair value, DST should seek to either simplify its structure materially or consider an outright sale.
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Steady, predictable and abundant free cash flow generation Relatively low debt with ample interest coverage Good core businesses with modest growth potential Large asset portfolio which can be borrowed against or sold
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Return calculations assume 40% equity contribution, 3 year term, 6x exit multiple, 1.6bn long term debt at exit, $450mm terminal EBITDA, 5% interest rate
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(1) Return scenario also assumes $250mm in annual FCF which is used entirely to pay down new and existing debt
State Street has been a long time partner of DST since 1970 and has numerous operational, strategic and business tie-ups with the company In purchasing DST, State Street would not only be able to capture cost synergies and achieve further cross selling opportunities, it would also accomplish a number of other objectives, including:
Cancel the 2% of STT shares outstanding that DST owns thereby creating EPS accretion Save $7.5mm annually in dividends currently paid to DST BFDS is DSTs largest customer at 11% of revenue; an acquisition of DST by STT would remove the need to perpetually pay DST for its services
It is also possible that one of DSTs large, well-capitalized competitors such as BNY would be interested in acquiring the company 42
Queue up DST for an outright sale by removing non-core assets from the picture and simplifying DSTs structure Create a portfolio of assets that may interest a new class of investors that would not otherwise be interested in DST shares Simplify the DST story, remove the discount to fair value in its shares and give investors more choice in terms of the assets they would rather own
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Fidelity National
Market Cap (mm) Enterprise Value EV / 2011E EBITDA $9,654 $14,562 8.33
Fiserv
Broadridge Financial
$2,696 $3,108 8.67
Median
$8,948 $11,786 8.40
CSG Systems
$624 $796
4.61
Sum-Of-The-Parts Analysis
Asset Financial Services
Financial Services Healthcare Solutions
(1)
High Multiple 7x 9x 5x Add: Non-Core Assets Add: Cash Less: Debt(2) Equity Value Shares Outstanding Implied Price
Current Price
EV Low 1500 600 $280 1827 139.8 1262.1 3084.9 46.5 66.40
47.72
EV High 1750 675 $350 2052 139.8 1262.1 3704.4 46.5 79.73
47.72
Output Solutions
On a sum-of-the-parts basis, DST shares are currently worth between $66-$80, materially higher than where buyout offers are rumored to have come in. Additionally, a financial sponsor or strategic acquirer could likely pay a price significant above these levels and still generate an acceptable rate of return. Looking at it in a different way, at current levels you are buying DSTs non-core investment portfolio at or around fair value and getting its entire operating business nearly for free
(1) Based on consensus Wall Street estimates
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(2) Excludes $125mm accounts receivable securitization and 50% of $125.8mm of related party credit agreements
DST is a complicated story with a number of moving pieces Conglomerate structure creates added difficulty in trying to determine the companys intrinsic value Poor disclosures and investor relations program DSTs financial statements have historically been somewhat complex and non-transparent. Additionally, the company does not have much of an investor relations presence, has a severely lacking website, no investor presentations and by and large has failed to effectively communicate its story to The Street. Limited sell-side coverage DST is a lightly followed name with only a handful of sell-side analysts covering the stock, which has allowed it to float beneath the radar and remain inefficiently priced
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Risks
Sub-Accounting Threat
DST has numerous embedded offsets in its higher growth business segments to make up for a loss in revenue from sub-accounting shifts Experienced and capable management team is taking tackling the sub-accounting threat on all fronts Due to the nature of the mutual fund industry and DSTs particular business mix, a reasonable estimate can be made around how many registered accounts DST will ultimately lose, providing visibility and a theoretical cap Additionally, the market is factoring in highly inflated account loss estimates which are unlikely to materialize Given the gross undervaluation of DST shares, it appears that any decline in DSTs core business is more than priced in
Concentrated Shareholder
A concentrated shareholder typically creates difficulty in effectuating change at a company However, George Argyros, former US Ambassador to Spain, DST Director and DSTs largest shareholder with ~21% of outstanding shares, does not create this obstacle Mr. Argyros acquired his shares when he sold his business, USCS International, to DST in 1998 Mr. Argyros does not have emotional ties to DST but rather appears to be purely economically motivated and thus would be open to a strategic transaction In a recent news article, Mr. Argyros indicated that he thinks shares are worth closer to $80 and is confident with the direction the company is going in
Conclusion
Conclusion Attractive core business coupled with a separate investment portfolio worth up to 93% of the companys current market capitalization Trades at a material discount to intrinsic value, providing wide margin of safety and limited downside Break-up value is materially higher than current share price Multiple bidders for the company have recently emerged and provide a floor valuation Simplification or sale of business to financial or strategic buyer presents catalyst to realize value
Upside potential: 39-67%
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