Moody's Corp. (NYSE:MCO)
Goldman Sachs Financial Services Conference Transcript
December 5, 2012 11:00 AM ET
Linda Huber - Executive Vice President and CFO
Brian - Goldman Sachs
Brian - Goldman Sachs
All right. Good morning, everybody. It’s 11 o’clock. And welcome to our next session here with the Moody’s Corporation. And I’m pleased to introduce our next guest, Linda Huber, Executive Vice President and Chief Financial Officer of Moody’s. Linda welcome.
Brian - Goldman Sachs
Linda will be walking through a presentation this morning, then afterward I’ll ask few questions and then we’ll open up to you guys for as many questions as you’d like. Linda, the stage is yours?
Thank you. We’ve got about half an hour, so I’m going to move through these slides rather quickly and then happy to take any questions, anyone might have. And you don’t need to read the disclaimer.
But moving on from there, first, I’m going to talk little bit about what’s going on at Moody’s, some information on our financial outlook and then overview. Talk a little bit about macro conditions, always of interest, few specifics on the rating agency and then few specifics on Moody’s Analytics.
Okay, so far everyone has followed the company for awhile. This is a well-known slide. Again, about two-thirds of our revenue coming from the rating agency and about a third of our revenue is coming from Moody’s Analytics. [Audio Gap]
But, again, we are in different as to whether investors would like to use our ratings or actually buy from us the tools to do their own credit work. So, all of our businesses fit under this umbrella.
Now, this slide which we first used at Investor Day has proven to be quite popular, what we are trying to do here is show you, the reason why we believe that we can achieve double-digit revenue growth over the intermediate term, with that four components here of growth that Ray initially introduced at Investor Day.
The first would be that, we believe the debt issuance will continue to grow based on global GDP growth and in fact in access of global GDP growth.
Secondly, disintermediation is very helpful to Moody’s. This is in fact the fact that the banks are perhaps less willing or able lend then they were before.
Thirdly is the growth in our Moody’s Analytics business, which has been very helpful to us as a tailwind.
And then lastly, Moody’s pricing power, in which we align pricing increases with value, but provide us with about 4% growth for our topline.
Now, again, looking at our businesses on the pie in the upper left, you see again that the two-thirds of the business come from the rating agency. Moody’s Analytics providing one-third and our business is a little bit more skewed toward the U.S., at least was in the third quarter, but generally pretty well-balanced between U.S. and international.
Another feature that needs to be well understood is that the Corporation is balanced 50-50 between transaction revenues and recurring revenues. The rating agency though has more transaction revenue than recurring revenue, whereas Moody’s Analytics works exactly the opposite.
This is 78% subscription revenue, only 22% transaction. So the two businesses blend together well to come to 50-50 transaction and recurring. Again, if we have a quarter of less than robust bond issuance, we can get through that, because of the heavy weight of our recurring revenue.
Now, one other things that we like to show is that, we put together the rating agency and Moody’s Analytics, because interestingly, the rating agency while a high margin business is a volatile business. So if you look at the change in revenue, you notice is sort of time curve pattern. But, again, you see the volatility that the rating agency displays overtime.
Interestingly, Moody’s Analytics is a much more stable growth business and provide some nice offset for the Corporation as a whole. What you see is some dampening of the Corporation’s revenue line by providing the two businesses that tend to work in slightly different ways.
Now our financial overview for the third quarter at the top and year-to-date. We are very proud of these numbers and it was a very strong quarter for Moody’s. You can see that led by corporate finance at the top, very strong performance in the third quarter.
And our Moody’s Analytics business, the second set of bars also had the strong performance, 70% growth in the research, data and analytics business, and 26% growth in the enterprise risk software business.
Professional services here look interesting because we are still processing the businesses that we bought last November. So we have a bit of a factor here that we haven’t quite left those acquisitions yet.
And third quarter year-to-date, again, numbers are very strong. And what we are seeing, if they close in the U.S. it’s been outpacing growth, outside the U.S. for this period of time. But, again, the numbers have been strong and as you’re aware we’ve increased guidance three times this year.
This slide provides a very interesting view that in 2011 we reobtained the revenue that we had in 2007. But the components of that revenue have shifted quite a bit. What’s important though is that the CAGR over this period is 13% topline growth and we are able to do this though the components of the business have shifted.
So this piece of the bar, will bar as structured finance, you’ll notice its revenues are about half what they were at the peak. Corporate finance is about twice what it was during that earlier period. Public project and infrastructure and FIG remained about the same proportionately. But Moody’s Analytics here at the top is providing a much greater percentage of our revenue. So, again, the revenue mix has shifted but our growth has continued to be quite compelling.
Now, for those of you who are interested in margin and most Moody’s shareholders are very interested in margin. Another similar view overtime since the financial crisis, our margin has come down. But what you see is that the margin has started to recover and we are experiencing margin expansion.
So what you see here is coming off the natter of 2010. We are guiding back up to 40% margin for 2012. We’ve also added the adjusted operating margin measure which adds back G&A primarily. As a way to look at our business because the competitors to Moody’s Analytics more often use the EBITDA type of margin measure.
Well, you can also see here is that there are margin difference between the rating agency and Moody’s Analytics and again, they blend very nicely for the Corporation as a whole. Again the rating agency is the higher margin but more volatile growth business and MA is the somewhat lower margin but higher growth business.
And if you are interested in cash flow, the Corporation continues to generate very strong cash flow. You see the increase here. We’ve added a free cash flow measure, which is just normal operating cash flow left rather modest to capital expenditures. We continue to be a strong cash flow generator with very modest capital expenditures.
And another piece that’s under appreciated is that, Moody’s tax rate has come down over the period since the early 2000. The good offset to the fact that the margin has also come down. This is helpful to the shareholders.
You see the tax rate was 41%. This year we are guiding to 32%. And that has saved approximately $360 million since 2004 and we continue to look at our tax planning every year. Now that we are 50-50 U.S. and international, we have opportunities to think about our financing and how to think that is tax efficient is possible.
Now, we also get the question about, what we do with the strong cash flow and what are our thoughts on how that should be redeployed? So the strong cash flow, our preference would be to invest organically and to potentially increase our ownership in our joint ventures.
But very few of the acquisitions are actionable in the rating agency. For example, we own 49% of our joint venture, CCXI in China. We would like to acquire the rest of it. The Chinese government has other thoughts about that. And so we don’t find that we can repurchase the rest of that business.
In India, we own 29% of our ICRA business. We would like to own more of that. But again the price of the piece held by the Indian banks trades at a very high P/E and in fact would be quite dilutive for us to acquire. So the issues here is the targets are scaled are few and far between, and we are in most of the places where we need to be in terms of offices.
So then we look at the second screen, which is Moody’s Analytics, and we want to invest organically to help our product growth. But we also continue to look very carefully at acquisitions, primarily bolt-on acquisitions. I don’t think you’ll see Moody’s moving to a third leg, that’s not something we are interested in. And most of these deals tend to be on the smaller side, we are sweet spot of sort of $200 million and below.
So, again, we stay very close to our core and we are very thoughtful about how we handle acquisitions. You may want to take a look at Investor Day presentation, where Rob Fauber, our Head of Corporate Development goes through how we think about hurdle rates and other acquisition activities.
So if we are not able to use all of our cash flow within the rating agency first and analytics second, then we want to return our capital to shareholders. And there are two ways that we use to do this, the first is share repurchase, the second is dividend.
We’ve said $225 million of share repurchase this year and we are guiding to $200 million, $300 million in the future. And our dividend, we’ve increased three times recently, 25% each time and we plan announce our dividend for 2013 in the coming week.
But, again, the dividend CAGR has moved up well and we are very cognizant that some of our shareholders save our dividend, some save our share repurchase, some save a balance and we are very cautious in how we think about that.
This slide comes from the Investor Day presentation, when we are asked, how we think about overall capital allocation. And generally in the last close to five years, what you see is we returned 65% of capital to shareholders through this combination of share repurchase and dividend, and 35% of the capital was spent on acquisitions and then capital expenditures. So, our use of cash flow and capital would really be sort of two-thirds, one-third and that’s the ratio that we are pretty comfortable with.
Our balance sheet remains pretty clear cut. We have about $200 million of net debt. We did a bond deal back in August and our cash flow sits about 50-50 U.S., non-U.S.
This is our guidance for 2012. This guidance was as of October 26. Again, our third guidance increased this year. You see revenue and expenses in the mid-teens range, margin we’ve got it up to 40%, tax rate of 32% and EPS both GAAP and pro forma there and we have indicated our share repurchase plans for this year.
Now, in terms of the macro view, this is a new slide. You see that issuance has been very choppy. Last year, first two quarters very strong, second two quarters with the euro crisis quite weak. The first quarter of 2012 came roaring back and the third quarter of 2012 was also very strong as well.
These numbers indicate what we’re seeing for third and fourth quarter -- sorry for October and November and October was very strong, November as well. We do not yet have data on speculative grade bank loan origination. So sorry about that but if you check up October and November, you can see that the fourth quarter is closing in on the very strong third quarter. And we’re seeing that we should finish up the year on a pretty good issuance note.
Again this is just looking at the issuance overview. One other things that we’re also watching is the impact of disintermediation on Moody’s. What you can see here is the growth in European bond issuance moving along at 16% CAGR with loan growth that’s flattened out in Europe and is growing at only 5%.
Now, this mix traditionally has been very different for Europe in terms of the U.S. -- versus U.S. The European market is sort of 80-20, thanks to bonds. U.S. is about 50-50 And what we’ve said is that if this line were extrapolated just the same slope that we have there, that’s about $600 million revenue opportunity for Moody’s over 10 years, if we just continue to see the disintermediation that we have in Europe to this point.
Also you’re starting to see European corporate issue in the U.S. market in earnest, Yankee bonds to the third quarter of 2012 that would be bonds issued in U.S by European issuers have been very, very strong. And perhaps most importantly for Moody’s, we are able to drive demand in the rating agency. We are not just takers of demand.
So what you see here is our commercial efforts, which I would say is very much in the early innings for Moody’s. You see that we have close to 600 companies, high-yield companies, the orange bar there is Europe asking for new ratings so that they can be prepared to issue bonds. And this drives our new demands for the future and additional revenue stream.
We do charge for a new rating and then we would again collect to see when debt is issued and an additional fee for the monitoring of that debt. Investment-grade same-store to trends but both investment-grade companies that would like to have ratings have already done so. Again these are new rating and you can only be newly rated one time.
Now, we get a lot of questions about it’s been a very strong year in 2012, what about 2013 and forward. This is what we call our wall of refinancing with that investment grade go forward, spec rate and bank loans. And this is debt that is rated by Moody’s and we would expect to see that back in house when it goes forward.
So what you see here is truly the dollars of refinancing. Investment grade bonds and spec grade bonds particularly increasing to 2016, that’s the U.S. view. This is the EMEA view and you see the same sort of trends much stronger in investment grade bonds in 2013 and ‘14.
Now, we took a new shot at this, the new slide for those of you who watch closely. And what you can see is we have measure of uses of proceeds because one of the questions we get would be, so refinancing is running strongly what about everything else. What’s going on here is we have our capital market group accounts mentioned in prospectuses for use of proceeds. So, in other words, you may see general corporate purposes and debt refinancing and M&A and investment purposes.
So you may see four or five uses of proceeds. But if you look just that accounts, you can see that half of the use is for debt refinancing, for investment grade bond issuance and the other half is for other sake. So what we’re trying to show here is that we do see a trend to do other things other than refinancing. And in fact, we’re waiting for these other three cylinders of the company to fire up.
You see here the green line is the same in each chart. It shows bond issuance trailing 12 months. But when you see that M&A volumes have been a little bit stalled, you see that stock buybacks and bond issuance have been okay but not as strong as they were in 2007 and CapEx has also been a little bit stalled perhaps because of financial cliff issue -- fiscal cliff issue, excuse me. So what we’re hoping is that these three reasons for bond issuance can fire up a little bit more heavily in 2013.
Last but not least, you see very good trends here in the emerging markets for bond issuance. It’s a small number but this is very helpful to us.
Now, the rating agency, going back to it as a whole, CAGR of 11% since 2000. You see the components of the rating agency. Again, structured finance whose debt has been greatly exaggerated in terms of the reporting of it is our second figures to this business at 20% of the pie for the rating agency. And again you see the other business is here kind of equally sized with corporate finance having lion share right now.
This shows a little bit about how those sectors have been moving. Again the third quarter has been very strong indeed. As now we’re onto regulatory development, really two to focus on here. In the U.S., we await final rules on Dodd-Frank. This has not -- those final rules have not yet arrived but we are very clear on the direction that we think that those rules will take.
And then the European Union, we have some news. On November 27, these three groups reached political agreement on the CRA3 framework. And the process we would stress is not yet finalized. It needs to be voted on and -- but it needs to be translated into 23 languages. And we expect vote will take place in January and the completion of the process will take three to nine months. But for the first time, we are able to see the shape of what is being proposed for CRA3.
Lastly, Moody’s analytics, the CAGR of 22%. Again, this includes acquisitions but this is a very fast growing and increasingly important part of our business. You see research data in analytics at 57% of the pie for analytics and our risk solution business, the software business at 30% of the pie. Professional services which includes our coupon knowledge outsourcing business is down 13%.
So each of these businesses are growing quite well. Guidance has scored the high teens this year and very good additions from Moody’s analytics. What you can see is that we have different products for different parts of the world. So in the emerging market, you will see that professional services talking with companies about -- and banks particularly how they want to manage their risk reporting view would come first. Then they might buy risk software and then they might buy research data in analytical products from us.
So in a developed market like the U.S. it’s much more RD&A, same with Japan. But in a developing market, you would see that we’re selling much more in a percentage terms in software. So we have appropriate products for all parts of the market development cycle.
And lastly, we wanted to show you that the penetration for Moody’s analytics is good but there is a long way to go. So we would show you that we penetrated of asset managers banks and insurance companies and so on. That’s the percentage that we’re selling to. And of those in the top quintile, in other words, the top 20%, you see how many of those are buying our products. And you see the average fees of $125,000 to $650,000 in the Moody’s analytics business. This is very sticky recurring revenue and we’re very pleased with the growth again from the company.
So, with that, I’ll sit back down with Brian and see what he would like to ask.
Brian - Goldman Sachs
Thank you, Linda. I’ll actually ask you about analytics before I open it up to the audience. It’s a broader question. I guess, the first question there on, I think somewhat on cheered on risk, you answered some of it. But we often here with these business that this fell into the financial services complex in this environment, particularly sell side of investment banking side and in Europe, things have been decelerated broadly there. New business has not, maybe, walk us through reasons why it hasn’t and why you think it will be more redundant than it was three, four years ago on last cycle?
Sure. In the last cycle, we did see some unfortunate events where large investment banks combined. In other words, the Merrill Lynch and Bank of America becoming one, and what we saw was sort of, if you want to think of it as two plus two became three. That was challenging to manage.
Right now, we are seeing very strong growth in the fixed income market and its participation. And we’re seeing additional seeds coming into fixed income, which generally means more purchase of research for us. And on software side, we primarily saw into banks and insurers who need this software to be able to accomplish regulatory risk reporting.
In other words, the regulatory deal provides a very strong hook for us in terms of those products. So that tends to exist regardless of the economic climate and our research has proven to be quite sticky and one that people would love to give up. So we found that we’re able to actually grow that business despite some difficult conditions in the industry.
Brian - Goldman Sachs
Okay. And there was actually bifurcation to growth between the enterprise risk and the RD&A side.
Brian - Goldman Sachs
20% levels of growth enterprise risk. I know you don’t explicitly talk about organic versus acquired but it help us understand what was the good way to think about the trajectory that enterprise business was a couple of years?
Sure. We do talk explicitly about Moody’s analytics and I’m sorry I didn’t mention that we said on the third quarter call, the growth is 50% organic and 50% acquired. And that holds true for the enterprise risk software business as well.
Brian - Goldman Sachs
Okay. And for that one, how much visibility you tend to have in your pipeline?
We probably have about a quarter worth visibility about three months. They tend to be long large projects. We obviously have to recognize revenue in a very particular way and so the revenue recognition cycle tends to be quite long in the enterprise with software business. But we can see those projects coming a bit of evasive way. It’s not something that one understand too lightly to trade out reporting software for bank.
Brian - Goldman Sachs
Yeah. We have actually less than 10 minute left and then we’ll open up the audience for question at this point.
Just talk a little bit about -- just talk a little bit about what you think the growth in both Moody's analytics and Moody's ratings will be non-U.S. versus U.S.?
I would say that generally the international businesses have been growing faster than the U.S., but the situation in the EU has caused the non-U.S. businesses to slow unusually. We have been moving to a world in which the U.S. was a smaller piece, but that has slowed and in fact changed up for the near-term.
We would expect that the Moody's analytics business, which is a much stronger business outside the U.S., in other words think of emerging market banks, who need our software. I think we would expect higher growth outside the U.S. for the Moody's analytics business in longer term and the rating agency given the headwind for facing in Europe right now.
I think we will probably continue with the U.S. being the stronger piece at least in the near-term. But we are seeing very good growth in Latin America and some of the Asian markets as well. So it’s a little bit sporty, but I think that’s directionally how it will layout. Encourage you to dial in when we do guidance for 2013 in early February and we will see, if we can give you some more information about that then.
Hi. In corporate bonds and bank loans when you rate them with our private placements with insurance companies or other investors, are they in the corporate bond or the bank loan segment?
They will be in corporate side is that end.
The corporate side?
And I guess it’s probably because it’s SEC registered and so forth, it’s like a bank, okay. On structured vehicles you said, it’s still a healthy business, but is this more credit card receivables in auto loans because CMBS and RMBS, I mean there is not much activity in that areas in there?
Well, let me take it piece-by-piece. Structured, we have the four components. So, the asset backed side right now is doing very well, coming off a low base, but again doing quite well. So, asset backed securities would include mainly auto financing, financing of asset tariffs, which might include securitized cell phone towers things like that.
And also airplanes securitization for example and fleet -- auto fleet securitization, so that business has been doing quite well. Contrary what you said I take the other side of that. CMBS has also have been doing relatively well recently and we’ve seen pretty good activity in the CMBS market.
The derivatives market would include collateralized loan obligation, which are really the hotspot right now. And we’ve seen more CLOs in 2012 than we did from the period of 2008 through 2011. There is a week last month, where they were five CLOs in one week, which was quite extraordinary.
So, the derivative part of business upheld by CLOs has been doing reasonably well also. The placement is weak. Its residential mortgage backed securities, RMBS. And we’ve really wait to see what will happen with the next part of the cycle there. We may see some pickup in those ratings at the end of 2013, more likely 2014, but that will require that the role of Fannie and Freddie in those markets, we better understood.
So, structured actually is doing reasonably well and three out of the four segments are doing pretty well year-over-year. We have seen this structured business doing $70 million, then $80 million, then $90 million a quarter and one of the banks, in fact, its Barclays had said last week that they expect structured to grow at 10% for 2013.
Now, not sure that we will get all the way to that number, but it’s interesting to see that various market participants are relatively optimistic about structured finance. Hope that answers your question.
Yeah. You mentioned on the new rating it’s a one-time fee that the issue would pay. Let’s say, you have an investment grade issuer and they payoff their bonds and notes, now they have no outstandings and they come back decide to issue, so they have to pay the fee again?
If they have had no outstanding debt, I believe so. I don’t know the absolute answer to that, but I think yeah. If they have canceled all outstanding debt then they would come back to the market to Novo and I think they would pay the new issuer base.
I guess, one final question, with the more competition at least announced a few years ago because of problems going back to '08. I guess it hasn’t hurt your business, but I mean you are getting more competition from Duff & Phelps and A.M. Best or some new company in the rating business, rating side?
There is lots of competition. And in certain areas, yeah, we do get quite a bit of competition. The CMBS space would be one. You mentioned A.M. Best in the insurance space absolutely a strong competitor in that space. In Canada, Dominion Bond Rating Service strong competitor and Fitch around the world strong number three player to S&P and then Moody's.
Some of the smaller players find themselves being acquired and the regulatory burden that’s put on the smaller companies can be somewhat difficult. So, often times you find that they are acquired by larger players. But both in Europe and in the U.S. and it’s been around the world, there are nationally domicile players and emerging players all the time and we welcome the competition. And we will expect that we will continue to see some more of it as time goes on.
A. M. Best though they haven’t branched out beyond insurance as far as…
Not that I’m aware of primarily an insurance rating business, yeah.
Okay. Thank you very much.
Can I just ask you, how are things going in Europe in terms of regulation or agencies?
Sure. That’s what I spoke about in terms of the slide that we put up on European regulation. So, if you want to look on the website of the Finance Minister of the European Council you can see 78 pages on the third phase of Credit Rating Agency Regulation. The goal of that regulation was to increase transparency and competition and some of the changes that you will see there involved rotation of rating agencies, but that’s limited just to we believe, we interpret just re-securitization of structured finance products.
There are also some rules there around the release of Sovereign ratings in Europe and few other things. But again, we’re caution that those rules are not yet final and they need to be voted on and then translated and we’re months away from all of that.
I actually jump in on excess cash, as you have more of your business from the current revenue on the analytic side. Any change in your view on how much excess cash you really need to keep on hand?
It’s an interesting question. I think we've said that obviously we are going to keep in investment grade rating. We rated BBB+ now by just Standard & Poor's and we are going to keep a conservative capital structure, but we are thoughtful about the amount of leverage that we have and we did do that second bond deal in August 2012. So, we kind of like to keep our leverage about where it is.
Okay. And then on full forward effects, I know you had comments on the third quarter call, any updates there as we gotten deeper and closer to some of the quick effect?
I think go forward sort of a perpetual cycle and one that is frankly less detrimental to us and might be realize. Because here is the end of 2012, we maybe pulling forward the part of '13 but then as we get into '13, we may pull forward the some of 2014.
So, what we find it’s been investment grade companies can issue well ahead of when their bonds would be called when they would be due. High yield companies have to issue much closer. Generally, they let their bonds come to term and then they would issue.
But issuance has been strong and rates are historically low. And again we’ve seen from a number of the banks, we’ve seen about a trillion dollars of debt financing, debt issuance in 2012. Most to the banks are calling for a similar amount of issuance in 2013 plus or minus 5%. So again those conditions that sort of issuance would be helpful to Moody's and clarifying when we are working at record high levels of debt issuance.
Brian - Goldman Sachs
Very well and we are exactly out of time. So, Linda, thank you very much, today.
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