MSCI Inc. (NYSE:MSCI) Q4 2022 Earnings Call Transcript

MSCI Inc. (NYSE:MSCI) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good day, ladies and gentlemen, and welcome to the MSCI Fourth Quarter 2022 Earnings Conference Call. As a reminder, this call is being recorded. I would like to now turn the call over to Jeremy Ulan, Head of Investor Relations and Treasurer. You may now begin.

Jeremy Ulan: Thank you, operator. Good day, and welcome to the MSCI fourth quarter 2022 earnings conference call. Earlier this morning, we issued a press release announcing our results for the fourth quarter of 2022. This press release, along with an earnings presentation, will be referenced on this call as well as a brief quarterly update, are available on our website, msci.com, under the Investor Relations tab. Let me remind you that this call contains 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 a discussion of additional risks and uncertainties, please see the risk factors and forward-looking statements disclaimer in our most recent Form 10-K and in our other SEC filings.

During today's call, in addition to results presented on the basis of U.S. GAAP, we also refer to non-GAAP measures, including, but not limited to, 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 insight 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 in the appendix of the earnings presentation. We will also discuss run rate, which estimates at a particular point in time the annualized value of the recurring revenues under our client agreements for the next 12 months subject to a variety of adjustments and exclusions that we detail in our SEC filings.

As a result of those adjustments and exclusions, the actual amount of recurring revenues we will realize over the following 12 months will differ from run rate. We, therefore, caution you not to place undue reliance on run rate to estimate or forecast recurring revenues. We will also discuss organic 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 Fernandez, our Chairman and CEO; Baer Pettit, our President and COO; and Andy Wiechmann, our Chief Financial Officer. Finally, I would like to point out that members of the media may be on the call this morning in a listen-only mode. With that, let me now turn the call over to Henry Fernandez. Henry?

Henry Fernandez: Thank you, Jeremy. Welcome, everyone, and thank you for joining us today. In the face of significant global headwinds, MSCI delivered strong fourth quarter results to cap off another successful year. Among our fourth quarter highlights, we posted organic revenue growth of 7%, including organic subscription revenue growth of 16% despite a reduction in our AUM-linked revenue. This growth, combined with our intense focus on expense management, drove adjusted EPS growth of 13%. In terms of capital management, we repurchased more than $70 million worth of MSCI shares. You would also note that our Board of Directors has approved increasing the dividend by 10% to $1.38 per share. For 2022 as a whole, we posted organic revenue growth of 9%, including organic subscription revenue growth of 15%.

We also achieved adjusted EPS growth of 15%, and our share repurchases totaled nearly $1.3 billion. We delivered these results despite historic levels of market volatility, which makes us cautiously optimistic about the year ahead. MSCI continues to benefit from our diversified all-weather franchise, which allows us to thrive in all environments. In 2022, over 97% of our revenue came from three recurring revenue streams, including recurring subscription revenue, which was about 74% of the total; recurring AUM-linked revenue, which was 21%; and recurrent listed futures and options transaction-based revenue, which was about 3%. While the external environment created headwinds and more variability for AUM, our subscription and transaction-based derivatives businesses performed well through difficult operating conditions.

We have once again demonstrated the balance, adaptability and resilience of our franchise, which has enabled us to continue making critical investments in long-term secular growth areas. These investments are helping MSCI expand and enhance our solutions to meet the needs of an increasingly diversified and diverse client base. Baer will talk about our solutions in greater detail. For now, I would like to explore the strategic backdrop for both our 2022 results and our 2023 priorities. MSCI continues to see enormous growth opportunities across product lines, asset classes and client segments. At times like this, investors become even more reliant on high-quality data, models, analytics and research to help them understand fast-moving market changes.

MSCI is constantly monitoring for signs of pressure that our clients could face from reduced budgets and longer sales cycles to increased layoffs and fewer new fund raises. That being said, we are cautiously optimistic on the path forward. Our strategy continues to capture major structural shifts in the investment world. For starters, index investing is increasingly popular across regions, asset classes and investor types. The reason is simple. Index investing gives investors an efficient mechanism to express their investment thesis and preferences and to focus on asset allocation. During periods of financial turmoil, the unique strength of MSCI's Index business become even more salient. We can offer one-stop shop for different types of indices across many layers, including asset classes, exposures, styles and investment teams.

I have spoken before about the massive potential of direct indexing in particular. I want to emphasize that MSCI dramatically strengthened our direct indexing market position in 2022. For the full year, we increased our total number of direct indexing clients by 200%. The index investing trend reflects a broader shift toward outcome-oriented investment strategies. ESG investing is a big part of that. As you know, ESG has become a hot button political issue, especially in the United States. However, political noise is different from investment reality. And the reality is that ESG risks are financial risks. That is why even as the parties and the bank gets launder, investors continue to make ESG integration a priority. For example, the Index Industry Association recently surveyed investment fund companies across the U.S., U.K., Germany and France.

An overwhelming majority of the respondents said that ESG has become more important to their investment strategy between 2021 and 2022. These findings are reinforced by client demand for MSCI's ESG solutions, which has remained strong. No single issue has done more to elevate ESG than climate change. In 2022, climate risk became increasingly visible as countries around the world suffer from record heat waves, record drought conditions and record flooding. What is true of ESG risk in general is true of climate risks, in particular. There can be material financial risks. Investors understand that. For example, in a recent Deutsche Bank investor survey, more than 3/4 of respondents said that climate change either is already having a severely negative impact on the global economy or will have such an impact over the next 10 years if left unchecked.

Investors recognize that climate change is also not only at risk but an opportunity. Consider a recent report from the International Energy Agency on renewable technologies. The IEA now projects that the world will have as much renewable power in the next five years as it did in the past 20. MSCI is determined to become the undisputed leader in climate-related investment tools. To support these ambitions, we continue to make key investments across asset classes and geographies. As a result, MSCI is now well positioned to help all types of clients achieve the net zero pledges. In 2022, we saw especially strong growth in climate sales among nontraditional client segments, especially corporates, banks and traders, wealth managers and hedge funds.

We have also developed innovative climate tools for private assets, an area where we continue to see tremendous possibilities for growth. One example is the carbon foot printing of private equity and private debt funds tool that we launched with Burgiss towards the end of 2021. The key enablers for all of this remain our data and technology. MSCI's ongoing tech-driven data transformation is helping us improve the client experience in so many different ways. Last month, we expanded our strategic partnership with Microsoft to support our new MSCI One technology platform, which is built on Microsoft Azure. Just last week, MSCI announced another strategic partnership with Google Cloud to build an investment data acquisition and development platform.

This new platform will make it easier for ourselves and our clients to translate world data into actionable insights. As I mentioned earlier, the importance of our data, models, analytics and research only increases during periods of market turmoil. Our solutions play an essential role in helping investors navigate today's volatile landscape and build better portfolios. At the same time, MSCI's resilient, all-weather franchise continues to allow us to invest for the future while maintaining strong profitability growth. Just one final note before I turn the call over to Baer. Earlier this morning, we issued a press release announcing that Baer has been appointed to the MSCI Board of Directors effective immediately. I would like to congratulate him on his well-deserved appointment.

As many of you know, Baer and I have been close business partners for 23 years, and he has been instrumental in building MSCI into what it is today. Baer's unique skills, experience and strategic thinking will significantly strengthen the Board's effectiveness and ability to continue to create shareholder value. I would also like to be clear that my role is not changing at all. I have no plans or timetable to retire or step down as CEO or Chairman of the Board. I remain extremely engaged and energized by the company's tremendous growth prospects. If anything, I am more excited today but our significant opportunities that I have been at any time in the 27 years that I've been leading this business. I look forward to continuing to partner very closely with Baer for many more years as CEO and President and now as fellow Board members.

Again, congratulations to Baer, whom I now will turn the call over to. Baer?

Baer Pettit: Thank you, Henry. I'm excited to join the Board and serve our shareholders in this very important role. MSCI is in the midst of many strategic transformations. As President and Chief Operating Officer, I've developed the operational insights and strategic vision that I believe will bring a new dimension to the Board to help MSCI drive shareholder value and deliver on our growth initiatives. Now I will turn to my comments on our quarterly performance. I'll begin by going over some of the highlights for the quarter, the steps that we took to manage in the current environment and some of our priorities for 2023. MSCI's continued ability to deliver strong organic growth and resilient retention during the quarter is directly linked to the investments that we have consistently made over the years, both in good markets and in less supportive ones.

As we had indicated to you previously, with the backdrop of unprecedented market headwinds and volatility, we aggressively managed the pace of our discretionary spend and also made select head count realignments to best position MSCI for 2023 and beyond and to preserve our ability to deploy our investments to the greatest opportunities guided by client demand. For our 2023 investment plan, these areas continue to include climate, ESG, client design indexes, fixed income and the ongoing modernization of the client experience. To further illustrate the success of our approach, I will spotlight specific accomplishments during the quarter in Index, Analytics and climate. In Index, we delivered 12% organic recurring subscription revenue growth and 95% retention, which was certainly reflective of the strength of our franchise, our strong client relationships and the investments we've made.

Photo by Sebastian Herrmann on Unsplash

In custom indexes, our subscription run rate grew 15% as we continue to invest heavily in the development of our models, software and data to deliver custom indexes at scale. These investments have increased our index building capabilities, reduced turnaround time and strengthened our global support model, positioning us well to capture the enormous opportunities that we see ahead. We are also benefiting from continued investments into our index derivatives franchise. In listed futures and options, we've delivered record full year revenue of $61 million, where we're benefiting from new product launches for Paris-aligned climate action and low carbon target indexes with exchanges driven by ongoing asset owner demand to facilitate the net zero transition.

In addition, sales of structured products linked to our indexes were $23 million, growing more than 60% year-on-year for the full year. We remain excited by the opportunities in fixed income indexes, another long-term investment area for MSCI, especially in the current period where investors are focused on credit allocations now that they can earn higher yields with less duration. At the end of December, fixed income ETF AUM linked to MSCI's proprietary and partner indexes was $46 billion, after attracting more than $19 billion of inflows during 2022. We believe our flanking strategy, where we play to MSCI's strength in ESG and climate, as well as our ability to forge partnerships with key players in the fixed income space have all been growth enablers.

Let me now turn to Analytics, where we drove 7% subscription run rate growth, excluding FX. New subscription sales were lower versus a strong fourth quarter in 2021 while also experiencing higher cancels which were not so much reflective of higher cancel volumes, but rather from a few concentrated large client events. It's important to remember what MSCI is trying to achieve in Analytics. We already have a large business in enterprise risk and performance, which drove about 60% of our new subscription sales. These tools can serve as large operating systems for investors to help investors in asset allocation decisions and in calculating and understanding their risk and performance attribution. We also offer tools for more targeted use cases such as our equity models and portfolio construction tools that clients can integrate into their investment processes and third-party vendors can integrate into their platforms.

These offerings comprise roughly 1/3 of our new recurring sales during the quarter. Throughout 2022, our Analytics growth came from both types of tools, and we believe the same will be true in 2023. The investments MSCI has made in modern, flexible distribution channels are enabling us to chip away at new opportunities. including with front office investment professionals and increasingly for climate use cases where we see a strong pipeline for the upcoming year. These include our investments in platforms such as Climate Lab Enterprise, where we have delivered over 15,000 climate reports throughout the year for our analytics clients since our launch in late 2021. Our unique position of having our clients' portfolios loaded in maps represents a competitive differentiator.

It has allowed us to help clients understand all the carbon emissions as well as physical and transition risks associated with their holdings. As Henry indicated, climate remains one of the most attractive and tangible opportunities for MSCI as a firm to help the investment industry. Across all MSCI product lines, we delivered $79 million of run rate, growing around 80% year-over-year, with momentum across all client segments and regions. Back in June, we launched our total portfolio footprinting tool, which helps clients measure portfolio-wide emissions across ad cases, including equities, munis, corporate bonds, sovereigns and private assets. Since then, it's been a key enabler for closing several strategic deals with asset managers banks, insurance companies and others.

It's also enabled us to help clients align with emerging PCAP standards. We also continue to drive new wins with large asset manager and asset owner clients to help them with specific use cases, including TCFD reporting, climate stress testing and scenario analysis. Following the recent launch of MSCI One, I wanted to make a few clarifying observations as to what we're trying to accomplish. It is not a new product or a stand-alone new platform to replace other products. It is instead a vehicle for integrating MSCI's world-leading content and analytics using software powered by Azure. We are now up providing clients with a common entry point to access some of our key products and applications that they rely on day-to-day, including climate lab, RiskManager, ESG manager and others, which we believe will also enable self-servicing, self-discovery and upsell opportunities.

In summary, the high-returning investments we made in 2022 and our rigorous financial management helped us execute successfully during the year. Our success provides a template for how MSCI will continue to operate and thrive in 2023 and the years ahead. And with that, I'll turn the call over to Andy. Andy?

Andy Wiechmann: Thanks, Baer, and hi, everyone. As Henry mentioned, we completed 2022 by delivering organic subscription revenue growth nearly 16% for the quarter and 15% for the full year, outperforming our long-term target of low double-digit growth. In the face of market headwinds, our results reflect the durability of our franchise and the benefits of the consistent investments we've made into attractive high-growth areas. In Index, subscription run rate growth was 12% in the quarter, our 36th consecutive quarter of double-digit growth. We've seen tremendous traction and healthy growth within our market cap-weighted modules as our buy-side clients broaden their usage of our indexes. And we continue to see the utility of our index content expand across a wide range of high-growth segments.

Across our Index subscription base, asset managers and asset owners together had subscription run rate growth of 10%, while hedge funds, broker-dealers and wealth managers together grew 17%. We also saw continued momentum in our investment thesis index offerings with nonmarket cap index modules collectively achieving a subscription run rate growth of 14%. From the end of September through year-end, market appreciation contributed approximately $119 billion to AUM balances of equity ETFs linked to MSCI indexes, although for the full year, we saw a net decline of $284 billion in AUM balances. Additionally, we were encouraged by the $23 billion of cash inflows into ETFs linked to our equity indexes during the quarter with roughly $15 billion of inflows into emerging market exposures and over $9 billion into developed market exposures.

Equity ETFs linked to MSCI ESG and climate indexes experienced inflows of $6.5 billion, representing approximately 70% market share. Flows into ETFs linked to MSCI factor indexes were more muted but still positive with investor appetite more focused on yield and income where we have less presence than on other factors where indexes are more widely used, such as momentum and minimum volatility. During the fourth quarter, the run rate basis points on AUM paid to us by ETF clients was flat year-over-year supported by a mix shift out of lower fee products. Despite the steady levels over the last year, we continue to believe the average basis points on AUM paid to us by ETF clients will gradually decline over time, although we expect the declines will be more than offset by strong growth in assets.

In listed futures and options, we once again saw some of the natural hedges embedded in our asset-based fee revenue line as traded volumes showed healthy growth against the choppy market backdrop. Looking ahead, if market levels continue to rebound and stabilize, we would hope this would be constructive to AUM-linked revenues from ETFs and non-ETF passive. At the same time, futures and options volume and revenues may decline compared to the volatile period a year ago. We continue to believe our opportunity is significant in licensing indexes for both AUM-linked ETF and non-ETF passive products as well as in transaction-based listed derivatives products. In Analytics, subscription run rate growth was nearly 7%, excluding FX. As Bart mentioned, we continue to gain traction in front-office use cases supported by tremendous strength in our factory analytics and our climate tools in recent quarters.

Additionally, our growth has been supported by firm-wide enhancements to our interfaces and progress in delivering broader, more flexible access to our content. However, as we have previously noted, we expect some lumpiness in the segment across both sales and cancels given the broad range of clients and use cases that we support. In our ESG and Climate segment, new recurring subscription sales grew 64% from the third quarter as we saw some rebound in large-ticket deals in both ESG research and in Climate and tremendous traction in closing deals in EMEA. Climate remains one of the most attractive growth engines for MSCI. Our firm-wide climate run rate reached $79 million, an increase of 80% from a year ago, reflecting exceptional growth across geographies, product offerings and client segments.

Across all of our segments, we continue to see strong secular demand for mission-critical must-have tools, and we continue to see a strong sales pipeline, although we remain cautious given the market backdrop. As we have mentioned previously, in past periods of sustained equity market pullbacks, we can sometimes see slightly elevated levels of cancels and lengthening of sales cycles. In connection with our downturn playbook, we continue to identify efficiencies to aggressively reposition our expense base to drive attractive profitability growth while preserving investments in the most critical growth opportunities. As part of our regular review of our talent and our expense base in the fourth quarter, we took proactive actions to regrade our employee footprint, resulting in a $16 million severance charge, which was roughly $13 million higher than a year ago.

These tough actions have allowed us to preserve and even enhance our investment spending in certain key areas. This expense discipline, coupled with our subscription revenue growth, has enabled us to drive strong growth in adjusted EPS even through tough environments. The tremendous growth in our subscription base has been supported by doing more for our clients, continuing to penetrate newer large addressable markets and capturing price increases enabled by the continuous enhancements to our products and client experience. During the fourth quarter, price increases contributed about 35% of our new subscription sales firm-wide across all products and more than 40% within index. We ended the year with a cash balance of $994 million, of which well over $600 million is readily available.

Free cash flow came in slightly below the low end of our previous guidance. We saw a small slowdown in client collection cycles as a result of extra approvals within certain clients, which we believe is related to the market backdrop. But we believe overall collections remain healthy, and we see no issues around collectability. Our capital allocation framework, which is focused on maximizing shareholder returns, remained unchanged. We will continue to deploy our investment dollars towards the highest returning organic growth areas, return capital through a steady dividend that increases with adjusted EPS and opportunistically capitalize on share repurchases and pursue value-generative MP&A. As Henry indicated earlier, we have decided to increase our dividend in the first quarter.

We are not making any changes to our dividend policy or a broader approach to capital allocation. We have decided to shift our annual dividend increase from the third quarter, where we have historically announced the increase to the first quarter in order to more closely align with our annual planning process. Lastly, I want to underscore that we also continue to actively evaluate and source bolt-on M&A opportunities, particularly in areas of unique content and differentiating capabilities such as private assets, climate and ESG as well as fixed income. Lastly, I would like to turn to our 2023 guidance, which we published earlier this morning. Our guidance ranges reflect the assumption of continued volatility in financial markets with overall equity market levels down slightly from current levels during the first half of the year and gradually recovering in the second half of the year.

Our expense guidance range reflects the efficiency actions we have taken in recent months and captures the investments we will continue to make in order to deliver growth. We expect normal seasonality in our expenses with $15 million to $20 million of elevated benefits and compensation-related expenses in the first quarter. I also want to highlight that our CapEx guidance reflects a continued high level of software capitalization as we continue to enhance our platforms and interfaces across product lines. Our tax rate guidance highlights that we expect our effective tax rate to increase slightly year-over-year primarily reflecting that we expect to receive a smaller windfall benefit in the first quarter as a result of where the share price is relative to the price at grant as well as based on the amount of awards vesting.

There could be pressure on year-over-year adjusted EPS growth in the first quarter due to the higher tax rate and the significant decline in average ETF AUM levels relative to the average levels during Q1 of last year. Lastly, I want to highlight that our free cash flow guidance reflects the expectation of higher cash tax payments in 2023 as well as a slight degree of caution on client collection cycles based on the environment, consistent with what we saw in the fourth quarter. Overall, we're well positioned for the year ahead, and we're excited to continue to drive growth and differentiation. In periods of volatility and uncertainty, we believe MSCI is uniquely positioned to help our clients capitalize on unique opportunities and drive value creation.

These are the times when MSCI thrives. We look forward to keeping you all posted on our progress. And with that, operator, please open the line for questions.

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