MSCI Inc. (MSCI) Earnings Call Transcript & Summary

Thanks for having me. Great to be here.

Yes. So let's start at a high level with our discussion. MSCI's mission is to help investors build better portfolios that are increasingly complex with full-scale solutions across multiple asset classes.

Can you talk a little bit about some of the secular trends that you're seeing that are helping to drive the business forward in terms of complexity, index investing, ESG, certainly topical?

Sure, sure. Yes. And I think you touched on some of the most important trends, but maybe I can take it at a few levels. And I would highlight that these are, for the most part, trends that have fueled MSCI's growth to this point and long-term trends that have a long way to go. At the highest level, what we see globally is institutions, individuals, sovereign entities growing their savings. We see savings continue to accumulate, and those savings get directed into what we call the investment industry to achieve productive returns. So on one side, you have growth in global assets and AUM. And on the other side, you see more markets becoming investable, more security types, more asset classes and more information about all of those. And so like, as you alluded to, complexity is growing. Complexity is growing rapidly. And so this increasing pool of savings, chasing a more complex pool of investment opportunities needs standard frameworks to define markets, understand how to segment them, and then ultimately, understand the drivers of risk and return in those markets. That is what MSCI does. And so that trend of savings growth around the world and the increasing number of investment opportunities puts MSCI at the epicenter for tremendous growth opportunities. When you drill down a layer, and you were alluding to this, there are 3 or 4 major trends taking place within the composition of investable assets. And this is in terms of where fees are going and where assets are going. One is personalization or customization. That has been a big trend that you've seen in recent years and feels early in its journey. And so you're seeing more investors, both at a wealth-driven investment process as well as an institutional investment process trying to achieve customized outcomes. And so you see that manifest itself in the use of more systematic strategies. To be able to do that at scale, you need frameworks that allow you to customize at scale, and that's what our frameworks, namely our indexes, can do. Our indexes can be a very efficient mechanism to reflect a systematic investment strategy because -- or the foundation of our indexes is these frameworks that segment the investable market across geographies, countries, sizes, sectors, factors, ESG, climate, et cetera. Another trend related to that is outcome-oriented type solutions. And so you see growth in liability-driven investing, balance fund, multi-asset class solutions. To be able to develop those strategies, you need those interoperable frameworks and tools that compare the risk and return drivers of multiple asset classes or security types in a consistent, systematic fashion. That's something where we're very differentiated. Public to private. So one of the highest growth areas in assets, but also fees paid to managers is private portfolios or private equity, private real estate, infrastructure, private credit, which is a huge buzzword right now. And that market does not have standard frameworks generally. And so MSCI is now uniquely positioned to create those frameworks. And then last but certainly not least is sustainability, which I know there's a lot of noise right now, but it's a tremendous opportunity that we are in the early days of, and MSCI is in the epicenter of that. And so how that manifests itself -- all those trends manifest themselves for us and kind of product or solution trends we see. Indexation, as we would say, the proliferation of indexes is an efficient tool to achieve your outcomes. Related to that, multi-asset class insights and tools, ESG and Climate tools and then creating MSCI Private Assets. So we're very excited about these long-term trends. They're cyclical. Overlays on the pathway to get there. But ultimately, this is what's fueling the growth of MSCI.

Yes, yes. Makes sense. Now last year, MSCI began exercising its downturn playbook. But given the strong GDP growth we saw last quarter and given the fact that AUMs have been going up, is the downturn playbook still in effect? And if so, which areas of the business are you focused on tempering costs?

So the upturn and downturn nomenclature can be a little misleading because it's all relative. So upturn is relative to a prior period. Downturn is relative to a prior period. And so whether we're in an upturn or downturn right now is probably less important than the calibration that we're continually doing on the pace of spend in the business. And so to your point, if we look back a year ago, we implemented our downturn playbook, which was relative to the trajectory of spend that we had back in the middle of 2022. We slowed down that pace of spend. So we put in place a number of expense controls, proactive expense management, drove some aggressive efficiencies, and we came into 2023 with a cautious outlook. Now, our guidance for the year was based on the assumption that, as you alluded to, markets remain generally flat. We said slightly down in the first half of the year and then rebound in the back half of the year. AUM levels have been better than that scenario, which underscored our guidance or underlined our guidance at the beginning of the year. And so we have been picking up the pace of spend. I wouldn't necessarily call it upturn because overall, we're still of a very cautious mindset. We do have expense controls in place across the business, continue to have expense controls and continue to drive structural efficiencies. But we are -- whether it's upturn or downturn, we are very intentional with our actions. So we're very targeted with where we reduce expenses and where we increase expenses. The increase of expenses has been in those key growth areas for us. So enhancing ESG quality, broadening the range of securities that we cover, enhancing our custom indexes at scale and the infrastructure there that underlies it as well as the research and go-to-market teams around that as well as things like our MSCI ONE application and initiatives, so these very important key growth drivers for the business. On the flip side, the areas where we have been more constrained and continue to have expense controls is on the run-the-business, as we say, parts of the organization. Those areas that are less directly related to growth, less time-sensitive and critical. So those tend to be corporate functions. Those tend to be areas where we are a little bit more in a steady state, and we've got degrees of freedom and flexibility to pace expenses a little bit lower than we normally would. And so we're continuing to be cautious. We are -- we have taken up the pace of spend in certain areas. But overall, it's going to be a continual calibration based on business performance, market levels, outlook, a whole host of factors.

Yes. Makes sense. On a long-term basis, you're targeting low double-digit revenue growth and EBITDA margins in the high 50s. We've seen a lot of things change with ESG, interest rates, geopolitics. Do you still stand by your long-term targets? And if so, what would you say are the top key 2 or 3 drivers to get there?

Well, there have been no changes to our long-term targets for all the reasons that I mentioned. On your first question, we continue to believe that there are tremendous growth opportunities for the firm. Those secular trends that I talked about will continue to fuel each of our product lines. And in many of them, we feel like we are early in those journeys. And so those long-term targets, I think, underscore the opportunity size, the pace of adoption, our market position. But over the long term, there's been no change to that outlook. There are cyclical dynamics at play, as you alluded to, right now. So I would mention that those long-term targets are exactly that, long term. They are through the cycle. There will be fluctuations in growth rates for a whole host of factors. But we do continue to believe in those targets. I mean if you look at the performance right now where growth has slowed, we're still generating 11% subscription growth in Index; 7% growth in Analytics; ESG and Climate is 20%-plus growth; and what we've called Private Assets, but it's our Real Asset franchise up until the third quarter, has been kind of high single digit, close to 10% growth. And so even with the cyclical pressures at play, we're still seeing pretty strong momentum across the organization.

Makes sense. Let's dive into some of the recent revenue trends. Index subscription revenue grew 11% in the third quarter, which was very resilient, consistent with past quarters despite an uncertain macro environment. What are you seeing with client spending behavior, specifically in the Index business on the subscription side?

Yes. So it is -- to your point, it's been quite resilient. We've seen this long track record of delivering double-digit subscription run rate growth within our Index franchise. And I think that speaks to a few things, the mission-critical nature of what we're doing. Without a doubt, there are cyclical pressures at play right now, the same things we see across other parts of the business. We are seeing longer sales cycles, particularly for larger deals. We are seeing a slight pickup in client events, which leads to elevated cancels. But the great thing about our indexes is they are usually very closely linked to the strategies of our clients. They are mission-critical to whatever objective those clients have, whether it is an integral component into their portfolio management process or even directly related to the product that they're promoting or marketing. And so that creates this resilience on the retention rate but also the demand. And as I alluded to in your first question, we see this tremendous growth in indexation. And so yes, there are parts of the industry that are feeling pressure, contracting, but there are parts that are growing, and indexes can play a critical role in that growth. And so we see high single-digit growth in our market cap modules but mid- to high teens growth in our nonmarket cap-weighted modules. From a client segment dimension, we see 9% growth within asset managers, but mid-teens to even mid-20s growth among some of these client segments where we are smaller today and see big opportunities like wealth management, even hedge funds, broker-dealers. And so there are multitude of avenues of growth that help to support the franchise even when we are seeing cyclical pressures, which we are, for sure.

Right. In the third quarter, Index net new recurring subscription sales did decline on a quarter-over-quarter and year-over-year basis. It hasn't happened often. Maybe it's happened 2 times over the past 3 years. Does this negative inflection in Index net new concern you? Is it a start of a new trend? Or is it just a blip in your view?

Yes. So I would say it is reflective of the environment we're in, as I alluded to before. We have seen in past down-markets or sideways markets or periods of uncertainty that Index subscription growth slow. And so we have seen it slow a little bit, and I think those environmental pressures are likely to continue for some time here. But as I alluded to, the long-term secular dynamics remain quite healthy. And so there will be some movement. Granted, in the Index segment, it tends to be quite small and muted, but these are things that we have seen in the past. And in these environments, you will see the subscription run rate growth slow a bit. But as I said, the long-term dynamics don't change.

Right. Makes sense. If you look at the asset-based fee part of the business within Index, continues to have positive momentum through the third quarter and expand year-over-year, driven by AUM growth. How would you describe the overall pricing and competitive environment within the AUM fee-based business?

So maybe I'll take -- the dynamic -- there are some related dynamics, but I'll take ETFs and then non-ETF passive, which are the 2 major components of our AUM-based revenue. Within the ETF component, I'd say the dynamics are consistent with what we've seen over the last 7, 8 years. So there haven't been major changes there. Where -- and I think we've been pretty vocal about this, we see higher growth from lower fee products. And so on a blended average basis, fund fees as well as our -- the basis points that we receive on those assets that are linked to our indexes will gradually come down, and that's what we've seen over time, and we expect that to continue. Now we do believe there are -- continue to be massive opportunity, growth opportunities across new geographies, across new product areas, across broader uses of ETFs and investment processes that will allow the growth in assets to offset the fee compression. And so we do believe it continues to be an attractive growth area, ETFs specifically over time, even though we expect the fees to come down. You have seen, although over the last year and change, fees be quite resilient for us. If you look at our average basis points, they've hovered around the 2.5 basis point level now for several quarters. There's even a quarter where they ticked up. There's a couple of things going on there that are worth noting. One is cyclical dynamics. And so we do have some fee arrangements where our fees adjust with the assets, namely when assets go up, our fee might go up. And then similarly, when assets go down, our fee -- sorry, it goes the other way. When assets go up, our fees come down. When assets go down, our fees go up. And so you've seen, for some products where the assets have gone down, actually, we jump into a higher tier fee as the asset level drops. And so that is one component driving some stability in the overall fees. And then the other is high growth of nonmarket cap-weighted products. And so all else equal, a nonmarket cap-weighted product oftentimes, not always, but oftentimes has a higher fee than a market cap-weighted product. And so we've seen tremendous growth over the last several years in nonmarket cap-weighted products. And that's a trend we expect to continue, and that provides some support to the fees. Now in the non-ETF passive, we call it non-ETF passive although we cringe when we say passive because oftentimes, it is much broader than just the passive strategy. It's -- as we were talking about at the beginning, it's an institution who is optimizing it for their own objectives. And so when they are using nonmarket cap-weighted products, which is where we were seeing some of the highest growth in that non-ETF category, the fees tend to be higher as well. And so we've seen very strong resiliency of fees in the non-ETF category, and that relates to this indexation trend that I was talking about at the beginning, where institutions and increasingly wealth organizations through direct indexing are using indexes as a way to personalize or customize their objectives. And those mandates tend to have a higher fee than just a market cap mandate. And so that's an encouraging trend for us over the long term.

Right. Right. Let's turn and talk about ESG, certainly a popular topic. ESG and Climate organic revenue growth decelerated in the third quarter to about 20% from 29% in the second quarter. It appears most of the slowdown came from the Americas, which grew about 15%, whereas EMEA growth was strong, 35%. APAC also strong at 20-percent plus. So why is ESG seeing greater headwinds in the Americas compared to EMEA and APAC?

Yes. So I would say Americas is -- and this is a generalization because there's a lot of dynamics at play. But in general, in the U.S., and I'll speak specifically about the U.S., which is the bulk of the Americas, ESG is earlier in its adoption. And so related to that, I think there has been less consistent use of it for what we believe is the right use of ESG and which is to help drive better outcomes or better risk-adjusted returns and less acceptance around the way to do that than in Europe. So it's earlier in that journey. And as a result, there's a lot of noise about what ESG is and what it is not. And so we are seeing clients -- and you can see this in the retention rates at 96%. Clients are not saying it doesn't matter, I don't need it. But they are being very measured in additional purchases from us. And I think they are on this journey, this maturation of how do I integrate ESG as a way to enhance my overall risk-adjusted returns, how do I communicate that strategy to my clients, what do my clients care about, how do I navigate potential regulations and public scrutiny right now because there is a lot of noise out there. And so clients are being very measured about what they buy in the Americas on ESG because they are working through exactly how to use it to differentiate and ultimately add value. And that's something that we believe, and that's why ESG matters because it is a financial risk that investors have to incorporate. We need to help them on that journey versus, I think in Europe, it is generally accepted that this is a financial risk you have to account for. And so the engagement with our clients is much more how do we help them continue to differentiate, what additional tools can we sell them. And so there are, for sure, cyclical dynamics at play, but the clients there have generally accepted that this is something that they must have and continue to build on. We think the U.S. will get there, it's just part of a maturation process.

Right. The 35% growth that you saw in EMEA in ESG does come above your long-term target growth in the mid- to high 20s for ESG. Does that suggest that ESG concerns in Europe are, at this point, resolved? Or would you say the growth would have been stronger if the external environment were more cooperative?

So I would say it this way. Firstly, there are cyclical factors at play in EMEA or Europe, the same way we see in the U.S. So clients are feeling pressure. We're seeing budget pressures that lead to longer sales cycles. We are seeing pickup in client events, which causes a pickup in cancels, as I alluded to earlier. So that's even embedded in the number. But as I was alluding to, ESG is a secular opportunity. And that's reflected in the multitude of solutions and values that we can add to our clients. And so the areas that they are spending in Europe, in particular, these organizations are in areas oftentimes around sustainability where we can help them. And we've got a long list, a continuing evolving list of products and solutions that we can help them on that journey and serve broader parts of the organization to ultimately help them achieve better outcomes. And so I think it is reflective -- the higher growth in Europe is reflective of what we think are more mature -- although that growth rate's now reflective of a mature business, but at least when you have that general acceptance of ESG as a critical input into an investment process, what the opportunity set can be. And it's reflective of that long-term secular demand that I alluded to earlier in the conversation. The other thing that I would highlight that is in there is Climate as well, which we do think about Climate separate from ESG. And there is tremendous traction and growth in many different climate solutions that we have as investors think about how to more systematically navigate a transition to a low-carbon economy and oftentimes have -- they have either regulatory reporting or mandates put on them around climate.

Right. Makes sense. Let's talk a little bit about Analytics. The growth there came in about 6.5% in the third quarter. It did accelerate a little bit from the second quarter but still comes a bit below your long-term target of high single-digit growth. Can you talk a little bit about some of the factors that could be weighing on Analytics' growth and what catalysts can drive that growth to accelerate?

So there are the cyclical pressures at play within Analytics. We have actually -- and there's actually positive cyclical dynamics at play. So we see the same budget constraints and client events. But at the same time, we do see some demand for many of our risk solutions, both our equity risk models or risk models more generally, which we're seeing strong appetite for as investors are trying to understand what is driving the markets systematically. And that's exactly what our risk models can help with. But also some of our enterprise risk solutions, which are key tool and solution for a risk manager and even tools like our liquidity analytics. So we have seen some strong demand that's helping to support the growth of Analytics in this environment. But the drivers of growth that we have conviction are not only going to support Analytics and help achieve those long-term targets that you alluded to, but also be very strategic for us as an organization kind of across a few dimensions. Firstly, front office tools. So we are prioritizing investment into our factor tools, our equity risk models, as I alluded to, our equity factor models, tools like our Optimizer and some of our portfolio applications. Fixed income. So we have, over the last 5, 6 years, invested heavily into our fixed income content. So the quality of our curves, the data that underlies it, the breadth of securities we cover, the models around hard-to-model securities like mortgage backs and corporate loans and things like, as I alluded to, liquidity analytics and performance attribution. We have built a really robust tool set there. That has been where we've been investing, and we see outsized growth on that front. And that is white space for us. There are competitors there, but those are new markets that we historically have not touched. We have served the fixed income part of a multi-asset class portfolio, but in terms of serving the fixed income investment process specifically, those are new areas for us, and we are seeing outsized growth. And then for the enterprise risk and performance, which you'll sometimes hear us refer to as our middle office type solution used by a Chief Risk Officer, although as asset owners, sometimes it is also used by Chief Investment Officers, we are making it easier to use. And so that's a combination of investing in our interfaces, both the APIs, but also the user interfaces to make it easier for clients to interact with the full range of content that we have, as well as integrate into their workflow. And related to that, we've been very aggressive in partnering with other workflow providers to just make it easier to clients to ultimately use our Analytics and use the full range of our Analytics. And so it becomes something that is an efficiency for our clients, but also adding incremental value to them as it's easier for them to access our factor models as well as the market risk tools that we have and integrating into different parts of their organization and tools that they use. And so we see -- the encouraging thing is we see outsized growth in those areas. And so there are parts of the business that we're investing less in, and you've seen that based on the margin trajectory of Analytics. But the areas where we -- and that will create some noise. And so you hear us say, we'll continue to see some lumpiness. But the areas where we are seeing sustained growth tend to be the areas we're investing in. The last area, which I didn't mention but is important is Climate as well. So we have an enterprise, we call it Client Lab Enterprise tool, which allows, again, a Chief Risk Officer to help navigate climate risk systematically across an organization.

Right. That makes sense. MSCI closed on the acquisition of its remaining stake in Burgiss in October. Can you provide an update on the integration of that acquisition and how Burgiss is helping MSCI strategically in the Private Assets business?

Sure. Yes. So one of the good things about integration with Burgiss is we've been an investor. We were an investor in Burgiss for a few years before we actually took control of it. And so we have a pretty good understanding of what they do and how they do it. And so it has been -- it's never a small undertaking. There's a lot of work that goes into it. But I think we've been executing pretty effectively across all aspects of the integration. And so I would call out, to part of your question, a few areas where we are focused on ensuring that we execute effectively to unlock the value. Ultimately, that's why we acquired it because we see value there, and there's a few layers to that. The first is distribution. And so we have had some collaboration with Burgiss over the last few years since we've been an investor. But now, having the whole of MSCI's sales force focused on Burgiss, having senior leaders within our coverage organization accountable for driving sales, having our senior account managers similarly have full access to the Burgiss team are critical things to unlock the full value. And I think we're making good progress on that. As we alluded to when we did the acquisition, Burgiss has a very U.S.-focused client base, and they're heavily focused with endowments, foundations, family offices. That's -- MSCI is very complementary in that we have a very global footprint with asset owners. And we are heavily embedded with pension funds, sovereign wealth funds, even insurance companies, so areas where Burgiss is smaller. And so that -- those cross-selling or upselling opportunities are very tangible. And I think that is an area we're very focused on from an integration standpoint. Related to that, driving benchmark wins as we call them. Now that's very early days, but really trying to promote some standardization in how asset owners think about tracking their private portfolios. And that's an area where MSCI can be enormously impactful and helpful because that's what we've done with their equity portfolios. And so that relates to distribution, but a big area we're focused on. The second area I would call out is on the operational side. And so there are a number of areas where Burgiss has done things very well. That is why they have -- or we have the best data set of private equity investment performance -- investment-quality performance data and even increasingly asset-level data. But they have done it with a lot of people in low-cost locations. And so there are opportunities for us to bring technology and operation -- our operational excellence to what they do to enhance that further, to broaden the range of data points they can collect, broaden the range of investment vehicles that they can cover. And so that is an area we're very focused on. And then the last area I would call out is innovation. Now that takes the longest. But we now have access to this treasure trove of data that they have, this really enormous database. And from that, creating the performance and risk tools and climate insights that MSCI provides within other asset classes, we are providing a full range of those tools within the Private Assets. And that is foundational to creating the MSCI Private Assets, which we have this vision for, and Burgiss is a key component of that.

Right. Makes sense. So last quarter, MSCI raised its expense -- EBITDA expense guidance by $30 million. $20 million of that comes from Burgiss, and then another $10 million of that comes from the underlying business. Can you talk a little bit about what's driving the increase in underlying EBITDA expenses and whether that will annualize into next year and sort of carry into 2024?

Yes. I mean as I alluded to on your question about the upturn and downturn, those investments and the pickup of spend are in mostly key long-term growth areas for the firm. So I'll leave it at that. Those are areas that we want to invest in. Having said that, I don't want to be too specific about next year and the impacts. There's a whole host of things that feed into what the expense base will be next year. As you alluded to, clearly, the Burgiss expenses will come in, in the fourth quarter and continue into next year. But those increment -- the $10 million of incremental spend on the year is something that will be in areas that will hopefully continue into next year. Now we are, as I alluded to, continually calibrating. So based on AUM levels, the market outlook, business performance, we will continually calibrate expenses, and so I'll be able to provide more detail when we release our year-end results.

Right. Anything else we should keep in mind as it relates to expenses?

So one thing I would -- actually, a couple of things that I would call out, and these are more housekeeping items. So firstly, on the interest income line, because we finance the -- or we didn't finance, we used cash for the Burgiss acquisition. So our cash balance on September 30 was close to $1 billion. The proceeds for the Burgiss acquisition were used from cash on hand, and so our cash balance has dropped down to around $300 million, most of which is actually outside the U.S. where yields are a bit lower. So you will see a meaningful drop in our interest income line. So that is something to be mindful of. And also related to Burgiss, on the tax rate line, there was a $140 million gain related to our existing stake in Burgiss. So effectively marking that stake to the valuation that we paid for the change of control. That gain is mostly nontaxable, and so that results in a lowering of the effective tax rate for the business. But we are excluding that gain from our adjusted metrics. So our adjusted EPS will not include that gain. And so the tax rate applicable to our adjusted EPS will be about 1 percentage point higher than the effective tax rate guidance range that we have. So 17.5% to 19%, which, if you look at that, implies that the rate in the fourth quarter will likely be slightly higher than we've seen on the year.

Right. Makes sense. Now MSCI continues to pursue bolt-on acquisitions, as you stated in the past, given a relatively attractive M&A market at the expense of potentially lower share buybacks. Can you talk a little bit about your capital allocation priorities and what your overall capital allocation strategy is?

Sure. Sure. Yes. So our approach to capital allocation has not changed. We continue to want to pursue both repurchases and acquisitions. Now to your point, to the extent we're using cash for acquisitions, that will reduce the amount we have for repurchases, but we are continually looking for opportunities for both, and we are opportunistic on both fronts. Now in the current environment, we are seeing acquisition opportunities, mostly very small bolt-on type acquisitions that otherwise were not available to us. I think given the cost of capital and access to capital for many early-stage companies and the difficulties that they are seeing in selling in these environments, are driving growth organically. We're seeing a lot of these early-stage companies who are open to either partnerships or acquisitions that otherwise would not be engaging with us. Many of them still have very high valuation expectations. But to the extent some are reasonable, there are strategic opportunities out there for us to get unique data sets, add unique capabilities. You saw us do it with Trove, get a foothold in what we believe will be a very big market, in that case, the voluntary carbon market, but also an area where MSCI can help drive adoption and grow these. And so we are seeing those opportunities, and we'll continue to focus on them. As I alluded to, most of them are kind of small bolt-on acquisitions, but we also are continually thinking about share repurchases. But a key input into our share repurchases is available cash, and we're in a position right now where we don't have meaningful available cash.

Right. Last question. As you think about M&A, which areas of the business are you most focused on, are you most keen on adding inorganic contributions?

Yes. It's similar areas to what we see organically. And so oftentimes, we view M&A as an accelerator, areas that we otherwise would be building out or we get very unique content that will reinforce our franchise. And so those tend to be areas like Climate, where there are platforms out there that have very unique data that can help us enhance our climate insights. Also areas like Private Assets. And you saw it with Burgiss, but getting access to unique data or a unique angle within the ecosystem of investors and the investment process in Private Assets is compelling to us, as well as even areas like custom indexes and that could be a thematic data set. It could be a capability that helps us enhance our custom index capabilities over time. And so they tend to align very nicely with the organic areas that we're focused on growing.

That's fantastic. Andy, thank you so much for the color and insights.

Thank you for having me here. Thanks so much, George.

Appreciate it.