MSCI Inc. (NYSE:MSCI) Q1 2023 Earnings Call Transcript

MSCI Inc. (NYSE:MSCI) Q1 2023 Earnings Call Transcript April 25, 2023

MSCI Inc. beats earnings expectations. Reported EPS is $3.14, expectations were $2.99.

Operator: Good day, ladies and gentlemen and welcome to the MSCI First Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded. I would now like to turn the call over to Jeremy Ulan, Head of Investor Relations and Treasurer. You may begin.

Jeremy Ulan: Thank you, operator. Good day, and welcome to the MSCI first quarter 2023 earnings conference call. Earlier this morning, we issued a press release announcing our results for the first quarter 2023. This press release, along with an earnings presentation we will reference on this call as well as a brief quarterly update are available on our website, msci.com, under the Investor Relations tab. Let me remind you that this call contains forward-looking statements. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made and are governed by the language on the second slide of today’s presentation. For a discussion of additional risks and uncertainties, please see the risk factors and forward-looking statements disclaimer in our most recent Form 10-K and in our other SEC filings.

During today’s call, in addition to results presented on the basis of U.S. GAAP, we also refer to non-GAAP measures, including, but not limited to, adjusted EBITDA, adjusted EBITDA expenses, adjusted EPS and free cash flow. We believe our non-GAAP measures facilitate meaningful period-to-period comparisons and provide insight into our core operating performance. You will find a reconciliation to the equivalent GAAP measures in the earnings materials and an explanation of why we deem this information to be meaningful as well as how management uses these measures in the appendix of the earnings presentation. We will also discuss run rate, which estimates at a particular point in time the annualized value of the recurring revenues under our client agreements for the next 12 months, subject to a variety of adjustments and exclusions that we detail in our SEC filings.

As a result of those adjustments and exclusions, the actual amount of recurring revenues we will realize over the following 12 months will differ from run rate. We, therefore, caution you not to place undue reliance on run rate to estimate or forecast recurring revenues. We will also discuss organic growth figures, which exclude the impact of changes in foreign currency and the impact of any acquisitions or divestitures. On the call today are Henry Fernandez, our Chairman and CEO; Baer Pettit, our President and COO; and Andy Wiechmann, our Chief Financial Officer. Finally, I would like to point out that members of the media may be on the call this morning in a listen-only mode. With that, let me now turn the call over to Henry Fernandez. Henry?

Henry Fernandez: Thank you, Jeremy. Welcome, everyone, and thank you for joining us today. MSCI delivered solid first quarter results in a challenging external environment, confirming the underlying strength of our franchise and our proactive financial management. We have not been immune to the market turmoil, but our resilience continues to stand out as seen in the headline numbers from the quarter, which include adjusted EPS growth of over 5%, organic subscription run rate growth of 12% and a retention rate of over 95%. On a segment level, we posted our 37th consecutive quarter of double-digit run-rate growth in index recurring subscriptions. We also maintain our momentum in equity portfolio analytics, achieving run rate growth of over 10%.

Meanwhile, climate continued to drive a wide range of growth opportunities, including with many emerging client segments, such as banks, wealth managers and insurance companies. MSCI delivered 68% climate run rate growth across our product lines and a climate retention rate of over 96%. The difficult environment has certainly affected buying behavior of our clients. In some areas, client budgets have tightened and sales cycles have lengthened, especially for larger purchases. ESG sales have also been affected by regulatory uncertainty in Europe and by a slowdown among wealth managers and retail investors in the United States, although institutional investor demand remains healthy and steady. As we have noted in recent quarters, our AUM-linked revenue tends to be an early mover in market cycles, while our subscription revenue tends to see a lagging effect.

Still, our client engagement levels remains very healthy, and we continue to find a steady demand for our products and services. Even in tough environment, MSCI’s unique competitive advantages endure. Clients need our data, models, analytics and research to navigate a rapidly changing investment landscape. With that in mind, we continue prioritizing core investments in areas we believe we can fuel growth while maintaining very rigorous overall expense discipline. We also recognize the periods of turmoil can spur opportunistic M&A at more attractive valuations than we have seen in prior years, especially as this market cycle persists. We’re actively exploring potential bolt-on acquisitions that could accelerate our strategy. Looking ahead, a key driver of that strategy will be the network effects produced by our One MSCI ecosystem.

Our content and IP across product lines are already highly interoperable throughout the investment process. For example, clients can use MSCI tools to design an index-based portfolio, implement ESG or climate overlays on that portfolio and then run analytics on it. All companies at times face short-term wins, yet we continue to see powerful secular tailwinds for MSCI. This is true across product lines, asset classes and client segments. In a bull market, a rising tide can lift all boats. In a bear market, companies like MSCI differentiate themselves. MSCI remains confident that we can use this opportunity, this market cycle to strengthen our client relationships and/or increase our competitive advantages. With that, let me turn the call over to Baer.

Baer Pettit: Thank you, Henry, and greetings, everyone. My comments today will focus on our business results this quarter, what we’re seeing and hearing from clients and how we are continuing to deliver on our dual commitment to our shareholders, namely the execution of our long-term growth agenda to capture more of our addressable markets while maintaining the profitability of the company. We finished March with $1.84 billion of recurring subscription run-rate with an organic growth rate of 12% after closing more than $56 million of new recurring subscription sales during the quarter. It has been a slower environment for closing new sales as you can see from the year-over-year comparisons in our operating metrics, as we continue to see tighter client budgets and longer sales cycles.

While we cannot control the macro environment, we maintain our conviction in the mission-critical nature of MSCI’s data models, research and tools. Our sales pipeline and depth of client engagement across products and regions remain steady, and we have some promising larger deals that the teams are working hard to close in the second quarter. Retention rates across the firm are holding up well in the tough environment with both index and ESG and climate reporting over 96% retention and 94% and 92% retention in Analytics and Private Assets, respectively. This is a reflection of the investments we’ve been making not only in our products but also in our client servicing capabilities. I’ll now review a few additional highlights across product lines.

In index, we drove 12% organic recurring subscription run rate growth with broad-based strength in both our most well established and emerging client segments and product lines. For example, in market cap-weighted index modules, our subscription run rate is now almost $600 million, and it grew 11% during the quarter. Investors are still turning to our market cap indexes to understand their global investment opportunity set across sectors, styles, sizes and geographies to implement rules-based strategies. They are also using our indexes to implement customized strategies and to express an investment thesis. Our custom and specialized index modules are now $108 million of our subscription run rate and grew 13% during the quarter. Our index subscription run rate with asset managers expanded by over 10% this quarter including from areas where we have existing strength such as our core market cap index modules.

Our subscription run rate with wealth managers has expanded by 23% year-over-year, supported by the licensing of our custom indexes for model portfolios and direct indexing use cases. In Analytics, we drove 6% subscription run rate growth, excluding FX. New recurring subscription sales were almost $14 million during the quarter, roughly level with our performance in the same period last year. The current environment emphasizes the mission-critical nature of our analytics capabilities for institutional investors, and we’re able to close several new strategic sales for both our equity risk models and enterprise risk and performance tools. Specifically, in equity portfolio management, we closed nearly $6 million of new recurring sales driven by equity risk model sales to hedge funds who use our models and tools to actively position their portfolios to benefit from volatility and market dislocation while also managing downside risk.

Image by Sergei Tokmakov Terms.Law from Pixabay

During the recent period of market instability, our clients relied heavily on our analytics, models, research and tools, significantly increasing their usage on our platforms, helping them to better understand potential risks and associated exposures within their portfolios. Stress testing, factor performance, liquidity risk and counterparty risk all remain in the spotlight as clients try to assess and manage their counterparty and market-risk exposure according to potential swings in market sentiment. Across all product lines, our ESG and climate run rate is now $453 million, which grew 20% year-over-year. Our firm-wide climate run rate is now $84 million, which grew 68% and continues to be one of the most attractive growth engines for us.

We continue to launch new tools for our clients to better equip them to understand and manage climate risks and opportunities in the context of their investment portfolios. In the past quarter, we have introduced biodiversity screens and insights as well as multi-horizon climate probability of default. Additionally, to keep pace with the growing number of public and private assets our clients are invested in, we expanded both our asset location database and the coverage universe of our implied temperature rise network which helps financial institutions incorporation set and meet climate targets. We believe our continued investments will help clients effectively navigate the evolving regulatory requirements impacting them, which will be a long-term catalyst for growth.

However, in the short term, some clients are slowing down buying decisions in order to better understand new proposed or potential regulations. As we have previously stated, we are preserving investment capacity to secure new growth. Our intention is to preserve as much investment as possible in key areas aligned with client demand and where we believe we can deliver attractive returns, such as climate, ESG, client design indexes, fixed income and the ongoing modernization of the client experience. In parallel, we are equally focused on creating greater efficiencies across the company to allow us to fund these important investments. As I stated at the outset, we will continue to deliver on our dual commitment to shareholders, which means executing on our long-term growth agenda while maintaining the profitability of the company.

With that, I will turn the call over to Andy. Andy?

Andy Wiechmann: Thanks, Baer and hi everyone. The financial results in the quarter showcase the attractiveness of our financial model and the effectiveness of our actions. Subscription revenue, which is 75% of total revenue, remained steady with 13% organic growth while we continue to feel the pressure from year-over-year declines in AUM-related revenue with ABF revenue down 8%. While the first quarter tends to be seasonally lower for new sales. Our results in the quarter were softer than last year, reflecting several factors. Relative to a year ago, we saw some lengthening of sales cycles and fewer larger ticket deals. These dynamics were particularly pronounced in the Americas and within our ESG and climate segment. In ESG and climate, the impact of macro pressures and constrained client budgets had a more pronounced impact where the details of pending or recently released regulations have not been fully clarified or interpreted and where there is likely a higher level of more discretionary purchases in certain use cases.

Additionally, in some areas of the firm, we saw a modest decline in retention, most notably coming from smaller hedge funds, broker dealers and real estate brokers and developers, although importantly, firm-wide retention rates remain fairly strong overall and in line with historical averages. While the longer term demand and pipeline remain steady, we expect some of these cyclical ESG dynamics to persist in the short-term. But overall, we continue to operate from a position of strength with strong momentum and healthy client engagement across our subscription base. In index, subscription run rate growth was 12% in the quarter. Client demand for active and passive index strategies remained healthy. We again saw notable strength within our market cap modules as clients continue to integrate indexes more heavily into their investment processes, and we continue to benefit from a growing trading ecosystem.

Since the end of December, AUM balances and MSCI-linked ETFs have rebounded by over $82 billion, including over $7 billion of cash inflows, which helped asset-based fees improved by 6% since year-end. We saw strong flows into both developed markets outside the U.S. and emerging market funds, both areas where ETFs based on MSCI indexes had strong market share capture. Recently, one of our clients completed the largest ETF launch in history based on AUM, which is linked to MSCI’s Climate Action indexes. Traded volumes of listed futures and options linked to MSCI indexes remained slightly elevated but saw some normalization relative to the high market volatility environment last year. Within those cyclical dynamics, we continue to see the secular build of volumes resulting from the growing liquidity and trading ecosystem around financial products linked to our indexes, and the growing volumes of listed futures and options have helped drive growth in the broader index derivatives franchise.

We continue to see healthy client appetite for structured products and OTC derivatives linked to MSCI indexes as well as strong demand from trading firms and hedge funds for our index data. These areas help to support both recurring and onetime sales volumes. In Analytics, subscription run rate growth was 6%, excluding FX. We continue to see strong demand from the buy side for our equity risk models and our broader equity portfolio management tools. Despite some of the previously mentioned pressures, the mission-critical nature of our analytics tools in these environments continues to provide a path of steady growth. In our ESG and climate segment, we saw overall organic subscription run rate growth of 30% with growth in EMEA at 34%, while growth in the Americas slowed to 24%.

Coinciding with the slowdown in new ESG fund launches in the region and some slowdown in client buying decisions related to the previously mentioned factors. In climate, we continue to see good momentum and very engaging discussions across client segments, although some of the factors impacting ESG sales did, to a smaller degree, also impact climate sales. Our climate subscription run rate growth across all products was 68%, which was roughly the same as the Climate ABF growth rate. In real assets, we continued to deliver double-digit organic subscription run rate growth of 10%. We see strong engagement from our clients as they look for insights into the highly dynamic market, including around climate and income risk, although we did see some pickup in cancels from smaller clients in the quarter.

I’ll now go over the puts and takes of our 5% growth in adjusted EPS in the first quarter. While asset-based fees were lower than last year, growth in subscription revenues was a significant driver of the $0.16 adjusted EPS expansion year-on-year. The lower share count drove $0.07 of the year-over-year increase, benefiting from the significant level of opportunistic share repurchases we executed last year. I would note that our Q1 adjusted EBITDA expenses of $247 million included about $22 million of seasonally higher compensation and benefits-related expenses that we had anticipated and indicated to you previously, although we did have some comp-related accruals and non-comp items that were slightly more favorable than expected. We remain well capitalized and ended March with a cash balance of nearly $1.1 billion.

On client collections, we continue to see slightly longer payment cycles consistent with our prior comments due in part, we believe, to the opportunity cost of a high-rate environment. There were no share repurchases during the quarter, although we continue to be poised for and actively focused on attractive repurchase and potentially compelling bolt-on M&A opportunities. We continue to believe this environment could result in some repricing and/or unlocking of previously unavailable acquisition opportunities. Lastly, I would like to turn to our 2023 guidance. Our guidance ranges across all categories remain unchanged. It is important to note that we have based our guidance on the assumption that ETF AUM balances declined slightly from current levels in the second quarter and gradually rebound in the second half of the year.

While the environment may result in some caution from clients in the next quarter or two, we have the financial model and the proactive management levers to drive investment in the very compelling long-term growth opportunities while delivering very attractive financial performance. We remain encouraged by the strong client engagement across numerous growth opportunities, and we continue to be closely aligned with the long-term trends transforming the investment industry. We look forward to keeping you all posted on our progress. And with that, operator, please open the line for questions.

See also 11 Most Promising Clean Energy Stocks and 17 Best Gambling Stocks to Buy Now.

Q&A Session

Operator: Our first question comes from Manav Patnaik with Barclays. Please go ahead.

Manav Patnaik: Thank you. Good morning. I just wanted to just talk about the ESG slowdown specifically, I mean, is the comments around the regulatory delay, is that just people waiting. I just want to understand why that would impact whether they needed the data that you guys have or not. And then just hoping you could just break out the strong growth rates in ESG, like how much of that is new sales versus cross-selling or upselling and pricing, just to help understand which part of that dynamic is being impacted the most?

Henry Fernandez: Manav, thank you for the question. First of all, let me just level set a little bit. As Andy indicated, ESG and climate, the – we had a 30% run rate growth in the segment per se with 34% in EMEA, over 20-plus percent in the Americas. And we had a 21% run rate growth firm-wide in ESG and climate despite the lower AUM-linked revenues that we have had given the decline in equity values around the world. So in any environment, these are not too shabby numbers to begin with, they’re definitely lower than the recent past, but not bad at all. So we’re very pleased about that. The second point that I will make before I go directly to your answer, Manav, is that we’re very excited about a number of new products that we’re launching in ESG and climate.

First of all, we are continuing our ESG rating coverage expansion into more equities and more fixed income and other private assets that will bode well for additional sales. We’re very excited about the uptake on the total portfolio, carbon footprinting service that we’re offering, which includes public and private assets and includes corporate bonds, for example, for banks. We have launched a European bank regulatory product in which – for climate risk. So that’s important. We’re launching a biodiversity set of data and products with a partnership with the firm. On climate risk, we’re very excited about the Climate Lab Enterprise. In addition to the climate probability of default, we believe that climate risk will be a major driver of risk analytics in the future and the like.

So now, there is a lot that we can say about that. So now in direct answer to your question on the slowdown, there are two components – there are two major regions where our ESG and climate sales are happening is clearly the Americas and EMEA. And the Americas, especially in the U.S., we have seen a meaningful slowdown in sales due to some of the geopolitical issues and political involved discussions that are going on about ESG. And the institutions that we deal with, they are all continuing to subscribe to the product line and they are continuing to integrate ESG and climate into their portfolios. They are trying to stay low key so that they don’t get in the crossfire of the political system. And what we have seen is definitely a slowdown in retail demand, wealth managers, mutual fund launches and the like because a lot of the asset managers, again, are trying to assess the whole political landscape and being cautious not to get caught in the middle of that.

We believe that, that’s going to persist maybe for a year or more, given the elections coming up. But at some point, it’s going to have to revive because ESG and climate are an integral part of the investment universe. In EMEA, our sales have held up pretty steady from prior quarters, no meaningful reduction in sales. But obviously, in EMEA, the regulators have come up with a new system as to what is an ESG fund and what is not. So similarly to what I was saying in the Americas, the institutional demand remains pretty steady and very robust. The retail demand is going through a little bit of an adjustment as to what is an article 9 fund, what is an article 8 fund. So our clients are sort of – sorting out how their product lines up to a lot of that.

And we believe that once they finish that process, they are going to start launching ESG and climate funds because the fundamental demand in EMEA continues to be very strong. So in a nutshell, we continue very excited about this segment. The growth has slowed down a little bit in addition to because of the cautionary budget that exists in the world plus these other things, the political situation in the U.S. and the regulatory situation in EMEA. But the fundamental demand is there. This is a product that is here to stay especially the – in all aspects, actually, the integration and the impact investing and all of that. And it’s just a question of when we begin to see a return to higher growth rates.

Andy Wiechmann: And Manav, just very quickly on the composition of new recurring sales to your question, the strong majority of new recurring sales continue to come from the new clients and new services or upselling our existing clients. I’d say, the breakdown between those is roughly even. So roughly even contribution from new clients and new services. I would highlight price is contributing a slightly higher percentage than what we’ve seen in the past to new sales?

Manav Patnaik: Okay. That’s very helpful. Thank you. Just on the M&A, I think you guys mentioned it a few times in terms of the valuations coming down and exploring bolt-ons. I was hoping you could just elaborate a bit more on that. It sounds like it would be a series of small to midsize tuck-ins and in the obvious areas of ESG and data and so forth? Or just hoping that you could give a little bit more color there.

Henry Fernandez: So as we said, Manav, these are all smaller bolt-on acquisitions. There is nothing sizable or transformational that we can see on the horizon that obviously can change at any point, but we don’t see that happening. So we have been – as you have seen, as we’ve been relatively muted in our acquisition past in the last few years because we’re very disciplined buyers. Even if an asset is very strategic, it has to have financial underpinning stores. It has to make sense financially. We saw a lot of our competitors bidding up assets to levels that we would not want to participate in, in the past. So we’re waiting to see if this environment brings down those valuations that make a lot more sense and obviously only in the strategic areas that we’re interested in.

So that’s why we wanted to emphasize that and especially in the context of the lack of repurchases because we don’t have a huge amount of cash, and we have wanted to preserve cash for these opportunities when and if they come.

Manav Patnaik: Okay, fair enough. Thank you.

Operator: The next question comes from Toni Kaplan with Morgan Stanley. Please go ahead.

Toni Kaplan: Thanks so much. Just wanted to follow-up on ESG questions. I guess I definitely understand what you just mentioned on political environment and retail, etcetera. I guess do you see ESG getting worse before it gets better? Or is – should we just expect sort of a maybe modest environment for the next year?

Henry Fernandez: Thank you for that, Toni. First of all, let me just reiterate that our ESG franchise is very diversified – ESG and climate franchise is very diversified across regions, across types of customers that – what we call client segments, whether it’s an institution – an institutional investor manager managing institution of money versus a manager managing individual or wealth money across banks and across, as I said, regions of the world, and use cases. So this is very varied and the like. So what I want to make sure we all recognize is that the U.S. marketplace is a clearly important one. But within the U.S. marketplace, you’ve got to break it down into what is going on with the – with managers who are managing retail money versus people who are managing institutional money versus the banks who have a different driver versus the hedge funds and all of that.

So therefore, it’s a lot of different areas that we need to look at. My sense – our sense at MSCI is that the area of the market that it is asset managers managing mutual fund money or ETF money or wealth money is going to stay subdued and for a couple of reasons. One, the client segment, half of them are blue and half of them are red and some of them are going to have different views as to what this product line should be. Secondly, a lot of asset managers are trying to stay below the radar screen of a lot of these political wins. They don’t want to be attacked, so they don’t want to be making a lot of fanfare about new products, they are launches – launching, etcetera. So in the U.S., it’s going to stay a little bit subdued on that segment of the market, but it will not be on the institutional market, and it will not be on climate for banks, for example, climate risk for banks and others.

In EMEA, I think this process of reclassifying funds and reordering things, it’s going to – still may take a few months, a few quarters, and then the demand will pick up again in the context, obviously, of a total operating environment. And when we’re beginning to see a lot of traction in Asia in all client segments and that is virgin territory for us.