MSCI Inc. (MSCI) Earnings Call Transcript & Summary

My name is George Tong. I'm really pleased to be joined by Andy Wiechmann, CFO of MSCI. Andy, thank you for being here with us today.

Absolutely, my pleasure. It's a great event to, though, say and it's a pleasure to be part of it. So thank you for having us.

Of course, so let's start at a high level. MSCI's mission is to help investors build better portfolios in an increasingly complex investing landscape. Can you talk a little bit about some of the secular tailwinds that are benefiting and driving MSCI's growth? What are the top key trends that you're seeing in the investing landscape that are contributing to top line performance of the company?

So I'll spend a moment talking about the trends in the investment landscape, but it probably makes sense to spend a minute talking about the trends that are fueling investing more generally and as a result, MSCI -- if you start at the highest level, you see -- and you've seen rapid growth in global savings and that savings by institutions, but also savings by individuals and those savings are increasingly being channeled into professional management to achieve returns, what we call the investment industry. And so you see this pool of investable assets continuing to grow at a rapid pace. On the other side, you have more opportunities for investments. You have more asset classes becoming available, more markets opening up for investment, more investors who can invest outside their home country, you have more securities, more security types. And around all those, you have more information that's becoming available. And so you have more choices and more complexity with more information. This is right where MSCI fits in between these two. We create these systematic frameworks, these structured frameworks for investors to navigate that complexity in a structured fashion. So how to think about geographies, countries, sizes, styles, sectors, ESG considerations and be able to understand the risk and performance dynamics of those dimensions. And then ultimately construct the portfolio to achieve their objectives. And so these high-level trends are fueling the need for the tools that we generate. If you drill down a layer and look at the structure of the investment industry or some of the trends to your question that are taking place, you are seeing growth in indexation where the utility of indexes continues to grow as indexes represent a very efficient and effective mechanism to reflect a view and then implement it with a rules-based approach. That's effectively what an index is. And so as the systematic personalized rules-based objectives continue to grow, not only indexes, but MSCI indexes are uniquely positioned to help meet these various use cases that are driving this indexation trend. Related to that, you see growth in outcome-oriented investment solutions that look across asset classes and are trying to achieve an optimal objective for a specific investor or group of investors based on their specific needs or objectives. To be able to do that, you need tools that can look across asset classes, namely our multi-asset class factor models and some of our broader multi-asset class risk and performance solutions that we have that can enable these investors to develop these outcome-oriented solutions. Very oftentimes, indexes will be the mechanism that they manifest -- that they ultimately put to use that strategy or will be part of the strategy that they're developing. So it complements that index opportunity I alluded to. You're seeing growth in sustainable investing. And that means a lot of different things to a lot of different people, but we are at the epicenter of that trend. And then you're seeing more and more assets and more and more fees allocated to private assets and the investors in private assets are increasingly demanding, transparency and tools that they have in the public asset classes for the private asset classes, tools that help them understand the addressable universe of investment opportunities, but the drivers of performance and risk and how that risk correlates with the rest of their investments in portfolio. These are things where we are uniquely focused and uniquely well positioned to capitalize. So a lot of very compelling trends that we're very excited about.

Right. So you've got this overarching series of trends that are driving the business, driving growth. On a near-term basis, of course, markets are down. And 20% to 25% of revenues are directly indexed to fees and AUMs. And so can you talk a little bit about how MSCI is managing the business in a down market, you're exercising your downturn playbook. What does that mean? And what are the financial implications of exercising that downturn playbook?

So it is -- and you alluded to this, but it's important to underscore that while we do have exposure to assets under management and products that are linked to our indexes, we have a tremendous franchise that is stable, recurring subscription that's growing at a nice growth rate. Just to dimension that, about 22% of our total run rate is within, what we call, asset-based fees. Within that asset-based fee line, about $60 million of run rate is associated with listed futures and options that are based on our indexes. And the dynamics there tend to be countercyclical with secular growth, but there's countercyclical pieces that offset that AUM fluctuation. So if you exclude that, it's about 19% of our total run rate is exposed to assets under management products linked to our indexes. As you said, we've seen pullbacks in equity markets this year that has hit our top line through the assets under management and through the asset-based fee line. And we are continually investing to drive long-term growth, but we also, as owners ourselves, are continually focused on generating attractive financial profile, more specifically attractive profitability growth for the company. And so we have what we call our downturn playbook. We also have an upturn playbook. It sounds somewhat binary in nature, but I call it a continual financial management planning process, where we're continually evaluating the outlook and the trajectory of the business and the financial profile and either increasing the rate of spend and investment or cutting back on it. And I'd say, in up environments, we're generally putting more into investments. In down environments, we're cutting our run-the-business expenses. And so the levers that we go to, firstly, it is worth noting that our self-adjusting measures that we have, things like our comp accrual, a big chunk of the bonus accrual is tied to the performance of the company. So as you start to see the performance deviate from targets, the accruals will come down. We've also benefited enormously from the appreciating U.S. dollar with 45% of our expenses exposed to non-USD currencies. With the dollar appreciating, we've gotten some expense benefits. But beyond that, we have taken proactive actions as well. And so on the non-comp side, we've gone to some of the less time-sensitive, business-critical areas with areas like professional fees. We have discretion as to when we use contractors and third parties for some of our activities, and we could slow down some of those less time-sensitive areas. We can squeeze certain office-related expenses, T&E, nonclient-related travel, certain events. We have levers that we can pull there. And then on the compensation side, we do go to hiring first on a very targeted basis. So again, in those less critical time-sensitive areas, the noninvestment parts of the business, we do slow down the pace of hiring. In certain areas, we will freeze hiring. And then we have gone to taking proactive actions on the headcount side as well. In the guidance that we put out -- the expense guidance we put out with our third quarter results, those include about $15 million of severance, which is quite a bit higher than we typically have. And so that's a reflection of the proactive actions that we're taking. We, normally at this time of year, do proactive performance evaluations, but we've done it to a higher degree, given the environment. The important thing to underscore, and I alluded to this, we are protecting our investments. So the parts of the business that are critical to establish leadership today are going to drive long-term growth. We continue to invest in those areas. And as much as possible, we don't want to touch those with our downturn actions.

Right. On a long-term basis, you're targeting low double-digit top line growth, high 50s EBITDA margins. Has the pandemic or the recent market volatility at all changed or altered your longer-term view on what kind of financials the company can deliver longer term?

Yes. So the long-term targets that we put in place in February of last year at our Investor Day, and they were largely similar to the targets that we had. Before that, there were some minor tweaks to them and adjustments. The only adjustment that we've made since we put them in place was to our All Other segment, our Real Asset segment, where we adjusted both the top line growth target as well as the expense growth target, both up. So we took the Real asset revenue growth target from mid-teens to high teens, and we took the Real asset expense growth target from low teens to mid-teens. That's a reflection of the tremendous opportunity that we see on the heels of the RCA acquisition that we made a year ago. So we adjusted those when we made the acquisition of RCA. Beyond that, they've stayed stable, and we continue to believe that we can achieve those targets in the long term and you've actually seen in the recent environment, we've generally across almost every area have been delivering on them. As you said, we have a low double-digit, non-ABF revenue growth target. In the most recent quarter, the organic recurring subscription growth rate was 14%. And so we're there as a company. And then across index, we're in the low double-digit category. In ESG and Climate, we've been above the long-term target of mid- to high 20% growth. In Real Estate, it's actually probably one area where we have been tracking a little bit below, but we continue to have confidence that the opportunity over the long term is quite compelling and can get to that target. And Analytics, while it's been bouncing around and for much of the time has been more in the mid-single-digit growth category, in recent quarters, it's actually climbed up to closer to the high single-digit category with the third quarter, the organic subscription run rate growth in Analytics was, I think, 8.1%.

Right. You touched on this earlier. About 75% of the business is subscription-based. The run rate growth was a healthy 14% in the last quarter. So it doesn't seem like the subscription business is really being affected by the market downturn. If you look at historic recessions and historic downturns, how did subscription revenues react? And at what point did subscription revenues come under pressure?

So, it's very much varied in past downturns. We have seen in certain environments, certain pullbacks that there is some impact on the subscription business. I think we've alluded to, and I've been public in saying, when you have sustained equity market pullbacks, you do see an increase in client events, so things like downsizing risks, closing offices, fund closures, desk closures, all those things can lead to down sales for us or a pickup in cancellations. But that's not always been the case. And I'd say the impact can be quite muted. So I don't want to overstate the impact of those types of things. And to your point, it tends to be on a lag. So it tends to be a few quarters after you see the equity markets pull back. Just to highlight a couple of examples in the pandemic. The market's really pulled back in March of 2020. And if you look at what happened to our subscription run rate growth, our organic subscription run rate growth, it went from -- I think it was 10-and-change in -- don't quote me on this, but [ 10-and-change ] in late 2019 to, call it, [ 9-and-change ] by Q4 of 2020. And so it started to show up a couple of quarters after that market pullback during the pandemic, but it was relatively muted in terms of the overall impact to growth of the company. The impact was more significant in the financial crisis, although we are a much different company at that point, much smaller, less established, less breadth of use cases and users, less established in many of those client segments. But you did see -- the markets during the financial crisis, you say started to drop at the beginning of 2018. I think we started to see impacts to our subscription growth in -- sorry, in 2008, started dropping in early 2008. We started to see impact in late 2008 and into 2009. And so it tends to be a little bit on a lag. Although I would highlight, we've seen major market corrections in the interim, things like the correction in 2015. There was a correction in -- pretty significant correction in 2018. And there weren't any noticeable impacts on the subscription franchise. So it is quite resilient, and I don't want to overstate the impact. But when you do start to see some of these client events, that's when you will start to see some impact on our business, although it really is a machine and the growth really doesn't move a whole lot.

At a high level, how many quarters of downturns or what kind of depth of a pullback would trigger a more noticeable impact to subscription performance?

It all depends on the facts and circumstances of the pullback. I hate to be too prescriptive on that one. I would say during the financial crisis, even the early days of the pandemic, there were systemic questions about the financial system. And so the going concern of banks, you had a lot of highly levered financial institutions that we're feeling enormous pressure. That had ramifications across the capital markets in the investment industry. You saw similar things in the early days of the pandemic where there are questions about the survivability of certain aspects of the financial system. When that happens, there's probably going to be a larger impact on the investment industry and as a result on our business. And so the dynamics of any pullback or downturn are different. But as I said, those 2 examples, it was, call it, 2 to 3 to 4 quarters before you start to see -- start to see it show up in the results. But as I said, there are many instances where we just didn't see an impact. And even in the pandemic as I alluded to, it was quite a small impact.

Right. You mentioned that fund closures or consolidation could have an impact on the business. Can you talk a little bit about trends you're seeing with retention, perhaps, in the index business and in the analytics business, retention was quite strong. But on the index side, what are you seeing there? Are you seeing any potential signs of strain or are customer retention trends pretty resilient still?

Yes. I mean despite all these cautionary questions and discussions here, the retention rates have been quite resilient. As you said, almost close to or at record levels in almost every segment of the company. I think, firstly, it speaks to the mission-critical nature of our tools and the fact that when clients are spending, they're choosing to spend in the areas that we are providing tools in. but more generally, I think you're seeing that those client events haven't really started to happen. So the health of clients is -- there are pockets where they're feeling strain without a doubt, and we're seeing some caution from them. But generally, they are quite healthy and they're buying decisions of our tools. And then in the Index side, I would highlight that how they are using our tools and indexes are in those critical growth areas for them. So if you think about asset owners and asset managers, we are part and parcel with investment mandates. With broker-dealers, an area where they are, growing and it's a low capital-intensive area, over-the-counter derivative structured products, index-linked notes, those are places where we are helping them. Wealth managers are transitioning from more of a commission-based model to the fee-based advisory model and they're creating model portfolios based on our indexes. And with hedge funds, we are -- in a number of funds, our indexes are being used to help them implement new strategies, whether those are index arb strategies or there are more quantitative-type strategies. And so these are areas that have strong momentum regardless of the backdrop and environment, and we're well positioned to continue to capitalize.

Right. Makes Sense. Cross-selling is a key growth driver for MSCI. Can you talk a little bit about the level of cross-selling activity you're currently seeing in -- against the current market backdrop?

Yes. So cross-selling, it's probably unfair to call out cross-selling. I think what you might be more generally referring to is selling more to our existing clients, which is our largest source of new subscription sales, which is either selling the new modules or more usage of our existing modules or more solutions and applications. That has been the largest source of sales, and we project will continue to be the largest source of sales going forward. As you can tell by just the business performance, it's been quite healthy for us to this point. The 14% organic subscription run rate growth is close to all-time highs or at least highs for us over the last 10 years. And so we're quite encouraged by the momentum that we have seen on that front, although we are cautious. We recognize many of our clients are feeling pressure. We recognize there could be more client events, and so we are proceeding with caution. But to this point, we've seen very strong momentum.

Great. Let's talk a little bit about Climate. Very strong performance in the last quarter, nearly doubled in terms of run rate growth. What's really fueling that? And perhaps talk a little bit about the separation of it in performance between Climate and ESG.

So Climate, and we've been quite vocal about this. Climate is something that is a massive opportunity for MSCI. It could be, and Henry would probably say likely will be bigger than ESG in its own right. If you think about what ultimately is driving the opportunity for us in Climate, you have really this existential, I hate to say, threat because I'm confident and optimistic we can address it. But you have this existential trend of changes to the globe and as a result, changes to society, changes to the composition of the economy, which will impact capital flows and ultimately, asset prices. And so investors need to pay attention to climate change, the transition to a low-carbon economy. And we are uniquely positioned, not only because that's what we do is help understand the drivers of the performance of risk. But because we have this well-established firstly, ESG, but now specifically Climate franchise, which helps with that. And so we are seeing very strong momentum. We're very optimistic about the long-term opportunity. The thing that is very encouraging for us is, I think, as you alluded to, we have $65 million of run rate today that was growing at close to 90% year-over-year. That is broken up across many different solutions across many different parts of the business. And so across all those areas, we're relatively small. We're small, not only in terms of size, but in terms of penetration and adoption in the markets that we're serving. There are big markets that we're not serving. We're relatively early in releasing tools to help our clients win this adventure and with this journey. And you're -- we're at the precipice of a number of regulations that are going to continue to come and be catalyst for investors in the financial services industry more broadly to be focused on this. And we are in a good position to capitalize. So we're very bullish on the long-term prospects of climate and you're starting to see it manifest itself and have an impact. $65 million is not huge for us as a business, but the growth is attractive and that long-term opportunity is enormous.

Right. And maybe continuing that on the ESG side, in the last quarter, you saw a little bit of impact from a cyclical perspective, where sales cycles were a little bit elongated, maybe fewer large deals. Can you talk about why there was a little bit of a dichotomy in performance between Climate and ESG even though they're sort of in the same category of structural growth?

Yes. It's important to keep in mind that they are related without a doubt to your point, where at the core of our ESG solutions, we have a wide range of ESG solutions for a wide range of use cases. But our ESG ratings and research are meant to identify those ESG considerations that are important for financial risk of security. Those factors differ based on the sector and company. And so for many sectors, environmental or climate-related risks are important risk factors to be aware of and consider. And so climate is a component of ESG. And it's also a consideration for some of the screening tools we offer. Certain regulatory areas like SFDR, which we group into our ESG category, but Climate is distinct in its own right. And so the tools that we are offering in Climate are geared towards helping clients integrate Climate into their investment process, understand the Climate attributes of the security of a portfolio not only the carbon footprint and targets, but what technologies or industries or environmental considerations they're exposed to. We have tools that help them understand quantitatively what their risk is to a transition to a low-carbon economy. We have tools that help them understand their alignment with certain temperature rise scenarios. And so those are very specific climate use cases. The dynamics are different, just like the dynamics across each of our solutions are different. And so I think importantly, over time, you're going to see the growth rates fluctuate within each of the tools, but also for the segment because there are so many competing dynamics across users and use cases and regulation and level of adoption versus infancy of certain sorts of products that we have as well as certain regulations that come in or don't come in. Those will all cause the growth rate within our ESG and Climate segment to fluctuate over time, but also within ESG and Climate. Importantly, we believe the opportunity for both is quite significant. And as I said in the last topic, we believe the opportunity for Climate could be even bigger than ESG opportunity.

Right, right. So asset-based fees represent 22% of revenues. If you clean out the exchange-traded derivatives, 19% tied to market performance. What kind of -- what expectations do you have for market performance for the -- over the next couple of quarters in terms of what's embedded in your outlook?

Yes. So we haven't disclosed that. We did put out with our third quarter guidance that our guidance assumes relatively flat markets for the balance of the year, although we said they're likely to be volatile. So the flat markets for the balance of the year underscored the guidance that we put out with the third quarter. Although I would say our financial management processes that we're talking about earlier are not just based on AUMs at any point in time or the outlook in a given quarter. We are taking a longer-term look at the trends that are taking place not only with AUM and asset-based fees, but across the business, what's working, what's not working, and the overall financial profile and profitability profile of the company. And so it is an ongoing calibration based on that longer-term outlook. But in the short term, our guidance was based on the assumption of a flat market.

Great. I'm going to pause there and see if there are any questions from the audience before continuing. No. Okay. Let's talk a little bit about MSCI versus its competitors. So S&P's Index business is guided to grow mid-single digits on a full year basis this year. What, in your view, accounts for the difference between S&P's Index revenue growth and MSCI's equivalent index fee-based revenue growth.

Meaning the asset-based fee part of our index franchise. So I don't want to comment too specifically on S&P and to be candid, I don't know the exact dynamics that are feeding into that growth number that you quoted, how much of it's impacted by their acquisition of IHS Markit and various market and FX dynamics. So let me talk about our asset-based fee franchise, and you can probably infer and I'll reference some of the comparisons to other index providers there. So our asset-based fees are about $480 million of run rate as of 9/30, as of September 30. The biggest component of that is where we license our indexes to ETF providers, and we get [ paid ] basis points on assets under management in those ETFs. It is important to underscore there that unlike many index providers, we are not concentrated, and that franchise is not concentrated around the small group of indexes or a single index. It is quite broad. And so there are over 1,000 ETFs linked to our indexes in many different indexes. And so that creates a very diverse AUM mosaic there across geographies where only about 30% of that AUM is exposed to the U.S. market, 70% to international markets and very broadly across international markets. I think it's about 27% is emerging markets. But also it's diverse across index types. And so now more than today, north of 30% of that AUM is in ETFs linked to our ESG and Climate and Factor Indexes and even higher linked to our non-market cap indexes, and that's a huge growth area. And so the dynamics can be quite different in those areas versus the broader markets. And so that breadth of exposure, that diversity of AUM and ETFs dampens any fluctuations in specific markets or specific sectors or specific strategies. I would say those dynamics are probably even more pronounced in the non-ETF passive bucket. So within that $480 million of run rate, about $280 million is ETF run rate, about $140 million is non-ETF passive and that's where we're licensing our indexes to a manager who's going to track the index in a wrapper other than an ETF. It might be a mutual fund, but a huge growth area for us is institutional passive where an institution gives an index mandate to track one of our indexes in something like a separately managed account or maybe a co-mingled account. And that's an area where we're seeing tremendous demand for nonmarket cap weighted indexes and mandates or custom indexes. We call them client-designed indexes increasingly. And that creates a more dynamic picture of the overall AUM exposure, not only because the underlying indexes are diverse but also the redemption and new creation dynamics tend to be different than in ETFs as well as, I'd say, the revenue recognition. We tend to recognize any fluctuations on a lag because we depend on our clients reporting assets to us. That tends to create movement that's different than the ETF movement. And so overall, you see dampening effects between those 2 categories. And then we touched on futures and options, which is the last piece, about $60 million of that $480 million. And that is generally countercyclical outperforms in periods of volatility and uncertainty, and we've seen that in the recent environment, and that provides a nice counterbalance as well in asset-based fee line. And so we have this very dynamic asset-based fee line, which a lot of people think is just ETFs, and we're exposed to ETFs, but it is much more dynamic. And importantly, the long-term growth dynamics are quite exciting, and we've continued to see flows into the products despite some of the market volatility.

Right. Let's talk a little bit about margins. So you mentioned exercising your downturn playbook. What -- as you exercise the downturn playbook, what margins are you targeting on a near-term basis? What do you have in mind?

Yes. So we -- I'd say we're generally not focused on a specific margin or a margin target. We are -- when we go to our downturn playbook and our upturn playbook and our ongoing financial management, usually, we're balancing 2 things, which is investing in the business to drive long-term growth while preserving an attractive financial profile. And when I say financial -- attractive financial profile, it's generally talking about profitability growth. And so we are as much focused on profitability growth and EPS growth as a specific margin. Sometimes, we will think about the margin and margin dynamics, but generally, we're focused on driving that trajectory of attractive EPS growth.

And you mentioned as you're thinking about running this downturn playbook, certain areas of the business, you're not touching, areas where you're investing for growth. What are some of those areas that are secret that you're really not changing your investing and cadence on and you're continuing to double down?

Yes. It's a lot of the areas that we've talked about today and probably not surprising to hear. But it's around things like our client-designed indexes or custom indexes or even brought it into non-market cap weighted indexes where we see tremendous demand across many different dimensions and different client segments and different investment vehicles. But to be able to scale up and meet that opportunity, we're investing in the technology infrastructure to support a faster pace of creation and maintenance of more indexes and more client designed indexes or personalized indexes. It's investing in the researchers who are creating the frameworks to allow us to create -- to provide more dimensions to investors to optimize around. So areas like thematics, where they are providing the frameworks to understand different dimensions of mega trends or broader thematic considerations as well as scaling up to meet the demand for specific climate objectives or ESG objectives or factor objectives. And so that takes researchers and product professionals to do that and then go to market as well on that side. So being able to unlock and capture the demands we see across many of the client segments that I alluded to, but broker-dealers, wealth managers, direct index and opportunities just massive opportunities on the index side. It's continuing to drive leadership in ESG, and that involves investing in broadening the data that we're using to inform our tools, enhancing the quality and frequency of the data that we already have, enhancing our client service to allow us to provide a better value proposition and interact more regularly with our clients as well as the issuers themselves, which we believe is an important part of the ecosystem and reinforces the differentiation of our tools as well as in the technology. So the technology to not only source the data in a scalable and accurate fashion but also the technology that enhances how users can access our content and use the content, establishing client leadership. There's a fervent pace of new product creation on the Climate side, as I alluded to, but it's also on the go-to-market side where we're continually enhancing the tools that we have, but also broadening the range of tools that we have to help meet the varied use cases out there. Private assets is an area that we are heavily focused on continuing to drive leadership in. And so we are investing in content and technology and go-to-market on that side. Our fixed income franchise across every segment of the company almost with the exception of probably private assets, but even private credit, it falls within there. But it's analytics. It's fixed income indexes, it's fixed income insights around the ESG and Climate. We are investing on all those fronts, and that's an area where we are getting nice traction. But then more broadly, it is the data and technology infrastructure that's going to allow us to scale in an efficient fashion. So cloud investments or migration into the cloud and cloud-enabled tools as well as the ISaaS road map. So those are broadly the sacred cows for us or the areas that we don't want to touch.

Great. And then capital allocation, MSCI returned a significant amount of capital to shareholders, $1.3 billion in share repurchases done through 3Q. Can you broadly talk about your capital allocation philosophy and what targets you have to deploy free cash flows?

So I'd say our approach generally has not changed. We are a business that benefits from generating very attractive free cash flows and a lot of free cash flow that lends itself also to permanent debt. So our leverage target has not changed of gross debt of 3x to 3.5x gross debt to trailing EBITDA. We're currently towards the higher end of that range. We think the cash flow generated by the business plus incremental leverage allow us to be opportunistic in buying our shares back and creating value that way, but also being nimble on the MP&A front. And so we are making sure we are positioned to both take advantage of volatility in the market where we might see attractive value and when we have more cash, but also potential dislocation that happens in private markets and M&A opportunities. We think M&A can be for us a very strategic accelerator in those growth areas of investment areas that I talked about. We're not looking to add a whole new division or diversify the business, but we think M&A, particularly in areas like ESG and Climate and private assets can get us access to unique data or embed us in these ecosystems that are important. And so we are very focused on ensuring we can be nimble and move quickly if we do see opportunities there.

Great. We've got time maybe for 1 question. Any questions from the audience? No. Andy, thank you for your time and insight.

George, thank you so much. This was great. Thank you, everyone. Appreciate it.

Thank you.