MSCI Inc. (MSCI) Earnings Call Transcript & Summary

All right. Good morning, everybody. Thank you [ to everyone ] for webcasting or zooming in here. My name is Manav Patnaik. I'm Barclays' business and information services analyst. And we're very pleased to kick off day 3 here at Global Financial Services Conference with MSCI. I'm especially pleased to have Linda Huber here, who's the CFO. So thank you for being here, Linda.

You're welcome.

Just some quick logistics. We're going to be -- Linda is going to be doing a presentation for the first, call it, 25, 30 minutes, and then we'll take some questions at the end. There should be a Q&A box on your left, if you would like to send anything in. And also maybe a poll or 2 there if you would be willing to take that. But otherwise, let's get right into it. Linda, over to you.

Thank you very much, Manav. And thank you very much to everyone who's attending this morning. You should see on your screen, our MSCI Inc. investor presentation dated August 7, 2020. And as we move ahead in the slides, you'll see our usual disclaimer language on the next few pages. I'll ask you first to focus on Page 4, which is our table of contents. And what I'm going to do this morning, is do a quick overview of MSCI. I'll do a financial review, and this is all based on our second quarter earnings review -- earnings reporting. And then I'll cover the segment highlights of each of our businesses, and then we'll have some time for Q&A. So moving forward to the company overview. If you focus upon Page 6, MSCI, on the right-hand side, where you see, what we do. We provide essential products and services that investors use to build better portfolios. And as we move forward in the ESG world, this is quite true that we're doing this to help build a better world. So MSCI has quite a number of clients, 7,800 of them in 90 countries. And these are best known investment firms in the world. These are must-have products and services that we provide; $1.65 billion of run rate as of June 30 for the trailing 12 months; and very strong year-over-year, in this case, 10% organic subscription run rate growth in the second quarter of 2020. And we're very pleased with the growth the company has put up for quite a consistent period of time. We have very strong performance culture, which is quite inclusive, it's global. And we are very intent upon driving innovation in the marketplace. We have about 3,500 employees. They are in 22 different countries, 35 locations. We skew rather dramatically toward the emerging markets for 64% of our employees. This is helpful in terms of managing our costs. And of course, we have an extensive knowledge of the investment process based on the fact that many employees have worked in the asset management industry. As we move on to Page 7. Our tools, as we said, are critical in the investment process. You can see on the right what those tools do, including some things that are defining investable universes, asset allocation, now focusing on sustainability. We have analytical tools, benchmarking tools. We provide reporting, regulatory compliance. And with our new focus on carbon value-at-risk (sic) [ Climate Value-at-Risk ] and Carbon Delta, we provide information on that sector as well. So this is a virtuous cycle that we have with asset managers, pension funds, asset owners and brokerages. So we are very well represented across all parts of the asset management industry. If you go on to Page 8, we talked a lot about our strategic initiatives. And in the second quarter, we talked about our efforts to expand in fixed income and private assets through our partnership with Burgiss, in which we own a minority investment. And we're continuing to provide new products and content for ESG; climate change, which is important even beyond ESG; factors; risk models; thematics; and futures and options. We're making great progress in a number of those areas, and I'll talk about that in a minute. We're expanding our client segments. So we're expanding into wealth management, high-end wealth management, also serving corporates and insurance companies. And we are working on our technology. You may have seen our strategic alliance with Microsoft, which is very exciting, particularly in the ESG space. If we go on to Page 9, we have talked about $140 million in change the business investments in 2020. Very important to note that all of this is already in the full year guidance. So no need to be concerned that any of this is incremental. Our investments include client coverage, which allows us to ensure that our clients know about what we're able to do and how help them -- how we can help them solve problems. Our product offerings are being enhanced, obviously, as we expand, particularly in ESG and climate. And then in technology, we continue to work on our platforms and so on to make our interactions with clients even easier. So $140 million in change the business investments. We are moving dramatically into the ESG space, in particular, and we'll show you some more about that, as we go through the presentation. As we go on to the financial review, on Page 11, we're very proud of these numbers. Since 2015, our revenue growth has shown a 10% CAGR. Our adjusted EBITDA growth has been 15%. Our free cash flow growth on the bottom left is 25%, and adjusted earnings per share growth is a 28% CAGR. So again, the numbers that MSCI has put up has been a very powerful story, and our focus particularly is on growth. We believe that the company is valued because of its strong growth, and of course, its attractive margins, but the growth potential is really the most important component of the MSCI story. And as we move on to Page 12, you can see the 3 business lines, the top being Index. This business obviously has seen great growth in revenues. In the trailing 12 months, we're closing in on $1 billion of revenue, 74.1% EBITDA margin -- adjusted EBITDA margin in that business. So a very attractive one. The Analytics business in the middle has had 3% revenue growth, and there, we've been focusing on the margin. You'll see the adjusted EBITDA margin has gone up to 31.5% from 22%, even about 5 years ago. So very good progress there. And then our other segment at the bottom has had 14% revenue growth and has an adjusted EBITDA margin of around 18%. This business is carrying the -- some of the investment that we have in ESG, where we are investing, as we had said before. So all 3 businesses, healthy margins and good growth. And now looking at the client base on Page 13. You can see on the left-hand side, the differences in the revenue split of business: Index, 60% of the revenue base; Analytics, 31%; and ESG and Real Estate are the other pieces. You can see on the right that we're pretty well split between the Americas, EMEA and APAC. And 74% of this business comes from recurring subscriptions. So you can think about this as, basically, close to 3 quarters of the revenue base is highly predictable due to its subscription nature. And the asset-based fees part of our business is one which is a little tougher to predict, but has recovered nicely following the difficulties in the market in March and April, and I'll speak about that here in just a minute. Going on to Page 14. Our balance sheet provides us with plenty of flexibility. At the end of the second quarter, our cash balance was about $1.385 billion and our total debt of $3.3 billion. However, if you offset those, the net debt is about $1.9 billion. And we've refinanced our debt to a point that we have none coming due until 2026. We've worked hard to bring our coupons down and done a number of refinancings. We did some of that in May. We have a new 3.875% coupon transaction that we had done there. And so we have a balance sheet which is well-laddered with coupons, which are now quite low and nothing that is coming due until 2026. So again, plenty of cash on hand, good flexibility and leverage that we can handle quite well. On Page 15, you'll see our return of capital to shareholders. We've repurchased quite a number of shares. We've returned $3.8 billion since 2015. We rely on opportunistic share repurchase. But we do have a dividend, which has grown nicely. Our payout target is 40% to 50% of adjusted EPS. And in July, we increased that dividend by 15% to $0.78 a share, which is payable beginning in the third quarter. In addition to share repurchase, which we did quite a bit of in the March and April time frame, we use a Triple-Crown framework to look at all of our various investment opportunities and measure all of them against the alternative of share repurchase. So you can see we've reduced our share count from 2015 from 110 million shares to 85 million shares, again using opportunistic share repurchase. And moving on to Page 16. We have a view on our guidance. Our operating expense, you can see from $790 million to $840 million, with adjusted EBITDA expense ranging from $700 million to $750 million. Our interest expense will be about $158 million. Everyone should be aware, though, that cash on hand is, its returns are being impacted by the lower rates in the market right now. So that interest income has come down a bit, and that's something that you should think about as remodeling. Depreciation and amortization, about $90 million. Our tax rate is now at 16% to 19%. CapEx $50 million to $60 million. And then down at the bottom, free cash flow in the range of $540 million to $600 million, toward the upper end of the range. So very pleased with that guidance. And now we'll move through -- just touch on the financial model, and then I'll go into the segment highlights. So on Page 17, again, if you consider our visibility into our revenues, about 97% is recurring revenue, given the various means that we have to look at our revenue base. We have very strong operating efficiency. Our margins are quite high, and we feel that we've done a good job of managing the business in that regard. The business does generate quite a bit of cash, and we've had a 25% increase in the free cash flow from 2015. For example, we manage our working capital very closely, managing our collections very well through this COVID time. And our balance sheet is designed for flexibility. And as we had -- as I had said previously, we have quite a while before we have any debt payments coming due. So again, we feel that we're ready for any opportunity that could present itself. Now moving on to the segment highlights, on Page 19. Looking first at the Index business, again, the large business. It's split into 2 parts. We have the subscription run rate, and then asset-based fees. The subscription run rate on the left, $587 million as of the second quarter. This includes the market cap weighted indexes, factor and ESG indexes are in this part of the business and custom and specialized indexes as well. These are priced on license fees. And we are able to grow the business from run rate growth and growth to new clients with a retention of almost 95%. So a very attractive part of the business. Asset-based fees, $362 million, come off ETFs and futures and options. Futures and options tend to trade more frequently when the market is more volatile. So this business is a nice offset in periods of volatility. And we've found that this business has a numbers -- number of areas for growth, which I'll talk about a bit further. But again, asset-based fees have recovered quite nicely following the earlier market volatility this year. On Page 20, some further information on index subscription. You can see the 10.4% growth from this time last year. And you can see the particularly strong growth in the orange bar, which is custom and specialized. And then factor and ESG growth, obviously, has been very strong as well at 24.3%. The geographic split again is about 40/40/20, as we had touched on before. Page 21 gives a bit of a different view of the subscription run rate. You can see the consistency of the growth in this business. And please note that your pricing increases are less than 1/3 of what we're doing here. So this is increasing use cases and new customers and new adoption, which is driving the growth of this business primarily. And again, the steady nature of this growth has been quite attractive to our shareholders. Moving on to Page 22. This is the asset-based fees detail. This is a little complicated. But despite the market challenges over the past year, you can see that we have had some growth in our asset-based fees. Revenue on the left-hand side, we demonstrate here that we've had a very small decrease in basis points on those asset-based fees, but please be aware that a change in mix in any given quarter can change this algorithm quite a bit. So we have said that we do expect a continuing trend of a decrease in these fees, but that will move according to the mix in -- where these revenues are coming from. And then you can see the quarter end AUM exposures, back on the previous page, have recovered nicely after the first quarter drop in the market. So this chart shows at the end of the second quarter, $825 billion. And this number is now back up over $900 billion as we are coming to the close of the third quarter. Moving on to the next page, futures and options. As I said, a very attractive business, CAGR of 18% from 2016 until 2020. And the run rate here on the right-hand side in the gray, a growth rate of 42%, has been very attractive. We're focusing on this business quite hard. And as you see increased hedging activity in the market, this is where these tools come in. And again, this is an area of great growth in which we are investing and has performed quite well for us. Page 24 shows the virtuous cycle of what we're doing here. We have index-linked products on the upper right, which are based on our strong index franchise that drives deeper liquidity in these products, which allows more effective hedging of these products, and that drives more users and more use cases. We're seeing an expansion in, for example, the number of time zones that we can access at one point, the number of currencies that can be accessed. So these tools are growing more sophisticated, which is very helpful to customers as they're looking to hedge their positions as we see market volatility. Now going to the Analytics business, Page 25. This business sees -- has seen run rate growth of 6%. And you can see the 5.9% growth in multi-asset class and 6% in the equities part of the business. Again, this business is split pretty diversified in terms of its revenue, 54% in the Americas, EMEA at 30% and Asia Pac at 16%. And then going on to Page 26, what do we do in this business? We provide tools to benchmark portfolios, to manage risk in portfolios, to report performance, to manage asset allocation, to stress test and to run analytics on these portfolios. These are some of the most complex and well-known tools in the marketplace. They are quite hard to displace. And we like to believe that we have the best and most sophisticated tools available in the marketplace for clients, who are looking to perform these activities on their portfolios. Page 27 addresses the total available market in this business, which we think is $20 billion plus. We can market to greenfield opportunities, which would be new clients and looking at their thoughts on factors, regulation and best practices. We can replace internal client spend as asset managers look to increase their own profitability by outsourcing parts of their value chain that don't have to do with increasing alpha. And we can also displace smaller providers as asset managers look to deal with fewer and larger vendors. So all of these things have worked to our benefit in the Analytics business. Turning to the All Other segment, on Page 28. This combines 2 different things. It combines our ESG research business, and then also the Real Estate business. In blue, you can see the ESG research business growing at almost 28% and the Real Estate business growing at 5.3%. This business -- these businesses, the other segment, a little bit more focused on EMEA at 53% of the revenues with Americas and APAC making up 38% and 9%, respectively. And as we look at Page 29, again, focusing very much on our ESG business here. We do provide a rating service. You can see some of the ratings characteristics in the upper right, a tear sheet in the middle right as to what our research looks like. In the middle left, you can see Climate Value-at-Risk. We bought a business called Carbon Delta that allows us to work in this space, and this has been very helpful to us. We see that on the bottom, investors are less tolerant of ESG incidents. We would add some of the backward-looking incidents at McDonald's to this case and the WeWork situation and others that have been in the news. We found that signals coming off the ESG index would allow you to, and company ratings would allow you to, avoid some of these downside risks. And now as we've move through the COVID period, we found that there is alpha generation coming from a more ESG-focused portfolio. So we've noted the increasing adoption of ESG strategies, and we do expect that to continue as we move forward in time. Going on to Page 30. This is a slide which we are very, very proud. Our ESG research in the dark blue has been growing quite rapidly. That business has more than doubled since 2016. And then you can see the ESG index business in the gray. That business has doubled since 2018, which is really quite remarkable. So again, an explosion in the ESG index space, where we feel we are a leading competitor, and again, this business has been dynamic in terms of its performance. And we are particularly focused on ensuring that we are among the leaders in this space, as I've said. Page 31, a little bit more information on ESG. So as I had mentioned, almost a 30% CAGR in the run rate from 2010. It's about 20% penetration now of 3,000 signatories of the UN Principles for Responsible Investing document. So we've got about 20% of those signatories as clients, and we're looking to expand that. And on the right-hand side, you can see some of the use cases, Climate Value-at-Risk for Real Estate would include such things as if you're making a real estate purchase or lease. What is the flood risk, given climate change, use cases like that are very important to real estate investors. We also see increased focus from fixed income investors and our increased depth of coverage in this area. We cover about 8,000 securities for our ESG ratings business is one, which is very helpful to the investment market. Lastly, Real Estate on Page 32. We have our MSCI Real Estate Global Intel part of the business, which is very helpful. We also have indexes and benchmarks. So real estate investors can measure their returns against what other firms are able to do. We have analytical tools, and then as we said, our Climate Value-at-Risk tool has been picked up very well in terms of adoption as climate change comes to the fore. So the Real Estate product is really our springboard into the private asset space. As we've said, we are a minority investor, a minority owner of the Burgiss company, which is a private firm, which has 30 years of private equity investment data, which is something that we are looking to work on monetizing with them. And that acquisition happened earlier this year. So in summary, a very healthy business. We believe that we run it quite effectively, very attractive market opportunity, particularly in the ESG space and the futures and options space. And we think our financial performance is such that the company's future looks very bright. So with that, I will turn it back over to Manav to see if there are any questions.

Yes. Thank you for that, Linda, appreciate it. So I was just looking -- we did a few polling questions on the left, and it seems to be consistent with what we're hearing. But -- so firstly, it sounds like most investors are either overweight the stock or not involved. So there's no negativity involved. But the second question was more just around risk. And it sounds like most people were worried about valuation. But the second thing they were worried about was self-indexing. And I was just curious if you could give us your view on how real a threat do you guys perceive self-indexing to be?

Sure, Manav. Self-indexing to us is not really a threat. Oftentimes, it's a different use of our tools. If you listen to Henry Fernandez and Baer Pettit, who are our Chairman and CEO and our COO, respectively, speak about this area, we're very happy to sell our tools to other investment firms who might want to create their own indexes and white label them or self-label them. So in other words, we sell the tools that allow investment firms to get their own indexes up and running very quickly. You could sort of think of it as an MSCI inside sort of strategy. So in a number of cases, we, in fact, are involved in those efforts. And it's one which is profitable for us and one which we're very happy to support. So we'll sell tools, we'll sell indexes. We're very happy as we operate on an open platform to do whatever clients might need.

Got it. That's helpful. The third question we had in there was what the investors thought was the biggest market opportunity. And between ESG and passive, it was pretty overwhelming, the response there. So maybe let's touch on passive first, just sticking with Index. Where do you think we are in terms of the innings? And let's stick with the equities first, and then we can touch fixed income later.

Sure. I think the penetration has been good, but there's still a long way to go. So I would say, Manav, middle innings, maybe fourth or fifth. We continue to develop more products in this area. Indexing has worked very well for most investors in this market period. It seems to be something that is very much favored as a low-cost way to invest wisely for millennial and younger investors. So we found that this has been a great set of tools to offer to the investment community. And we found that returns, in many cases, have exceeded active management. So with that kind of a track record, we think that this will continue to -- this area will continue to grow. It is well penetrated, but the number of new things happening in factors, which allow you to focus on investing in whatever you like, smart cities, millennials, technology bets, things -- evolution in medicine and so on. Those kinds of factor investing have also grown very much in popularity. So we see a lot of opportunity there. And we think that is naturally our space.

Got it. And on the fixed income side, I mean, clearly, there were some assets out there in the past, and you guys, S&P-wise, didn't get them, right? So what is the path into becoming bigger in fixed income index for you guys?

Sure. It's similar to what we've done in futures and options, Manav, in that we would rather not go head-to-head with the incumbent competitors. We'd rather do what Henry describes as a flanking strategy. So using our expertise and specialty to go to perhaps more sophisticated tools, tools which might be multi-currency, multi-time zone, more sophisticated tools rather than just going head on toward the -- toward competition with the incumbents, that served us very well in equities, and we'd like to continue to try the same -- we will continue the same flanking strategy in fixed income as well.

Got it. And just since you mentioned futures and options, can you just give us an update there in terms of how well that's doing? You just -- or you signed a bunch of partnerships recently. Just how big that is? How big you think it can be?

I don't have that data at my fingertips here, Manav. I'm not sure if we've sized that market. I think we did note in the press release that our move from the Singapore Exchange to the Hong Kong Exchange, we view as being helpful because there are just so many more contracts traded on the Hong Kong Exchange. I'm sorry, I don't have that number ready. But we feel that this is going to be a very big opportunity going forward for us. And so far so good. We'll have more to say about this when we get to our third quarter earnings call in a couple of weeks.

Got it. And then just moving on to ESG. I think one of the questions we've been getting a lot lately from clients is just trying to size a TAM to it, right? I think everyone gets a feel that it is a big hot topic. It is probably a big opportunity, but how big? I know you guys gave the UN PRI and you're less than 20% of the 3,000. But Moody's talked about $1.5 billion to $2 billion. Does that sound close to you? Or maybe that's just a specific area of ESG for you?

This is something also that we're working on sizing right now, as we go through our strategic process and as we come into third quarter earnings and talk more about our enhanced focus on ESG. So if everybody would hang on for a little bit, we will be coming back with more specific numbers on this. Also one of the more complicating factors here, Manav, is we're about, obviously, to go into an election in the U.S. The outcome of the election, we believe, will have an impact on adoption. It is possible if we do have a change in administration that the pace of adoption of ESG could pick up much more significantly. So we want to think that through before we put a number out there. So with a bit of patience, we'll have more to say about that in a bit.

Got it. And the 80%-or-so of the signatories that are not clients of yours, is that more a question of they use somebody else or just awareness and sales penetration that's required there?