2023-11-17 13:22:17 ET
Summary
- MSCI's revenue for the quarter increased by 11.6% year-over-year, driven by growth in index, analytics, and ESG & Climate segments.
- Concerns over the deceleration in ESG & Climate growth and declining net new recurring subscription sales are valid, but I remain positive over the long term.
- MSCI's focus on improving its data base and its strong brand and network effect gives it a competitive advantage and potential for long-term growth.
Summary
Following my coverage of MSCI (MSCI), I recommended a buy rating as I expected MSCI to continue growing steadily as it did in the past. I also expected growth to accelerate in FY24, given the easy comps in FY23. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for MSCI as I don't see any major issue with the ESG & Climate segment, which is likely to be causing the negative sentiment for the stock. My long-term outlook for MSCI remains very positive as they continue to reinvest in the business, and its distribution and competition advantage remains intact.
Investment thesis
MSCI's revenue for 3Q23 was $625.4 million, up 11.6% y/y (10.9% organically). Index revenues grew 12.5% y/y, Analytics revenues grew 6.6%, ESG & Climate revenues grew 20%, and Private Assets revenues dropped 1.3%, all on an organic basis. Overall run-rate growth was 12% as the run rate for recurring subscriptions increased by 11.5% y/y and the run rate for asset-based fees increased by 13.8%. On the other hand, net new recurring subscription sales dropped 16.7% y/y, worse than the 15% decline seen in the previous quarter. Segment-wise, declines in Index subscriptions were 11.6%, Analytics subscriptions were 2.6%, ESG & Climate subscriptions were 26.9%, and Private Assets subscriptions were 52.9%.
For the bears, the focus was a major deceleration in ESG & Climate growth and also a decline in net new recurring subscription sales. I think it is a valid concern. Growth in organic sales for ESG & Climate slowed to 20% y/y in 3Q23 from 29% in 2Q23, with the Americas showing much slower growth (at 15%) than the rest of the world (35% in EMEA and 22% in APAC). There are, in my view, two aspects to this. Firstly, the macro environment has certainly impacted buyers, such that budgets are being scrutinized, which elongates sales cycles. Second, the regulatory climate is adding a great deal of complexity to the buying decision process, thereby delaying the entire purchase process (although it is a catalyst that drives long-term growth). To make matters worse, management anticipates that these more complex and extended sales cycles will continue for a number of quarters, which has, in my opinion, put pressure on the valuation.
some element of regulation being a catalyst. It is also something that is resulting in longer sales cycles as well as investors and broader financial services firms navigate these regulations. 3Q23 earnings results call
Indeed, sentiments around ESG are negative for sure, and new recurring subscription sales in this segment are declining both annually and sequentially. But that doesn't mean the positives should be ignored. At 95%, customer retention is still strong, and the Climate subscription revenue run rate has increased by 48% to $98 million, while the ESG subscription revenue run rate has increased by 21% (still a lot faster than the 10% growth I am projecting for the business as a whole). In my opinion, the company with the most comprehensive and in-depth proprietary ESG data will emerge victorious in the long run. MSCI is incomparably superior in this area. For instance, it has a wide variety of climate-related datasets already included, letting users construct models for detecting temperature conformity with international climate agreements, risk assessment, and scenario development. As a further indication of MSCI's commitment to investing in proprietary data, MSCI recently acquired Trove Research . By combining MSCI's climate solutions with this Trove Research, I believe MSCI's ESG & Climate product will be enhanced even further. This is because MSCI will be in a better position to offer carbon-neutral transition plans to businesses, evaluate the credibility of carbon credits, and forecast the cost of carbon offsets. Given the growing interest in carbon credits, I think this purchase is also very timely.
MSCI's long-term growth will, in my opinion, be significantly influenced by management's focus on creating solutions to handle the regulatory environment for its clients from an ESG and climate perspective. Let's also not forget that over the past decade, a lot of asset managers have already incorporated MSCI's ESG & Climate product into their workflow processes, making it extremely difficult to replace. As MSCI continues to build out its product and improve its database, I see the potential for it to become a "table stake" product, where investment managers who do not have access to MSCI's data would be losing out. I think one good example to illustrate this "table stake" situation might be the rise of alternative data that guys like YipitData are providing. Because a lot of investment managers are using Yipit, the ones that are not using it will be losing out in terms of information; hence, they are at a disadvantage when making investment decisions. I foresee the same happening to MSCI ESG and Climate products over time.
MSCI's brand and network effect is an additional competitive advantage that, in my opinion, is underappreciated. By catering to the requirements of asset owners (who, for example, are looking to invest in ESG), MSCI is able to generate a strong network effect. In a typical investing process, the asset owner has a specific investment target in mind (ESG, for instance), and they will set a mandate for the asset managers (hedge fund, for instance). In this case, the asset managers will need access to ESG data (which MSCI provides). As such, the more access MSCI has to large asset owners, the stronger this effect is. True enough, global pension funds and sovereign wealth funds make up the bulk of MSCI's asset -owner client base. As such, MSCI has a strong competitive advantage in distributing its product. Thus, I think MSCI's competitive position remains very strong, and it should be able to continue growing.
Valuation
Own calculation
My growth and margin assumptions remain the same for MSCI, as I see no structural impairments to the business. The key update to my model is the forward earnings multiple expectations. I valued the business at 40x forward earnings previously; however, I believe the negative ESG sentiment has pressured MSCI's valuation, such that it is now trading below peers. Note that MSCI has been trading at a premium for the past 5 years. Given the stronger margin and growth profile vs. peers on average, even with the negative sentiment, I would expect MSCI to at least trade in line with peers. At 38x forward earnings, my target price for MSCI is ~$640.
Risk
The growth of ESG and climate-related investments may be slower than I anticipate. Given the substantial investment MSCI has made, this would be a very bad scenario. Also, it is debatable whether or not ESG data can be used to generate outperformance, and the data that users buy is often not standardized and inconsistent between MSCI and other providers. Consequently, the validity of MSCI data can be questioned, which could have an effect on adoption.
Conclusion
Despite concerns regarding MSCI's ESG & Climate segment, my long-term outlook for the company remains bullish. The company's commitment to enhancing its proprietary ESG data, as seen by the acquisition of Trove Research, is positive for future growth. In addition, I believe MSCI's strong position in providing comprehensive ESG data and its network effect with asset owners ensure a competitive edge that's difficult to replace.
For further details see:
MSCI: Long-Term Outlook Remains Sound Despite ESG & Climate Concern