Moody's Corporation (MCO) Earnings Call Transcript & Summary

Hello and welcome. My name is Andrew Nicholas, and I'm a research analyst covering the info services, consulting and HR technology sectors here at William Blair. Before getting started, I a.m. required to inform you that for a complete list of research disclosures or potential conflicts of interest, please visit our website at williamblair.com. With that out of the way, I'm very pleased to welcome Moody's Corporation and their Chief Operating Officer, Robert Fauber, to the 40th Annual William Blair Growth Stock Conference. Thank you very much for joining me today, Rob.

Thank you, Andrew.

I'm guessing most everyone is familiar with Moody's here on the webcast, and we only have 30 minutes today. So I'll pass on the typical business overview question and get right into it.

You typically describe the growth algorithm for MIS as a combination of growth and issuance volumes, coverage and price. I'd love to talk to the various factors affecting issuance trends in a little bit. I think price is relatively self-explanatory. But I was hoping you could maybe start us off by talking about coverage expansion as a growth driver and which areas have the potential to really move the needle for MIS as a whole.

Sure. Thanks again, Andrew, for hosting us today. It's a pleasure to be with everybody. Our coverage in developed markets is pretty comprehensive, and it's actually been very steady for a number of years now. So I'd say that really, the main opportunity for ongoing coverage gains is really in emerging markets. And emerging markets, and especially China, are a key growth focus for us in the rating agency. On balance, I think that we expect emerging markets to grow faster than developed markets over time, given the lower levels of disintermediation, and that's going to provide support for these new rating mandates and recurring revenue growth. We're well positioned across a number of emerging markets, including China, and more broadly, Asia Pacific, Latin America and what we call the EMEA region. And we've been growing emerging market revenue growth over the last decade at around a 14% CAGR. And I think it's interesting to note that we serve the emerging markets in ratings through both our cross-border rating business as well as our domestic ratings business and we've got leading presences in some of these domestic ratings markets in places like South Korea, like Israel, like India. We recently launched something called Moody's Local in Latin America, and that's a domestic credit rating and research platform in Peru, Panama, Bolivia. We've got a minority stake in Chile, and we're going to look to expand across the region to better serve those domestic markets, which are quite important in Latin America. And China is -- we talk about China a lot. It's the second largest onshore bond market, something like $14 trillion and continuing to grow quite rapidly. We've got a leading position in both the domestic market through our 30% ownership of CCXI, and that's the leading domestic rating agency in China, as well as the cross-border market through our Hong Kong office where we rate another, call it, 400 credits or so across the region. And then maybe the last thing I'll touch on as it relates to how the issuance volumes grow, we always talk about the drivers being GDP growth and disintermediation. Obviously, we're having a severe contraction in global GDP right now. But economic growth is going to resume, and I think we're going to start seeing that as the economies begin to open. And I think importantly, we also look at that $3.5 trillion of debt in North America and EMEA. That's outstanding and is going to mature over the coming 3, 4, 5 years. And we published these refunding studies on moodys.com. So there's some very significant refinancing needs ahead of us in the coming years. The last thing, Andrew, I'd touch on is price. It is a contributor to our growth. We've typically been able to capture 3% to 4% pricing increases a year across the corporation, on average, and we think that's going to continue, given the strong demand and the business-critical value propositions around our products.

Great. That's very helpful color. And kind of as a segue, you talked about maybe longer-term growth trends for issuance, but maybe a little bit shorter term. At the end of April, you lowered your guidance for MIS revenue to a high single-digit decline compared to 2019, which I believe embeds a low double-digit decline in global debt issuance. I was hoping you could maybe unpack the different components of that guidance a bit further. And then maybe more importantly, speak to how the debt markets have performed relative to your expectations thus far in the second quarter and maybe more specifically over the past month or so.

Yes. Sure. And Andrew, I think maybe I'll start with just highlighting that the guidance that you're referencing is as of April 30. To the extent that the behavior of the credit markets has varied from what we assumed, we -- at the time we gave our guidance, we provided investors with a really kind of a macro framework. And I'm going to highlight that in a second because that will allow people to triangulate where they think we are now versus where we were back at the end of April. As we mentioned on the first quarter earnings call, we anticipate issuance to decline in the low double-digit percent range, and we think that we're going to see a decrease in first-time mandates in the 600 range. And when you break that down, we're looking at corporate finance investment-grade issuance to be up in the range of 10% with a 20% decline in high yield and a 40% decline in bank loans. Our guidance also assumes that CLO issuance will decline similarly to what we're going to see in leverage loans. It's again down somewhere in the neighborhood of 40%. And other types of securitization are broadly expected to be down 20% to 25% or so. We think that -- obviously, we're seeing this liquidity-driven issuance really continuing. And I think the strength of that issuance has been, I think, surprising. We do expect fewer M&A financings, and that's going to weigh on total rated issuance. We're thinking that M&A activity will be -- and activity-driven issuance will be down somewhere in the neighborhood of 25% to 30%. But the macro environment underpinning our 2020 base case scenario, it assumes that economic activity is going to remain relatively weak into the third quarter and possibly the fourth quarter. So we had assumed U.S. and European GDP to decline in the 5.7% to 6.5% range, respectively, that U.S. full year unemployment would be somewhere in the neighborhood of 10%.. We also assumed that benchmark rates would stay very, very low and U.S. high-yield spreads would widen out. Now I would note that high-yield spreads are well below that level that we had assumed in our guidance. And we've seen some very healthy issuance activity in the high-yield sector. We also have -- are calling for high-yield default rates to be in the range of 11% to 16%. And that was underpinning, in part, our views about what was going to happen with high-yield spreads. But as you guys can see from public research and reporting, April and May were very active months for investment-grade issuance, and U.S. high-yield bonds were also quite active. The real question, Andrew, I think, is the sustainability of that liquidity-driven issuance that we saw beginning in March, as I said, I think, it's been surprising, the strength and length of that liquidity-driven issuance. There is the possibility. That said, that investment-grade issuers decide to reenter the market in order to refinance upcoming maturities or perhaps even current financings if spreads tighten further. So we're going to keep an eye on the impact of escalating defaults. So are we seeing that predicted rise in defaults? And then, of course, the progress of the real economy and in treating the health situation with COVID. The -- maybe the last thing I'd touch on, because we've gotten some questions about this, is just in our thoughts around leverage loan issuance where we had it down 40%. And we have expected a challenging environment for leverage loans. We've seen very muted leverage loan activity so far. And the reason for that, I think there's a few, one, the rating distribution of leverage loan issuers is skewed more heavily to the lower end of the rating spectrum. And the current stress that we're seeing in the CLO market is also going to dampen the investor bid for leverage loans. And then finally, the fact that benchmark rates are expected to remain very low for considerably longer means that we're seeing an investor preference shift into fixed-rate, high-yield and away from floating-rate leverage loans.

Got it. No, that's helpful. Helpful detail. Maybe moving past issuance for a little bit, I'd like to spend some time on some of the key growth initiatives you've identified and been investing in over the past several years. First, I was hoping we could kind of start with the firm's ESG capabilities. How big is that business today? How fast is it growing? And how do you kind of think about Moody's capabilities in ESG compared to the other large primary competitors in that space?

Yes. So on our fourth quarter earnings call, we said that we expect to generate somewhere between $15 million to $20 million in revenues from our ESG businesses in 2020. And I would say that just as significant is also the ongoing relevance that our ESG investments provide to both the MIS ratings business as well as MA's product offerings. And you mentioned competitors, Andrew, unlike some companies in the ESG space, we don't have our own index business to help monetize that ESG content. So we see the opportunity in 2 broad customer segments, issuers on one hand and investors and financial institutions on the other. I'll call that maybe the risk market. For issuers in the first quarter, we had something like 50 mandates for sustainability ratings, sustainability-linked loan assessments and second-party opinions for label bonds. So those are the kind of products that we offer to issuers. And we think that the market for, what we call, labeled bonds, so that's green bonds, social bonds, sustainability bonds, that that's going to be somewhere in the neighborhood of $275 billion to $325 billion of issuance in 2020. So this is a very good-sized market. On the other hand, for investors and financial institutions, again, that kind of risked market, we've got ESG ratings on over 4,700 listed companies. And we've got climate-risk scores on over 1 million facilities. So issuers and -- excuse me, investors and financial institutions can use that for portfolio construction, portfolio monitoring. We're also integrating huge customer base around banks, insurance companies and investors, and that includes things like data feeds, green stress testing for banks in physical risk scores that are being offered on our commercial real estate platform through Reis. And even things like ESG training and certification, we're seeing demand for that as well. Ray, our CEO, has referred to ESG as -- he calls it a nongeographic emerging market. And I think we're seeing that this could monetize faster than perhaps we thought maybe a year or 2 ago. And the reason for that, I think as companies begin to focus more on transparency for their broader stakeholder universe, sustainability ratings are going to become more interesting for them, right? So as companies increasingly care about these ratings and their CSR and ESG profile, we think that companies are going to want to engage with a company like Moody's, similar to how they engage for a credit rating by sharing information, understanding our methodologies and engaging with experienced and knowledgeable analysts. And we think that, that opportunity in the risk space can be just as meaningful. As I said, banks and insurance companies around the world, including the U.S., are increasingly wanting to understand the ESG profile and the climate profile associated with companies that they are lending to, they are investing in or that they're doing business with. And on the ratings side, we're going to -- we're very active in integrating ESG considerations into our credit ratings, into our methodologies, and that includes a suite of credit-specific -- and that's very important for the rating agency -- credit-specific ESG metrics. So we're going to keep investing in this space to position us to be a leader in ESG and climate for the years to come and to be able to serve the needs of our very diverse customer base.

All right. That's helpful. That makes sense. Particularly given the relationships you already have with these companies and these management teams, it makes sense that you have that kind of avenue already opened up. Obviously, I mean, you mentioned it briefly, but another growth initiative that you've identified and talked to decent bit about is commercial real estate. You bought Reis in late 2018. For investors who are less familiar, can you walk through the CRE assets, how they fit within the broader MA portfolio and how you're thinking about the size of that opportunity?

Yes. Sure. I guess maybe the first answer is the commercial real estate market, like a number of other areas, is under some very intense pressure right now. And many of our customers are really trying to think through the impact to their investment portfolios, to their credit portfolios, right? So there's a lot of demand for data and analytics in this space given, I think, some of the distress. The size of the opportunity is significant, and that's because U.S. banks have just about as much exposure to the commercial real estate sector as they do commercial and industrial loans. So commercial real estate is a big part of bank loan books. And that's an important part of why we made the investment, to allow us to better serve our core banking customer base in an area that's very important to them and sitting right alongside the C&I portfolio that we have a very nice product suite, and it leverages many of our core competencies. So we're making some good progress on the integration of Reis into our broader business. We think that one way for us to compete is to take advantage of some of these unique capabilities that we bring to bear to have a more integrated offering that pulls together not only property data but economic data and forecasts, climate data and analytics, credit data and analytics and even structured CMBS data and insight. We've got some work to do to continue to build out that Reis and commercial real estate platform. We developed a new Reis data ecosystem. It's in its early days, but we're seeing some very good interest from our customers who participate in some pilots when the product was in beta. We also rolled out a new-and-improved website earlier this year for Reis, and we also -- and on top of that, rolled out a COVID-specific site that's available to the public. And we are integrating our Four Twenty Seven climate data into that Reis platform that I mentioned earlier because we think that it's those kinds of things that are going to give us a unique offering for our customers.

Got it. Yes. Great, great detail. I appreciate that. Kind of sticking with the M&A front and as a growth driver in MA, I mean, earlier this year, you acquired Regulatory DataCorp, or RDC, in an effort, I believe, to expand your capabilities in the KYC space, which is obviously fast-growing and something that you've talked about in the past. Can you talk a little bit about that RDC asset, how it's synergistic to your earlier acquisition in '17 of BvD and the market opportunity there? And then -- and I know this is a long-winded question, but if there's any early takeaways or color you can add in terms of the integration of RDC and how that's progressing, that'd be helpful.

Yes. Great. We're really excited about that acquisition of RDC. That was a business that was formed after 9/11 as a consortium to combat terrorist financing. And we have been working on integrating BvD and RDC. And the obvious goal here is to make sure that 1 plus 1 equal more than 2. And we think that's certainly going to be the case. RDC, alongside the BvD assets and capabilities, really helps us expand our risk-assessment offering and provides us with, we think, a hard-to-replicate suite of solutions that brings together decades of experience in company, people and new screening and proprietary databases and AI capabilities that improve the speed and the effectiveness in identifying risks and complying with regulations, particularly, as you note, in that know-your-customer space. And the combination of RDC and BvD, specifically in that know-your-customer space, has really positioned us to be a leader. As I said, RDC has got a specialized and unique data set on over 11 million curated risk-relevant people and one of the world's best adverse media screening platforms. And you put that together with what Bureau van Dijk has, which is the world's largest database on companies. And those are the things -- those are the ingredients that you need for a KYC program at any bank around the world. So what it does is it allows banks to be more efficient. It gives them a one-stop customer solution that is otherwise very costly and time-intensive for banks. And many of you are probably familiar with Chartis, and they do those landscape overviews, and we've got some very good recognition of the combined capabilities of BvD and RDC in the KYC space. And so we think it's just a very compelling combination for our customers. To give you a sense of the size of the opportunity, on a pro forma basis for 2019, Bureau van Dijk's compliance products, along with RDC, generated sales of about $150 million. And we said on our February earnings call that we expected that figure to more than double by 2023. And overall, that KYC space is almost $1 billion vendor spend market, and that's growing at almost 20% a year. And in addition, there are billions of dollars that are being spent by banks and other companies in-house on very repetitive manual tasks that can be replaced by our AI-driven solutions at Moody's Analytics. So there's a big opportunity to displace that spending. And I think the pandemic also illustrated that there's an opportunity to move potentially from just knowing your customer to knowing your supplier or knowing who you are doing business with, right? This is -- we're seeing that companies want to have a better understanding of the risks of companies they are doing business with, not just onboarding them as customers as required by regulation. And lastly, you asked about some of the synergies and integration. There's some very natural synergies across sales and marketing, in addition to that -- the product fit that I talked about. And RDC was primarily a U.S.-based business. BvD has primarily been -- has a larger customer concentration in Europe. There's a very natural fit there. We see some very good synergies. We see an opportunity to sell more into governments and insurance companies where RDC had virtually no footprint and really packaging BvD's Orbis solution along with RDC to sell into those existing RDC customers in the United States. So we're making some strategic investments in sales, marketing, product development in order to best capture the full opportunity that's in front of us.

Got it. Got it. Well, certainly, a lot of different investment areas that seem promising. Kind of moving to maybe the expense side a little bit. Despite the more challenging environment for top line growth, we've talked about the issuance headwinds a little bit. You're still guiding to adjusted operating margins of 46% to 48% in 2020, which isn't too far off from the high 40s long-term target. So kind of with that in mind, I was hoping you could speak to the different cost actions that you've undertaken concerning margin in the current environment. And then also maybe more importantly, what are some of the ongoing efficiency initiatives that you have underway that could potentially drive margins beyond that long-term target or that existing target threshold of high 40s in years to come?

Yes. So in response to what's going on, as you'd imagine, we've reduced a number of costs. Some of those were related to social distancing and travel. We mentioned on our earnings call that MA is evolving its selling approach. That's really true across Moody's. We're adapting to -- adapting selling to a virtual format, just like we're doing here today and I think getting more and more comfortable with that, and our customers are getting more comfortable with that. All that obviously contributes to much lower T&E costs. Also, when this first -- when the COVID crisis first really broke out, we evaluated all of our spending plans. We went through a reprioritization process in light of the new environment. We delayed certain things. Other things just weren't feasible or as relevant in the environment that we find ourselves in. We're looking at -- in terms of phasing our expenses, we've previously indicated first quarter or fourth quarter, we'd have a ramp of $20 million to $30 million increase. Now that's going to be something like a $10 million to $20 million decrease. And a lot of our cost base is personnel, and our incentive comp is very well aligned with our financial performance and, of course, our revised guidance. That's -- maybe stepping back for a second. We're really looking at what I would call new ways of working. The firm is working remarkably well right now. Despite all the challenges, our folks are doing a really great job. But I think going forward, you're going to see that we're going to have a lot more workplace flexibility and remote work. And that's obviously, I think, going to provide the potential for real estate and travel savings in the future, and we're just starting to work through that and work with our employees to think about how we're going to do that. We had announced a restructuring program kind of back in 2018, '19. We've also been able to harvest some savings from that. And some of those savings, we've reinvested back into the business in some of these areas that we've talked about, like ESG, like KYC and China. The other thing I would say is as we've got everybody working remotely, this is a great opportunity for us to just look across the entire global office footprint, make sure that we've got the right jobs in the right places. Over the last year or 2, we've been really proactive in building out regional operational centers in India, Lithuania and Costa Rica. We also have built out a technology hub in Charlotte. And in addition to being able to lower our cost, it's been able for us to tap into the right kind of talent for the right kinds of jobs. And that technology hub in Charlotte has been very important because it's also been -- allowed us to in-source critical technology talent and I think, really better get after technology enablement for various parts of our business.

Great. Great. We've also -- we've already talked about some of the growth opportunities that have kind of presented themselves via M&A and acquisitions over the past couple of years. I guess I'm interested in -- and I realize that in the second quarter, right this instant, things are a little choppy. But looking towards the back half of the year or beyond, do you continue to expect M&A to be a major part of the growth story of the company? And of the numerous different adjacencies you've identified, whether it be CRE, ESG, I think we haven't talked about it, but cyber is another one that you've talked about in the past, is there one area where growth via acquisition makes the most sense? Or how are you kind of thinking about that opportunity set?

Yes. I think we're going to have a consistent approach. What you've seen from us over the years, I think we've done a good job of finding attractive acquisitions and integrating them into our broader business. We've done a number of bolt-on acquisitions over the years, and we have a very, very active corporate development effort. So we feel we have a very good sense of what's in the market and what fits our portfolio. The key is that we've got to make sure that there's really compelling industrial logic for anything that we look at, that it fits our strategy around risk assessment. And ideally, we want assets that are -- they have proprietary or unique or curated or hard-to-replicate data that are scalable and that have ideally high levels of recurring revenue. Those are things that fit nicely into our business. And it's critical, again, that we've got that industrial logic for our customers. You mentioned ESG and cyber. Those are probably areas that we're going to continue to look to build out because, again, we're hearing from our customers that these are areas that are important. They're looking to us for solutions. They're looking for us to be able to integrate some of this kind of content and some of these other risk domains into our broader offerings. So I think you may see us make investments in areas like that. I think supply chain risk is an area we've heard a lot about in the pandemic, and I think that's an area that would very naturally leverage our capabilities in Bureau van Dijk and RDC that I talked about earlier in understanding the risk of the enterprises that companies are doing business with. But I think you'll look for us to be -- I think we'll be active, but we're going to continue to be disciplined.

Great. Great. Maybe squeeze one more in. I think we have a minute or 2 left. Kind of going back to the first question I asked about coverage, I think you mentioned the opportunity in China. Just kind of curious how the recent tensions between U.S. and China impacted the outlook for that business, for the expansion of ratings in the region and whether it changes your opinion in terms of operating through CCXI or potentially considering an organic build somewhere down the line.

Yes. This is one I could probably take more than a minute or 2, but I'm going to keep it tight, my answer tight, because we're just about out of time. We haven't really seen a negative impact to our cross-border business. And as I said, we've got a leading position there. Certainly, what's going on, the U.S.-Sino tensions is not helpful. I think most of you know that we've got a 30% stake in CCXI. That's the largest rating agency domestically, has a leadership position something like 1,700-rated credits and a 40% share in a one rating market. So we are working through the leading Chinese rating agency in the domestic market. We're the only international CRA that's got that kind of domestic joint venture, and we're actively collaborating with CCXI in terms of commercial outreach and market engagement. So you have an opportunity to get the best of a local rating agency and the best of an international rating agency. We've seen peaks and valleys in the U.S.-Sino relationship. Since that trade deal was signed, we haven't been able to travel to China and continue an in-person dialogue, but we maintain a very active and constructive dialogue with the Chinese authorities. We are very pleased with our position in CCXI. It's been a very successful business to date. And I think you can expect us to look for further opportunities to contribute our knowledge, our expertise and skills in credit analysis and risk assessment to both support CCXI. And I think you'll see them continue to expand into sectors like ESG and structured finance and grow their nonratings business, but also be a constructive player around credit and risk assessment through our offerings in MIS.

Outstanding. Well, thank you very much, Rob, for your time today. I hope you have a great rest of the day. And we'll be in touch.

Yes. Thank you for having me again, Andrew. Take care.

Of course.