2023-04-03 13:06:15 ET
Summary
- MSCI is uniquely positioned to benefit from the global wealth accumulation trend and the increasing convenience of saving and investing.
- With 16,000 proprietary indexes, MSCI is a leader in the exponentially growing index market, which is dominated by very few companies.
- Through its ESG & Climate, Real Assets, Analytics and Index segments, 97% of the company's products and services are purchased through recurring fixed and variable fee arrangements.
- Unfortunately, as high quality as it is, and despite the great growth prospects it has, MSCI seems overvalued. I expect the company will continue to impress fundamentally, but I find the potential upside to be very limited.
- At 45.5 forward P/E and 32.7 forward EV / EBITDA, the company is trading above its historical average, and way above its competitors. I rate the stock a Hold, with a fair value of $494.70 per share.
MSCI Inc. ( MSCI ) is a unique asset in the financial services sector. Each one of its Index, Analytics, ESG & Climate, and Real Assets businesses is growing and should continue to grow at a rapid pace, with 97% of the company's revenues coming from recurring arrangements, and with retention rates above 90%. I find the company to be an industry leader with immense quality. However, at a 45.5 forward P/E, the company is trading above its historical average and way above its peers. I estimate MSCI's fair value at $494.70 per share, which represents a 11.6% downside compared to its market value at the time of writing. Thus, I rate the stock a Hold and plan to keep it on my watchlist.
Company Overview
MSCI provides investment support tools and solutions for 6,600 clients in more than 90 countries. The company operates under four reportable segments: Index, Analytics, ESG & Climate, and All Other - Private Assets.
The Index segment provides asset managers and investment institutions with 16,000 indexes which are used for developing indexed financial products (e.g., ETFs), performance benchmarking, portfolio construction, and asset allocation. The Index segment also includes revenues from licenses of the global industry classification standard (GICS), jointly developed with SP Global ( SPGI ). In 2022, 58.0% of MSCI's revenues were attributable to the Index segment, of which 40.5% were asset-based fees.
The Analytics segment offers portfolio management applications and services that reduce the operational burden on investment firms to collect and analyze information independently. Key products include RiskManager, BarraOne, Barra Portfolio Manager, Climate Lab Enterprise, and Risk Insights. In 2022, 25.6% of MSCI's revenues were attributable to the Analytics segment.
The ESG & Climate segment offers products and services that help institutional investors assess ESG and climate considerations, with over 10,000 analyzed entities worldwide. In 2022, 10.2% of the company's revenues were attributable to the ESG & Climate segment.
The All Other - Private Assets segment offers data, intel, and analysis for private assets such as real estate and infrastructure. In 2022, 6.3% of MSCI's revenues were attributable to the segment.
Investment Thesis
The company's products and services from all segments are purchased primarily through recurring fixed and variable fee arrangements. Every operating segment of MSCI is positioned to capitalize on the global wealth accumulation trend, but among them, the Index segment is the cornerstone of my investment thesis.
The Index Segment Is The Cornerstone
As of February 2023, global ETF total assets are estimated at $9.3Tn, after growing at a CAGR of 19.0% between 2006-2023. During that time, it never occurred once that total assets didn't grow on a 2-year basis. ETFs are not the only use of MSCI's indexes but they paint a clear picture - indexed investments grow at or above the pace of global wealth accumulation, strengthened by the increasing convenience of saving and investing. According to SPGI, ETF total AUM is projected to double by 2026. MSCI's index business is uniquely positioned to benefit from this trend.
Index revenues are a combination of fixed fees (index subscriptions) and variable fees (asset-based fees) which are sensitive to linked AUM. This is the main reason I consider MSCI a superior play on indexed investing to ETF providers like BlackRock ( BLK ).
First, most of MSCI's index revenues are fixed and growing regardless of market conditions, as its clients are investment managers that need to constantly diversify their offerings and they will remain active even when the market drops.
As we all know, 2022 wasn't a great year for the overall market and for asset managers specifically. BlackRock, one of MSCI's largest clients, saw 14.1% of its AUM evaporate, which resulted in a 7.8% decrease in the company's revenues. Meanwhile, MSCI's revenues increased by 4.1%, despite a 15.8% linked AUM decline.
It's important to note that as linked AUM grows over time, asset-based fees could outgrow subscription fees, which means MSCI's index revenues will become increasingly volatile. However, MSCI will continue to enjoy stability in one of its major revenue streams with index subscriptions.
Another reason I find index providers a superior play to ETFs is that the index landscape is much less competitive than ETFs. Just think about how many ETFs are indexed to the one S&P 500 index.
The question that arises at this point is whether MSCI is the best index provider pick among its competitors. Well, my answer is simple. There isn't any other company where the index business provides the majority of revenues. Taking SP Global for example, indexes are only 12.0% of total revenues in 2022, and that was a down year for its ratings business. For MSCI, the index business is 58.0% of revenues.
Other Segments
The Index segment is not the only segment that enjoys recurring revenues. Actually, 97% of MSCI's revenues are recurring. However, the Index segment is the main reason I consider investing in the company, as it is dominated by MSCI and SP Global. Other competitors include the FTSE Russell, which is a subsidiary of the London Exchange Group ( LNSTY ), and CME Group ( CME ).
The other segments, however, are much more competitive, although they are still very attractive, with above 90% retention rates throughout MSCI's entire product suite. In Analytics, ESG, and All Other, the company competes with FactSet ( FDS ), Bloomberg, Moody's ( MCO ), CapitalIQ (owned by SP Global), Morningstar ( MORN ), and many more.
One of the reasons I refrained from investing in MSCI was that I'm not a huge believer in ESG & Climate investing. Although a small one currently, the ESG & Climate segment is a significant growth engine for the company. Usually, I don't invest in a company that has a line of business I don't like if it's too significant to ignore.
Recently, my view changed by 180 degrees. Not about ESG & Climate investing, but about MSCI's business in the field. I work for a very large pension fund in Israel, and not long ago, we started working with some of MSCI's ESG and Climate solutions. Even we, a very old and non-innovative company, became clients. That's because we lack the capability and willingness to deal with ESG aspects in-house, and I'm 100% sure, there are thousands more like us globally. If you read One Up On Wall Street, by Peter Lynch, then you know I felt like this was my 'edge'.
All over the world regulators and journalists are putting pressure on asset managers to include ESG and Climate considerations in their decision-making process. Whether you think it's right or not, MSCI's ESG and Climate segment's EBITDA doubled in 2022, and it's projected to grow at a mid-to-high-20s pace for the foreseeable future.
Competitors & Multiples
MSCI is a unique company. I can't say there's a truly similar company upon which we can base a perfect competitor comparison. However, there are many companies with one or more similar businesses.
MSCI has significantly outperformed its peers with a 1,710.8% total return in the last 10 years, and a 28.2% compounded annual dividend growth rate during the last 5. The company is trading near its 52-week high, whereas all its peers are on double-digit dips.
Looking at growth, MSCI's outperformance seems somewhat justified. Acknowledging the large acquisitions made by the London Stock Exchange Group and SP Global, MSCI's growth, which is primarily organic, is even more impressive. Additionally, there is no sign the company is slowing down. On the contrary, the management is guiding for continued double-digit growth for the foreseeable future.
Talking about margins, MSCI is a leader as well. The company's gross margins represent a huge opportunity for additional operational leverage. Thinking about the company's products, there's barely any incremental cost for duplication. Assuming MSCI will see continued revenue growth in the future, a margin expansion is almost inevitable. The only situation I can think of where MSCI's margins don't increase over time is if its lower-margin businesses become a much more significant portion of the company's revenues.
The relative valuation is where I find myself alarmed. Based on every multiple, MSCI gets a very high premium compared to its peers. This premium is even higher than what appears on paper, as many of the companies on our list have experienced declines at least in some parts of their businesses during the last year, and are expected to recover in the near term.
Overall, I find MSCI to be the highest quality among its peers. The company is concentrated on high-margin businesses, with steady recurring revenues which are projected to grow at a double-digit pace. Retention rates for MSCI are industry-leading, and there's no better way to get exposure to an index provider. For those reasons, I understand the premium the company is getting. Even so, I don't see how the current valuation leaves room for a reasonable upside for investors.
Valuation
I used a discounted cash flow methodology to evaluate MSCI's fair value. I assume the company will grow revenues at a CAGR of 10.5% between 2022-2030, which is according to the company's long-term growth targets. I believe revenues will grow at that pace due to high growth in AUM linked to existing indexes, as well as the continued introduction of new offerings. Additionally, I expect exponential growth in ESG and Climate, as regulatory pressures increase. Lastly, I project Analytics and All Other to continue to grow according to the management's guidance.
I find this growth rate to be reasonable, as it assumes MSCI will grow at the pace of the index market and according to management's guidance. That said, I consider double-digit long-term growth as a generally high expectation for every company.
I project MSCI's EBITDA margins to increase incrementally up to 60.4%, slightly above the management's long-term target of the high 50s. I find management's guidance to be overly conservative, as most of its products leverage economies of scale and the company is already at a 58.9% EBITDA margin.
The management is guiding for operational leverage, as it projects double-digit consolidated revenue growth and lower EBITDA expense growth. Thus, I see no reason why the company's EBITDA margin, which currently stands at 58.9%, won't increase at least by 1.5 percentage points in the mid-term. It's true that in the short term, the lower-margin ESG & Climate segment should outpace the growth of the higher-margin Index segment, but in the long term, I believe the Index segment will remain the major source of revenues. Additionally, I project the margins of the ESG & Climate segment will improve over time as well.
Taking a WACC of 7.6%, I estimate MSCI's fair value at $39.6B or $494.7 per share, which represents a 11.6% downside compared to its market value at the time of writing. While this does represent an arguably high P/E multiple on 2023 earnings (39.9), it's 20% below the company's 5-year average forward P/E of 45.0.
Despite it being a very high-quality company, MSCI is just too expensive for me at current levels. MSCI will remain on my watchlist until I find it to be at least fairly valued.
Risks
The first risk with MSCI is obviously, valuation. Disregarding my DCF model, there are other key metrics that reflect MSCI is overvalued. First, we saw its high premium compared to its competitors. Second, MSCI is currently trading above its own historical P/E ratios. Third, by assigning a 37.5 exit P/E multiple on my $17.1 EPS projection for 2025, we get a fair value per share of $641 at the end of 2025. In other words, if MSCI is able to achieve $17.1 EPS in 2025, which means over 16.0% EPS growth per year, and the stock will trade at a 37.5 P/E, then investors would have gotten a mere 7.0% annual return (excluding dividends), which is below my estimated WACC.
The second risk I'd address is competition. As it currently stands, MSCI's core Index segment enjoys a wide competitive moat, as it dominates the market along with SP Global. However, I do see a possibility the index landscape becomes more competitive, as technological advancements allow for easier analysis of a large number of companies, markets, and geographies. The rest of the segments are already operating in highly competitive environments, and there is a possibility the premium MSCI gets for its core business will be diluted.
Overall, I don't view MSCI as a company with high operational risks. I believe that fundamentally, the company will continue to impress and grow for the foreseeable future. However, I find the current valuation to provide very limited potential upside for investors.
Conclusion
More often than not, we see high-quality companies like MSCI trading for rich valuations, with immense optimism baked in the price. For me, I don't mind buying at what is an objectively high multiple, as exceptional quality doesn't come cheap, and I seek to invest in companies for the very long term. However, MSCI is currently too rich even for my taste. I rate the stock a Hold and estimate its fair value at $494.7 per share. If the stock drops to below $500, or a P/E below 40, I will consider initiating a position.
For further details see:
MSCI: This Index Provider Is A Great (But Expensive) Stock