Index provider and manager MSCI Inc. (MSCI) is thriving in the current market environment in terms of both increasing subscriptions and its stock price – which is up ~60% over the past 12 months. While the company’s growth rate is solid, the rich valuation should give investors pause. That said, MSCI is more than an index manager: it has a substantial and growing recurring subscription model that is somewhat akin to the SaaS based model that the market is currently so fond of. As a result, some of MSCI’s valuation is based on a rational long-term perspective that is based on the strength (and endurance) of its brand and its subscription based revenue growth.
Most investors are aware of at least a few MSCI indexes – primarily the popular market-cap indexes. But they may be surprised at the total breadth of MSCI’s offerings that span across multiple categories:
- Market Cap Indexes (Consumer Staples, Energy, Healthcare, IT, etc.)
- Factor and Multi-Factor Indexes
- Strategy Indexes
- Thematic Indexes
- Custom Indexes
- ESG Indexes
- Real Estate Indexes
- Fixed Income Indexes
MSCI has benefited from the shift from active investing to low-cost, transparent, and typically more tax-efficient passive investing in major market indexes. The popularity of indexes such as the Invesco QQQ ETF (QQQ), BlackRock’s iShares ETFs, and sector based ETFs like the Consumer Staples Select Sector SPDR ETF (XLP) are examples of ETFs that have been warmly embraced by investors. Meantime, educated investors – who may have been burned by their individual stock picks – have learned about the benefits of investing in low-cost funds over time:
The strength of the MSCI brand across the global investment horizon is what makes the company’s research and analytics valuable to wealth managers, institutional clients, and asset managers and asset owners. After all, money managers are most likely to work with an asset manager that actually manages the market index that directly aligns with their funds’ stated objective. This is why MSCI’s subscription service – and recurring revenue model – is so strong and resilient whether the market is up or down. And that business is growing – as are operating margins.
That is evident in the latest EPS report despite the fact that revenue grew 8.6% in 2019 but decelerated somewhat in Q2FY20 (6.2%):
Source: Q2 EPS Report
As can be seen in the above graphic, operating income, operating margin, and adjusted EBITDA all posted impressive growth yoy. That’s primarily due to the increase in recurring subscription revenues (+7.2%), non-recurring revenue growth (+34.4%), high retention rates, and – critically – new recurring subscription sales growth of (+15.5%).
That’s critical because new recurring subscription rates figure into the reported Q2 “total run rate”, which is MSCI’s current projection of fee revenue over the coming 12 months from subscriptions and product licensing revenue. The total run rate, as of end of Q2, was $1.65 billion – up 8.5% yoy. The increase was fueled primarily by a $112.7 million increase in recurring revenue from subscriptions.
In Q2, MSCI boosted the quarterly dividend with a 14.7% increase to $0.78/share. The company’s target is for a payout in the range of 40%-50% of adjusted EPS. In Q2, $88.0 million was returned to shareholders through a combination of share repurchases and dividends (diluted shares outstanding declined 1.2% yoy).
Wall Street’s embrace of recurring revenue models (like the software-as-a-service, or SaaS, models) has driven many companies to what I consider to be extreme valuation levels. See my Seeking Alpha articles on companies like Adobe Systems (ADBE) and Ansys (NASDAQ:ANSS) as examples (here and here). That being the case, it is no surprise that MSCI has caught the attention of Wall Street and also been bid up to what I consider to be a very high valuation relative to its demonstrated revenue and earnings growth:
The primary risk in my opinion is the current market valuation – based simply on price-to-earnings ratio – of a company whose revenue growth does appear to support a forward P/E of 50x.
There is institutional client risk as well. Back in 2012, Vanguard switched 22 of its funds away from MSCI indexes in order to cut the cost for investors. News of the switch caused MSCI’s stock to drop some 30%.
Note that MSCI’s latest 10-Q filing reported that BlackRock accounted for 10.9% of the company’s consolidated revenue over the first 6 months of 2020. If BlackRock were to take a page from Vanguard’s book, that would likely have a large and material impact on the stock price.
Summary & Conclusion
I like MSCI’s brand and business model. And I am impressed with the growth in its recurring revenue base and its total run-rate metrics. The future looks bright. That said, the valuation seems very rich despite the very positive subscription service potential. Even if a client like BlackRock didn’t pull a move like Vanguard did in 2012, BlackRock appears to be in a position of strength to negotiate more favorable terms, which would negatively affect MSCI’s margins. So, even while I admire MSCI’s business model and am bullish on the company’s future, the company is currently overvalued in my opinion. To be fair, Oppenheimer has a different opinion and considers the company an “outperform” with a one-year price target of $416. That equates to a one-year return of ~14%. That is not worth the downside risk in my opinion.
Disclosure: I am/we are long QQQ XLP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.