MSCI Inc (MSCI) — Q4 2018 Earnings Call Transcript

Thank you, Victor. Good day, everyone. Welcome to the MSCI fourth quarter and full-year 2018 earnings conference call. Earlier this morning, we issued a press release announcing our results for the fourth quarter and full-year 2018. A copy of the release and the slide presentation that we have prepared for this call may be viewed at msci.com under the Investor Relations tab. Let me remind you that this call may contain 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 discussion of additional risks and uncertainties, please see the risk factors and forward-looking statements in our most recent Form 10-K and our other SEC filings. During today's call, in addition to results presented on the basis of US GAAP, we also refer to non-GAAP measures, including but not limited to financial measures excluding the impact of foreign currency, 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 insights into our core operating performance. You'll 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 on pages 23 to 27 of the earnings presentation. We will also discuss organic run rate 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 A. Fernandez, our Chairman and CEO; Baer Pettit, our President; and Kathleen Winters, our Chief Financial Officer. With that, let me now turn the call over to Mr. Henry Fernandez.

Thank you, everyone, for joining us today. I hope that you are all staying warm in this frigid weather. The volatility of the US market over the last several months gave us the opportunity to demonstrate the resiliency of our diversified business model and the effectiveness of our capital allocation strategy, all of which have shown tremendous strength. I would like to spend a few minutes shedding some light on how we have managed through this recent market volatility. First and very importantly, across almost all areas of MSCI, we have seen little to no impact. Despite the elevated market uncertainty, we have seen continuous trends in the selling environment across client segments with no noticeable changes to client behavior, which is reflected by the fact that we drove our second highest quarter ever of both recurring sales and recurring net new sales as well as our highest quarter ever for index sales and one-time sales. In addition, we witnessed relatively low cancels and our highest Q4 retention rate ever, coupled with the strong payment behavior from our clients, which accelerated our receivables collection efforts and generated record free cash flow. This strength and resiliency was fairly consistent across all regions of the world in which we operate. Even though many international markets have been in a sustained period of market pullback and volatility for as long as ten months. Furthermore, after relatively soft cash inflows in Q3, we have seen fairly healthy inflows in Q4 into ETFs linked to MSCI indices. There has been about $31.7 billion of total inflows since Q3 through last Friday, January 25. AUM equity ETFs linked to our indices are now back to over $740 billion. On the other hand, this volatile environment has put tremendous pressure on the valuation of ETFs linked to our indices. In Q4 we saw nearly $95 billion of negative market movement on the level of AUM in ETFs linked to MSCI indices, which was driven by the market sell-off and compounded by the appreciation in the US dollar. Conversely, we saw tremendous volumes in listed futures and options contracts based on our indices with a 27% growth quarter-over-quarter in contract volume. As we have indicated in the past, this is an area of significant focus by MSCI and tremendous potential. On a particular note, our continued discipline on the capital front, including the opportunistic financing transaction we did in May and the modest level of repurchases during the benign environment earlier in the year allowed us to take full advantage of the recent volatility and repurchased $755 million of shares since the beginning of October and through January 25th. This is a clear demonstration of the confidence and belief that we have in our business model and the franchise of our company. Well, we are only about four months into this period of market choppiness in the U.S., let us remind ourselves the developed markets outside of the U.S. and for sure emerging markets have been under significant pressure for most of 2018. Our recent successes highlight the outstanding resiliency of our business model and our franchise, the differentiating and mission-critical nature of our solutions as well as the strong secular tailwinds that are propelling many parts of our business. The MSCI franchise remains incredibly strong and getting stronger. The Q1 pipeline looks pretty healthy. The rest of the year pipeline also looks pretty healthy, and we feel confident about our prospects in 2019. We all look forward to providing additional insights and perspectives into the strength of our franchise and the significant opportunities ahead of us during our Investor Day on Thursday, February 28th. Let me turn the call over to Baer now, to talk some more about how we are executing and how we are continuing to fund the significant growth opportunities that we have.

Thank you, Henry. I am pleased to share with you some key accomplishments we achieved in Q4, driven by the consistent execution of our strategy and supported by our diversified business for all weather franchise. A large focus for us over the last several years has been enhancing our internal capital allocation processes to allow us to effectively allocate resources and ensure we are concentrated on high-return growth initiatives, increasing speed to market with new products, enhancements to existing products, and improvements in our technology. We have established the systems and processes to rigorously measure and track our investments, which has enabled us to drive growth by allocating our resources to the most strategic and highest return areas. We have focused on driving efficiencies and scalability in our cost base utilizing the most recent technologies and the continuous expansion of our emerging market talent base. Additionally, we have been expanding the portion of our expenses allocated to growth initiatives affording us the ability to enhance our value proposition and provide our clients with the right tools to manage their portfolios during these volatile times. We have been keen on ensuring that we have a balanced portfolio of short-term high return projects as well as longer-term strategic bets that will fuel growth in different markets and time horizons. The success we have had on this front is clearly evidenced within our index in the most recent quarter, where we delivered an 11.4% subscription run rate growth, 16.9% growth in recurring sales for the fourth quarter, and 18.5% for the full-year. This quarter marked the 20th consecutive quarter of double-digit subscription run-rate growth. Our growth is increasingly fueled by the areas we have been investing at. In the fourth quarter, the subscription run-rate growth of our ESG factor custom and specialized index modules was 20% and sales of these modules represented approximately 30% of new sales for the full-year, compared to 19% for 2015, showing our ability to generate new sales within the index segment. Similarly, $12 billion or close to half of the Q4 inflows into the ETFs based on our indexes were into funds based on our factor and ESG indexes. Furthermore, 30% of total sales for the full-year 2018 were to wealth managers and broker-dealers as compared to 23% of sales in the full-year 2015 helping drive some acceleration in the subscription run-rate growth. All of these index areas are benefiting from the resources of the entire MSCI franchise, and these key growth areas were built through very deliberate and targeted investments in new content, the build-out of our client coverage team across new client segments, geographies, and use cases, and proactive engagement with our clients and industry participants. Enhancements and investments to our data and technology infrastructure were required and have enabled continuous improvements to quality accessibility and scalability. With continued investments in areas such as ESG research and factor analytics, our index offerings have been the clear beneficiary of our strategic bets across multiple product segments. Some of our recent key launches and client wins highlight the success we are seeing in these new areas. During 2018, we launched a significant number of new products, including new thematic indexes that allow investors to get exposure to trends such as cybersecurity, robotics, the aging society, and efficient energy, a wide range of additional ESG products, new data modules, such as our USA module targeting specific exposures. The MSCI had a wealth 30 index as well as several China Index series, and our factor classification standard and factor box, which has already been adopted by 50 clients. In addition to these product launches, we continue to enhance our data and technology delivery model with improvements to our index production capabilities and the release of an important API that improves access to our content and which is fully integrated into our analytics platform. This continual evolution and reinvention is not unique to index, and it has been a key driver of the strong growth we are seeing across all parts of the business. I look forward to providing further updates on future calls. With that I turn the call over to Kathleen.

Thanks Baer, and hello to everyone on the call. I will start on Slide 6. We had a very strong Q4 and finish to the year resulting in 2018 full-year revenue growth of 12.5%, adjusted EBITDA margin expansion of over 200 basis points, and adjusted EPS growth of 34%. In Q4, we delivered solid results across all of our key metrics. Recurring subscription revenue grew 9% in the quarter, excluding the impact of FX and 12% excluding the impact of FX and divestitures, driven by continued strength in index and ESG, up 11% and 32% respectively. As we continue to see particular strength across our newer modules such as custom and factor index modules and the increasing adoption of ESG into the investment process across client types, geographies, and asset classes. Asset-based fees revenue grew 4% and was driven by the strong cash inflows into ETFs based on our indexes, growth in the AUM and non-ETF passive funds, particularly from higher fee products and increases in the volume of exchange-traded futures and options contracts linked to our indexes. This was slightly offset by declines in market levels of the AUM and equity ETFs linked to our indexes and a decline in the average basis point fee year-over-year resulting primarily from product mix. Our 2018 expenses were in line with our expectations and guidance. We continue to take a very disciplined approach to expenses and prioritizing investments. Our Q4 expenses reflect our normal run-the-business type spending as well as additional discretionary activities we executed in the quarter to better position us for 2019. This includes about $5 million of severance, which is more than double our quarterly average. We took actions to optimize our organization and streamline as well as reallocate resources in our client coverage team to better serve some of our fastest growing client segments such as wealth management. We also made strategic investments in our IT infrastructure and marketing activities. We upgraded parts of our IT infrastructure and migrated legacy systems to newer and more advanced technologies to increase productivity. These investments are expected to yield benefits in 2019 such as faster time to market with new product features and increased back-office productivity. Excluding these discretionary investments and incremental severance, our Q4 adjusted EBITDA expense growth compared to Q4 2017 would have been about 4.8% excluding the impact of FX. Moving to Slide 7, let me highlight the key drivers of our adjusted EPS growth. Growth in our core subscription business continues to be driven by exceptionally strong sales and elevated retention rates, and we have not seen any changes to our clients' buying behavior. Adjusted EPS also benefited from the lower share count as we ramped up our repurchase activity to take advantage of the volatility in our share price.

Yes, so let me give you the general direction and Kathleen can comment more specifically on the numbers, if any. Look, I think first of all, if we are - we continue to see enormous growth opportunities in our franchise and in our business. We started three years ago looking very heavily, and we found many, many more opportunities than we even expected and have been funding them and growing in them as you see, evidenced in the top line growth. So, we want to continue to do that. With respect to the outlook for this market, we expect 2019 to be with respect to the AUM or at least the passive management part of the AUM. Remember, AUM also has futures and options in there, but what is expected from the passive management part of the AUM, we expect 2019 to be a flattish kind of year; put maybe a slight amount of cash inflows going into ETFs and therefore - and the reason is because bear in mind that the developed markets outside of the U.S. and the emerging markets have already been highly depressed levels for a lot of 2018. Can they go lower? Sure, they can go lower, but we have estimated that at this point, that, you know, they may not, you know, they may not correct much more than that. We do expect significant volatility in the U.S. market, but not a bear market, so we think that there will be a lot of volatility up and down, but not a sustained bear market. So that's what is embedded in our thoughts processes into the conclusion of a flat or so, you know, market level with an increasing amount of inflows that give you a little bit of a positive impact on AUM. Therefore, based on that, our projection and the guidance we are giving you on expenses is around those assumptions, and since we don't assume that there will be either a U.S. bear market or a global bear market further than, you know, over the years outside of the U.S., we do not anticipate changing any of the expense numbers as a reaction to volatility in the markets.

Yes, so let me just add to that a little bit. It's a really important question, Alex; so, thank you. You know, look at the somewhat more challenging planning environment than we had at this point in time last year, challenging planning in terms of more uncertainty in the market with potentially slowing global growth, but you know, as Henry we are very confident in the top-line growth opportunities that we have and so very focused on continuing to fund those growth opportunities. I shared with you the expense guidance at 3% to 6%, and I think you are asking about kind of how you think about that during the course of the year and also how we can flex that up and down if needed. The 3% to 6%, think about it closer to the higher end of the guidance range in the first half of the year and closer to the lower end of the guidance range in the second half of the year. In terms of, you know, should conditions be different than we are expecting our planning right now, I mean flexibility is certainly the key here. We have got a strong franchise, but we certainly need to make sure we have the flexibility to go in either direction, either kind of ratcheting things up or down. And on the downside, that's where our downturn playbook comes in, and we are ready; we are constantly looking at that and ready to go as needed. We have got lots of granularity and numerous, you know, a couple of different tiers of levers in the downturn playbook that we can go to.

Really, Alex, it was very consistent. You know, so I think, the type of investments our clients are making with us are typically, you know, fairly infrastructural. They're not the type of thing that is affected by momentary market volatility. So, you know, we didn't see any changes in the normal pattern of business nor did we see evidence that people were freezing anything or anything of that kind. So, you know, very consistent with previous quarters, and you know, exactly as you see reflected in the numbers.

Yes. Thank you. I guess I just wanted to hone in on the cost a little bit more. You know, I think you talked about - you know, you have I guess an ongoing space of expands and investments; on top of that, I don't know if you want to call that fixed cost, variable cost, just to address your kind of downturn playbook like what - can you have break out what those expenses break out into just to think about where the levels are, should you need to pull them?

So I think the way we think about it internally is to distinguish the business expenses versus run the business expenses, obviously change the business are investments, not just expenses versus run the business. And what we have been able to achieve in the last three years or so is a significant squeezing of the run the business expenses and freeing up of resources to go into change the business. So when you look at our new investment plans for 2019 compared to the prior year in the change the business is up also like 25% as an example. You know that - and we want to continue hammering that; you know, we want to operate as efficiently. We think we still have some ways to go there in creating technology and data sets internally to operate better; obviously, at some point, there are diminishing returns of that efficiency and productivity of running the business. But we keep at it in order to increase the amount of money that we put in the change the business and some of those initiatives are the ones you know, I mean we cannot spend enough on ESG for the expansion of the equity universe of ESG, the continuation of the expansion in fixed income; we still have a lot of runway there. We currently rate about 15,000 issuers between equity and fixed income and that's going into a significant number; above that we are getting requests by clients to do ESG ratings in private equities and in real estate and so on and so forth, and so that's an area, obviously, factor investing. We are getting requests for both in factor investing in indices and also in factor investing between, you know, combining factors on ESG into portfolios into market cap portfolios to sell them, so we have a lot of demand there and we need to fund that substantially.

Hi, good morning. How do you think about the active asset management environment over the next year? Do you see things getting harder for your clients? You have a lot of new products to help, you know, get them through challenging times and new products that could help them grow revenue, but at the same time, if it is a challenging environment, you know, budgets could tighten or maybe it's harder to drive new sales, so just help us think about your outlook on active this year. Thanks.

Sure. I think our, you know, I would say thematically our main focus is on helping our clients be more efficient; so a lot of our tools are helping both within the investment processes of our clients within their infrastructure and looking at the range of information, software, etc. that they use in their investment process and finding ways of making that more efficient and more streamlined. So I think just about everything we do fits into that category, one way or another, but I think that that is the main approach that we are taking, and notably, we are doing that at more senior levels at our clients and we have done historically with the CIOs, the CEOs, et cetera, and working on that in a kind of a holistic manner. So, and I think then the other question is that it may be that a more volatile market while providing challenges also creates opportunities in active management and that's where a lot of our research, etc., comes into help our clients. It's across. We were always running a balance, you know, a meaningful amount of factors a meaningful amount of ESG, a meaningful amount is also, you know, the analytics platform that we are investing in. We are putting some money into wealth management, which is a rapidly growing client segment for a lot of people including us, and we are just on their waiting a lot of our growth there at the moment, we need to do a lot more over time. Real estate, that's a story that we haven't talked about; we will tell you more about in the Investor Day, but it is really coming nicely; and therefore, that is encouraging us to put a lot more effort into the private asset classes; to think about this way, we have built the MSCI of the public asset classes we want to build the MSCI of the private asset classes. So that's an area, so there is a lot that is happening in the company.

Hi. I guess I wanted to review or ask about opportunities on the M&A front and anything you might be targeting. Obviously, the cash flow has been healthy and you have got some new initiatives ESG, fixed, factor, wealth, private that could move the dial. Are you looking at anything in those areas to the extent you can talk about it, and then how do you feel about M&A, given all the commentary around volatility.

So we always look, you know, quite carefully and intensely and have a draconian discipline and obviously everything has been fairly frothy in the last two-three years. So we have done very little if anything; we have been on the opposite side, selling non-strategic parts of our business. We are, you know, and obviously it's going to be very strategic and value-added financially for us. You know, we are ringing our hands a little bit that at some point if that volatility continues and increases, there may be certain things that may become more actionable and we will look at them and obviously make the right decisions at that time. So, with that increase in volatility you are mentioning, maybe opportunities present themselves, but it's too early to tell, right; we only had a few months of volatility.

Thank you all for joining us today. As always, please feel free to reach out with any additional questions. We look forward to keeping you posted on our progress and look forward to seeing many of you at our Investor Day in a month. Thank you again and have a great day.