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

Rob, welcome back.

Thank you. Good to be here. I thought maybe there's like going to be a chemistry lecture here or something, but we'll focus on Moody's.

Yes. Good days. Good days. So Moody's Analytics is about a $3 billion business, recurring, growing double digit. Just take some time for everybody in the audience to go through what are some of the businesses in there, how do they work well together. And just as a quick background, Alex and I published a report on this same subject if you want to -- but just give us what's working and what is still on the to-do list to work.

Yes. So Andrew, I think this is important because of how much the firm has evolved over the last 5 years, right? And everybody is, I think, very familiar with the Rating business. It's one of the world's great businesses. But now, over 1/2 of the revenues are coming from Moody's Analytics. And it's really a set of scaling and crown jewel businesses that really work very neatly together. So if you think about what is in Moody's Analytics, we have a wonderful fixed income and economic research business that's subscription-based business. We have, in our data business, one of the world's largest databases on companies and credit, and that powers our Data Solutions unit. And then in Decision Solutions, which is roughly 1/2 of Moody's Analytics' revenue, we've got 3 cloud-based Software-as-a-Service businesses that serve banking, insurance and know-your-customer workflows. And at the end of the day, if you look across Moody's, and I include Ratings in this, almost everything that we do across these businesses does generally 1 of 3 things for our customers. And who are our customers? It's the largest banks, insurers, corporates and government organizations around the world. And the first of those things is they help a customer originate a risk exposure or a customer relationship, right, to make a decision, a well-informed decision about that. Second, they help our customers measure and manage risk over the life of that exposure or relationship. And third, on the back end, they help our customers comply, plan, report. And to help our customers do all that, we leverage something that we call at the firm a risk operating system. It's probably not quite as neat as it sounds, but what that really is, is a vast collection of proprietary data, analytics and insights on $70 trillion in credit, 470 million companies, 20 million properties, ESG, economies, securities. And we weave that through those solutions in ways that our customers want and need. And that makes those solutions very sticky and very differentiated. And I'm going to give you one example, Andrew, of how we do that in our banking SaaS business. We have -- one of our biggest products helps banks with loan origination. It's called CreditLens. Literally, commercial bankers are using this to underwrite commercial loans at banks all over the world. So they -- it integrates our AI spreading tool when you get the financials in, and it maps to the bank's chart of accounts. It then uses our risk-scoring engines to help the bank with a view of credit risk, probability of default. It populates the credit memo with all sorts of firmographic data about the company. It will do a KYC prescreen before you even get to your compliance folks and let you know, can I do business with this company? So there's a lot of integration that goes into that. And then recently, we launched an offering for commercial real estate lending. So it's CreditLens specifically for commercial real estate because oftentimes in a bank, that is a different workflow, oftentimes a different department. So there, we took that CreditLens workflow, and we integrated more content into it. So we integrated all of our property data, information that we have about the creditworthiness of the tenants of those commercial properties, market forecasts, physical risk scores so you can understand the risk of the collateral that you're -- the real estate you're taking as collateral. And that's been a really nice product launch for us, building off of that core loan origination offering we have just by then leveraging the content out of that risk-operating system to create a new growth opportunity for our banking business.

Right. You just mentioned CRE a couple times, commercial real estate. Like you did the acquisition there years ago, but it just seems like right now, you're evolving the product suite. Like has CRE as a category been as big as you would have hoped?

Yes, I think we probably think about CRE at Moody's as more of an important capability that having really rich commercial property data is something that we weave through a number of our different solutions. So I just gave an example in banking. We also offer that content to folks in -- who are investing in commercial real estate, obviously very important in the insurance sector. And we're also monetizing that through our insights around research in the asset management industry. So I think we view that as we're not trying to grow commercial real estate in and of itself as a huge business, but much more importantly, thinking about how important it is to have really good commercial property data that enriches our various solutions.

When you think about these various areas within MA, do you feel like you're addressing white space opportunities? Or do you feel like you always have to win from a competitor, and it would probably end up being a pretty varied suite of competitors?

It would be. It's a mixture, Andrew, and maybe I'll just -- I'll go back to those big businesses that I talked about. Research, that's a pretty mature business, although what we're doing around our Research Assistant in GenAI is a really exciting opportunity for us.

We'll get back to that.

Yes, I'm sure we will. A lot of -- I'd argue there's a lot of white space opportunity there. But that's generally a fairly mature, well-penetrated space, right? And so the growth opportunity there that is white space is around things like ESG. When you think about our -- thinking about banking, a lot of times, we're competing against in-house builds. And so it's not so much about displacing a vendor. It is sometimes, but a lot of times, it's about the bank has decided they were going to build something themselves and has decided they want a third-party solution.

Right. That's like white space.

Yes. That is white space. And then in KYC, there's a lot of white space.

Right.

In fact, Andrew, you may remember early on, a couple of years ago, we talked about kind of a $10 billion estimated in-house spend at our customers, mostly financial institutions. All of the teams that are doing all of the financial crime compliance, I mean these are enormous teams, that's the spend that we're going after. And so I'd say there's white space in 2 ways: one is trying to displace the in-house spend; and then two, KYC itself is broadening. So it's no longer just banks, but it's -- when Russia invaded Ukraine, companies had to comply with sanctions. And many of them had to adopt solutions for the first time. And so it was a great opportunity for us.

That makes sense. Why don't we switch over to Research Assistant since you mentioned it? In general, as your products that are innovative and based on generative AI, do you feel like this could end up being a module in and of itself priced separately, like the Microsoft approach currently? Or do you feel like these are things that enhance our current products? Of course, we always want to enhance and add more value, and we'll get that through price increases.

Well, broadly, it will be all of those. Now Research Assistant is our first commercial product with generative AI. We have plenty of AI solutions, particularly in KYC, but we're already in the market with Research Assistant. That is an a la carte offering. So we've had -- I said on the earnings call, we had north of 150 customers on preview mode. We're engaging with many more customers than that at this point.

And you mean paid customers, right?

So they were trialing it, and now we're out having sales cycles with those customers based on the feedback that we are getting from them. So that would be a la carte. But Andrew, I think we've got teams all over the company. I mean we took a decision earlier this year where we said we're going to be very proactive in leaning into this opportunity because we think it has enormous relevance for our business and can unlock an enormous opportunity to provide unique value to our customers. I mean at the end of the day, it's what it's all about. So we deployed an internal copilot to all 14,000 of our people. All of our product teams are working with generative AI, and you're going to see that we're going to be weaving this into our entire product suite. In some ways, it will be a la carte. In some ways, it will simply be a product enhancement, right, that will support a pricing increase.

Okay. In terms of cloud partners, and this also leads back to AI strategy, you've chosen multiple strategic partnership like with Microsoft and Google Cloud. What do kind of each of these partnerships offer in terms of particularly an AI strategy that's unique? Or is it really just we just don't know which one is going to be best, so we want to just take the best of all?

I would say, first of all, just in terms of our own approach to cloud, we have taken a multi-cloud approach rather than be beholden to one cloud provider. I'm sure you can understand why there are benefits to that approach. And what we did with Microsoft was a very multifaceted strategic partnership. So we became a customer of Microsoft and Azure and Azure OpenAI. They became a customer of us around all of our master data and powering a number of different use cases across Microsoft. We deployed Teams, and we are actually working side-by-side with their developers building applications to deploy in Teams, making Moody's content accessible in the Teams' environment. And we're looking at going even beyond Teams into some of their other offerings. So it's very exciting, right, because we haven't figured out the way we're going to monetize that yet. We're starting to have those discussions, but it's very exciting because it presents an opportunity to expose Moody's content to a completely different audience, right? Millions and millions of people who do not have access to our content today. And one reason we're really excited about working with Microsoft is exactly that. They have this enterprise application ecosystem that we want to be able to deploy our content into, and they're excited about getting our content into their applications. With Google, what we did was -- I'd almost say it's more like an R&D project. So they've taken an approach where they're developing specialty fine-tuned industry-specific LLMs. And they did that first in health care. They had a medical LLM. We've announced that we're going to be working with them around an LLM trained as effectively in financial analysis. So it's not using our content. It's really using our expertise to fine-tune their model. And I guess to answer the last part of the question, like why are we partnering with multiple firms, I mean I think you're going to see us partner with a lot of folks because there are a lot of opportunities and interest in accessing our proprietary content and us in accessing new ecosystems and channels to distribute that content, Andrew. So I think you're going to see us try to pick and choose and leverage the strengths of each of these partners in some ways that I think will be different than our approach historically.

So maybe we should turn to MIS. If you just stopped right here at this moment in time and looked at kind of current activity for credit issuance and just rolled it forward, like do you feel like we're in a pathway for continued credit ratings growth and credit issuance recovery?

I mean, yes. And there are several things that lead me to think that, Andrew. Do you want me to kind of expand on that?

Course I do.

I thought you probably did want me to do that.

Course I do.

So just looking out, right, into 2024, like what's on our mind in terms of what the backdrop looks like? Well and we just -- I was just meeting with our Chief Economist, Mark Zandi yesterday, getting his latest view. So it does look like the base case now is a soft landing in the United States, no recession, at least one rate cut in the second half of next year. When we -- the soft landing also then -- when we think about what our default rate outlook is for speculative-grade companies, it's only modestly next year above long-term averages. And that's important because that means that spread should be relatively well behaved. So that would lead you to think you have a pretty constructive environment. There's plenty of headline risk. Back in October, when we had the earnings call, it was doom and gloom because of some jobs report, higher for longer. Now the market is excited, thinks that maybe we're at the top, right? I mean -- so we still have headline risk. We have plenty of geopolitical headline risk. The world is a complicated, risky place at the moment. And then I think about we've had very subdued M&A now for almost 2 years. That's going to come back at some point and sponsor-driven M&A, in particular. Sponsors are sitting on enormous amounts of dry powder that has to and will get deployed. So -- and then we've got the refi walls. And those may be a little bit more of a 2- to 3-year, 3-, 4-year, but all of that, Andrew, leads me to believe that, yes, we have reason to have some cautious optimism looking out into next year.

Right. And when you gave the fourth quarter guide for MIS, do you think that also portrayed cautious optimism?

So I talked about what the fourth quarter guide implied in terms of issuance relative to the third quarter because I thought that was a good way to look at it, current levels of activity. I did say on that call that I thought there was a little bit more downside risk than upside. We know from what we can see in the public that issuance in October was a little slower, right? But issuance has been fairly robust the last couple of weeks, so we are not -- I'm not doing -- I'm not reaffirming or changing anything about the guidance here today.

But would you still say the same thing, a little more downside than upside risk?

Yes. I'm not changing anything I said from that earnings call. So I think that all still holds.

Okay. That's fair. And how confident do you feel about the medium-term outlook? Particularly I'm talking about the one for MIS growth.

Yes. The MIS medium-term targets, the subject of much discussion. It's really hard to forecast issuance 1 quarter out.

That's why it's medium-term.

Exactly. It's impossible to forecast it multiple years out. So the medium-term guidance, if I'm being honest, has been a bit unsatisfying to people. And just look at how much volatility we've had over the last couple of years since we put out the guidance. So we did, Andrew, put out this long-term growth algorithm that we have talked about for years in the rating agency and really resonated, frankly, with investors. So we said, you know what, let's go back to talking about the building blocks of growth in the rating agency. I'm going to touch on this just for a second. Ultimately, the growth of the rating business is tied to economic growth and capital investment and business investment. So we believe that 2 to 3 percentage points of our growth algorithm come from just the long-term economic growth. Now that's one where you can toggle it up and down based on where we are in the cycle. If you believe we're in a 0 growth environment, then you take that 2% to 3% down. Second is -- gosh, what's the phrase we use for -- we don't call it pricing initiatives.

Value?

Value. We always want to deliver value to our customers. We've talked about how we have, on average, across the company, a 3% to 4% opportunity around pricing annually. That's still intact. That value proposition of the ratings is still very much intact. So there's your 3% to 4%. And then the last part is what we call developing capital markets. So you've got either emerging markets in the cross-border market or you have these domestic local currency markets. So China has a big local currency market. We participate in that through a 30% ownership in a leading Chinese rating agency called CCXI. We've been investing in building out our domestic rating presence across Latin America because that's a very meaningful part of the overall revenue opportunity, rating opportunity in Latin America. You have to be present in those domestic markets. And we say that's about 1% to 2%. So you can toggle that up and down, depending on economic cycles, but that would get you in kind of the mid- to high single-digit growth as a long-term algorithm for the rating agency.

Okay. And then going back to MA, eventually, that business is supposed to accelerate to low to mid-teens. What needs to happen from here to there for that acceleration to happen?

So it has been accelerating, if you look at the trend lines. And I would say about those medium-term targets, Andrew, I understand the great importance of underpromising and overdelivering. That's the way you want to roll, but I balance that with aspiration. And we believe we have a great opportunity in front of us. And if you look at our medium-term targets relative to our peer group, and I have this discussion all the time, they're rather different, right? And so I stand behind those medium-term targets, but I will say that they're stretchy targets. They're ambitious targets. I mean look at relative to our peer group. And there are several things we're doing to make sure we hit those targets, and I'm happy to touch on that if it's useful to share. So why do we think that bending -- continuing to bend the revenue curve is achievable? First, we just have a much broader suite of solutions to sell than we did several years ago when we were doing 8% growth in Moody's Analytics, a much broader set of solutions. Second, we're platforming our technology that's going to allow us to go to market faster. It's going to create a better user experience and give us a better sense of what customers are doing across our platform. It's very important. Third, we're moving from really a product-centric sales approach to more of a solutions-based selling approach, which means that we're having ultimately better, bigger discussions with our customers about what we can do with them. We've invested heavily in our sales organization and the capabilities there. And then lastly, back to GenAI. I mean we jumped in on this because we saw a wonderful opportunity to deliver unique value to our customers. Research Assistant, good example. That gives us more confidence that we are going to be able to achieve those ambitious targets. And I will say one more thing about GenAI. Not only -- so take my relatively mature research business, which now has a really exciting, new GenAI-enabled capability. So we're having that conversation with every one of our customers, but it's also allowing us to have a different discussion with our customers. If you are doing something around AI, in generative AI, that's meaningful, you can have a conversation with the C-suite at your customers. So that's -- it's really changing the dynamic. So I'm now able to have -- I and my team are able to have those discussions at a different level in the organization. And then we start to talk about the other things that AI and GenAI can enable in terms of a multifaceted view of risk. And that is -- really speaks to our strong suit in terms of bringing these data sets and insights and capabilities together to create unique insights for our customers.

Okay. So you talked about MA's medium-term growth targets being ambitious, but you are going after that ambition. How about the medium-term MA margin targets? They're not -- I don't know. I mean you could judge it. It's mid-30s versus 30%, 31% right here, and that's like a 2027 goal. Like would you describe your margin targets in MA as ambitious?

I would say that you -- Andrew, you've got to remember what we're focused on, which is -- I mean, take -- I mean you asked about the white space opportunity. It's a great question. As long as I think I've got meaningful white space opportunity, I've got to prioritize customer acquisition, right? Because look at the retention rates across our suite of solutions. They're in the mid-90s. So when a new corporate comes into the market to adopt a know-your-customer supplier risk solution, you got one shot at that for about 8 years, right? Once they adopt and they link it up to their master data and -- right, the retention rates are very high. So I want to get in, I want to acquire that customer. That is more important, I believe, than simply harvesting the margin in the near term. As long as I've got that white space opportunity, and as you all see as investors, you're looking for proof points that we're continuing to accelerate revenue growth. If we are, we should keep investing in that. So I would say back to the margin point, it's probably -- I know people in their models like straight lines, and it's probably not going to be a line that looks just like that.

Let me ask you about the pathway. I said just the 37%, like does this seem like an ambitious target to you, given the growth profile that you want to have? Or you have a high incremental margin business, so if you're growing fast, you should be able to move margins forward. You have 2027 to get there.

Right. So I'm not trying to optimize for an ambitious margin target. I think it's a reasonable margin target balancing the growth opportunity that we have is the way I would answer it.

Right. I think that makes a lot of sense. Questions from the audience? Go ahead.

So they were raising funding for a CLO that would acquire credits originated from their credit -- their own credit platform, basically. So just trying to understand what role do you play at a private credit level, and then what role could you play as well on the CLO origination? Meaning that the playbook seems pretty similar to syndicated loans and then just being...

Great question. And I -- let's take it from the vantage point of maybe one of the giant private equity alternative asset managers, the Blackstones and Apollos of the world. We have enormous relationships with them, primarily in the rating agency. And if you think about it, we're rating their overall entities, right? So we'll be rating their fund vehicles. And in private equity, we're providing a rating on almost every portfolio company in their private equity portfolio, right, who's raising high-yield debt and leveraged loans. We're rating the CLOs that they issue. We're providing -- if we don't have a rating, we're providing a credit estimate on those other exposures in the CLOs that they're issuing. We're rating now their BDCs. Recently, we have expanded our offerings so that we can actually provide a credit assessment of companies in the BDCs themselves. That's new. There are new types of structures that these private equity firms are -- private credit players are creating. We're developing methodologies. We're rating some of those. We're not rating some of those. Some of those players own insurance companies and are rating massive amounts of structured -- originating massive amounts of structured credit, esoteric securitizations. We're doing that. We're trying -- we're having a dialogue with those folks to make sure we understand what's the direction of travel, so that we can resource appropriately, so that we can have the right methodologies. So we have big relationships with them. We just announced, I think, last week that we've appointed a woman who is now Global Co-Head of FIG and Global Head of Private Credit so that we can more effectively face off with those players. Instead of across the rating agency, really have one senior point of contact so that we understand, again, what kinds of things are you going to be originating, where is this heading so that we can have the right tools to be able to serve those players? So I feel better about this than I did 18 months ago. And when the market -- public markets had seized up and things were going into private credit, now we're figuring out more ways to engage with those players, to serve them. And also the bigger it gets...

How's the pricing for that?

What's that?

How's the pricing? For when you're serving private credit and Blackstones, like are you getting what you would call fair pricing for the ratings?

Yes. So I mean it depends on what you think of as fair. I would say this, Andrew, that we price typically based on the value. The value of a rating in public debt is different than the value of a credit assessment on a company that's in a BDC. Just there's a different value to that, what we're providing. We price commensurately with that. But -- so yes, that may be a -- we may have lower economics on that, also have a different production cost on that. It's not a full-blown rating. We may be using -- to produce credit estimates, it's much different than what it looks like to produce a public rating. And there's an opportunity for us to develop a commercial relationship and a view on credit with a company that, until recently, we didn't have a relationship with. So in a way, I actually view that as a positive because many of these companies are going to grow, and they're going to come into the public markets.

Right. And is it moving the needle? Like is there revenue with, let's call it, private credit enough that you can notice it?

I would say it's relative to a $3 billion rating P&L. It's -- if I said what are we making from the way I started the question, which is all the things we're doing for the Blackstones, that's a very meaningful number. At the margin, the new things, that's still quite small.

Last question, Rob. What do you think we'll be talking about at next Ultimate Services Conference that we just didn't talk about today, things that will be important a year from now, things that maybe we should just keep in mind as the months ahead come through?

For Moody's? For Moody's?

Yes.

Gosh, and by the way, I had a town hall with my team recently and said, "Just think about what we're talking about at this town hall." Most of this stuff didn't even exist when we started the year. Like the idea that we're talking about Microsoft partnerships and we have a large language model team and master prompt engineering. I mean it -- none of that even was in the lexicon in the beginning of the year. So I think things are going to keep moving very quickly, to be honest with you. And who knows what the world of AI and generative AI is going to look like, but -- I don't know, but one thing we've talked about and we've learned a lot at the company this year is that we want to be nimble and agile. And I'm going to go back to the way we launched Research Assistant. It wasn't lots of product committees and PowerPoints. It was get a prototype, put it in front of your customers, get feedback. And we've learned a lot from that. We've learned a lot from working with Microsoft. And for us, that is more of the new way of working. We'll see what 2024 holds.

Sounds good. Thank you very much, Rob.

Thank you, Andrew.