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Morningstar | MSCI Not Impacted by Q4 Market Declines Though It Appears Customers Are Taking Longer to Pay

Wide-moat rated MSCI had a terrific 2018 and finish to its year, which is what we expected. For the quarter, MSCI produced revenue of $361.7 million, representing year-over-year and sequential growth of 8% and 1%, respectively. This growth comes despite the pull back in markets experienced during the fourth quarter. Asset-based fees, which account for about 23% of consolidated revenue, declined 0.7% sequentially. However, that’s really the only visible headwind to MSCI’s revenue. MSCI’s recurring index revenue increased 3.8% from the previous quarter, even analytics generated growth despite the less-than-favorable environment encountered by MSCI’s end markets. MSCI’s spending came in below our expectations as the company generated 34.9% growth in pretax income for full-year 2018. We’ll be taking MSCI’s full-year results into our model and anticipate no material changes to our $119 fair value estimate. All in, MSCI is an impressive company, and its share price more than reflects this.

MSCI is managing impressive growth despite market pressure on asset managers. During the call, management shrugged off suggestions that as active managers struggle, MSCI will not be able to realize double-digit sales growth while adding pricing accounts for about 25% to 30% of new sales. Though we’re largely positive on MSCI’s near-term business, there is one area of concern we’re watching. Over the last year, MSCI’s customers have been taking considerably longer to pay the company. By our math, days sales outstanding was 107 days this quarter, a nearly 24% increase from the previous year. We don’t know what’s driving this, but asset managers struggling with declining revenue may be electing to slow paying its vendors. In addition, it’s interesting because management called out higher cash collections during the quarter as the reason for the improvement in free cash flow.

MSCI’s “all other” segment, which should really be called its ESG and Other Products segment, reignited its revenue growth, increasing revenue by nearly 10% from the previous quarter. Most of this growth is being driven by adoption of ESG products. Despite this impressive expansion in revenue, MSCI has taken a significant hit to the segment’s profitability. For the quarter, this segment achieved an operating margin of 10.8%, a more than 1,000-basis-point decline over the past two quarters. That said, this shouldn’t worry investors, we suspect some of this is seasonal, but much of the spending will result in valuable IP, generating good returns many periods into the future.

Much of management’s discussion during the call revolved around expenses. It appears the company is signaling margin expansion will be more modest than it has been in recent years. Some of this is likely the result of recent market declines, but some of this is attributable to investments in new products and innovation. When discussing 2018 spending, we like that management called out IT infrastructure spending that management thinks will result in a faster time-to-market. This less glamorous type of spending isn’t likely to win the applause of analysts, but we like it. For indexes, being the first to market is often a key determinant of success as it’s hard to know what new asset class investors will find attractive. It doesn’t bother us if MSCI continues to spend on increasing its speed to market as we believe it’s additive to the company’s wide moat.

Finally, we found management’s comments on what it thinks will be the next ESG or hot new product for the company’s customers to be informative. Based on management's remarks, it appears MSCI is becoming increasingly focused on private asset classes like real estate and private equity. Specifically, CEO Henry Fernandez said, pensions “…have about 14% allocation into private asset classes. That number of a 10-year period can easily be 25% to 30%, and we want to be in that area.” It would appear MSCI is looking to build the same data, analytics, and benchmarks it built for international equity markets for private asset classes. Building these products will be expensive and may frustrate analysts focused on margins, but in our opinion they are worthwhile investments.