What does MSCI do?

The most important part of an investment analysis is understanding what the company does. If you cannot simply explain to your grandmother what the company does, you shouldn’t invest in it.

MSCI is a “leading provider of critical decision support tools and solutions for the global investment community”. That is how the company describes what they do and your ROA granny does not want to hear this.

What your ROA granny wants to hear is that MSCI has five major operating segments: Index, Analytics, ESG & Climate, Real Assets and Private Capital Solutions. But they report the performance in four segments:

• Index

• Analytics

• ESG & Climate

• Private Assets

The Index segment offers equity and fixed income indexes (by the way indices and indexes are both acceptable plurals for the word index).

The Analytics segment offers risk management, performance attribution and portfolio management content (basically finance stuff for asset management).

The ESG & Climate segment offers products that help institutional investors (big investors) understand how these factors can affect their portfolios (ESG means environmental, social and governance).

The Real Assets segment offers data, benchmarks, return-analytics, climate assessments and market insights for tangible assets such as real estate.

The Private Capital Solutions segments offers tools to help private asset investors manage their investments. This includes evaluating operating performance, managing risk, etc.

In summary, MSCI provides financial data and tools to different segments of the investment industry.

Show me the money

Now that ROA granny understands the products, she wants to know where the money is coming from. Lets visualise that with a diagram.

Dark blue shows the regions around the world where money is made. Light blue shows you what each segment earns. Red is operating expenses and tax. Green is profit before and after tax.

In this case, we can see that Index (57%) is the largest percentage of revenue, followed by Analytics (24%), ESG & Climate (11%) and Private Assets (7%).

How sticky is the biz?

Not all businesses are created equal. MSCI is in the favourable position of selling a recurring service to a wide range of customers around the world.

This is an important statement because:

• Services are high margin businesses.

• A wide range of customers reduces concentration risk – i.e. the risk of being dependent on a few customers.

• Recurring business means that MSCI doesn’t have to find new customers every day. The same customers keep buying.

MSCI has very sticky revenue, 74% comes from subscriptions. The next 22% comes from asset-based fees, which means that the client has to pay a fee based on assets under management. This also means that the customer cannot stop paying the fee while using MSCI’s products, so it is sticky revenue. Only 4% of revenue comes from non-recurring services.

MSCI has a good business model. This is why it is able to create value for its shareholders.

ROA granny loves shareholder value creation.

Number crunching

I prepared a selection of numbers that will give you an overview of MSCI.

Returns

MSCI has an average Return on Capital Employed (ROCE) of 28.7%. Anything above 15% is extremely good. You can think of ROCE like an interest rate on a bank balance. It is the amount that the company has earned in a year, on the money that was invested in the business.

Margins

Margins refer to the profit number in question divided by revenues. MSCI has very high gross profit margins, which average around 82%. The average company in the S&P500 has a gross profit margin closer to 40%. But we would expect high margins because MSCI sells a service. The free cash flow (FCF) margin averages 43.3%, which is also very high.

Cash conversion 

A company’s management can manipulate profits – because the calculation of profit requires estimates. It is much harder (but not impossible) to manipulate cash flow – because either the cash is there or it’s not.

We use cash conversion to see how much of net income ends up as cash. Ideally, we want it to be 100% or more. In this case, MSCI converts over 100% of their profit into cash. That is a great sign.

Growth

Free cash flow has been growing at about 18.3% per year. This is fabulous. Anything above 10% is good.

We also notice that the share price has been growing faster than the cash flow. This is gives us a clue that MSCI might have a high valuation. But we will look at that later.

Stock-based compensation

I’ve talked about stock-based compensation (SBC) before (here). It refers to paying the staff in shares instead of cash. This might be good for staff, but it is not good for shareholders because the company is being given away.

MSCI’s average of 6.3% is not too bad, especially when compared to some of the tech companies like Facebook (31%), Adobe (19%), Amazon (116%), Nvidia (25%) and Google (31%).

Capital expenditure

Capital expenditure (capex) refers to investing in equipment and assets to grow the business. MSCI spends about 2.4% of operating cash flow in capital expenditure. This is not high and you would not expect it to be high because MSCI provides services.

Equity dilution

Equity dilution is where we see what is going on with the shares of the company. Since they pay staff with stock, we would expect the share count to be increasing. However, it is decreasing, which indicates the MSCI is buying back shares. In this case a negative number is a good thing.

Debt

In terms of debt, MSCI has a total debt to free cash flow multiple of 5.5 times. This tells us that after paying all expenses, they could pay off the debt in 5 years without putting the company in distress. Interest payments are around 13% of operating profit. That is not insignificant, but MSCI generates a lot of cash, so it is not a warning sign.

Weird stuff

MSCI has one anomaly that you should be aware of - negative equity.

Equity divided by assets is a negative number. Normally, it should be a positive number which tells us how much debt and equity were used to purchase the assets.

Negative equity can be a sign that a company is going bankrupt. Negative equity can be caused by high dividend payments, amortisation of intangibles and borrowing a lot of money. Be aware that this is not the norm, most companies will have positive equity.

Granny likes positive equity because you can’t go bust if you don’t have a lot of debt.

Valuation

We touched on valuation earlier and noticed that the share price was growing faster than free cash flow.

If we look at the valuation multiple, MSCI is selling on 39.6 times free cash flow. That means investors have paid up for almost 40 years of free cash flow in advance. That is indicative of a very high valuation.

The stock is selling at $493 per share. My shoot the lights out valuation scenario gives a share price of $518, while my cruising along scenario gives a share price of $381.

Before you buy the share, BEWARE of investing in companies which have to shoot the lights out to justify the current share price. In finance terms, we call it being “priced for perfection”.

You do not want to require perfection for your stock to do well. This is currently a problem investors face with US stocks. Many of them are highly priced, even for extraordinary companies.

Before making any investment, always ask WWGD - What Would Granny Do?

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