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

Good morning, everybody. This is Shlomo Rosenbaum. I'm the business services analyst here at Stifel. I want to welcome everybody, and thank you for joining Stifel's hopefully last virtual CSI conference. We hope to see everybody in-person next year. I want to welcome the Moody's team to our conference, Mark Kaye, the CFO; and Shivani Kak, who's -- so I have a list of prepared questions. And I'm going to talk to management about it, but I want to encourage people to submit questions as well through the website. And as you submit questions, I'll be here to read them and ask Mark and Shivani for -- to address those questions. And with that, again, thank you very much, Mark, for joining us. And if you wouldn't mind, I think I'm going to -- I think I'm going to -- can you hear me, by the way, Mark? I just got a notification -- okay. I think I'm going to start with the questions with Moody's Information Services, the MIS business and then afterwards, kind of move over to MA and then business for just kind of the format, so it makes it kind of clean.

So just starting out with that, can you talk a little bit about the company's expectations around the debt issuance mix shift that's happening now versus what it was in 2020? And what do you see out there that kind of supports the company's view that Moody's should get mid-single-digit revenue growth in the MIS segment versus kind of the expectations for overall debt issuance growth that's actually going to be a low single-digit decline according to your projections? So what are the factors that drive the Moody's growth, revenue growth versus the overall debt issuance growth?

All right. First, Shlomo and Stifel, thank you very much for hosting today. It's a pleasure to be here with you. And just turning specifically to your question, you'll see here on Slide 28, and this is really about when we spoke about guidance in our first quarter earnings call. We did mention that we expected overall issuance to your point to decline, albeit modestly from 2020's pandemic-related surge, but it would still be above the 5-year average. We also noted that despite overall issuance decline, we expected total MIS revenue to increase in the mid-single-digit range, which to your point, is primarily due to favorable mix. Specifically, we're expecting leverage loans and structured finance to have strong issuance volume growth this year, high-yield bonds and financial institutions to be relatively flattish and investment grade to see some of the largest relative year-over-year declines. I'd also add that the differences between issuance volumes and MIS revenue growth can be nuanced. They are also due to multiple factors including, for example, the nature of the issuance. So you often write about large issuances by issuers on our frequent issuer pricing constructs, typically generate less revenue per dollar of issuance than the same aggregate issuance amount comprised of many smaller issuance from issuers on the infrequent issuer based pricing. Second reason could be level of complexity. Typically, there is a correlation between the level of analysis required and the fee. If it's a very complicated structured transaction, that could have a higher fee then plain vanilla corporate issuance. And then similarly, I'd say that if the issuance relates to a large M&A process, that may need to be evaluated, which then could require incremental work, which would then charge for accordingly. And so while that's maybe not an exhaustive list, it should give you a sense of some of the factors that we're considering.

Great. And then there's been kind of a rush to refinance in terms of companies thinking or noticing that we're starting to see some interest rates increase. Can you gauge how much debt issuance pull forward might have happened in the first quarter of '21? It was such a strong debt issuance quarter. And if you are able to gauge it, do you -- can you tell exactly like where it might have come from? Was it the end of '21? Is it something that might have been pulled forward from the beginning of '22 even? How do you guys think about that when you make your forecast and you kind of assess what's happening?

So a great question. So we touched on this during our April earnings call. And our guidance specifically considers the potential for some pull forward out of the second half of the year. With spreads tightening, we did see a surge in issuance in the first quarter of the year. And we heard from many of the banks and other data that many borrowers have opportunistically accelerated some of their 2021 funding plans to take advantage of these favorable rates. We haven't disclosed a specific figure for our pull-forward assumption. We also last updated our refinancing needs analysis in the fall of last year, and you'll be able to see that on the slide that I'm pulling up now, Slide 21. And at that time, we were still seeing a good amount of debt in 2022 to be refinanced. This study is obviously done annually, and we'll put forward another update in autumn later this year.

And just piggybacking on that question. So as the CFO yourself, just to ask you, you said you're factoring in some of the stuff in the second half of the year. When you think about your own refinancing, how you do it, is that typically how you do it, maybe 6 to 9 months in advance, that's usually as far out as you would go just in terms of thinking about it because you made that comment about bringing it from the second half into the first half?

Yes. Shlomo, specifically for Moody's own debt capital structure. Our next refinancing is really due in late 2022. And we were very active last year in taking advantage of favorable rates and spreads. And you saw we issued a 40-year bond towards the tail end of 2020. So in terms of how we think about refinancing, we definitely don't wait to, I'd say, the last moment-ish. And that could be somewhere between 3 to 6 months prior to maturity. We really want to take advantage of market conditions as they present themselves.

Perfect. And then one of the things that I've thought about or I don't know how to get a handle about on as much is kind of the recent strength in the SPAC market in terms of debt issuance. Is the SPAC market kind of -- is it going to -- is cooling? Is that going to represent any headwind to new debt issuance? Or are you -- do you really see the M&A environment from the corporate issuers really something that's going to step in to replace some of the SPAC deals for issuance volumes? I know I've had CEOs of companies tell me that, hey, we're not as active -- last year, they told me we're not as active in M&A because we're competing with some of the SPACs. And the valuations don't make sense. But when that SPAC market cools off, we'll be ready to engage more in M&A. Is that what you're seeing now? And how are you thinking about that?

Yes. So a fascinatingly interesting question. I think so far, stacks have been a relatively limited driver of overall issuance activity. I'd say maybe despite the slowdown in new SPACs, what we are hearing is that there is a backlog of -- this is a new term, de-SPAC activity. That, in term, is also going to create a bottleneck as SPAC deals have to wait until the de-SPACs are completed. So during or after the de-SPAC-ing process, I'm sure that's not a verb, which is just a quick reminder, that's really when SPACs, acquire or merge themselves with another company, we often see the actual debt reduce. And we see those de-SPAC-ed companies actually issue debt because they now have assets to borrow against. It's not clear if the SPAC activity we saw in 2020 and earlier this year will continue to that same level going forward. I think should the trend of SPACs and de-SPACs continue, it would likely be a modest net positive for MIS, especially since it's possible that the rated entity would be rated as a first-time mandate. And we see first-time mandate to some of the most attractive revenue opportunities as they contribute to both the current year's transaction revenue through the fee charged for the initial issuance, but they also add to the base of recurring revenue through the annual monitoring fees. And maybe furthermore, once the company issues [ public debt ], they tend to refinance that debt via the public markets, which creates future rating revenue growth opportunities down the road. We did release a very good MIS research report on SPACs and de-SPAC-ing, which you can see that we brought up on screen here. I think it's a worthwhile to read for our investor base.

Okay. Great. So main takeaway on that is modest net positive, but -- so therefore, the change any change that would really happen in the SPAC markets would not be a significant impact on what -- the way that you guys are thinking about the issuance environment. Okay. Great. Perfect. And again, I just want to let the investors know that you can submit questions through the website, and I'd be happy to go ahead and ask them. And in the meantime, I'm going to go ahead with the ones that I have prepared. Another one that's a very common question that people ask is that at least from a very short-term stock perspective, what we often see is that when there's an expectation for increasing interest rates, the stock will go ahead and sometimes come down. And the question is, is that a fair reaction? I think what's behind that movement is people thinking or investors thinking that, hey, as interest rates move up, you're not going to see the same kind of financing that we saw before. I guess there's some question about whether that really is true, whether that's something that is actually plugged into program trading that's made some of that happen. And I was wondering if you could kind of give us your opinion on that.

Yes. also a very, very good question. So based on what we have seen historically, and as we bought up on Slide #68, Moody's revenue is not strongly correlated to interest rates. In periods of significant increases to the 10-year treasury yield, we have seen Moody's revenue continue to grow, including most recently, you can see here in the 2012 to 2013 period. Sharp changes in rates and borrowing costs, however, now I think about also this from the perspective of overseeing our treasury department, they can have short-term impacts on issuance behavior. But our feeling is that they tend to be temporary in nature. The market can take a pause if there is rate volatility. And then it certainly can resume sort of once that rate volatility declines even if rates settle at slightly higher levels. The short-term impact of rate movements are not always obvious. They can also depend on the rate outlook. So if you think about rapid changes in rates, typically have gendered a pause, slight increases in rates in a pre-forecast or pre-indicated structure, typically don't cause that kind of disruption. Issuers tend to be able to react to that into the market. And in some cases, issues were actually pulled forward in anticipation of rates rising. I'd also say additionally, issuers are focused on their overall borrowing costs. So it's important to consider spreads as well as benchmark rates when thinking about this. And an example there is we saw continued issuance volumes in the first quarter of 2021 despite periods of rising benchmark rates because freights remain tight, keeping overall borrowing costs low and at attractive rates. Last thing I'd notice on Slide 11 here, we provided the assumptions for GDP rates and spreads that are reflected in our guidance outlook that we provided at the end of April.

Okay. Great. One other thing I would just comment and sometimes, besides the spreads is that sometimes when there's a thought that the interest is going to be moving up, you see kind of a little bit of more of a rush to refinance at that point in time can result in some of that. Okay, perfect. I think I want to shift over a little bit more to some of the MA-focused questions that I had. And given the profile of the assets in the Moody's Analytics business, shouldn't we see the margins in that business going up more to the mid- to high-30s over the next 5 years, similar to what I see with other companies with similar types of business models to the types of businesses that you have in there? Should we expect a steady move up in the margins in that business?

Sure. I'd say without necessarily getting into a comparison with other specific companies, We have said before that we don't see the 30% range here as a ceiling to the margin by any means. MA has a number of attractive growth opportunities ahead of it across multiple verticals with large addressable markets, including KYC and compliance, commercial real estate, insurance ESG and others. And it's important that we, as a management team, balance investment in those growth areas with margin expansion. And we're going to do that in our usual disciplined and deliberate manner. As you can see here on Slide 40, we think about really margins over a multiyear context, not necessarily just over 1 year. And that's with the intention of driving sustainable margin expansion over the long term while also ensuring that we invest enough to support continued revenue growth in the short term. And we have a strong track record of doing that. Margin expanded nearly 500 basis points since 2017. You can see here the total MA revenue grew 45% and MA recurring revenue grew nearly 70%.

So bottom line, expect the margins to keep moving up, and there's no reason why we shouldn't do that. You don't want to give longer-term guidance, obviously. But structurally, you're balancing what seems like the need to invest in the business to keep that going with the -- showing some leverage within the business. Is that accurate?

I think that's very well put, Shlomo.

Okay. Then just a little bit more on the short-term margins. The MA margin guidance for this year is kind of, I think, is approximately 30%. Now the first quarter was about 32.9%, I believe. And so that implies that the margin is going to come down during the year versus what we saw in the first quarter. So what's that play over here? What's going on? There's a certain amount of leverage. Now MA did not have that significant step-up all of a sudden like MIS did with all the debt issuance. So obviously, there are other factors that are at play over there. And maybe you could talk us through that and kind of the cadence of how to think about that through the year.

Yes. For 2021, again, similar to what we mentioned in our April earnings call, the implied lower margin for the remaining 9 months of the year is primarily related to the timing of our planned strategic investments, which we expect to increase over the remainder of the year. We have spoken about those investments on the last few earnings calls, and we really wanted to highlight that we see many attractive opportunities to innovate and invest in future growth. And you see this a little bit on the Investor Relations presentation, Slide #8. We also mentioned specifically in our April earnings call that we expected 100 to 150 basis points of impact from M&A and around 240 basis points of impact from strategic investments to MA's adjusted operating margin in 2021. So the underlying adjusted operating margin is, in fact, expected to expand 390 basis points in 2021 per our latest guidance. I'm also going to emphasize that similar to my earlier comments, that we think about margins over a multiyear context, not just 1 year. And that's what the intention, again, to drive the sustainable margin expansion over the long term while also ensuring that we invest enough today to support revenue growth. In other words, balancing out those 2 attributes.

Just when you talk about the margins that -- the weight on the margins from M&A, is that -- maybe you could just elaborate on that just a little bit more. As your buying companies that had -- you can enhance a lot more, maybe you can just delve into that. What goes into the investments in the M&A?

Absolutely. So in terms of M&A, we adopt a very disciplined approach to any acquisition. We typically look at 4 financial metrics in evaluating any opportunity that range from an IRR greater than the cost of WACC, the cash flow metric in terms of both near-term and long-term cash flow accretion. And then, of course, we look at adjusted EPS from an accounting accretion dilution perspective. Most M&As that we're able to -- or most recent acquisitions that we've brought on give us the opportunity to both accelerate growth of the underlying asset but also to accelerate margin and improve margin profile of those assets. And we're able to do that because the assets that we bring on present opportunities not just for growth on a stand-alone basis, but also for interoperability within the broader Moody's Analytics universe of assets. And that really allows us, again, that opportunity to expand both revenue and margin of the acquisitions that we bring on because they form part of our overall ecosystem. And that's a really key point as we, management think about, not just the financial metrics associated with any M&A, but also the strategic profile of those assets.

Okay. Great. And then the MA part of the business is really the faster-growing part of the business, and it has a lower margin profile than the MIS business. So when I think about the company kind of targeting low-teens EPS growth just on a regular basis, should I think of more of that growth coming in the future from top line growth driven by MA versus margin expansion? Because it's just the natural math, if you're growing the faster -- the faster-growing part of the business is lower margin. So won't that be a weight on the margins? And how should investors think about that?

Yes. Shlomo, we have not changed our long-term growth expectations. So we're still targeting high single-digit percent growth for revenue, high 40s for adjusted operating margin, low teens percent growth for EPS to the points. As you're correctly implying, there is a tradeoff in the short term between the pace of expansion between revenue and margin. We can drive short-term margin expansion quite easily by pulling back on investment spending. But longer term, that's going to have an adverse and, I'd call it, an undesirable impact on revenue growth. That's why we're so focused on this concept of sort of balancing that sustainable margin expansion over the long term, really with investments to drive future growth.

Okay. Great. And we have a question from 1 of the investors. This question is, can you please describe the business prospects and strategy for the Chinese credit market?

Sure. And maybe -- Shlomo, let me talk about China more broadly, and then I'll touch specifically on the question from the investors. So there are 3 main areas of Moody's business in China today: There's the MIS cross-border business; there's Moody's Analytics; and then there's the CCXI for a domestic credit ratings. We estimate the cross-border market to be approximately a $280 million market as of the end of last year. And we estimate Moody's share of that market to be approximately 42%. In Moody's Analytics, just again, giving you that broad perspective, we have established a new dedicated product development group, the Commercial Strategies Group, which is based in Shenzhen to develop data analytics and insight offerings that holistically serve China's domestic markets. In 2020, we generated, just for context here, a little bit over $50 million of MA revenue in China. You can see that actually quite easily here on Slide #34. In the domestic ratings market, Moody's participates both via its 30% stake in CCXI. And CCXI accounts for, call it, 40% of a market that's over $300 million at the end of 2020. CCXI is what we'd see as one of the market leaders. And just from an accounting perspective, we account for CCXI via equity income, which then flows through the other nonoperating income and expense line in our P&L. We also, as we think about the credit market developments, are very active in supporting the Chinese regulator in helping them develop the markets in the way that they would like to develop the markets. We really want to be is a supporting facilitator to them to be able to grow. I'd be remiss in touching on China if I didn't quickly mention that we do have investments also in SynTao Green Finance and an investment in MioTech. And that's a provider really of large company data. So you could think about this as being totally $169-ish million in revenue from MIS cross-border and MA activities. And an additional $19 million in attributable income from CCXI in 2020. And again, most importantly, our goal is to participate in the Chinese market in a constructive way that meets the broader objectives of the regulators as they develop their markets.

Great. One thing on acquisitions, I thought I'd ask you, one of the ones that closed and one that closed in March was Cortera. It's a competitor to D&B on the trade credit area. I've known this company for over a decade. And I guess the question I've got is in terms of that fitting into the Moody's environment, are you thinking of that being more of a focus -- helping you focus on your core financial services clients? Or when you looked in the credit database area, like they had a particular strength in kind of IT and in transportation and other areas where Moody's actually was not kind of your core client base. And I was wondering, are you planning to continue growing with what they were doing? Are you planning to kind of refocus them more into your core client base?

Yes. So with the acquisition of Cortera, we brought in-house data on millions of North American small- and medium-sized enterprise -- enterprises. And that enhanced our database of approximately 400 million public and private entities. As we said previously, the Cortera database really serves multiple use cases, including KYC, which is the largest and fastest-growing use case as well as corporate trade credit, as you've mentioned, among many others. You've also heard us talk about the interoperability, and we intend to further integrate Cortera's data into our offerings to better serve several markets. And that's going to potentially include commercial lending, customer onboarding and supply chain management. And really by combining the data from Cortera with what we think of as Moody's proprietary analytics, we are enhancing our comprehensive suite of reference and entity data. And that, when you take it together with our analytics and tools, does provide key insights across a wide range of industries and use cases. And the key point here is that reinforces our integrated risk assessment strategy. And so it's very aligned with where we are taking and growing our business.

Okay. Great. And in terms of the acquisitions you've made, you made several, I would say, smaller acquisitions over the last kind of 1.5 years or so. And how far along are you in terms of integrating the various acquisitions in terms of product development, the ability to share the data back and forth between the company that you bought and what you've got? And as you fully integrate those acquisitions, how does fully integrating them kind of bring you to kind of the potential that you're looking for?

We've spoken before as a management team about 3 strategic imperatives for our firm. And one of those strategic imperatives is a focus on collaborating, modernizing and innovating. And interoperability is really the heart of that objective. And consequently, we are focused on maximizing our data, our analytic and our technology capabilities on behalf of our customers. And part of the challenge there is that there are multiple opportunities, but we really have to prioritize down our activities to produce -- sorry, to pursue the most impactful ones first. For BvD, RDC, Cortera, I'd say we're pretty far along. There are significant product integrations that have already occurred. And yes, there still remains additional scope for interoperability between the offerings. But most of that is going to relate to the Cortera and the RDC data and ensuring it's accessible by Orbis and our compliance capitalist tool in a visual and an easy-to-access manner by our customers. But there are also opportunities for us to further integrate some of the combined solutions with other parts of MA beyond just Orbis. Another example could be in ESG. We've made significant progress integrating the Four Twenty Seven data into moodys.com. Again, lots of opportunities remain about the potential to integrate their data now into our lending and our risk management tools. And then maybe 1 final example in CRE. We've done a lot of work on the product launching the REIS network, and we've added hotel market data and analytics, and we've also integrated CMBS data into the platform. Again, there's opportunity for further integrating ESG and climate data into that real estate platform in addition to integrating the CRE data into Moody's credit decisioning and risk portfolio solutions. Overall, Shlomo, I'd say significant progress, but lots of opportunity for continued integration and potential upside here.

Great. I think I have time for one more. I think I'd be remiss if I don't go ahead and just ask you to talk a little bit about the potential to grow the ESG business and the various ways the data that Moody's gathers on ESG can be monetized.

Yes. We do have a number of growth opportunities for ESG across MIS, MA and on a stand-alone basis. In MIS, obviously, ESG factors are increasingly relevant to credit. So the measurement of ESG factors is efficient -- is quickly becoming table stakes. We've always considered certain ESG elements as part of the overall ratings process. And so now we've really developed a dedicated and transparent methodology. In MA, there are a number of areas where our customers are starting to measure their risk and performance across numerous ESG considerations. We see significant opportunity to help our customers, which really include banks, insurers, corporates, integrate ESG into their lending decisioning processes as an example. And then finally, ESG is a growing segment in and of its own right. We're rapidly expanding coverage of our ESG ratings in Vigeo Eiris or through Vigeo Eiris. And Vigeo Eiris has historically had really strong coverage in Europe, and it's all about expanding that coverage now to worldwide. And we expect to double our coverage universe by the end of the year.

Well, okay. I think we've come up on the end of the half hour. I want to really thank you, Mark and Shivani, for joining us. I appreciate the time that you've given us, and I appreciate the answers that you've given to the various questions that are here. And like I said, I look forward to welcome you next year in person.

Absolutely, Shlomo. Thank you very much to yourself and Stifel again this morning. It was a pleasure to be here.