Description

Thesis

Extremely high-quality globally diversified asset light company focused on financial indexes and analytics.

• Wide moat based on Network Effects and Brand with premium industry margins and a dominant niche (indexes) with one main competitor.
• Recurring customer business with high retention rates due to switching costs.
• Industry tail winds including equity growth + EM and Foreign capital market formation + trend of continuing shift towards passive investing.
• Founder lead management with 20 years of experience (65 y.o.) including incredible stock returns and great stock buyback history.
• Highly probably double-digit cashflow growth (averaged 18% past 10 yrs.) with a reasonable valuation.
• Cashflow positive in all markets – anti-fragile business.

MSCI had earnings come out on 4/22/2024 and the market was disappointed with the stock falling 13.43%. It’s now down substantially over the past couple of years by roughly 25% from its peak.

I have watched these guys for years and always felt like it was an amazing company but just too expensive to buy. Well….one of the all-time compounding greats is on sale.

I read William Thorndike’s book The Outsiders a few years back which was a study on a handful of great CEOs that used stock return as a key metric for inclusion. In general, they ran companies with a focus on cash flow growth and capital allocation. They didn’t ‘manage’ earnings or seek attention. They focused on the long-term health of their companies and stock performance.

Henry Fernandez (65 yo) CEO has been with MSCI since the beginning when MSCI was part of Morgan Stanley. He has been at the helm since their IPO in 2007. He owns a substantial amount of shares in MSCI so he has skin in the game. Numerous studies show founder lead companies have substantially outperformed the market. There is also research that shows companies that buy back shares outperform. Easy to find this data. I am glad he is at the helm.

Management discussion of capital allocation – exactly why I like these guys…

Our approach to capital allocation remains unchanged. We will continue to invest in the business to drive strong top line growth over the long-term, while continuing to deliver attractive free cash flow and EPS growth. We will continue to optimize our capital structure, return excess cash to shareholders through regular dividends that grow with adjusted EPS and opportunistically pursue share buyback and value generative bolt-on M&A that accelerates our strategy in key growth areas.

A lot of the top-line growth came in the early years.

But the growth has continued in every year in the past decade with margins incrementally higher virtually every year.

Their profits aren’t diluted much by SBC and the business is asset light with little capex needs.

They have purchased about a third of their shares back in the past decade. In fact, in the past 11 years they have purchased $5.8 billion at an average price of $117 per share.

MSCIs dominant business is licensing subscriptions for their indexes to various asset managers globally. A portion of these fees are tied to the value of the assets benchmarked against their indexes which currently average 2.5 basis points. Margins tend to increase with software and sales subscriptions due to operational leverage.

90% of their run rate in 2023 was comprised of clients purchasing from more than one of MSCIs product lines. More than 60% of their run rate was comprised of clients purchasing from more than three of their products.

Their index business is their crown jewel. MSCI offers 160,000 indexes for everything you can think of and everywhere in the world.

Global stock market capitalization is $109 trillion as of November 23, 2023. Emerging markets represented about 27% of the market cap but 45% of the global GDP implying additional market cap growth with continuing development of emerging capital markets.

According to BofA Global Research (2-8-24) 47% of assets are actively down from 80% in 2009. 2023 was one of the worst years ever for active managers with the Mag 7 cause 88% of active managers to trail the SP500 Index.

Growing equity values + developing capital emerging markets + trend towards passive investing is driving their runway for growth.

ESG and Climate Analytics is the fastest growing area at 20% y/y with strong uptake in Europe and a bit slower and more polarizing in the US. EU finalized new regulations requiring certification of ESG ratings companies that are non-EU based by an EU ratings agency. Additionally, ESG ratings need to be clearly defined. ESG ratings must be kept materially separate from the Analytics, Indexing, and Benchmarking business within a company. We assess that this may initially present some minor challenges but will create a major hurdle for smaller competitors.

Their quarterly earnings spooked the market and the stock got hammered for a slight miss on revenue and adjusted EBITDA though they actually beat FactSet consensus EPS of $3.45 by 7 cents. The main culprit was recuring sales were weaker than expected. Some of this was explained by a merger between customers.  This was most prominent in their index business and ESG which has a been a faster growing area recently. The state of Texas and others have pushed back against ESG yet the results show that the growth which may be under some pressure continues.

As I review this I see a company with a small hiccup that maintains industry leading margins and positioning. This sell off is providing an opportunity to get into this great company.

Valuation

5 years from now they will have 5% to 10% fewer shares outstanding. They will grow EBIT or FCF or whatever profit metric you prefer by 10%+ a year. What’s a proper multiple? They are trading at a cashflow yield of about 3.2%. FCF is $1.18 billion in TTM and likely to be about $2 billion in 5 years. They have about 79.5 million shares maybe that declines to 76 million. They kick you 1.25% in dividends annually.

“When you find a really good business run by first class people, chances are a price that looks high isn’t high. The combination is rare enough, it’s worth a pretty good price.” Warren Buffett

Catalyst

Active managers once again took a beating last year making a strong results based case to move to passive indexing. Recency effect suggests the trend towards passive investing will continue or even accelerate. There remains a long runway.