Value Seeker‘s analysis on Moody’s Corporation (MCO).
Overview of Moody’s Corporation (MCO)
- Separated from Dunn & Bradstreet (D&B) on September 30, 2000
- 50% of revenue is recurring, with 39% at Moody’s Investor Services (MIS) and 74% at Moody’s Analytics (MA)
- MIS margins are more than twice that of MA, and thus MIS contributes over 75% of MCO’s operating income (oftentimes in mid-80%)
- As a whole, MCO has very strong margins –low-to-mid 40% operating margin
What Matters the Most:
- Investors still have appetites for high-yield, as well as the market is conducive for HY issuance (on average) –HY is ~highest margin business at Moody’s (likely 3-4x the fees versus investment grade issuance)
- Depends on default rates, risk appetite, credit spreads
- Structured Products market share, as fees are lucrative (MCO has strong market share –see “regulation” section)
- Regulationaround competition and pricing structure
- Europe CRA3 regulation and desire for increased competition could erode market share; if successful, could see similar regulation in U.S./other regions
- Market share stability
- SEC (U.S.) focused on conflicts of interest
- Capital light model leads to share repurchases
- From 2005 to Q2-2015, share reduction contributed 30.3% of the EPS increase. Business performance helped 58.4%, and the remaining delta due to tax planning.
Debt Issuance: YTD 2016
- Despite volatility, energy concerns, and other headwinds, 2016 is still tracking 2013-2015 issuance in USD, which were record years, and slightly behind is Euro denominated issuance
Debt Issuance: 2016 down versus 2015
- Consensus estimated of lower U.S. bond issuance in 2016 leads to Moody’s outlook in “corporate finance” sub-segment to be “flat” in revenue
- Although HY issuance expectations seem to change from week-to-week, generally expects issuance down 10-20% from 2015 levels, which deteriorated in 2H 2015
Why Own Moody’s Corporation (MCO):
- Strong business model –“the plumbing in the financial system”
- Exceptionally high returns on invested capital (needs very little capital)
- 50% of revenues are recurring, helps mitigate some of the ‘cyclical’ transaction activity
- Top 2 globally as a Credit Rating Agency (with S&P)
- Barriers to Entry are strong (but not unbreakable)
- Regulation and fees to become NRSRO, a CRA
- Deep network effects of Moody’s and S&P helps global comparability of debt
- Dependence by investors/IPS mandates to purchase debt only rated by MCO/S&P
- MCO entrenched in issuers business, know business “inside and out”, know capital plans, management, strategy, the industry
- Value proposition to issuers: rating by MCO (or S&P) can significantly lower borrowing costs, around 30-60 bps, versus a cost of <10 bps (varies on numerous factors)
- Necessity to customers: a rating by MCO is imperative to floating debt in public markets. Furthermore, issuers need annual maintenance of debt post-issuance for investors to monitor rating, have independent review
- Industry is not “winner takes all” –helps competitive landscape, as issuers will often get a rating from at least 2 issuers but no more than 3 (which explains why Moody’s and S&P have such strong market share, with Fitch having a respectable share as well)
- Limited capital needs
Valuation:
- At ~ $90/share, the shares are priced at ~15.5x 2016 FCFE per share, which is roughly in-line with the S&P 500. However, Moody’s is a first-class business based on total shareholder return growth, margins, capital intensity, and market position. It should trade at a premium.
- Guidance for 2016 is strong considering the headwinds:
- Default rates increasing
- High-yield issuance deteriorating
- Increased pricing in of a U.S. recession
- Potentially above-average (pull forward) bond issuance in 2013-2015 for corporates due to low rates
- Lower GDP growth
- Potential FX headwinds continuing
- See end of Slide Deck for more detailed valuation information
Global Market Share Leader:
- Market share resiliency despite credit quality issues during 2008-9
- MIS “ratings” is a “must have” for issuers
- More market share information under “Regulation” section
Limited Capital Needs
- Mostly spending on technology for compliance and process improvement
- 2007-2010 include costs to build-out New York and London HQs
- Normalized spending between $70 to $90 million (2-4% of revenues)
Moody’s ‘Credit Rating’ Provides Tangible Value
- The value proposition for MCO’s customers is strong
- For an investment grade issuer, new issuance fees is approx. 6 bps, but a rating by MCO often lowers funding costs for the issuer far exceeding the fees MCO charges
- Case study illustrating value:
See full slides below.
