Yesterday morning, Vanguard announced it would be dropping Msci Inc (NYSE:MSCI) as its index provider on 22 ETFs. In addition to an estimated $0.13 annualized EPS (JMP estimates) impact from this loss, investors believe Vanguard’s announcement highlighted a range of risks to MSCI including pricing risks in the ETF business, the risk that other clients could also switch e xisting ETFs away from MSCI (including BlackRock), and the potential for pricing pressure to spread to the broader index subscription business. It seems that the stock did over-react, dropping 27%, if 2013 EPS will only be $2.11 instead of $2.24 (or 5%), according to JMP.
Msci Inc (NYSE:MSCI) indicates that these ETFs represent $131 billion of AUM and that the annualized financial impact will be $24 million in both revenues and operating income or, we estimate $0.13 in annualized EPS.
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Focus Turns to Blackrock:
While the Vanguard news is a clear disappointment and a surprise to investors (Credit Suisse unaware of other established funds of this size transitioning index providers), Credit Suisse does not think it foreshadows a similar move by BlackRock, Inc. (NYSE:BLK), Msci Inc (NYSE:MSCI)’s largest customer (8% of 2011 revenue). BlackRock, Inc. (NYSE:BLK)’s iShares products have more of an institutional following that places a higher value on the underlying benchmark (MSCI), relative to Vanguard’s greater retail-orienation. However, with Blackrock accounting for a disproportionate amount of MSCI-linked ETF AUM, Credit Suisse expects pricing to come under pressure.
More important than the transition by Vanguard is the potential impact on MSCI’s relationship with BlackRock, Inc. (NYSE:BLK), the largest global ETF provider, and MSCI’s largest customer. Post Vanguard’s transition, analysts estimates that Blackrock will be ~9% of MSCI’s total revenue in 2013 (and likely 10%+ in 2014).
Why BlackRock May Be Different than Vanguard:
While the move by Vanguard has put focus on the stability of the relationship with BlackRock, Inc. (NYSE:BLK) MSCI’s largest customer. Vanguard markets itself as a low cost ETF and has more of a retail focus, which could make it easier to switch benchmarks. Following this announcement, BlackRock, Inc. (NYSE:BLK) made a public comment supporting the quality of MSCI indexes and acknowledging plans to deepen its partnership with the company. BlackRock’s relationship with MSCI could be used as a selling point on quality.
Two lessons for investors:
1. Companies that rely on a large chunk of their revenue from one or only several sources, are riskier. If company A depends on company B for 30% of that revenue, and something happens to that deal, Company A could be in big trouble. The more diversified the revenue stream the better.
2. This could be a buying opportunity for Msci Inc (NYSE:MSCI). We believe the market is not rational. If EPS should be down 5%, it does not make sense that the stock would drop 27%. Obviously, investors must do their due diligence and there are other factors besides the drop by Vanguard. However, this might be a good time to look at MSCI as a buy.
Disclosure: No p positions