2023-03-07 09:49:11 ET
Summary
- MSCI is a leading financial institution, primarily providing index services.
- We think strong growth will continue as interest grows in ESG investing and more individuals globally choose to invest.
- The bear market has not stopped MSCI from achieving growth but has contributed to its slowing. We see this as a small headwind.
- MSCI is operationally fantastic. The company has 90%+ retention and an FCF conversion of 36%.
- MSCI's valuation is steep at 35x LTM EBITDA but a business like this will never go on sale. It is far too resilient.
Company description:
MSCI Inc. ( MSCI ) is a company that provides investment decision support tools to clients worldwide. The company operates through four segments:
- Index - This segment provides investment indexes, such as ETFs, mutual funds, and options.
- Analytic - This segment offers risk management, performance attribution, and portfolio management services.
- ESG and Climate - This segment provides products and services to help institutional investors understand how ESG factors impact their portfolio's long-term risk and return.
- All Other - Private Assets - This segment includes real estate market and transaction data, benchmarks, and return analytics.
Share price:
MSCI's share price has performed extremely well over the last decade, returning over 1000% to shareholders. This has been driven by compounding gains over the period, with markets and the company seeing consistent gains.
With a noticeable drop from its ATH and market weakening, now is a great time to consider where MSCI currently stands. The company has shown incredible consistency in its financial performance and gains. This looks to be an amazing long-term hold, with investors essentially betting on market prosperity in the decades to come. Our objective is to consider the long-term quality of MSCI, with a view on factors impacting the business/industry. This is alongside an analysis of the company's financial performance, with the view of deriving if there is still value to be gained.
ESG:
One of the key trends impacting the investing industry is the growing importance of sustainable investing. Many investors are increasingly focused on investing in companies that demonstrate strong ESG values, with many having contractual mandates to invest, and not invest, within certain types of businesses. As a result, there is a growing demand for ESG-related investing services. MSCI has been at the forefront of this trend, developing a range of ESG indices and analytical tools that are widely used by institutional investors. As the following illustrates, MSCI has achieved nothing short of incredible growth in this segment.
ESG and Climate growth ((MSCI))
What is impressive is how resilient this growth has remained, with growth in other segments slowing to a greater degree. This to us suggests the industry is still closer to infancy than maturity, with a substantial level of growth remaining. Our view is that MSCI can continue to grow at these levels due to its market-leading position for an extended period of time. Management is forecasting a long-term growth rate of mid-to-high 20s.
Investing:
The long-term growth of MSCI is dependent on healthy growth in market investment activities by investors. We are seeing an uptick in passive investment strategies, such as exchange-traded funds and index funds, which have become increasingly popular in recent years as investors seek low-cost, diversified exposure to the market. We must remember that the vast majority of people know nothing about financial markets yet understand that they can be beneficial, thus the natural route into investing is index/ETFs. PwC is forecasting a 15% growth rate in ETF AuM going into 2026 . Additionally, the number of people investing in the US has been increasing in the last decade, reaching levels not seen since the aftermath of the financial crisis . We can see this growth remaining sustainable as the number of people investing globally as a percentage of the population remains low currently outside of the US. As more people are lifted out of poverty and a greater number of people see the benefits of investing, the total market size will only increase.
Geographical:
One of the superior characteristics of MSCI is its geographical split, with significant revenue generated from different regions. In Q4-22, the company's Subscription run rate breaks down as follows.
Subscription run rate ((MSCI))
The benefit of this is that MSCI is more insulated from region-specific shocks which could reduce subscription gains. EMEA has seen robust growth in the last few quarters, offsetting softening from other regions. This has contributed to performance resilience during what is a bear market. The reason we put value in this is that the US has seen the lion's share of growth in the last few decades but this is not necessarily how things may develop in the future. Therefore, having a mature offering in key geographies will allow the business to enjoy growth regardless of where it is.
Retention:
MSCI's services are vital for market participants, with the company boasting impressive retention statistics. Despite the global bear market and disruptions across the supply chain, MSCI has seen growth remain in excess of 10% and retention remain above 93%. Interestingly, the company's retention has not dipped below its Q4-17 level, even during COVID. This suggests the company is not cyclical in nature although will inevitably experience a slight slowdown.
One of the reasons demand has remained sticky is due to MSCI's client base, which is primarily financial institutions that are taking a long-term view. These institutions are unlikely to collapse or face distress to the extent they will cease to use MSCI's services. This is why a business like MSCI is far more resilient than say an exchange, which faces a sharp decline in transaction volume during a downturn when retail investors disappear.
MSCI client base ((MSCI))
Financials:
MSCI Financials (Tikr Terminal)
Presented above is MSCI's financial performance. As we have suggested previously, they are fantastic.
Revenue has grown at a CAGR of 11%, driven by strong market gains, especially in the US and Asia. As the following breakdown illustrates, MSCI's exposure is primarily to Index services, which have only continued to grow as financial institutions market investing solutions to individuals.
MSCI revenue split ((MSCI))
The most recent period's growth has slowed due to the impact of the bear market. Although the company is resilient in maintaining growth, it does face some softening, primarily in the decline in AUM value (MSCI-linked Equity ETFs) which is illustrated below. This has contributed to a decline in asset-based fee run rate, which realistically will continue to do so in FY23.
With a technology/service-backed operation, the expectation should be that cost efficiencies are consistently achieved. This is because the incremental cost of providing an additional subscription should be substantial. This is observed with MSCI, as its GPM and EBITDA margin has increased by 10% and 9% respectively. As the number of customers increases, margins will only expand further.
Another benefit of an operation of this type is the lack of a material working capital mechanism. For this reason, these profits flow directly into FCF, with the company achieving a mouth-watering 36% FCF conversion. This will fund continued inorganic growth, which MSCI does undertake on occasion, as well as distributions to shareholders.
Moving onto the balance sheet, the company's position is incredibly clean. Improving operational efficiency and effective capital allocation is reflected in the gradual uptick in ROA, which has doubled in the last 10 years.
The company has raised debt in recent years to fund the most recent acquisition, as well as sustain impressive distributions to shareholders. The company has aggressively repurchased shares, with its treasury shares balance increasing 48% in 10 years. Alongside this, investors have received consistent dividend growth. Our view is that buybacks and dividends are sustainable but not at the Dec22 level. The company is forecasting FCF of ~$1BN in 2023 which alongside its cash balance, gives MSCI ~$2BN for the year. As the below shows, no material debt is coming due and so much of this can be directly distributed.
Debt profile - MSCI ((MSCI))
With a ND/EBITDA ratio of 2.76x, the company can afford a greater debt balance if required. This is due to the growth and FCF conversion MSCI is able to achieve. We do not suggest this but the company maintains the flexibility to undertake M&A or reward shareholders. Presented below is its current credit rating.
MSCI Credit rating ((MSCI))
Outlook:
With the continued tailwinds we are expecting and impressive financials, the forecast should be business as usual, without any missteps.
MSCI Consensus analysts' forecast (Tikr Terminal)
Analysts are forecasting just this, with 8% revenue growth and greater gains on the bottom line. As we have mentioned, the nature of the business allows for margins to continue to improve, with analysts expecting a mammoth 16% from FY22 levels by FY27F. This does look slightly optimistic but the big-picture message is more important here. Growth will continue to be strong and margins will expand.
Valuation:
With an industry and company that is this attractive, it is unsurprising to see the company trading at a steep valuation. Seeking Alpha succinctly communicates this as illustrated below.
MSCI Valuation (Seeking Alpha)
The difficulty here is that good businesses will always trade at an expensive valuation, investors are not going to find MSCI at a discount, as shown by MSCI's 5 year average. Is the business more attractive than it was 5 years ago? Yes, margins have improved and growth has continued. Will the company be more attractive in the coming 5 years? Yes, we think so, forecasts support this and so does our analysis. In this case, it is difficult to argue against investing in the company. If we thought a bear market would bring growth to a standstill in FY23, we could suggest a change in sentiment is possible. But this is not the case.
Final thoughts:
The financial data sub-sector that MSCI operates within is incredibly attractive. We see outsized returns in the medium term with ESG and sustainable long-term growth through greater investing activities by individuals globally. MSCI is perfectly positioned to maximize returns from both with its market-leading position. Looking at the business itself, it boasts attractive metrics, with 90%+ retention and an impressive profitability profile. We see no reason why returns cannot compound long-term, with investors seeing the majority of the cash flows through distributions. The key risk with MSCI is a major decline in market conditions, driving away growth. This feels unrealistic at this stage.
The valuation is a difficult one to rationalize as its prices in MSCI remain exactly as it for an extended period of time. Any reader who thinks weak market conditions could bring MSCI's price down, or that there is a chink in its armor, should certainly not consider buying at this price. However, we struggle to see any issues over a 5-10 year period.
For further details see:
MSCI: A Long-Term Compounder