MSCI: Empire Builder, Still Trading At A Premium

In August 2021, I believed that shares of MSCI Inc. (NYSE:MSCI) were on fire, but running a bit too hot. I thought that the business was a prime beneficiary of a search for stable and secular growth plays in a low interest rate environment.

The valuation had risen too much, however, in my view, as the business announced an interesting bolt-on deal, which even as it was interesting, did not move the needle.

Today, we find ourselves in a much higher interest rate environment, as valuations have come down a great deal, while the business has seen decent growth. This results in much lower multiples, yet still premium multiples here, making me await pullbacks before potentially getting involved at levels around the $400 mark.

A Recap

MSCI is a supporter of the investment process, supporting the built-out of investment portfolios with ESG, climate, data and other services to providers and users of capital, as well as financial intermediaries.

The company collects data from hundreds of vendors, creating factual information and price data to serve end clients. A $1.7 billion business in the summer of 2021 was a huge play on index products, responsible for just over a billion in sales. This was complemented by half a billion analytics segment, as well as a smaller ESG and private asset business.

While such a kind of business is a great business to invest in, a $628 share in the summer 2021 was awarded a dazzling valuation with earnings power limited to just over $8 per share, for a hefty 75 times earnings multiple.

In fact, 83 million shares outstanding granted the business at $52 billion equity valuation at the time, or even higher valuation if we factor in $2.1 billion in net debt. The resulting and near $55 billion enterprise valuation worked down to a 29 times sales multiple with revenues trending at $1.9 billion a year, and over 50 times EBITDA.

These valuations would come down a bit following a $950 million deal for Real Capital Analytics, adding $70 million in interesting sales, marking a bolt-on deal. Even as forwarding looking earnings per share trended around $10 per share, which reduced the earnings multiple to about 60 times, it was a mere 1.6% earnings yield which made me far from enthusiastic on the shares.

Interest Rates Do The Trick

Fast-forwarding two years in time, we see shares trade at $538, down about $100 per share (or 15%) over a two-year time period. These are dismal returns, but quite frankly shares have held up quite well given the outside environment (that is rapidly rising interest rates and compressing valuations at large).

Shares of MSCI have fallen to lows of $400 per share in 2022. In fact, they traded in the high $300s. Nonetheless, it has seen a major outperformance versus the likes of Morningstar (MORN), which has been suffering from poor execution, on top of the same external developments.

Fast-forwarding again to early this year, MSCI posted a solid 10% increase in 2022 sales to $2.25 billion, although that fourth quarter growth slowed down to 5%. Operating margins of 53% are unheard of, with adjusted earnings per share increasing by 15% to $11.45 per share, with EBITDA advancing to $1.33 billion. Growth is driven by all four segments, but notably the smaller ESG and private asset business as a net debt load of $3.5 billion worked down to a leverage ratio in the mid-2s.

In April, MSCI posted solid first quarter results with revenues up a solid near 6% on the year before. In July, the company posted an acceleration in second quarter sales growth, with revenues up as much as 12% to $621 million, for a run rate around $2.5 billion. Amidst modest operating leverage, the company squeezed out adjusted earnings of $3.26 per share, for a run rate of $13 per share.

Net debt actually ticked up to $3.7 billion, yet as EBITDA has improved to one and a half billion, leverage ratios are no big issue. With a share count of 80 million shares the company now commands a $43 billion equity valuation, or near $47 billion enterprise valuation.

This means that a 60 times earnings multiple has come down a long way although that a 41 times annualized earnings multiple remains steep in this interest rate environment, as the company still trades at 19 times sales.

Another Bolt-On Deal

In August, MSCI announced that it would acquire a remaining 66% stake in the Burgiss Group in a $697 million cash deal in order to increase its offerings for private assets.

The datasets offered by Burgiss includes decades long information on private equity, private real estate, private debt, etc. With a $90 million expected revenue contribution, the $1.05 billion valuation for 100% of the shares of the business, reveals that Burgiss is valued at 12 times sales, a far lower multiple compared to MSCI.

Contrary to that observation, Burgiss´ EBITDA margins are only seen in the mid-teens which means that the deal likely will be dilutive, due to interest costs and inferior margins reported by the business (vs. MSCI). This makes that the transaction is really a bolt-on deal, with margin expansion only seen after the integration, at which earnings per share accretion might be reasonably expected as well.

And Now?

The latest deal will have a minimal impact on sales (adding about 3-4 % to total sales) and be actually slightly dilutive to earnings per share. Pro forma net debt will jump to $4.6 billion, for a roughly 3 times leverage ratio, as the business continues to build out its empire.

MSCI has turned out to be a great capital allocator, as it has been gradually buying back stock, increasing the dividend, and announcing bolt-on deals to increase growth on top of the organic growth profile of its activities, all with the end goal to create long term shareholder value in a balanced approach.

While the profile has improved a lot, and earnings multiples have come down a great deal, the issue is that a >40 times earnings multiple in a 5% interest rate environment remains demanding, even with a solid >10% organic growth rate reported in the recent quarter.

Given this observation, I am waiting for more attractive valuations. I recognize the quality of the business, and I am willing to pay a premium multiple for MSCI Inc. Such a multiple would likely be limited to 30 times in this environment, making that shares look interesting if they re-test the post pandemic lows of $400, but I have no desire to get involved at prevailing levels.