MSCI Inc. (MSCI) Earnings Call Transcript & Summary

Okay. Good morning, everybody. Thank you for sticking with us here, and I'm extremely pleased to continue the day with MSCI's CEO, Henry Fernandez. So Henry, firstly, thank you so much for being here.

Thanks for having me, Manav.

Henry, I can't -- as you -- you've been with me for the last 2 years as well at this conference, and I can't have an ESG and climate session without talking to you. So I actually wanted to start the conversation where we left off, which was we kind of had a similar discussion around climate and ESG back in December at our ESG event. And at that point, I think you had mentioned climate change will lead to a historic reconstruction of the investment industry. Every investor will require ESG and climate, but a lot has changed since then, the Russia, Ukraine conflict, the rate hikes, recession prospects. You name it. Do you feel like there's been enough disruption, demand momentum that changes your view from what we talked about in December?

Yes. Quiet a lot has happened, clearly. Since then, of course, our hearts and prayers are with the Ukrainian people during this extremely challenging and difficult time with a country like Russia invading them and trying to take their land and their people and everything else. And that plus clearly the overheated economy in America for example, has created a different environment where inflation is much higher in terms of energy and food and other inflationary forces. Interest rates are increasing. And obviously, as it relates to our topic, energy prices have skyrocketed. And that environment of very high fossil fuel prices clearly has encouraged the development of more oil and gas fields in the world, more coal mines and so on and so forth. And in the case of Europe, particularly because of the Ukrainian war, they have had to substitute coal and other immediate sources of energy for the oil and the gas that these countries are getting from Russia. So on a short-term basis, we're likely to see a spike in carbonization in the world because of all these measures in this environment. But at the same time, I think it is important to underscore that many countries, especially in Europe, the U.K. and Germany have accelerated many of their renewable energy or clean energy initiatives in order to accelerate their energy security and given the reliance that they have in Russia on oil and gas. So I think that's a helpful sign. That's a positive sign. Also, clearly, because of the disruptions in supplies and the increase in commodities that are needed in many of the renewable energy projects in solar for example, and wind mills and all of that, the cost of a lot of these projects have increased. But also importantly, the viability of these projects have also increased given the high cost of energy. And therefore, a lot of projects that in the past were more difficult under a low energy cost, energy prices are becoming more attractive in the world today. So that's a positive sign of what we're seeing. Additionally, there is a huge amount of fossil fuel substitution taking place in the world. So for example, electric vehicle demand is really high because a lot of us would rather drive electric vehicles right now rather than pay the gas that is so dear for transportation. So I think that is another positive sign. So I think I am an optimistic person with respect to a lot of this. I think that the same forces that are causing a very short-term increase in carbon emissions and carbonization in the world are also putting the scenes and the impetus for faster move to renewable energy. If you were a country in Europe, for example, and you really want to get out of this buying that they're in, one of the easiest way to do that is to rely more on nuclear energy, for example, like France is going. I doubt that Germany will go that rather immediately, but other countries will. You can accelerate the development of wind mills and the like and development of solar energy. So I think we're going to -- it's a mix story right now in the short term. But I think when you look at the medium and longer term, we may be looking back at this period as a significant catalyst for the acceleration of the transition to a low-carbon economy.

Got it. And maybe -- I think you kind of answered the long-term question. But from an investment standpoint, the rise in commodity prices, as you've talked about, that's accelerated the debate in the investment world around the ESG funds and are suddenly lagging, right, because they probably didn't have exposure to that, more exposure to tech. What is your view there? Like, is that just also just a blip in the short term and in the long term ESG still wins out?

I think so. For sure, when we sit back and look at ESG and climate and let's try to do that separately, but when you look back and see that these 2 forces, ESG is about a transformation of capitalism from a form of capitalism that was not rising in all these externalities that are being costed in, let's say, in a multicultural society in which there may be companies that are only employing a part of the society, not all of the society. That cause is to be internalized in companies, the risk that these companies have. In terms of the environment, not only in climate change, but everything else society is demanding that companies, internalize those costs and clearly in governance. So when you look at ESG, this is not a short-term phenomenon. This is not a file. This is simply what the economists will always tell you is the internalization of these externalities that need to then be priced into the assets of those companies and needs to be incorporated into the capital allocation of every investor in the world. So that's not going to change at all. And similarly, in climate, if you are a company that is carbonized in the world, and that's going to create a big damage to society you need to be responsible for the price of that carbonization. And that should be included in your cost of capital and the pricing of your securities. And the investors in your company need to take that into account in their allocation of capital to you. So that's not going changed either at all. So I think what we're seeing right now is a continued realization of all of that. So yes, in the short term, there is always going to be a lot of end alone swinging in one direction or another. This transformation that the world is going on is, I would call it 3 Es. It's a huge balance in act on the 3 years for any country or society in the world, it's economic growth, energy security and environmental sustainability. And trying to navigate the balance in act on those 3 areas is not going to be a straight line. There will be times in which we are going to pivot towards energy security and create more carbonization and there will be times in which we're going to appeal more to environmental protection. And a lot of that has to be in the context of economic growth. We can simply slow down significantly any economic growth in the world, especially in developing countries. That will throw billions of people into poverty. So I think the longer-term trends and the medium-term trends are totally there, and there is going to be just like any business cycle, right? Just like any economic cycle, there will be times in which there'll be a lot more demand for ESG and climate and there'll be time there will be a little less. But the long-term secular trend is pretty clear. We're in an environment right now in which a lot of the ESG funds didn't do as well as others, but that's on the heels of an incredible performance over the last 2 years. And we're also in an environment right now in which weapon manufacturers and oil and gas companies are doing very well. But that's going to reverse at some point as well. So what I can tell you is clearly, we have 2 businesses, 2 forms of producing revenue. One is the subscription to ESG and climate tools. And the other one is the asset-based fees in many of the indices that are licensed to asset managers. So on the subscription side, our demand has not changed at all since the beginning of the year. If anything, it is -- it continues to be very, very strong, very strong. So that's not a worry. Now the assets that may be in ESG funds or in climate funds and the like, may slow down a bit. I don't think it's a decline. It's just a slowdown in the rate of growth, but they will accelerate sooner rather than later. So we are absolutely not worried at all with respect to the -- to our business and the fundamental demand for what we do and the investment that we need to make to capitalize on this enormous opportunity for us.

Got it. And so talking about -- you mentioned capital allocation before from the kind of investor and corporate standpoint. So talking about your decision in terms of investing in ESG and climate in the face of what the market seems to be telling us is, they expecting a downturn. So should we do enter a downturn whether you agree or not? How do you change the investment philosophy?

So we, at MSCI, clearly pleased to be cognizant of our revenues and our costs and our profitability. And we always try to take normal steps and measures to protect profitability in difficult times, so we normally call a downturn playbook. So if the world ends up being more difficult than we think it is going to be, we'll have to adjust certain investments that we're making in the company in the short term. But I'll remind you that except for the slowdown in the growth of asset-based fees, we have not seen any slowdown in the demand for our subscription business. That may change, but we are like different, data-dependent, right? We look at the data. I will say we got to react to that data. It's been a little surprising to me that there hasn't been even a slight amount of slowdown, and that may come, but we have not seen it yet, up to this point ,we've not seen it. So obviously, the asset-based fees are lower that others had anticipated they will be. So we'll have to make some adjustments to our investment plan in order to make sure that we protect profitability. But the question will be for us, the -- where do we make those adjustments. We just finished a 2-day strategy session with our board that we do every year and the consensus that came out of our Board is to not only protect all the investment that we're making in ESG and climate, but to figure out ways how do we increase it. And that will have to come from other areas or MSCI or may have to come from further efficiencies, further squeezing the day-to-day operating cost of the company because we see such an incredible opportunity ahead of us.

Got.it. And the comments you made on the demand for your subscription still staying fairly healthy. Was that specific to ESG and climate or broadly for MSCI?

Across the board.

Okay. All right.

In the subscription business, right? Clearly, we continue to have a lot of demand for indices for ETFs and other forms of passive instruments, but the growth of assets, just like the growth of all equity securities around the world is less bulling than it was last year.

Got it. So maybe just focusing on ESG and climate specifically again for the benefit of the audience. You're clearly one of the leaders out there in terms of ESG research, climate research, data, et cetera. Can you just help frame the size of your offering, whether it's revenues, employees, et cetera, just to help understand why you're number one out there?

So first of all, when you combine ESG and climate across all of MSCI, whether it is what we call ESG research or ESG ratings or climate metrics or climate models. All of that is in the segment called ESG and research -- ESG and climate research. And when you take into account the asset-based fees that our clients pay us for the indices that they use for passive products and other index subscriptions. All of that, as of the end of this quarter -- at the end of the first quarter of this year, was about $370 million. And out of that, about $215 million, $216 million of that is in the bucket of ESG and climate research and the balance is in the index business, mostly a little bit in analytics, mostly in index. And as of the first quarter compared to the prior year, that had a growth of about 53% year-over-year. And clearly, the ESG part has a slower growth than that on a much higher base. and the climate part on a much smaller base as a triple the growth rate somewhere in the high -- in the mid-100s growth rate. So we think that the overall business, ESG will continue to be -- to grow around the same levels, maybe a tad lower as we get bigger. But now you have this huge engine of growth in the climate tools that is going to grow potentially at triple digits for some time to come. So that's very exciting and could potentially accelerate the entire base of all of that. So we're very, very -- you can see that we are very excited about that. Now the potential for that, and I know we may be talking a little bit about that, is significant. Now we have about 800 people on a full-time equivalent basis dedicated to ESG and climate, and that is made of the research people that build the models, the data people that collect the data, the technologies that help us -- the data close across the applications that we use, the salespeople, the consultants that help our clients understand how to use these things, the climate service people and the likes of -- and counting. I mean there is a significant open positions in our investment plan to continue to hire on that front.

Got it. And in terms of the growth rates that you talked about, those are impressive growth rates. And I guess to appreciate how sustainable that is, the question is more around what the TAM is, how [Audio Gap] global CEO right before you, and he talked about thinking it's the first innings of a 9 innings game. Do you agree with that?

Totally, totally. There are a lot of ways to calculate the TAM, but the problem with a lot of our TAM calculations is that they are at a moment in time. Their study, it's almost like saying in 2001, 2002, what's the size of the Internet, e-commerce, what's the size of e-commerce. So you can come up with a TAM in 2002, 2003, and that number is going to be dramatically different in 2005 and 2010 and now in 2022, right? So that is the problem with those TAMs. And we, in our Investor Day, we put out a number of the TAM close to $4 billion. And everyone said, oh, that sounds like very small. And of course, it sounds very small, but it was because it was at a moment in time. So that's why I tried to stay away from calculating TAMs. What I can tell you, though, is that in this past few months leading up to the annual strategy sessions with our more -- this week for 2 days. We did an analysis of what are our opportunity for us would be in ESG and climate based on where we are today and thinking about 10 years out. And we arrived at a number like up to about 10x the revenue that we're producing today, right, in that 10-year horizon, right? So that gives you a sense of the magnitude of this. Now there is a lot that needs to happen to achieve that, the rate of growth, the investments that we need to make and the like. But that gives you a sense of the opportunity for us at MSCI.

Got it. And I think I understand and a lot of people do why everyone kind of separates ESG and climate. But do you think climate -- I know it's a much smaller business today, but will climate be a similar size as everything else in ESG? Is that why people want to separate it out?

Yes. So in our case, we like to separate ESG and climate. They currently intertwined. Climate is part of the ESG ratings, the ESG tools and everything else, but if you leave it under meet ESG, you're going to miss the opportunity because there is a lot of direct climate rules that you need to offer people that are separate from ESG. So that's one of the reasons. Secondly, you know all this controversy about ESG ratings and all that, and I'm sure we'll talk a little bit about that later. And the problem is that ESG ratings are not climate ratings. In some companies, the climate part is a small part of the company and other company it is a big part of the company. But it could be overpowered by the governance part or the social part or even other environmental issues. So it's important to segregate it and as a business, particularly. So our projections show that ESG will continue to grow significantly over that 10-year horizon to very large numbers. And that climate is going to be a very close second. When you do -- if you think about, can we increase our current revenues by 10x, our current run rate by 10x in a 10-year horizon, then the question becomes what is the breakdown to 10 years from now. And that breakdown, you have ESG and our projection is still higher, but climate is a very close second at that point. Now that's a 10-year horizon. Anything can happen along the way. And -- but my sense is the bias will be that we're underestimating the climate revenues compared to the ESG revenues.

Got it. Okay. That makes sense. We're going to be hearing from the ISSB right after this. And the question is around all the global now, I guess, regulatory bodies looking to standardize all the disclosures, get the right data out there. And so we often get the question, if all that data ends up coming out there by the corporates, it becomes more of a commodity. And therefore, does that impact your edge? Like how does MSCI evolve or differentiate in that scenario?

So the answer that I always give by analogy is that we're doing very well in indices with commoditized data that has not stopped us from creating incredible tools for the investment industry. And similarly, in our equity risk models and similarly in all of our analytics, we've been doing very well. So if anything, we, like any company, have scarce capital. Now we don't have an abundance of capital. And therefore, we would like to instead of applying our capital to be a data collector and a data builder, we would rather put our capital to work in creating the mission-critical tools for the investment and put the money with our client coverage people, more salespeople, more consultants and all of that, but we -- given the nature of the lack of data and the capacity of the data, we've had to put a significant amount of capital in the collection of data. So it hasn't been our first choice, but obviously, we got to do what we have to do, right, to do that. And that's one of the reasons that we have been very outspoken and an advocate with the regulators around the world to create much better disclosure of data by companies. At a minimum, companies or any issuers should be disclosed in their carbon footprint, the locations or their -- or most of their important facilities so that we can triangulate as to where the carbon emissions are coming from, who their suppliers are, so we can go back and track down the suppliers in order to then compute the scope 3 emissions and things like that. So I -- we are one of the entities that is looking to have more data. And if you want to call it commoditizing of that data, it is perfectly fine with us because that way we can put our capital towards going to serve our clients the best, which is in the tools and the workflows and all of that. In the meantime, we clearly have a competitive advantage by being the largest collector of a lot of this data and use that data to sell to clients and for our own purposes. So I think we win either way.

Got it. Somewhat tied to the need for standardization. You hear a lot of complaints. You've seen that in the recent media from high-profile activist, CEOs talking about the alphabet soup of ratings and research and scores out there. So I just wanted to give you the opportunity to try and just help us appreciate what is MSCI trying to do, and I guess it's tied to as this data, this commoditized data that comes out, how are you going to evolve to help address some of those questions we keep hearing from industry participants?

So the first thing is that ESG is a fairly comprehensive set of variables and factors. A lot of people love to compare ESG ratings to credit ratings, for example. And the first thing is credit ratings are largely unidimensional. It's about the cash flows of the company, the strength of the cash flows and the leverage of the company in order to come up with a good amount of credit worthiness of an issuer. In ESG, you have all sorts of governance issues, an incredible number of social issues, even a larger number of environmental issues. So if you and I have different ways on the factors, let's say, you say I'm going to apply 1/3, 1/3, 1/3 way on the environmental, on the social and the governance and they say, no, I'm going to apply 1 quarter, 20% for the other one and 55% to the other one, you are going to come out, we are going to come out with very different ratings, very different ratings because we're going to be weighting differently at that point. So that's one thing that people have to keep in mind. There is no such thing -- let me say, the other thing is ESG are opinions, they are sort of professional opinions as to what are the factors that are affecting security prices and the risk of company. And those opinions are -- think of them as political opinions, think of them as social opinions in a society. So I find it hard to believe that regulators are going to come and say, we are going to regulate your opinion. It's the same way that you will say, we're going to regulate what journalists have to say, what politicians have to say, what society has to say about matters, it's very hard to think of that. Now they can regulate the methodology. They can say you've got to be disclosing the methodology. You've got to be disclosing the sources of data and so on and so forth, which is you're trying to disclose much more the processes by which you regulate your opinions, similarly to a news organization saying we always we always check 3 sources before we publish a story. So that's an example of a process that you follow before you put a story out there and ensure its right thing. So that's one angle in this thing. The second angle is that investors are looking to solve for different things. So there are some impact investors that are willing -- they're feeling sure and mandate is that they're willing to give up returns in order to create an impact in what they do. That is what is embedded in the contract as a fiduciary. Other investors embedded in the contract is that you invest according to your values and principles, even if you give up returns in some areas. And the third, clearly, a type of investor is the one that says, no, I want very large risk-adjusted returns and therefore, take into account all the risks associated with ESG in a particular company or a particular issuer, that's called ESG integration. So in that case, the tools that you're going to use are tools that are going to demonstrate the risk of ESG to the company. If you are looking for an impact investing, you are going to do what are the risk of that company to the rest of the world. And if you're a values or principal investor, you're going to say, what are the risk -- what is the impact of that company or that issuer to the areas that I care, my values, if you care, my children, if you care about war harm and things like that, right? So investors are looking for different things. So the problem sometimes with the media and others is that they conflict all of this. They take what people are applying to ESG integration and then they move it to an impact investing setting or a values or principle-based setting and therefore, it creates a lot of confusion. So I don't think that, that is a proper. And lastly, clearly, this is an evolving deal. We are still in the first innings of creating the most advanced ESG ratings on a company because we're dealing with imperfect data. We don't have a lot of disclosure by companies. We have a lot of models that are trying to understand based on the data that we have, what the impact is and the risk on the companies and all of that. So as we have more data and as we perfect these models, I think we're going to get better and better at improving those ratings. But again, those ratings are going to be different between entities because you may end up putting a different weight on one factor versus another from another entity here.

Got it. And somewhat related question. When we spoke to Baer, your CEO at our London conference a couple of weeks ago. He mentioned that a lot of the corporate issuers are hungry for the ESG data as well, they're hungry for solutions. I know it's not a central part of your client base, but how do you balance that demand versus also just dealing with them to make sure they get the right data in the system and you interpret their data appropriately?

Actually, it is central to what we do. And the reason is a bigger picture reason first. And that is, we're not in the business of creating an ESG rating and giving it to an investor, so the investor penalizes a company. That's not the business, we're in the business of -- is ensuring that, that company is managing these assets in a way that, that either minimizes the risk to the investor, if it's an integration investor, if it is an impact investor that they fully understand the impact on society, about what they do, et cetera, et cetera. So therefore, from that perspective, what we're trying to do is help advance the state of the world in internalizing all these costs, all this impact into the value of the prices, into the prices of securities and the allocation of capital that will lead to a better society because capital will be optimized much better in what that society does. So therefore, in the context of that, MSCI is a connector, a connector between the data and the analysis and the assessment of what a company does with respect to ESG and what the investor is looking for. For us, success is not about creating a rating that is going to either penalize or reward a company. To us, success is that ultimately, that connectivity between the issuer or the user of the capital and the provider of the capital is such that there is transparency of what each of them is doing and leads to a better result for themselves and for society as a whole. And therefore, in that capacity, it is impossible to ignore the corporate sector. It's impossible to ignore the quality of the data that we're collecting for them. It's impossible to doing or their questions about what we do. So we need to cater to the needs and the demands of the corporate for the issuers or the users of the capital as well as the providers of the capital. So in order to do that, we have to create a lot more transparency, we need to give the data that we collect to the company so that they themselves have question on the data, we need to provide the methodology to them. So they themselves can say, I don't agree with this or that, and then we can have a process to understand how they view the world and how we view the world and provide a better analysis of the methodology and so on and so forth. So therefore, that takes us into not only our clients be the providers of capital, but also our clients be the suppliers of capital in terms of, we're going to give them their own data for free, but a lot of these companies will want to know the data of every other company that we collect in their industry or in related regions of the world, the related countries of the world or whatever. So I think that's why this function of being a connector is taking us into having the corporate world -- we normally say corporate, but it's really issuers of all sorts, whether it's a corporate issuer, whether it's a government issuer or municipality or whatever and a provincial issuer. So it takes us into having to cater to their needs and therefore be one more constituency and more -- one more client base at MSCI. And the same thing with the corporate advisers. We don't want to be advising entities as to how to improve the ratings. That will be a conflict in our view. But a lot of investment banks are going to help them do that. A lot of accounting firms, a lot of consulting firms are going to help those clients, those corporates improve what they do in climate and ESG. We're seeing that in banks right now because of the regulatory pressures, banks are hiring consulting firms to help them decarbonize their portfolios, so we're going to work with those corporate advisers and bank advisers to provide the data and the tools for them to help and advice their clients. So that's why it's taking us in that direction.

Got it. That's helpful. Last couple of questions to you, Henry. So firstly, right now, I mean there's no doubt in terms of breadth and depth. You have -- MSCI has the broadest suite of ESG solutions, there's obviously a lot of different angles of ESG. Is MSCI going to be -- is the focus going to be the breadth and depth to be everything for everybody? Or are you going to pick your corners where you want to be the best at?

Yes. We're going to pick our spots clearly, that's a focused strategy. The challenging part is that we have always served all providers of capital to the world, whether it's an asset allocator, as a provider of capital, whether it's an asset -- a manager of assets. That could be a hedge fund manager, a wealth manager, an ETF, a mutual fund manager, et cetera, right? We find benefit manager and the financial intermediaries, all of our tools that we have always provided are for all the providers of capital in the world. And therefore, we can't -- we won't be able to say we will provide ESG and climate tools to the asset allocator but other managers or not the financial intermediaries. That will be giving up on our mission, right? So that -- and then the second part is clearly, what we were talking about earlier, which is because we need to be a connector between the providers of capital, the user of capital as it relates to climate and ESG, we also have to cater to the needs of the issuers and the corporates more specifically. So therefore, it's a challenging act, right? It's very challenging because the space that we occupy is very wide and it's very, very large. Now we're not going to be providing consulting services, for example, to anybody, we're not going to be providing climate tools to consumers in the world, we're not going to be providing, et cetera, et cetera. So I think what we have is a focused strategy, which is along the lines of everything that we're doing so far, but it's still a very large area to focus on. So it will require significant investment. It will require a lot of sequencing of what we do first, what we do second. It will require being very astute about the -- how we serve those needs, what -- for example, what asset price -- I'm sorry, what asset class would do first, what asset class we do second, what do we do third, what do we do simultaneously, et cetera. But we are very confident that we will be a leading provider. We are very determined to be a leading provider of ESG and climate tools to the industry that we have always served and we're willing to put a lot of resources behind us to put the weight of MSCI behind that, to put a lot of the talented people we have in the company behind that.

Got it. Last question for you, Henry. You talked about it's a large area. You're going to make significant investment, it comes down to the capital allocation question. So kind of a 2-parter: One, I mean, do you feel like to be that leading player, are there a lot of white spaces where you need to make some acquisitions and hopefully -- I mean I think we all know there will be consolidation in the industry. Hopefully, with the market, even the private asset valuations have come down, so maybe it's more attractive to you. But just talk about the need for M&A and then how you balance that with your triple crown framework and your buyback plans?

Yes. So first of all, just going back to the organic investment, the beauty that we have is that this part of our business is growing by 50-plus percent a year. So without necessarily allowing yet the margin expansion on the area because we're building up the revenue base it allows us to put significant amount of investments every year and therefore, build a virtuous circle of high growth, good profitability and large amounts of investments every year. So that's clearly where we want to be. In terms of inorganic investment, we for sure look at everything that comes because that will accelerate significantly our organic path. Areas such as data is clearly one in which instead of spending a great deal of time and effort on collecting and people and all that, we can accelerate that by what we call MD&A. It could be an average acquisition of a company. It could be a minority investment in a company with a potential to control or it could be simply a partnership that we established with those companies for securing unique data sets and the like. Similarly, in modeling, when we acquire carbon metrics, that was -- a lot of the carbo metrics company, carbon data company that we've acquired, that is an area where we acquire a lot of modeling expertise. So that would be another -- you're basically acquiring a company for the people and the modelers and the like. So we will do that. Workflow tools, the technology and work flow tools will be another area. So we will be looking at everything. We have the benefit that given the incredible runway that we have, the incredible opportunities that we have, we can buy sourcing and monetize it at a large scale and therefore, pave well for the company and it still fits the triple crown criteria. Now there are certain assets that are going to go for outrageously high prices, and we're going to stay away from that, and we'll have to build that organically.

Got it. Well, Henry, we're right about out of time here. So I think I'll end it there. There's obviously a lot more to talk about your insights and vision are always helpful. So thank you again for joining us this year at our ESG conference.

Thanks for having me and good luck with the rest of the program.

Yes. Thank you. And for the audience, we're going to be moving on to having in a discussion with the Vice Chair of the ISSB, and that will be hosted by Marie Freier, who is the Head of our cross-asset ESG Research. So please do tune in shortly there. Thank you.