MSCI: A Tale of Activism & Quality Inflection
A case study in one of the best performing quality names of the last two decades
I’ve been spending some time looking at the index business. I have said this before, but financial services (ex-lending) are a great place to fish for ideas. Many financial businesses are commodities, but the nature of multi-party transactions demands a nexus of trust. It also helps that many financial intermediaries are well paid, and that they can afford, or are able to pass on, the costs of many a gatekeeper and toll collector.
Indices (think FTSE, S&P, MSCI, etc etc) tend to enjoy the same kind standard moats as the credit ratings agencies and FICO. There’s brand recognition, there’s a trust nexus, there’s something of a network effect, and there’s efficiencies in fewer recognised indexes rather than more. There are other microeconomic characteristics which make ownership of the index standards extraordinarily lucrative too. Primarily this is because ownership of the intellectual property is monetised through licencing deals which entails annual subscription revenues, and royalties. Importantly, the large ETF operators pay ongoing royalties based on the assets they managed under a MSCI index. Oh, and before I forget, they have pricing power.
This is an extraordinarily pure expression of the Gross Revenue Royalties economic model. The ETF operator would have little hope of raising assets without the brand recognition of a well known index. While running an ETF is a commodity business (the only competitive advantage that an ETF operator can hope to have is offering lower fees than the next guy), the index standard requires virtually no capital, no sales effort, and no significant capital expenditures. MSCI benefits are more and more assets accrue to passive index investing.
I was attracted to MSCI’s story because they have experienced a similar quality inflection (which I am very fond of investing in) that Coca Cola did under the leader of Roberto Guizeta, that Versign did in the early 2010s, that FICO did in 2018, and that Moody’s did in the early 2000s. What made this story a little different is that the inflection to quality did not come from within - it came from without, and with much fanfare. MSCI has also outperformed most of its peers during its life as a publicly trade company. The level of performance since listing in the November of 2007, is really only eclipsed by a handful of companies.
Historical context
The history of MSCI begin with Capital Group. Historically, and even today, Capital Group (CG) is more associated with funds management than indices. In the 1950s they came to significant prominence by being a prime beneficiary of the rise of mutual funds. Mutual funds would eventually be superseded en masse by the passive index fund. CG had a number of key innovations in the funds management world, with one of their niches being international investments. In the 1960s they began publishing indices for non US stocks. During the 1980’s Morgan Stanley licensed the rights to CG’s international indices - which would later be branded Morgan Stanley Capital International - and by the early 1990s they had become the standard benchmark for international equities.
The flagship MSCI index products have been in use since 1969, with historical data going back as far. The company was incorporated as a stand alone subsidiary within MS in 1998, with CG holding a minority equity stake. As has been the case with most wonderful franchise businesses, management acquired a number of lesser businesses too. While still under the MS banner, MSCI acquired Barra Inc. in 2004. Barra provides investment and analytics software aimed at helping financial professionals manage complex portfolios From 2010 to the present MSCI have acquired no fewer than 7 other data, analytics, and lately ESG-styled businesses. All that lovely high margin revenue poured into a veritable alphabet soup of various commercial enterprises, most of which MSCI has trouble explaining what they do.
MSCI, like other key financial intermediaries of our age, found great success in two constant themes of the post-war era. Firstly, American culture, in certain domains, has travelled extremely well. While the U.S. stands at the centre of all global capital markets, its standards have been held in high regard. Countries, and companies vie for inclusion in the American-conceived index products, and MSCI benefitted from sitting firmly in this nice. Secondly, the ever greater financialisation of the global economy has also been a boon for the company. As a large portion of their revenues and earnings has been derived from assets managed under their indices, the popularity of equity investments is directly proportional to a portion of MSCI’s success.
In 2007 MS began the process of spinning out MSCI entirely. It shouldn’t be surprising how strong its financials were pre-IPO:
There are a few interesting points here. Firstly, the large bump in revenue and consequent hit to operating margins during 2004 was a result of the Barra acquisition. Secondly, MSCI’s historic business model was, as the company would put it:
Our principal sales model is to license annual, recurring subscriptions to our products for use at specified locations by a given number of users for an annual fee paid upfront. The substantial majority of our revenues comes from these annual, recurring subscriptions.
MSCI 2007 Annual Report
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