MSCI Inc. (MSCI) Earnings Call Transcript & Summary

All right. We will go ahead and get started. Thanks, everybody. Thanks to everybody for joining us this afternoon. I'm Patrick O'Shaughnessy, capital markets technology analyst here at Raymond James. And of next, we have MSCI. On MSCI's behalf, we have CFO, Andy Wiechmann. Andy is going to go through a couple of brief slides, real quickly, just to provide a company overview and then we'll go into the Q&A. So with that, Andy, welcome.

No. Thank you, Patrick. Thank you for having me. This is really a great event and always enjoy being here. Great lineup of meetings and great discussion, as always. Yes, as you alluded to, I thought it would be helpful to spend a couple of minutes just providing a high-level overview of who MSCI is for those that are less familiar with the story. I would highlight three things about MSCI. We are uniquely compelling in terms of our focus and our business model, uniquely compelling on the market opportunities in front of us and uniquely compelling on the financial model of the business. We are the only company that is uniquely and intensely focused on helping investors with their most important job, which is building and managing portfolios. We are focused on delivering really niching critical tools that help investors understand the drivers of performance at risk, and ultimately build portfolios to achieve their objectives more effectively. We serve the who's who of investors throughout the entire investment process from asset owners through to managers as well as intermediaries, like broker-dealers, exchanges, consultants. We serve 6,600 organizations across over 95 countries. So we very much are embedded in that investment process, talking to the who's who of not only organizations, but the key investment decision-makers at those organizations. And that, as a result, leads to many of our solutions being embedded within the process, such that they become common languages. And so these IP-based solutions that are used to understand performance and risk, other attributes to understand market sizes and ultimately, construct portfolios to achieve objectives, become almost market standards, which leads to a very compelling opportunity for us. On that front, when you look at the trends taking place in the investment industry, we are in the sweet spot or in the strike zone of many of those trends. So at the highest level, you have more savings -- more global savings by individuals, by governments and by institutions. Those savings are looking for productive returns. And so they're put into professional management, or what we call the investment industry. So you have a growing pool of investable assets, chasing a more complex opportunity set. We have more markets that are becoming accessible, more asset classes, more security types, more vehicles. And across all of those, you have a richer data set of information and more information about them. This is MSCI's sweet spot, where we provide structure to that enormous data set to that additional information to allow investors to navigate the complexity and ultimately, achieve better outcomes. When you drill down a layer and look at the trends that are happening in the investment process, you see a move towards more outcome-oriented, rules-based customized type solutions, which is driving what we call indexation. So indexes are a very efficient mechanism to reflect a systematic rule-base strategy. And so you're seeing growth in the use of indexes across many different client segments and use cases. You see, as I alluded to, more outcome-oriented strategies that are looking across asset classes. And to build those, you need a consistent framework to understand the drivers of performance and risk across all these asset classes, our analytics tools, they're best in class on that front. You see more sustainability-oriented strategies in areas like ESG and Climate objectives where our tools are in a leading position. And then you see an increasing allocation of private assets, an area where we are creating and providing the tools and allowing users to navigate that, they'll take asset class. So we are in the strike zone of those trends. And all of that leads to a very compelling financial model, where 97% of our revenue is recurring. About 75% of that is recurring subscriptions. And these -- because we are in the sweet spot of these trends, the revenue growth and trajectory has been quite compelling. And we're licensing generally IP-based solutions, where under annual subscription contract, for the most part, where we get paid annually in advance, which leads to very compelling cash flow dynamics. And because we're producing things once and selling it to many different users for many different use cases, there's inherent operating leverage within these products that we're selling, which leads to a very attractive profitability profile as well as a very attractive cash flow growth profile. And ultimately, because we have a very disciplined approach to capital allocation on top of that, we get this very attractive trajectory of adjusted EPS. So a very compelling company and opportunity across not only the business model, but also the market opportunity in front of us and ultimately, the financial profile of the company.

Great. I appreciate that lead off. You touched on this a little bit, but maybe can you go a little bit deeper into what do you think is MSCI's key competitive advantage? And how does that advantage extend across the company's four segments?

So there are probably a number of competitive advantages cutting across areas like our unique data sets that we continue to build, our broader data capabilities. We're an organization that is ingesting, cleaning, interpreting massive amounts of data and creating derived content from it. We have very advanced analytical engines, calculation engines that are ahead of competitors out there. We have a very unique global employee footprint and culture. All those are competitive advantages. But maybe I can drill into, I'd say, three competitive advantages that relate to one of the points I made in the introductory comment, which is our client relationships and our client footprint. So one, we, very much, as I alluded to earlier, we're working with the who's who of investors, whether it's through just the informal discussions that we're having with our client organization and our researchers, engaging with these investment decision makers or more formally through things like our client advisory boards that we have or industry consultations that we run. We are continually understanding from our client base what objectives they are trying to achieve. We're getting insight into the direction of demand and direction of trends in the investment industry. And so it's a very important source of innovation and insight for us. And that's why we are at the forefront of investment trends, whether it was factor investing, ESG investing, Climate investing, Private Asset investing, increasing areas like Thematic investing or outcome-oriented investing. The solutions that we are delivering are not just because we think they're important because we hear -- it's more because we hear from our clients that they need these tools to achieve their objectives. Related to that ecosystem that has developed around our tools, I alluded to in the beginning that we've delivered these common languages that facilitate conversation, facilitate communication, facilitate objectives across the investment industry. Within that ecosystem, there's one constituency where we have a very strong position, which is with asset owners. So we serve the largest pension funds in the world, the largest insurance company, the largest sovereign wealth fund, the [ GAVINS ] foundations. And we are helping them think about their portfolio, not only how to view the investment opportunity set using our framework, but also how they're going to allocate assets and then ultimately adopt things like our policy benchmarks or think about their climate objectives along the lines of our climate tools or our ESG ratings. When they start to adopt things like a factor overlay on a strategy, they're using our factor tools to do that. And as a result, throughout the ecosystem, the managers that are managing money on their behalf as well as the intermediaries that are facilitating capital flows need to use those same frameworks and languages. And so this strong position we have with asset owners in particular, but the entire ecosystem, facilitates driving standardization and the use of our tools throughout the industry. And then the last thing I would touch on quickly, which relates to the prior two, is the interoperability of our tools. The fact that our ESG and Climate indexes are built on our leading ESG and Climate ratings, research and data tools, our factor indexes are built on our industry-leading factor models and risk models and analytics tools. The fact that our Analytics are using the same universe of securities and classification systems that our leading index franchises are built on creates this reinforcing ecosystem of driving standardization, but also create synergies across products, where clients that are trying to achieve specific objectives around performance, well managing risk and achieving specific objectives overlaid on it, can use all our tools together to achieve those objectives. And so we're unique in being able to offer analytics, ESG and Climate insights indexes, Private Asset insights in a cohesive similar language to achieve a multitude of outcomes and objectives for investors, which leads to natural upselling.

So you talked about how you work closely with your clients. What do you carry from your clients right now in terms of how comfortable they are with their budgets? And how concerned they are with the recession? And as it pertains to MSCI, how does that inform your outlook for your sales pipeline as well as client retention?

Yes. So we've been quite encouraged by the performance during 2022, both the growth -- with organic subscription run rate growth of 13% as well as the retention rate -- with retention rates across the business for the year north of 95% have been quite remarkable despite the market volatility. And I think that speaks to the fact that we are serving these mission-critical use cases that are deeply associated with the core function of our clients, which is investing and trying to differentiate themselves and achieve better returns -- better risk-adjusted returns. They're not going to cut our tools. We're the last thing they want to cut and when they are spending, they're prioritizing areas where we have tools. So we've been very, very, very encouraged by that. But to your point, we are pretty sober about the backdrop here. We have seen in past environments that when you have a sustained period of equity market pullback you tend to see clients tightening budgets, downsizing, and we have seen some layoffs in the investment industry, restructurings, changing of strategies, closing depths, closing funds. All those things you lead to pick up in cancelations, and they can lead to as well as things like budget tightening, which we know some organizations now tightened budgets as they've reset budgets for 2023 can lead to lengthening sales cycles. So we are cautious on the outlook here for all those reasons. But overall, I'd say the pipeline remains fairly healthy across the business and large in absolute terms. We've got a very strong pipeline, very healthy dialogue we recognize there are going to be some environmental pressures that we'll see likely throughout this year.

How are you thinking about MSCI's margin outlook at this point? And how big of a tailwind was a stronger U.S. dollar last year?

So we -- it is important to highlight that -- a couple of points around that. Firstly, we don't target a specific margin or rate of margin expansion. We are much more focused on balancing two main objectives. One is investing in the long-term growth of the business. So we very much prioritize continuing to invest in these areas of attractive secular demand and where we can be a leader and capture a massive part of those big markets. But at the same time, also delivering attractive EPS growth. And so margin is a little bit of a byproduct of both of those inputs here. We're really trying to deliver attractive EPS growth in all environments, while continuing to invest selectively in those key growth areas. And the areas outside of those key growth areas, we will flex our expenses up and down quite significantly, like as you saw do in the back half of 2022. I would say, just because you mentioned FX, it is worth highlighting, we do have this very nice natural hedge embedded in our expense base -- sorry, in our financial model, where about 11.5%, 12% of our revenue is exposed to non-U.S. dollar contracts revenue. And it's about 40% to 45% of our expense base is exposed to non-U.S. dollar expenses. And so given the relative sizes of revenue and expense and the concentration of currencies within there, they tend to move together. And so the net impact on EBITDA tends to be relatively muted. If you look at 2022, I think we had a revenue headwind from the appreciating dollar of about $35 million throughout the year, but we had a benefit on the expense side of about $38 million. And so you can see the net impact on EBITDA was relatively small, a few million dollars. The margin did get some benefit from that, not only because there is slightly more contribution from the benefit on expenses, but also the relative sizes of revenue and expense. And our margin profile meant that we got some margin benefit if the U.S. dollar does depreciate or begin to appreciate that will move in the other direction. But again, the net impact is relatively muted at the profitability line. Just because we're talking about expenses, I did want to highlight a couple of things just around the seasonality of expenses. So we commented and we've seen this in past years, first quarter is seasonally a high quarter for expenses for us because of certain compensation and benefit-related expenses. We tend to see elevated expenses to the tune of $15 million to $20 million, associated with the fact that we're paying bonuses or other payroll-related expenses and benefits expenses that are elevated there in the first quarter, and so we expect that this quarter. On top of that in the first quarter of this year for the current quarter, there are a couple of other items on top of that. One is, because last year, we were -- because of the AUM pressures that we saw, our bonus accrual was tracking below 100%. And so when we roll into a new year, at the beginning of the year, we start to track back towards 100% accrual on the bonus. And so that moved from accruing at a level below 100% back up to 100%, combined with some executive award -- expenses associated with some executive awards that were granted is leading to another $5 million or so of incremental expenses on top of that $15 million to $20 million. So I just wanted to make the market aware of that elevated expense we're expecting here in the first quarter. This is all within the guidance that we put out and continue to have the same guidance we put out with our year-end results here.

Circling back to the earlier discussion on your competitive advantages, how would you evaluate the competitive landscape, the MSCI cases? And maybe with a focus on your Analytics segment as well as your ESG and Climate segment?

Yes. So for all the reasons I highlighted at the beginning here, we are the premium offering in the market, and we tend to be the premium price solution provider in the market. Now the solutions, we're delivering, as I mentioned, are mission-critical to these organizations and usually closely tied to not only the investment mandates that our clients have, but they are closely tied to what our clients are trying to achieve and how they're trying to differentiate themselves, and so we are in a strong position there. But there are competitors across most of our offerings. And usually, they are -- often they are competing on costs. So they are offering a lower cost alternative to what we do. And -- because you mentioned Analytics, just to use some examples there, there are a small subset of providers out there that do offer similar performance and risk analytics and insights across the various solutions that we have, and they are usually trying to compete at a lower price point. They are also trying to deliver that efficiency or that cost saving to their clients by delivering a broader solution set. So oftentimes, they are offering it to clients at a much lower cost because those clients might have already a broad license to our subscriptions to terminals or workstations. The client might be looking to outsource all of their investment system architecture and so they find is easier to use a provider that has a front-to-back solution set, even though the risk and performance analytics and risk and performance management measurement tools are inferior to us. Sometimes the competitors are trying to offer a value proposition where they can do it at a cheaper cost and save the client an enormous amount of money. And so occasionally, on the analytics side, we do lose the competitors for cost. You can tell about the retention rate, that is the exception. But I do want to highlight some of the trends that are happening within investment technology that are breaking down some of those value propositions of those lower-cost competitors. Advancements in technology and things like advanced APIs, more flexible user interfaces are making it easier for clients to use tools and access calculation engines and content in a much more cost-effective fashion and integrate that into the workflow, regardless of the systems that they are using because of these modern interfaces. And this is an area where we have been investing heavily. Additionally, they are -- we've been investing and focused on heavily integrating with many different providers out there. So this is our ecosystem of partners, and we are integrating our tools with complementary solutions like order management systems, like data management or accounting systems to make it that much easier for clients to access our tools regardless of the tools that they are -- broader tools that they're using. And so we think the direction of travel works in our favor. Just quickly on the ESG and Climate front, I will break it down between the two because I think the dynamics are a little bit different. On the ESG side, it's really a couple of providers, us, as the largest provider of ESG ratings and research, and then there's one other provider Morningstar Sustainalytics, which is probably the #2 provider, less than half our size, providing solutions. I think the nature of what we're delivering lends itself to a small group of broad providers, and we think we're in a very good position there and continue to see a number of very compelling growth opportunities, which we are well positioned to capitalize on. The climate opportunity is much more in its infancy, and it is very multifaceted. And so there's a wider range of providers there offering a wide range of solutions for that climate integration. So if an investor is really just trying to integrate climate considerations into their investment process and understand how an investment where our portfolio is aligned with a transition to a low-carbon economy, that is where we are a leader and strongly positioned, although it's still very early days, and we see a very rapid growth rate. But there are a whole host of other opportunities from just providing miscellaneous data sets, through to helping corporates to understand their emissions footprint, through to sustainability notes and bonds. Where we haven't focused as much, we could over time, but there is a number of providers that are focused on those areas as well. And so it's a massive market. It will be a massive market that we're in the very early days, but we think we're well positioned not only in the areas where we have strong competitive positioning and investment process, but also across some of these new frontiers for us.

And building off of that, where would you say that we are in the growth stage for ESG versus Climate?

Well, -- it's always tough to calibrate this because they are both massive opportunity sets that are in their early days. So maybe I'll characterize it as this. ESG is still early days, and it is a massive opportunity. Climate is in its infancy, and it is a transformative opportunity not only for the investment industry and as a result, us as a provider to that industry, but for the economy more broadly. And I think the world is early in that evolution, in that journey. And so there will be massive opportunities. Just to provide some stats around where we stand on both those fronts. So if you look at just ESG, there is about $355 million of total run rate we have just in the ESG tools, about $260 million of that is subscription. So subscription services that cut across all of our product lines. That $260 million of subscription run rate in just ESG is growing close to 30% per year. So that's a big number growing. It's still a very healthy attractive growth rate. If we look at Climate, it's $79 million of run rate, of which about $56 million is subscription products. That $56 million is growing north of 80%. And so it's a smaller number growing at a much more compelling. And as you can tell, much earlier in its life cycle type growth rate for us. But we think there are so many dimensions of growth in climate that there's a long -- many layers of growth that will continue that elevated growth rate for us for some time. Just to provide one more data point on the dimension where we are in that journey and help you to size where we stand. There's about, call it, $220 billion -- $225 billion of -- and this is representative of kind of other parts of the investment industry. The $220 million to $225 billion of assets in ETFs -- equity ETF linked to our ESG and Climate indexes. That compares to about $1.3 trillion to all of the equity ETFs linked to our indexes. So it's still a relatively small part of the overall assets. And that compares to 7-plus trillion dollars in equity ETFs globally. And so it's still a small part of the market. And by the way, that $220 billion is still the majority. So we're capturing the majority of assets going into the ESG and Climate ETFs. We see similar dynamics in the non-ETF passive market, but also in the benchmarking market where institutions are adopting client aligned objectives and benchmarks or ESG specific benchmarks, and we are in a leading position to capture those assets. And we think, as I alluded to, that's a transformative move that will continue for some time, and we're in the strike zone there.

Turning to your index subscription business, which is your largest revenue line as you guys report, that business has grown 10%-plus every year since 2014. And while MSCI has seen particular strength in custom factor and ESG index subscriptions, even your market cap weighted subscription revenue continues to grow high single digits or low double digits. Beyond pricing, what's driving the outsized growth in the bigger legacy market cap weighted subscription business?

Yes. It's been encouraging to us to be frank about it. Yes. So just to put a finer point on that, the market cap weighted modules within that index subscription base in the fourth quarter grew at 11% year-over-year. And that is the more established content area for us within indexes. And it's been, as I alluded to, is very encouraging. And there are a number of dynamics at play. But if I were to summarize it at a high level and tie it back to my opening comments to describe the trends you're seeing in the investment industry, you're seeing a move within both institutional investment processes, but also within the wealth driven investment process to more systematic rules-based personalized investment products or solutions or strategies. And an index is a very efficient mechanism to reflect ultimately that customized rules-based strategy. And to be able to do that in a systematic fashion, you need to understand a few things. You need to understand the investment opportunity sets, which is what our market cap modules provide. It's the total opportunity set of investable securities. You need a systematic way to think about dividing up that opportunity set across sectors, styles, sizes, geographies, ultimately, things like factors and ESG. And so our modules provide those -- that kind of tool kit, if you will, or the framework that investors need to be able to make the allocation decision or an overweight/underweight decision across all those dimensions. And so the drive and need for our index content is very rich across many different need spaces. I talked about institutions that are trying to develop these personalized objectives or outcomes, which not only drives the need for our market cap modules and content, but it's also driving the need for our non-market cap weighted module if they're trying to put things like a climate overlay on it or a factor overlay or exceed certain thematic considerations or overweight other somatic considerations, all these are driven by the need for our index content. But you see this trend of personalization and rule-based strategies showing up within broker-dealers that are creating solutions for their institutional clients. They want our index content. You see it within wealth managers that are increasingly building model portfolios to put their end clients into. You see hedge funds that are increasingly wanting to trade in or arbitrage certain index creatable products out in the market. And so the proliferation of indexation and use of indexes is creating enormous opportunity for us across a number of dimensions.

Great. I think we have time left for one more question. So private assets. You mentioned one of your core strengths is your great relationship with endowments and the pensions and the other asset owners. And those clients yours have been demanding a solution in the private asset space. Why has it taken so long to really kind of have the momentum in that business match the sensible opportunity?

Yes. Within -- [indiscernible] to your question, it's something that has probably frustrated us a bit, the growth rate has not been where we wanted to be within our Private Assets segment. Listen, it's not too shabby, it was 12% organic subscription run rate growth in the fourth quarter. We do have a high-teens target, which we think is definitely achievable within that segment. I'd say there's a couple of factors at play. You alluded to -- and the reason we got into providing solutions for private asset investing because the LPs or the asset owners or client base are increasingly allocating larger portions of their portfolio to private assets, and they're paying oftentimes the majority of their fees to private asset managers. And as a result, they are screaming for these tools to help them understand. How do I -- the basic needs of -- what is the opportunity set? What is the performance of the market? What is the value that a manager is delivering to me beyond just the market, beyond just leverage? And so those are the tools we're trying to provide. However, because they are allocating more, the managers have not felt the pressure to disclose more information or the benchmark. Most of the large private asset managers can raise as much capital as they want or need, and they don't need to provide additional disclosure. And so there hasn't been that [ act ] there to push the GPs or the asset managers in the private asset space to disclose more or comply with things like benchmarks or certain other standards that asset owners want. That is something that is gradually changing, and we think one of that acts could be things like ESG and Climate, where you're seeing the private asset managers start to embrace it, but they're doing it on a more bespoke selective basis. But I think the asset owners are saying, "Listen, I've committed to certain climate objectives, I need you to disclose these things or I need you for you to confirm that you don't have these exposures." And that's a place where we can help drive some standardization. And so we think that will help accelerate things. The other factor that I would highlight is we have been building a solution set. And so today, for us, our private asset solutions are mainly in real assets, in large part, property market or real estate. And until 1.5 years ago when we acquired RCA, our coverage of the market and the data we had was only part of the market, mostly that core real estate market. With the acquisition of RCA, we now have a formidable data set -- the most formidable data set across the entire property market, including the values of properties, which allows us to develop these insights that we are looking to deliver. And so we now have a solution that we think that should be able to drive very attractive growth, and we're continuing to expand into other asset classes as well, together with some of our partners and believe we are in a position to, in the not-so-distant future, get to those high-teens growth rates and be really a leader in providing that insight and structure to the private asset investment process.

Great. Well, on that note, we are out of time. But thank you, everybody, for attending, and thank you, Andy.

Yes. Thank you, Patrick.