Moody's Corporation (NYSE:MCO)
Credit Suisse Global Services Conference
March 12, 2012 4:00 p.m. ET
Raymond McDaniel - Chairman and Chief Executive Officer
Salli Schwartz - Global Head of Investor Relations
Georgios Mihalos - Credit Suisse
Georgios Mihalos - Credit Suisse
Okay. I think we're ready to begin. My name again is Georgios Mihalos. I'm part of the data processing and IT services team here at Credit Suisse. Our next presenting Company is Moody's Corp., and representing the company is Raymond McDaniel, Chairman and CEO. And I do also want to point out that right in the front row is also Salli Schwartz, the Global Head of Investor Relations. And without further adieu I will turn it over to Raymond.
Okay. Thank you very much. Pleasure to be here and I appreciate the introduction. I don't have too much time so I'm going to jump right into this. And I will probably have to either offer some very abbreviated comments on a couple of slides or skip over a few slides. So if you have any areas of particular interest that I don't get to, make sure to catch me in the breakout session.
Okay, our disclaimer language. I'll quickly provide a corporate overview, financial profile, and then drill down a little bit into our two operating companies, Moody’s Investors Service and Moody’s Analytics. Before concluding with some comments about the macro environment and our current outlook. Starting with the corporate overview. Moody’s is comprised of two operating companies, Moody’s Investor Service and Moody’s Analytics.
The Moody’s Investor Service part of our business is the rating agency, that’s what most people are familiar with. Comprises about 69% of our 2011 revenue with Moody’s Analytics being the 31% contributor with overall 2011 revenue having reached a record last year at $2.28 billion. Moody’s has robust operating opportunities. And just briefly to summarize, our overall business targets are to achieve long-term revenue growth in the double-digit percent range. And long-term operating margin of 40% plus.
We see the principal opportunities in the business being debt associated and rating of debt associated with the growth in fixes income markets alongside GDP growth globally, disintermediation of financial institutions, the penetration of the potential client base for our Moody’s Analytics business. This is still a very fragmented sector of the financial markets for the products and services that we offer and presents opportunities to place those products. And to do so particularly in connection with expansion of bank and insurance regulatory requirements and then pricings that are aligned with areas where we can bring additional value.
This is a quick cut of the Moody’s business by -- Moody’s revenue by line of business in the upper left hand panel, and by geography in the upper right hand panel. You can see that the business is diversified both by our business lines and by our U.S. and international businesses. And then in the bottom left hand panel you can see the 2011 revenue by type split into transaction and recurring revenue. With Moody’s Investors Service having majority of its revenue derived from transactions and Moody’s Analytics, a majority of its revenue derived from recurring bases, subscription based revenue principally which provides an overall balance for the Moody’s corporate revenue picture.
Turning now to the financial overview. We had very strong performance in 2011. In the top panel here you see our fourth quarter 2011 performance, and then in the bottom panel our full year performance. And as you can see we had growth for the full year of 2011 in all lines of business at both Moody’s Investors Service and Moody’s Analytics. So a good year with double-digit growth outside the U.S. and high single-digit growth inside the U.S., double-digit growth overall.
We have -- let me back up as long as we are -- there we go. That’s what I was just talking about. The bottom panel showing the positive growth for all the lines of business at Moody’s Investors Service and Moody’s Analytics. Okay, I think this is an interesting slide. It shows our historical revenues and it shows the growth and then the fall off associated with the financial crisis before we resumed a double-digit growth rate. And you can see the two color coded bars, one for 2007, the second for 2011. And it shows how we have, as I mentioned, reached a record level of revenue in 2011 but at a very different margin then we had back in 2007. Rather than being in the mid-50s we were 39% margin last year.
This is due to a couple of factors. First of all, the shift in the mix of the business. That blue bar is the structured finance line and you can see how large that was in 2007 compared to 2011. The yellow bar being the corporate finance business and how that has grown in 2011. And then the brown bar at the top being the Moody’s Analytics business and how that has grown. So what we see is a shift away from structured finance and towards corporate finance within the ratings agency and then the growth of the Moody’s Analytics business.
The reason for the lower margins are that the rating agency itself is operating at lower margins than it did back then. Compliance and regulatory requirements being among the reasons. And then we have a larger contribution from the Moody’s Analytics business, which while being a business that we are very much focused on growing and believe is a very strong business, does not operate at the margins that the rating agency does.
Moving on to a couple of slides that I will only quickly touch on. You see here and on the next slide the operating metrics and our cash flow generation. I think these will be fairly easy for you to understand on your own and so I will not make any prepared remarks on this. And then again just quickly how our EPS has grown and the fact that it has been growing more quickly than revenue the last few years.
Now we do have a strong commitment to returning cash to shareholders. You see that as far as share repurchases are concerned we have recommenced share repurchase in 2010 and 2011 following the financial crisis. And we expect approximately $200 million of share repurchase over the course of 2012. For dividends, we held the dividend during the financial crisis but we have been increasing it again recently, several times in 2011 as a matter of fact. And we expect to continue the combination of both share repurchase and dividends in terms of returning cash.
And our balance sheet remains strong. We have about $1.2 billion in debt outstanding that has been fairly stable and we don’t have any large repayment commitments on debt until 2015, and our cash and cash equivalents have been growing. We finished 2011 with about $760 million in cash and about 70% of that was held overseas. We have $1 billion of additional capacity available under our revolving credit facility and as I said no major debt repayments until 2015.
Okay. Turning to Moody’s Investors Service and a bit of a drill down on this business. This slide has quite a bit of information on it but the top panel of this slide is really a look at recent revenue performance, the fourth quarter of 2011. And then the bottom panel is showing you long-term revenue performance for the MIS business. Although there is lot of interesting information on this slide, what I would point you to in the upper left hand corner is the balance that we have between recurring and transaction revenue and U.S. and international revenue. And keep that in mind for when I get over to the Moody’s Analytics business again.
Okay. Our strong first half last year was followed by a slower second half and that’s really the only point of this slide. We have very strong issuance, particularly in corporate finance in the first half last year. That slowed considerably in the third and fourth quarters. And as I will talk a little bit in our macro outlook there’s been a pickup in some areas at the early parts of this year.
Now we have another slide. Again, this is a drill down on corporate finance for those of you who are interested in the components of revenue for the corporate finance business. You can see here, how this is broken out and it’s investment grade, speculative grade, bank loans, and then the largest bar is other which is a variety of revenue sources ranging from commercial paper fees to monetary fees and medium term notes, things of that sort.
And then because any discussion of Moody’s Investors Service wouldn’t be complete without regulatory developments. In the United States, the SEC is expected to finalize its rule making under Dodd-Frank by the end of 2012. Regulatory authorities are in the process of reviewing their use of ratings and regulation and considering alternative measures as replacements. We are supportive of that process. We are involving ourselves in making suggestions about how that can happen. And the SEC study about, among other matters, the feasibility of establishing an alternative system for allocating credit, credit rating assignments for structured products is also expected to be completed by the end of this year.
So we have several areas of rule making that are going to be going on for 2012. In Europe we are now regulated as a rating agency under the European securities and markets authority. That became effective in July. Moody’s registration was approved in October and there is a third round of regulatory reform proposals being considered at this time, and those are known as CRA-3. And those are going to be considered over the course of 2012 as well. So we have rule making in the U.S. and potential rule making in Europe going on for most of this year.
And then you can see from a financial perspective in 2012, we expect incremental compliance and regulatory costs to be approximately $10 million to $15 million. They were $15 million last year, which was the low-end of our incremental expense range that we had discussed earlier in the year. This is detail on the CRA-3 initiative in Europe. I won't go through all of this other than to point out that the European commission has already released its proposals for additional reform measures. The European Parliament has made available on its website its views and the European Council of Ministers will offer its point of view and then those three bodies will have discussions and reach -- they’re expected to reach a common view for reform initiatives in Europe on a going forward basis.
Okay. Moody’s Analytics. The Moody’s Analytics financial profile, similar to what we have for Moody’s Investors Service. The top panel is recent revenue performance, the bottom panel longer term revenue performance. And again pointing you to the upper left hand panel, you can see that the Moody’s Analytics business unlike Moody’s Investors Service is much more heavily driven by recurring or subscription revenue with relatively little transaction revenue. And then unlike Moody’s Investors Service, a majority of its business, a solid majority of its business is located outside of the United States with 60% international and 40% U.S.
The breakout in the pie chart shows you the different reporting units of Moody’s Analytics and you can see their contribution to revenue in those pie slices. The revenue history at the bottom, the long-term revenue history, you can see 22% compound annual growth rate. This includes a number of acquisitions that we have made in the Moody’s analytics business and I will highlight those in just a moment. But it has been a very good growth story for Moody’s overall.
Now this slide again is a little bit dense, but I think is a very valuable slide in terms of understanding how we are thinking about the Moody’s analytics business, at least from one perspective. And that is thinking about how this business can contribute to Moody’s global growth from an emerging to a developed market scenario. You see in the top of this slide a continuum from emerging markets through the developed markets and immediately beneath that the three components of this business for us. Professional services, risk management software and research data and analytics.
And the point of this slide is to show to that the professional services part of our business is really the principal contributor in the emerging markets. With risk management software being the principal contributor in advanced emerging markets and then research data and analytics being the principal contributor in developed markets. So just as an example if you look at the topline and the bottom line, Asia, excluding Japan and then the United States, you can see that in Asia, that 53% of our sales in that region come from risk management software. And this is largely an advanced emerging market region. In comparison to the United States, where the vast majority of our sales in 2011 came from research data and analytics and a very very small portion from professional services or risk management software.
The Moody’s Analytics market position, and really this is just a timeline of acquisitions that we’ve made over the last decade in the Moody’s Analytics business, looking to build out the information services that we provide, the platforms for analyzing and modeling that information, the risk software platforms. And then the professional services that accompany those in terms of interpreting the information. So we are investing in the platform for risk management, risk measurement and modeling. The data that supports that and the advisory services that help interpret that information for risk management best practice.
Okay, turning to the macroeconomic summary. This first slide is new to me as well as to you. So what you see here is what's been happening very very recently in the corporate sector. Investment grade panel on the upper left and high yield on the upper right for U.S. dollar issuance. And the reason we added this slide was just to give some context in terms of activity. On the left hand side the first bar in green, you see the first quarter 2011 issuance volume. Then if you skip over to the two right hand green bars you see the monthly issuance in 2012. So it’s comparing the first quarter of 2011 to monthly issuance in 2012.
And you can see that 2012 has been very strong in the first two months. And is putting the investment grade issuance market in a position to what we saw in a strong first quarter of 2011. Similar story on the high yield side. It’s telling the same story. You can see the significant issuance that we had in the first half of 2011, both first and second quarters. And how January and February are stacking up against that very strong set of orders in the first half of last year. And again it is a good story from issuance because we did have such a robust first half last year and this year’s issuance for the first two months is holding up quite well.
Just quickly again, because I had mentioned that growth in debt outside of cyclical changes we assume roughly will mirror GDP growth. And you can see the current GDP growth outlook for 2012 and 2013 coming from Moody’s Analytics and the Moody’s -- Economy.com unit of Moody’s Analytics. And so that gives you at least our perspective on GDP growth.
This is European capital markets couple markets. A couple of pictures. On the upper left hand panel you can see in the red line European euro zone and UK loan issuance, loans outstanding. And then the bar charts, underneath that the mountain charts, are showing bond issuance. And while you have got a leveling of since 2009 of loans in the euro zone, the bond market has continued to grow, and this is the disintermediation that I have been talking about. And in the context of disintermediation, you can also see on the right hand side, the state of disintermediation or the degree of disintermediation for European corporates versus U.S. Where U.S. is about 50:50, but in Europe we are not yet at the 20% mark for the percentage of financial assets that are in the bond market as opposed to the loan market.
So if we roughly think of the U.S. as a mature market for disintermediation, you can see that there are several trillion dollars worth of disintermediation that can still occur in Europe to bring it in line with disintermediation levels in the U.S. And we think that that is a very good long-term opportunity. At this point in time being prodded forward really by deleveraging that’s going on in the banking system which is encouraging corporate to find alternatives mechanisms for capital or alternative means to raise capital, either on their own or the encouragement of the banks with whom they have relationships.
These are the number of issuers who had come in and received first time ratings, non-financial corporate issuers broken up by the U.S., Europe and the emerging markets. And again, outside of the financial crisis in 2008 and 2009, you see a good increase. And this is just a raw number of new issuers that are coming in and receiving ratings. A good increase year-on-year and a reasonably steady increase year-on-year going back all the way to 2000.
I won't take a lot of time on this. I am just pointing out that despite high levels of cash being held by corporates, the attractive interest rate environment and narrowing credit spreads are encouraging. Issuance, bond issuance and loan borrow despite the fact that there are substantial amounts of cash on hand. I think partly this is corporates thinking of safety first, in terms of having sufficient cash on hand. And I think it’s also the fact that a lot of cash for many corporates is being held offshore and not accessible or not accessible in an efficient way.
And this is the refunding slide that I am sure many of you have seen before. But the point here in the upper left is Moody’s rated corporates in the U.S. bonds and loans, and that on the right European rated corporates bonds and loans. And you can see they’re going out all the way to 2015-2016. We have substantial amounts of refinancing that has to occur. They don’t all have to occur in 2012 by any means, but with the attractive rate environment we think there is going to be opportunistic refinancing.
And I -- again there is probably more information on this slide then I can quickly cover, but just the fact that aside from refinancing mergers and acquisition activity, equity buybacks and capital expenditure for business expansion are other principal drivers for issuance in the corporate market, and have really not been featured today. So it’s been more of a refinancing story certainly in 2012.
And then finally, the emerging markets which are relatively small but growing are going to be an increasing part of this issuance and ratings profile. And just showing this activity, the real GDP growth rate in green against corporate bond issuance from the emerging markets in orange.
And then finally our full year 2012 guidance. Revenue, high single to low double-digit percent range. Operating expenses the same and operating margin of approximately 39%. And you can see our tax rate earnings per share in the $2.62 to $2.72 range.
So I thank you very much for listening to me and to the extent we have a minute for questions, I am happy to take those.
Georgios Mihalos - Credit Suisse
If there are any questions.
I am sorry, the....
Why is your G&A higher than your CapEx?
We have purchase accounting amortization in for several acquisitions that we have made in recent years. I think that’s probably the principal contributor.
Georgios Mihalos - Credit Suisse
Yes. Right here in the front.
I guess in Q3 and Q4 last year, when you talk about core issuance we also saw the IPO market close. Is your expectation that issuance, IPO market, that sort of gradually opens, or do you feel like it’s sort of is open now and you’ll see more activity and more ratings opportunities?
I think we, I would not anticipate seeing the levels of anxiety in 2012 that we saw in 2011. But that being said, I think we are going to go through periods where the window is open and the window is closed again in 2012. We still have a difficult situation potential in Europe, even with the apparent resolution of the Greek situation concerns, both at the sovereign level and at the banking system level and their inner relationship as well as the slowdown in China which we through Moody’s Economy.com, believe is still going to be a soft landing and is not going to cause a significant decline in GDP growth. But it seems safe to assume that there are going to be periods of relatively higher and relatively lower anxiety around those kinds of issues again in 2012.
So if we had half the year of euphoria and half the year of dread, your sort of high single, low double-digit growth would include another year that’s maybe split between fear and love?
Yeah, we were not anticipating a year of unalloyed growth and having been through, the markets having accustomed themselves to some of the volatility that we saw in 2011, 2010, I don’t think are going to a long-term negative view either, so.
Georgios Mihalos - Credit Suisse
Okay. So I think we will wrap up there. Thank you, Raymond.
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