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

Good morning, everyone, and thank you joining us at the first ever Bernstein Operational Decisions Conference. For those who don't know me, I am Christian Bolu, I'm Senior Analyst covering U.S. capital market stocks under the Autonomous brand at Bernstein. Kicking off the conference today is Moody's. Most of you know Moody's, the company and the stock. The stock has been an incredible compound over time led by its leading credit ratings business. But they do have a growing software and analytics business, which we think has a lot of structural tailwind. So joining us today from Moody's is Stephen Tulenko, who serves as the President for Moody's Analytics. A bit of on Mr. Tulenko. He's a 20-year veteran of Moody's. Prior to assuming his current role in 2019, Stephen had many leadership roles, including heading up Enterprise Risk Solutions business at Moody's as well as Senior Sales and Marketing roles in both Moody's Analytics and the core ratings business. So welcome to everyone, and Stephen, particularly welcome, and thanks for joining us for the first ever Operational Decisions Conference.

Thank you, Christian. Nice to be here.

Great. So before we get started, maybe some quick housekeeping for the listeners of the webcast. You can submit questions for Stephen on the left-hand side of your video panel. Also, there is a Procensus poll, I would like you to fill out on the right-hand side of the panel.

So with that, let's get started. So look, Stephen, this is a bit of generous conference. As I said, we know Moody's best for its credit ratings business. As I mentioned, we know Moody's best for its credit ratings business. But as I mentioned, you do have a growing and fast-growing analytics business that you run. So maybe can you give us a quick overview of the business, how it fits into the overall sort of company?

Sure. So maybe the way to think of it is, Moody's Analytics was born in January of 2008. Prior to that, there were a series of units that were really just a part of the rating agency. And in 2008, we had -- we sort of finalized our plans to create a new entity that was separate from the rating agency. We call that entity Moody's Analytics. Gosh, in 2008, I think Moody's Analytics was around $600 million in revenue, something like that. And since then, we've enjoyed a very nice run, growing at about a 12% CAGR over the last 10 or 12 years, probably 6.5% or 7% of those percentage points, excuse me, were organic growth. So we've acquired some companies along the way and integrated them in earnest and generated a very nice trajectory over the last decade or so. We are a business that's broken into 2 segments that we report on externally. One is called Research Data and Analytics, the other is called Enterprise Risk Solutions. RD&A roughly maybe 65% or 70% of the business and then the ERS business, 25%, 30% of the business. Yes, there we go. There's a nice chart to give you a sense for how we look. The majority of our business is a recurring revenue stream, subscription revenue. RD&A is virtually all recurring revenue. And Enterprise Risk Solutions is now about 80% recurring revenue. So the combined entity -- combined, the entity is generating something like roughly 90% of revenue in subscription form or recurring form and enjoys very nice retention rates in the high -- sorry, low to mid-90s over the years. So I would say we're in the business of helping investment managers, banks, insurance companies, especially and increasingly, corporates and government entities with understanding risks and especially understanding who they're going to do business with. If you think about it, when you buy a bond, you need to do some homework and understand who it is you might be interested in investing in. That's getting to know that company. When you're thinking about doing maybe extending some trade credit, you could do the same kind of thing. When you're making a loan, you're doing the same kind of thing. So we've invested quite a bit on helping you to get to know who it is you're going to do business with and think about that as maybe a credit question or maybe a cyber risk question or those other kinds of questions you might ask about a company before you do business. So maybe that's a way to think of us, in general. On mute there, Christian.

Right. Let's dig into the 2 businesses. We'll start with the Enterprise Risk Solutions business, which I think is a bit of a software-type business. But I think the whole concept of lending software or lending automation has been in massive spotlight given recent IPOs by a company called nCino and then Ellie Mae got acquired by ICE for $11 billion. So maybe we can start just how you think about the broad landscape for lending automation, lending software, credit technology. How do you think about that opportunity set? How big is that market? What are the secular drivers of growth and then we can after go into how Moody's fits into all that?

Yes. Okay. So I mean, let's think about addressing market for a second. A lot of ways you can think about addressing the markets. You can look at individual solutions that we sell. What's the grand total of spend on those kinds of things? You can think about the -- maybe the work that we replace. When you maybe provide one of those applications or one of those tools to help someone do their job every day, there might be some work that we replace or digitize or automate. And I would say that there's a pretty big difference between those 2 numbers. Our addressable market for the Enterprise Risk Solutions business is probably in the, if you go with very, very direct competition, in the $5 million or $6 million range -- $1 billion range rather each year. If you think about the work that we have the potential to replace, it could be multiples of that. So I think if you just think about maybe loan origination in terms of commercial and industrial loans, that addressable market is probably, I don't know, $1 billion worth of spend every year on tools and then probably another maybe $2 million or $3 million worth of work that we can help people obviate or redirect in other places. So just that particular market alone is in the few billion-dollar range, but I think it dramatically depends on what you're actually looking at there. We tend to think of it as -- in our franchise as an opportunity to help banks, insurance companies, especially make decisions. So using our analytic tools and our software in order to hang some of the capabilities that Moody's has available to it from a credit analytic perspective and risk analytic perspective so that they can make better decisions. Software is very much a chassis for us. We think of it as a way to maybe cross-sell other things that we do. We, of course, make and generate revenue from the actual tools themselves. But if you think about a loan decision as an example, if you're helping someone make credit decisions, by automating or digitizing the information you pull in when you're thinking about lending to a prospect or even doing homework on a prospect, and we can do that now. We've got data from the BvD acquisition where we have information on private companies as well as public companies, of course. We can pre-populate a prospect for a loan officer and then bring analytic tools to the table like a credit scoring tool. We have what I think is the world's best credit scoring tool for private companies out there. You populate that with some information. You can score it. You can get a good sense for who you're dealing with and then embark on the loan approval process and procedure. We spend time in the credit decision part of that loan process. So we don't spend too much time automating the booking of the loan, but we spend a lot of time helping them make the decisions. So our software, think of it as a chassis or a carriage where we bring other tools to the table to integrate risk management practice -- best practice, to the loan origination process. And we really bring risk management practices to the front office so that those decisions can be brought together and made simultaneously or considered simultaneously.

Very helpful. Thanks. Maybe talk about -- because I think you talked -- you're saying you're mainly focused on the credit decisioning part of the value chain. Help us understand how that fits into the wide value chain? Again, there's a lot of very fast fintechs like nCino, there are established providers like [indiscernible] and Jack Henry. Help us understand where you fit that -- essentially where you could expand and there are other opportunities to grow?

Yes. Yes. Sure. So let's -- we're just talking about loan origination right now. So with respect to that part of our business, and we have probably -- maybe just to give you a sense, we have about 1,500 customers in the loan origination space. Just to give you a sense, their banks have sometimes been very small banks, sometimes have very large banks. About 1,000 of them are in the U.S. And think of them as -- they need to -- wherever they can, they are increasingly aware of the benefits of automating the process of onboarding customers, keeping track of that information, deciding on who they might loan and what price and then thinking about their portfolio as well. What most of the competitor, the people that you mentioned, the Jack Henrys of the world, the nCinos of the world, I think of them as automation players, where they are helping you to process loans from end to end, really from -- now that I know something about this customer, I keep track of that information and then I follow that along through the process So they have a pretty robust means of managing the flow, the workflow associated with those decisions. We spend time, maybe if you were to envision them as a conveyor belt, we spend time with the few minutes that you need to spend, sometimes it's a few days, sometimes it's a few months. We try to make it not a few months anymore and turn it into a few minutes, thinking about the actual credit decision. So if you're on that conveyor belt, you take a step off that conveyor belt for a second, and you actually think about what should I do here with this particular opportunity? What's the right price? How does it compare to the rest of the portfolio? What should I be thinking about my CECL experience -- expectation, I should say, with respect to this loan? And considering the analytics side of this decision and incorporating some of the world-class analytics we bring to the table. So we basically take a minute off of that conveyor belt, process the decision that we think really makes a difference, right? If you think about it, the speed at which you process the loan end-to-end is worth some money because you save time and you automate. The decision to make the loan to the right one can really make a difference in terms of your loan losses and maybe your returns. So we spend the time on the stuff that takes maybe a little bit more qualitative judgment, maybe you need to understand why you might be approving a loan that doesn't fit your criteria exactly, and you need to document that. You need to demonstrate the approvals and what the committee might have decided. So we spend time on the decision part. They're better at the automation part end-to-end.

Perfect. So I think you mentioned C&I as a key category that you're fairly strong in. Maybe talk about other asset classes where you have strength that you plan to grow into? Let's just talk about any customer types, whether is it large banks, credit unions, where are your strengths and weaknesses and where do you see growth?

Yes. Well, the whole sector is growing quite a bit, I would say, first of all. We've enjoyed really good growth from our CreditLens product and CreditLens franchise in the last 1 year or 2. By the way, CreditLens is about 65% delivered in -- delivered as a service, Software-as-a-Service, true next-generation kind of software -- SaaS software platform, built for the cloud properly. We still have some people out there that prefer to install their software behind the firewall, which is interesting, but -- so we see a lot of opportunity. The C&I space is continuing to undergo change and "digitization or transformation." Again, our objective there is to pull risk management expertise to the front so you can make these kinds of decisions in real time and be informed in real time on what the impact might be on your bank overall. So we see good growth there. It's good growth still in areas like the CECL space. So connecting these decisions to what you do with allowances and providing integration across the onboarding tools, the decisioning tools and then leading to the analytics that are required to make sure your allowance is correct. So there's lots of interesting opportunities to integrate. I would say our strategy is start with decisions that are of high value and importance and then grow through ring-fenced activities around that center of excellence that we provide. So we have great capabilities at Moody's, especially in credit. We now have great capabilities in terms of knowing your customer, making sure that the customer you're about to do business with is somebody you can trust. So you may be familiar with the acquisition of Regulatory Data Corporation, the RDC acquisition from earlier this year, joining forces with the work we've done in the Bureau van Dijk unit. We now have what we think is one of the world's best, if not the world's best, ability to understand who you're doing business with from a know-your-customer perspective. So if you think about loan onboarding and managing risk when you're thinking about starting to do business with somebody, knowing your customer upfront, pulling in financial statements in an automated way, pulling that information into a model so you can understand and score that risk and then presenting it to somebody who's actually deciding, maybe it's an automated algorithm, but maybe it's a committee, deciding what you're doing in terms of whether or not to make that loan, we're bringing those things together. So where there's high-value decisions to be made, that's where we spend our time, starting with credit and then growing through concentric circles away from that core so that we can bring things together in an integrated fashion.

Perfect. So maybe if we try to just put it all together and you think about the next 3 to 5 years, first of all, help us understand what the growth of the business has been over the last few years? And how do you think about the next 3 to 5 years in terms of growth, given some of the acquisitions that you mentioned, RDC, et cetera, helping boost growth. I'd imagine there are sort of structural tailwinds out there. So help us understand how that plays into your future outlook?

Yes. So we're always careful about how we say these things. But I think it's fair to say that the growth rates that we've seen in the last couple of years from the ERS unit are the kinds of growth rates we would expect to see going forward. We need to continue to work hard to provide better decisions -- ability to make better decisions for our customers and continue to grow out our feature set and integrate those features together. One thing, the COVID experience here in 2020, I think, is one that I'm not treating as a normative change for us. I think we'll see some impact, thanks to COVID for the next little while. But the overall normative expectation for the ERS unit, for the lending space, especially is one of double-digit growth over the foreseeable future.

And can you just talk about -- so double-digit growth is a fairly healthy growth expectation. I think there's some concern or at least some thought that you have had tailwinds from regulation, where at CECL, IFRS that have actually helped boost that growth over time. So maybe just help us understand, if those things fall off, how you maintain sort of robust growth that you've had in that business over the next 3 to 5 years?

Yes. I don't if you have that slide that talks about the renewable portion of the book over time, but we could talk about that one, too. Yes, this one is the one, I think, it's useful. So maybe it's important just to note like the RD&A segment. Our ERS segment has now a high proportion of the revenue in this book that is recurring revenue. So when we sell these services around the CECL application and the CECL standard, we're selling software as a chassis to help people make those decisions and do the calculations on the allowances. We're bringing scenarios into the application so that those models and the tools we use to come up with those estimates can be conditioned by economic factors. So our projections for economic scenarios are brought into that software. And then, of course, we update the software with refreshed data and other tools that are considered -- the kind of tools that you need updates on all the time. So most of the revenue here is recurring. So you have a very nice solid base of business and then you have the opportunity to continue to enhance their ability to automate and digitize and think about, say, that CECL estimate by maybe including another model in the software or perhaps adding another data set in the software to help condition and understand their projections. So we see it as a very healthy base of business that should grow over time as we continue to bring other capabilities from Moody's to the table. And I think that's generally the strategy. We've been -- we've undertaken this strategy really, and I think I first started talking about it back in 2015, where we intentionally moved out of a world where we were selling software on a onetime kind of project basis, really delivering often behind the firewall projects that were considered license with maintenance revenue streams, instead, we've moved to subscription sales. There's still a little bit of onetime money out there. And you can see in this chart, we've kind of flattened out a bit on the ratio of recurring revenue and that's because we've had some good growth in the Middle East, where they don't really adopt SaaS software at this point yet. In fact, let me just give you a sense in the Middle East, they really don't have the same kind of AWS or Azure facilities out there that they do in other parts of the world. They literally have to build power plants to create those server farms. So it's literally a different world in that respect. So we've done some good business in the Middle East, and that's sort of brought our ratio down a bit. But we'll continue to drive recurring revenue growth and therefore, a very stable and growing -- business is growing nicely.

Okay. Perfect. Maybe we just switch over to RD&A. So that's the bigger part of the Moody's Analytics business. I think, as you mentioned about 70% of the MA business. That business had really strong growth as well. I think in the last quarter, you were up to 9% organic growth, which is decent for business of that size. Maybe just step back here as well and help us understand what's driving growth? Are there structural tailwinds that we should think about, are there more onetime episodic things from COVID? Help us understand what's going on there?

Yes. I mean, the #1 driver of the dynamics in the RD&A unit, without a doubt, is just really strong retention. Even in the COVID environment, our retention rates have been quite strong. And in fact, some of our units, our research business, for example, we've actually seen retention rates go up, and that's up from, say, 95%. So even though there's some very difficult circumstances out there, our content, our product, our capabilities really help people analyze uncertainty and understand or try to understand uncertainty and maybe even dimension that uncertainty with some ability to measure it. So our retention rates are really strong in figure -- a 94% retention rate on 94%, 95%, 96% recurring revenue, you start from a base that's very, very healthy and very reliable and very -- provides great ballast for the company overall. And then we have some, I would say, really good tailwinds in the KYC space. So we bought the company RDC that contributed nicely. Just to give you a sense, the BvD unit, which we bought a few years ago and are now actively integrating, their growth here it is -- their growth has been driven also -- I should say, on that last slide for me. Thanks. The growth in the BvD unit has been largely driven by compliance, AML and KYC activities as well. So just to give you a sense, this BvD unit, which Bureau van Dijk, for those of you who haven't heard them before, in general, it has produced around 12% kind of growth rates from our kind of core use cases, but this compliance and know your customer use case has been a real star for us. And we saw that happening, and that's why we went after the opportunity to grow together with the RDC unit. So combined, we're getting great growth from helping people knowing their customer, getting to know their customer before they do business with them. And that growth is coming from corporations and governments and financial institutions. So this is a big driver of success. And then we have our traditional units like the research business and the ratings feeds business, both of which have been performing very well.

Okay. Perfect. Can we -- can you talk about -- I mean, this is a fairly spectacular growth rate. So I'm curious what's actually going on with the competitive landscape. Can you dissect the business however you want, say, BvD, research, research feeds and help us understand who -- what's the competitive landscape like? Are there -- are you growing because there are new use cases? Are you growing because you are taking share? What are the complementary products? I'd love to understand sort of how sustainable the growth is vis-a-vis the competitive...

So maybe we'll just -- I don't know, Shivani, if you have this broken up in a pie chart somewhere. But we've got -- I think of it as 4 basic areas of interest. You've got content that comes from the rating agency, research and ratings data. You've got the BvD unit, which is -- think of it as private company information. Private company information. You've got our economics unit and our structured finance activities. There's some other things there. But those are the 4 big drivers of interest, I think. Structured finance is actually growing pretty nicely this year. It's a smaller base, growing pretty nicely in light of the fact that we've released some new products in that area. So growth rate wise, it's a nice performer, but not contributing as much money because it's a smaller base. The economics business is going very well, especially in light of scenario-based analysis. Our -- we construct tool -- we create tools that enable you to construct scenarios and then keep track of the elements that are behind those scenarios. So it's a very nice business for us, although, again, a little smaller. The ones that really are generating the growth, the piles of money that are contributing to the growth are the research business and ratings delivery service, the ratings feeds they continue to grow at high single-digit kind of rates. We think that's largely -- it's interesting that COVID, in some respects, is maybe even adding a little boost there because people are very interested to understand what's happening to rated entities in light of the situation and the circumstances and everything is changing every day. So we're continuing to provide value, and the rating agency has been very active in monitoring and analyzing the impact of COVID on entities they rate. The one that maybe you wouldn't expect is the BvD unit and think of that as anything you can get your hands on that's interesting to analyze a private company. And we cover, gosh, 370 million private entities, I think, if it's not 370 million, it's 375 million. It's some very amazing number. And again, that's million, not thousand. 375 million entities, we know something about. Let's say 40 million or 50 million of them in Europe. We can actually give you financial statements on them. In the U.S., there's, I don't know, 10 million or 20 million where we know something about them, we can confirm whether or not they're in business. The asset here that's really interesting from a growth perspective, there's the number -- 381 million now. 381 million. What we're trying to do here is create an index that is universally useful in terms of knowing those companies, whether or not they exist, who owns them? Who owns them? And what are the corporate hierarchies? What do those look like? And we think that, that index of companies can be extremely useful for all sorts of things going forward. If you can attach who are the individuals that are associated with those companies and maybe also understand whether or not those individuals have anything in their background that's worth looking at, this idea of people of interest or politically exposed people, people who are on the sanctions list in the various parts of the world. And if you combine those sanction lists with the work we're doing around using news and adverse new stories about individuals and then mapping those through some machine learning techniques so that we can literally monitor every news story in the world, virtually every news story of importance at least in the world to help you decide, gosh, I know something about the company, they exist. Now I can actually see how they're associated with other companies in terms of corporate hierarchy. I can see the individuals who are associated with them and now I have any new story that shows up with that person's name in it. And of course, we have to do a lot of work to make sure it's the same person named Christian Bolu, because one of them is a superhero at Bernstein, and one of them is a crook, right? But once we get those facts straight, we can be a very definitive source of comfort as you think about doing business with that company across whatever that use case might be. So this asset is a very interesting asset from a growth perspective, and we're very excited to pull these things together, integrate those capabilities, so you can have a holistic sense of who it is you're doing business with.