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Morningstar | MSCI: Unquestioned Leader in Global Benchmarks

MSCI is the unquestioned leader in providing global benchmarks to institutional investors. The company's recognized brand and high switching costs represent a steep challenge for rivals that is unlikely to be surmounted in the near to distant future. The company calculates over 190,000 benchmarks and 7,300 custom benchmarks for clients each day making MSCI's indexes a requirement for pension consultants. The firm's index segment currently accounts for three fourths of operating profits, with its analytics division generating another 22% of operating income. While less profitable than indexes, its analytics division helps create much of the intellectual property that MSCI's index segment uses to create indexes.During the past two calendar years, MSCI has improved operating margins by a staggering 600 basis points to 42.4%. Activist investors made the argument that MSCI is inefficient, hasn't integrated acquisitions well, and invests too much in analytics. In their view, it should have operating margins in the high-50s, comparable with its main rival S&P. While we believe MSCI can improve margins to approaching 50% by 2021, we worry that investors place too much of an emphasis on margins and steep cuts in spending will mean fewer new products and growth opportunities in the future. In addition, large, sudden cuts to spending could negatively affect retention levels. We appreciate MSCI's recent comments about spending growing along with sales and that margin expansion shouldn't be its only goal. Few companies have benefited more from the shift to low-cost passive investing than MSCI. While we believe this secular trend will continue, it does represent a risk for MSCI. A substantial amount (18%) of the firm's (2016) revenue is now directly or indirectly linked to fund asset levels, which would be severely impacted in a major market downturn. MSCI also faces the risk that indexes become commodities where price rather than brand and reputation becomes the key differentiator for end users, as active asset managers deal with an environment where fees and performance are under greater scrutiny than they ever have been before and look for more ways to cut costs.