S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

[ Thank you ] for joining us. I'm George Tong. I cover business and info services at Goldman Sachs. Really pleased to be joined by Ewout Steenbergen with S&P and really pleased to have you with us today.

Thank you, George. Thank you for hosting, and great event. So pleased to be here.

So topic du jour is the pending merger with IHS Markit. You've now secured both EU and U.S. regulatory approval for the deal. Can you talk about what outstanding items remain for the deal to close? What needs to happen for the deal to successfully close?

Absolutely. So after almost a year or just over a year, I think we have clear line of sight what needs to happen. It's relatively straightforward. We need to have a signed agreement with the buyer for the [ fusion ] business, a signed agreement with the buyer for the base chemical business of IHS Markit. And then those 2 respective buyers need to be approved by the regulators. Once we have that done, we're in a position to close on the main merger. So we cannot wait to get to that point, of course, and get really ready to manage the company in an integrated way going forward. But it's pretty straightforward what needs to happen. We also need to sell, as you know, LCD. But the LCD business, we have more time. So technically, we can get to an agreement with a buyer after the close of the main merger. So...

Got it. Got it. No, that makes sense. You continue to expect the merger to close in 1Q 2022, although you pushed the outside date of the merger agreement to May of 2022. Could you talk about what the motivation was that was for and what could potentially drive an extension of the deal to the May time frame?

Pure technical nature that we needed to extend the time lines, pure legal technical reason. It doesn't change anything with respect to the expected time line to the close. So we are still in the first quarter of next year. And Again, we're going as fast as we can to get to those 2 closing conditions so that we can move forward. So nothing should be read into that. It's pure technical matter to extend it by 6 months.

Got it. Got it. You've been doing due diligence on this transaction for quite some time now. Can you provide your latest views around potential revenue and cost synergies that can arise from this deal with any recent findings that you discovered during your course of due diligence?

Yes. So you saw during our last earnings release that we have increased the overall revenue and cost synergies that we are now expecting for the transaction. So revenue synergies in the range of $330 million to $360 million. And then cost synergy is in a range of $530 million to $580 million. So midpoint, you would be at around $900 million. Or if you look at an EBITDA, if you take, for example, 60% of flow-through of revenue synergies to the bottom line, you are at $760 million of benefit. So very meaningful, and we're happy that we're able to increase those synergy levels. And why we're able to do that is there's a lot of work going on. Over the last 12 months, we have had hundreds of people in multiple work streams looking very deep, bottoms up at all of the initiatives that are needed to get to those numbers. And we have a lot of rigor in place, very good structure around the integration offers and the value capture offers. In the meantime, we have had 4 rounds of synergy submissions. And of course, with every round of synergy submission, we are increasing the level of confidence around those numbers. We have a fifth round of synergy submission that's going to happen in January. That will be then the last round before the actual close. So yes, the level of confidence is clearly high, and it just is just telling that there is a clear strategic rationale behind this deal, the fact that the businesses are so complementary and that we're able to increase those numbers now after a year of hard work.

Right. In addition to the IHS Markit merger being strategic, China is another big strategic opportunity for S&P. Can you talk about how you're approaching China in both the Ratings business and outside of the Ratings business? And when you would expect to see material revenue contributions from that country?

Yes. Well, first of all, we do have material revenues from China already at this moment, but that is mostly on a cross-border ratings perspective and business. So this is Chinese companies that tap the global bond market and are rated on a global rating scale. So that's already a sizable business. With respect to the Chinese domestic market, this is going to be a mid- to long-term play. And that's the right thing because this is a lot of investment in order to help to get the markets more mature, to be aligned with the institutions and the regulators in China. We're very pleased that we were the first rating agency -- global rating agency to get a license in China in 2019. We see very nice growth this year in number of ratings that we can issue. I think to see that showing up from a financials perspective, that will still take a few years. And again, that's the right thing to do because this is the second largest bond market in the world. However, we're playing a different ballgame than the existing domestic Chinese rating agencies because most of them are rating the securities AAA and AA. We use a much wider spectrum. We have more transparency about the ratings, the ratings research and the rationale. And so we need to make sure that the markets get comfortable. And we're trying to help the market itself to get more mature over time. So that is something that we're investing deliberately for the long term. But clearly, the perspective in terms of the longer-term outlook is going to be phenomenal. And you're right also, our other divisions are investing in China. Market Intelligence is developing a Chinese language platform with more Chinese domestic data, a credit platform in China. So all of our businesses are investing there. And yes, we are quite optimistic what that can mean for the company from a long-term perspective.

Right. Another long-term play that investors have been increasingly focusing on is ESG. S&P recently presented at our Carbonomics conference. For those of investors who weren't able to attend, what's your positioning on ESG in general? And what would you say are the top 2 or 3 initiatives that you're working towards?

And George, now I'm going to speak about what we're doing ourselves with respect to ESG and sustainability. So not what we are offering commercially, but what we are doing ourselves as a company. And this is something I'm personally very passionate about because I think it's very important that companies set the right example. Our front runners show that it is in your DNA. And I think this is exactly what we're doing as S&P Global, and we're doing that in a couple of areas. First, we have clear targets and plans around our own emissions and other factors. So for example, we have a net-zero plan. You would say, well, many companies have that. But we have a 2040 target, but we have also a 2025 target. So we have a midterm target, which is important because any company can say, aspirationally, it's something I want to achieve far in the future, but the successor of my successor -- and maybe that successor needs to deliver on it. 2025, we have said that we're going to reduce our emissions by 25%. So that is one. Also, we are linking some of our plans to some other initiatives. For example, we have a sustainability-linked banking facility, the first in our industry, where we said we're not only setting those plans out, and we have external validation of those plans. We're willing to put some facilities -- banking facilities in relation to this, which, of course, now we have to make sure we hit those targets because there's no way that we cannot hit it and miss out of them. So that is one element. We're also putting new metrics out. We're focused, for example, on supply electricity. We have new metrics that we put out last year is carbon adjusted earnings per share. We were the first company in the U.S. that put carbon adjusted earnings per share out, which is our normal earnings per share adjusted and then further adjusted for the costs of our own carbon emissions, and to take that into account as well, which is relatively minimal, given our business model. But just to put that out is important. And the last is -- for us is the disclosures and the reporting. And we have now, in the meantime, 3 TCFD reports published. And we published a lot of other reports just to be out there with all of our information. I actually have a little bit of news for you today because we're very pleased to tell you that we got today an A score from CDP. CDP is the Carbon Disclosure Project, very well-known with respect to disclosures, with respect to sustainability, and we've got the highest score for our disclosures this year. So we're very happy about it.

Very nice. Okay. Let's dive a little bit into the businesses. If we start with the Ratings business. S&P looks for bond issuance volumes, excluding loans, to be flat 2021 and then down about 2% in 2022. Can you maybe elaborate on those growth projections and what the potential sources of upside or downside would be?

Yes. The minus 2 for next year, the buildup of that is corporates down 7%; financial institutions up 1%; and then structured finance up 3%. And that's the midpoint of the range. And I just also would like to emphasize that is the forecast that is being put out by the research group, the Ratings business. That's not management's forecast. We have a research group that is putting those forecasts out, and that excludes bank loans and bank loan ratings. But as you know, there are so many things that go into the mix because this year, we started around the same time last year with the forecast for 2021 of minus 3. We're ending up flat, as you mentioned. But at the same time, we're guiding Ratings revenue to low double-digit growth this year. So why is there such a large discrepancy that has to do with central factors? I already mentioned bank loans. We have non-transaction revenue, which is a very large component. Our commercial conditions that go into the mix. So there are so many different things. Ratings is, in fact, in my view, a much more stable business than sometimes is being perceived. Yes, there are many different variables, and they are not always going in the same direction, but they are also netting out. And overall, we have actually seen quite a steady development of the business over the last few years. Excluding external or legislative shocks is actually a very steady business from a top line growth perspective.

Right. Historically, macro trends have been the biggest driver of bond issuance. What's your latest macro outlook?

Our economists forecast that both global and U.S. GDP will grow around 5.5% this year, approximately 4.5% next year, maybe slightly being tuned down now due to the supply chain issues and the Omicron issues. However, if you take a few steps backwards, this is still going to be one of the fastest growth of the economy we have seen over the last decade. And overall, the debt market environment is mostly direct correlated with GDP. People are always thinking it is correlated with interest rates. It's actually far more correlated with GDP. If there's a lot of economic activity, companies are doing well. They're thinking about where to invest going forward. They need financing for those investments, and then they go to the bank market or the bond market in order to fund themselves. That is the main driver that we're seeing. So as long as the economy around the world is improving, is doing well, as long as we don't see a shock in the system by inflation getting overheated and central bankers didn't have to pull the emergency break, if that is all going in a more gradual way, we would expect economy doing well around the world. And then definitely, the debt markets will also stay very healthy.

Right. Now how do you expect the macro environment to pair with other determinants of debt issuance, like credit spreads and M&A activity and default rates? What's your outlook there? And what are the puts and takes?

Yes. As you know, credit spreads are relatively tight. So that will still create today quite a good environment because if you look at treasury rates plus spreads, it's still at a relatively low level. So that is a favorable element. The M&A environment is again directly correlated with the overall economy. We see it actually had the M&A environment as still quite strong and positive. I met a couple of executives of investment banks over the last few weeks, and they are all pointing out that they are very busy at this moment. Maybe not the really the mega deals, but the size below, there's a lot of activity going on. So again, as long as we are going through a very gradual transition coming out of this pandemic situation, we think many of those other drivers and factors should consider -- we should consider them remaining positive. The scenario I'm most concerned about again is overheating inflation and then a shock in the system, maybe asset values then being changed. And that is, of course, an impact that everyone will feel at that point in time.

Right, right. Now historically, refinancing activity has been one of the bigger uses of proceeds from new issuance. Given the low interest rates we've seen, what amount of pull forward is there or has there been from refinancing, from future periods, the current periods? And what impact will that have on future debt issuance?

Yes. Two things I can say about that, George. One is there's always an element of pull forward. If a treasurer is sitting here today and you have bonds maturing at the beginning of next year, you have already started your process. You have already worked with your bankers. You have already prepared your legal documentation. And it's a matter of timing when are you going to the market? You don't wait until the last day. So there's always tactically a bit of pull forward that is happening. So in my view, it's not so much is a pull forward, but it's the excessive pull forward that we need to look at. If you look at the data, there's maybe a little bit, but not so much. So for example, during our last earnings call, we put out a graph that looked at the total issuance of high yield and levered loans and the purpose of the proceeds. And the majority was going to M&A and to dividends. So not pointing at early refinancing that is coming out of that. So we think, overall, if you look at the refinancing pipeline, it continues to grow. And to some extent, you could say the liquidity-driven issuance that we've seen in the corporate market last year and the bank loan volumes that we are seeing this year ultimately is adding to the refinancing pipeline for the next 5 years. So in the end, it's going to be good for the business. It's just -- if an investor has a longer-term perspective of staying with the company and doesn't want to go in or out on a quarterly basis. Ultimately, they will see the benefit of that refinancing coming through our ratings business.

Right. If we dive into some of the specific debt categories. U.S. investment grade hit record issuance levels last year because of Fed backstopping actions. This year, U.S. investment grade taking a little bit of a breather. What's your view on near-term U.S. investment-grade activity? And what are the key drivers that you're looking at?

Actually, I looked at some of the data yesterday, when they came in, and I was very pleasantly surprised to see that in the month of November, investment-grade issuance in the U.S. was actually up year-over-year. And the reason how I explained that is we have passed the month of 2020 that were high comps because of all that liquidity-driven issuance that happened early summer, over the summer to late fall. So we have [ noted ] in our comps anymore. So I was actually happily surprised to see investment grade doing well in November. Hopefully, that's an indication that things start to normalize again also over the next few months and quarters.

Right. Now high-yield activity has declined also year-over-year as of the most recent quarter. How do you think about high-yield issuance compared to, say, investment-grade?

I see more high yield and levered loans as substitutes. It depends on where is supply and demand? There's definitely a large group of investors that are more interested in floating rate products. So we're more looking at high yields and levered loans in combination. And sometimes the market is moving more to fixed rates high-yield bonds, sometimes more to floating rates, bank loans. But we think looking at it in combination is the best approach. And if you look at that, actually, as you know, this is a very healthy year for the low investment-grade sector.

Right. Due largely to M&A activity?

Yes. Exactly.

Yes. So maybe we can touch a little bit on loan volumes. You don't include loan volumes in your guidance. It's just bond activity. But do you have a view on what leverage loans can do in the forthcoming quarters, especially given rising rates?

Yes. Our research group doesn't put out a forecast for levered loans. Maybe they will do that going forward. So that would definitely be helpful because, again, it's good to look at that in combination. So we have asked them to start to think about potentially putting both out going forward. So I can't give you specifics on it, but let me give you a couple of the drivers that I'm thinking about. Again, I was speaking about demand for floating rate products. I think if the market is continuing to expect that interest rates are going up, there's definitely a category of investors, but like floating rate, don't want to have immediate and negative mark-to-market if they buy a fixed rate product. So that is one element. If that continues to be the market expectation, that should help the loan market. The second is -- you were just referring to M&A. If the M&A environment remains active, that could be another factor that plays into it. The market has been very strong this year, as you said. So it is to be seen if next year will be as good as this year. But again, absent huge market shocks, some of those underlying drivers could potentially continue also into 2022.

Right. Now structured finance has also been a strong contributor to overall issuance volumes led by CLO formation. How long do you expect structured finance strength to persist?

Yes. Well, first of all, 2020, structured finance was really low. So again, everything is relative to the base. So that is one of the reasons why this year looks better. And then I can point to our research group that said structured finance up next year by another 3%. That's the midpoint of their forecast. What we see is CLOs, CMBS particularly strong, maybe some other categories like ABS. So I think, overall, I think the fact that this year is stronger is more the comparisons with last year.

Right. Let's switch gears and talk a little bit about your Market Intelligence business. It's impressively sustained mid- to high single-digit organic revenue growth throughout the pandemic, driven by various initiatives around ESG. You've got know-your-customer compliance and data. What in your mind are the key drivers behind this level of growth? How sustainable is it? What are your views there?

Yes. Well, first of all, as you know, it's largely a subscription business. So that's a good part of the subscription business. Running a subscription business like Market Intelligence and Platts is very stable and steady if there's any market headwind that is happening at some point in time. I'm looking at different drivers of revenues underneath. So the Desktop is, of course, the largest component. What we're seeing is good commercial activity there. Good growth of the business. So that is helping to see Market Intelligence growing faster now. We saw also the continued demand for data feeds, the data management solutions revenue stream to be very strong, and we would expect over time that to be in a low double-digit space. And then credit risk solutions is a part of our business that is also doing well, probably high single digit to low double digit in a normal quarter. And then on top of that, as you said, we are taking the benefit of some of the growth initiatives that we have been investing in over the last few years, ESG, climate, marketplace, private company data, the MI proposition in China. So other 1/3 of the growth you saw in the third quarter was coming from those new initiatives. So I think, indeed, that business is doing very well. We see this in a good position. And yes, it's a nice situation to be in.

Right. Your index business is on track to grow mid-teens plus this year driven by asset-linked fees. Can you talk a little bit about how sustainable that growth is, perhaps pricing dynamics that are happening in the index industry and drivers that you would expect to further sustain that level of growth?

Yes. The growth in the index business this year is exceptional. But again, everything you can explain there to what happened in 2020 because we saw the asset prices nosediving, coming back at some point, but the average AUM levels were down quite a bit. And therefore, the fee levels that we're able to collect last year were also quite low compared to this year. So clearly, the market run out. That is the main driver and the benefit. I wouldn't say those kind of growth levels are normal course. Normal course growth levels should be a bit lower than what you see this year, which is in the teens, double-digit level. That wouldn't be normal course of business. But what we are seeing is continued healthy movement from flows, from active to passive, market appreciation, the launch of a lot of new indices. I would expect to see a lot of innovation coming out of the index business over the next period. Factor-based investing, ESG, crypto, new economy indices and other Kensho-related indices. So a lot is happening in that business. Multi-asset class, when we combine with IHS Markit to fixed income indices, now we can have all the asset class indices. So I would expect a lot of innovation coming out of the index business over the next few quarters. And the business itself is having a kind of an inherent hedge because there's also the exchange rate derivative volumes. I think what happened in the last few weeks is the most optimal for the business. It's a lot of volatility, but the asset prices are quickly coming back up. So we didn't lose too much ground from ever...

It's a tough benefit.

And that's an exceptional benefit we're having over the last few weeks. Not normal course, but again, we are taking it.

Right, right. Your Platts business, on track to grow high single digits this year. What types of investments are you making to sustain that level of growth within Platts? And how is Platts competing in the current energy environment given the volatility, the ups and downs we've seen with commodity prices?

Yes. Our customers in Platts are definitely healthier with the current commodity prices. So that is helping the business with the subscription part of the book of business. Again, also, there are good commercial growth, good sales activity this year. And that book of business is developing well. And we have another part of the book of business that is called Global Training Services, again, linked to commodities derivative trading. Volatility nervousness around commodity prices is helping there. And then this business, we have also made a lot of investments in new growth initiatives. Think about LNG. Think about energy transition, recycled plastics, hydrogen, carbon pricing. There's a lot of new prices and a push around agriculture, commercial expansion in Asia. So a lot of things going on in the Platts business. High single-digit growth is the highest what we have seen in multiple years. So we're very pleased that, that was the growth level in the third quarter. And definitely, some of those innovation drivers, they should continue for Platts over the next period.

Right. Speaking of innovation, you're on track to achieve about $120 million in cost savings over the next several years. How do you balance reinvestments into innovation with flow-through from these cost savings that you're currently executing on?

Yes. We think those are completely different kind of activities because on the one hand, you should have the operational rigor and discipline to go after efficiencies, operating leverage, where can we do process automation? Where are the opportunities to move activities to lower-cost location? What can we do in terms of streamlining, thinking about our technology infrastructure and other areas? And then where can you reinvest? That doesn't have to be always in the same areas. We need to reinvest in the areas that make more sense for us strategically. Where are the best growth adjacencies? And to put significant dollars behind those areas in order to have a meaningful impact. So we spoke about China. That is a long-term investment, but we think it's the right thing to do. And over time, that could be a huge price that we are going after. So those are significant investments. So we are clearly separating the 2. This year, we have an investment program of approximately $100 million. By the way, investments in Kensho R&D are part of that as well. And we still need to determine what is then the investment program for next year. But also think about next year -- the investments we're doing in terms of realizing revenue synergies is also investments in commercial activities and innovation. So we will have a lot of dollars next year to invest in the company.

Right. makes sense. As you think about innovation, ESG, China, how do you rank order your priorities for innovation, for reinvestments? And how should that determine ultimately top line performance?

I'm not sure if there is a rank order. What we do is we always look strategically about what are the areas that are important because we need to make sure that the dollars we invest are linked to the areas we think strategically are important. We're looking at it from, of course, with our financial metrics to make sure that it makes sense. Mostly return on invested capital is the main metric we are looking at and make sure that after a number of years, we're exceeding our cost of capital. Some initiatives can pay off much shorter term. And we have a couple of great examples of that. For example, Marketplace in Market Intelligence is doing very well, and we have been investing 2, 3 years, and we get the [ bale ]. I think China is longer term. I'm fine to have a portfolio of initiatives that are paying off, shorter, midterm and longer term. That is completely fine as long as it makes sense on those strategic and financial metrics that I just -- as I just mentioned.

Right, right. S&P's medium-term target for operating margins is low 50s. How does the IHS Markit merger potentially change your medium or longer-term view on operating margins?

Yes. That low 50s we put out at an Investor Day, that's now a long time ago. It was in 2018. In the meantime, as you know, we're already at mid-50s. We have to blend this now with IHS Markit. And when we put IHS Markit on the same reporting protocol perspective, which includes stock-based compensation, which does not take out depreciation because we think if you capitalize expenses like software development costs and then you start to depreciate, that's the normal cost of doing business. So you shouldn't take that down. So we look at EBITA as the basis for our operating metrics and operating margin. Then you get to a combined company expected margin somewhere at mid- to high-40s. That is where I would expect to be the starting point, which is, by the way, fine because that's just the starting point. And we will give you and all the investors 8 quarters of comparable data for the new segments, how we will report going forward in that all-inclusive model in terms of margins. And now we have this starting point. We can start to realize operating leverage. We can start to realize all the synergies. So that will be your starting point then to expand the margins going forward again. So I just hope that other companies in the industry will follow because it's important this kind of way how we look at performance -- operating performance is apples-to-apples because I'm not a big fan to pull out certain elements. I think it's just good to have an all-in basis, and then we can really compare and benchmark. But for us, I think this will give us a great basis with the company. And you know how enthusiastic we are about the combination and what we can do with this company. This is going to be phenomenal. And I think that will give us a great basis then to build up those margins again in the future.

Right. Now structurally, is there any barrier that prevents you from potentially returning to low-50s longer term? You're at mid-50s now, but longer term, low-50s. Is that still within the realm of possibility?

Well, we haven't put out any aspirational margin targets. So I'm a little careful to give you a specific number. If you look at the elements that go into margin, it is -- I think any business in our industry, everything else equal, should be able to achieve operating leverage. Your top line should grow faster than your expense line for your next incremental dollar of revenue that comes in because you don't have your fixed cost. So your incremental margin should always be higher. We also should add there the benefit of the synergies, which are very meaningful. And then the question is, how much opportunity do you have to reinvest to drive future top line growth, which goes in the opposite direction? So those are the elements that go into the mix, into the formula. But I think the way how you have seen us operating over the last few years, I think, is a good indication of what we're trying to accomplish going forward as well.

Wonderful. Well, Ewout, thank you so much for joining us, a pleasure having you. Thank you.

Thank you.