Value Seeker’s Analysis On Moody’s Corporation (MCO) [Slides]

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

Moody's Corporation (MCO)

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Moody's Corporation (MCO)

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

Moody's Corporation (MCO)

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

Moody's Corporation (MCO)

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 Corporation (MCO)

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:

Moody's Corporation (MCO)

See full slides below.