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Moody’s Corporation (NYSE:MCO)

JPMorgan TMT Conference Call

May 15, 2012 11:20 am ET

Executives

Raymond W. McDaniel Jr. – President and Chief Executive Officer

Analysts

Andrew Simon – JPMorgan Chase & Co.

David Lewis – JPMorgan Chase & Co.

Andrew Simon – JPMorgan Chase & Co.

Welcome back this is the Moody’s presentation, thanks for joining us, this is Dave Lewis I’m Andrew Simon we cover business information services at JPMorgan and we are very pleased to be with the CEO of Moody’s Ray McDaniel, and I was thinking (inaudible).

Okay, great. So we’re going to start out with an overview of the company kind of the growth and margin profile. Just reminding people of what Moody’s does and how that drives business and Dave and I will have some questions for Ray. But this is meant for you the audience, so please join in and hopefully we will get a great dialogue going. So Ray if you don’t mind there are people who still don’t know what Moody’s does and what makes them a success and I’m surely I know you’ve been with Moody’s since 1987 but if you could give us a (inaudible) now we would really appreciate as a launching point.

Raymond McDaniel Jr.

Sure, I imagine everyone in the room is familiar with Moody’s on one side of our business the rating agency. And that is about two thirds a little bit over two thirds of our residents. The other third of our business comes from Moody’s analytics, which is a research risk management software and risk advisory set of products and services and that business has been a business that we have been growing fairly aggressively over the last four or five years both organically and through acquisition. So with the rating agency being about $1.6 billion in revenue and Moody’s Analytics being about $650 million in revenue. Those are the two operating units of the company.

We have been achieving double-digit growth over the last couple of years. We continue to aspire to do so, on average. And to aspire to have a 40% plus operating margin associated with that target for double-digit growth. So that’s a very quick overview of our businesses.

David Lewis – JPMorgan Chase & Co.

Okay, and that’s not EBITDA margin?

Raymond McDaniel Jr.

Operating margin, yeah.

David Lewis – JPMorgan Chase & Co.

Super, how do you guys make money?

Raymond McDaniel Jr.

The majority of the money that we make on Moody’s Investors Service side of business is charging issuers for debt ratings. The majority of the money that we make on the Moody’s Analytics side of the business is from sales of research and other subscription related services, data services, research services or licensed software, primarily to the institutional investor community in terms of research and data, and primarily to the financial institutions community in terms of risk management, software and risk services.

David Lewis – JPMorgan Chase & Co.

And when you look at those businesses, the way you described them, what percentage of your revenues in total would be subscription, we have per head revenues, total percentage of revenues and others, what would be transactional?

Raymond McDaniel Jr.

Yeah, overall for Moody’s Corporation, it’s almost perfectly split 50/50. I think its 51/49 in most recent quarter in terms of transaction versus revenue. But the Moody’s Investor Service business has a majority of its revenue coming from transactions, fees related to bond issuance, rated bank loan issuance and things of that sort. Whereas on the Moody’s Analytics side of the business, we are heavily weighted towards recurring revenue over 80% of the revenue in the Moody’s Analytics side is recurring revenue, subscription-based revenue.

David Lewis – JPMorgan Chase & Co.

You know its interesting to me and many people always know that being able to get a services that kind of business services for 17 years; is the rating agencies are now regulated industry and now they used to be if we go further back and there are even though I cover other industries where regulations are really at a hindrance and it seems like there have been rating agencies if I’m looking at Ray you know companies continues to be a leader do well have a profitable growth. Thinking about the history of pre-regulation to the current industry regulatory standards and have it been a benefit to the industry that is more regulated.

Raymond McDaniel Jr.

I think it would be – I think it would be difficult to find any executive in a business because there is more regulations is beneficial. But, lets call it a double-ended sword certainly our costs are significantly higher in part because of regulatory requirements around compliance and controls and reporting documenting the work that we do so that we can be properly inspected things of that sort. So there is a cost element and administrative element more personnel are needed, more systems are needed, more internal control functions are needed.

On the other hand the regulation that we now have in the U.S. and expect to – we do have regulation in Europe as well but that is also a fluid situation we expect more regulation. And has not changed, our business model has not changed the industry structure has not changed the demand for the ratings and research that we provide and I guess in some ways may actually discourage, other entrants in terms of entering the business because it may not look as attractive, because of some of the regulatory elements as it would have historically, so the, there are let’s not call in benefits but at least silver linings into a more regulated environment.

David Lewis – JPMorgan Chase & Co.

You know was there any real milestone time where – it went something its out regulated to really regulated inventory. Is there anything in the U.S. that still kind of keep in mind where you think in the future it could be in the regulatory environment, what do you think this is always come to a good size for us.

Raymond McDaniel Jr.

I think the U.S. is the regulatory environment for our industry has stabilized much more so than outside the U.S. the SEC still has some rule making to do and we anticipate that that will be completed by year-end. They are conducting some studies about the industry and we’ll see what the findings of those studies produce. But we have as you identify we have definitely moved and past both the past the inflection point I think both in reality and as a matter of corporate culture and psychology from an unregulated think of it more as a publishing kind of company to a regulated financial services company.

In Europe, that the regulatory environment remains more up in the air is more subject to ongoing debate and that is probably going to continue just as the broader reconsideration of the structural function profile of Europeans financial market, Europe’s financial markets evolves. We’re part of that dialog.

David Lewis – JPMorgan Chase & Co.

You talked about, you know high growth rate strategies growth and this seems, towards 40% operating margins you know what opportunity, Moody’s gets even most excited you know about the growth ahead growth long-term?

Raymond McDaniel Jr.

There is a couple of things, I will start on the Moody’s Investor Service, the rating agency side of the business, the ongoing disintermediation of the financial markets is a long-term trend it has a lot of run way left to go. The rest of the world may or may not ever come to look like the U.S. in terms of the degree of disintermediation, but even if it only moves a portion of the way towards the level of disintermediation we have in the U.S. in terms of assets that are in the banking system versus assets that are in the bond markets. It is a multi trillion-dollar movement of capital from one part of the system to another and that system demanding bond rates.

On the Moody’s Analytic side and I should say well we certainly would like to see a healthy banking system, a healthy banking system in Europe in particular, because that installs market confidence and business expansion and borrowing that is associated with that to the extend that there is pressure on banks and in particular banks in Europe that is hastening the disintermediation process because corporation are either being pushed away from their bank facilities as banks delever or they are proactively looking to diversify their sources of capital in the event that their banks are not there in the future or not there with the same kind of capacity as they’ve had in the past.

On the Moody’s Analytic side of the business, we think that we’ve had both organic and in-organic growth. We have been more actively engaged in acquisition in that side of the business including couple of acquisitions late last year. We anticipate a high teens growth rate, high teens revenue growth in that business this year, about half of it coming from organic and about half of it coming from acquired revenue. And we believe that risk management, risk measurement solutions around measuring risk and managing risk are going to continue to be a priority spent, for financial services firms, financial institutions, the insurance sector eventually perhaps more over into the corporate sector.

But that is an area of vertical that we think holds an awful lot of opportunity in part because banks are going trough regulation that is oriented towards enhanced risk management, in part because there are profit pressures, which lead them to look for high quality but lower cost solutions from firms that have scale and importantly across the emerging markets where financial institutions are looking to enhance what may have been relatively week risk measurement capabilities in the past and are looking for strong global solution providers that have been serving the developed markets. So there is a real emerging market opportunity on the Moody’s Analytic side, in addition to the growth of the bond markets in developing countries.

David Lewis – JPMorgan Chase & Co.

Thanks Ray, Ray on the Ray is the person to this can you just update us on the Abu Dhabi case or the ones that are, major ones outstanding.

Raymond McDaniel Jr.

Probably the most high profile cases are Abu Dhabi and Calpers. The Calpers case there the status of that is that there is one particular defense in that case that has advanced further than the rest of the case. This has to do with what is known as anti-SLAPP legislation in California, which is intended to protect speech and so it’s a little too loose to call it a state level first amendment, but it is legislation design to protect speech. And there have been two rulings on that, one, was that the judge did find that our ratings are protected speech, but then secondly the judge also found that discovery could move forward at lease in a limited way, despite the fact that we were engaged in protective speech.

So, what we have are at this point both sides in the case appealing the judges decision, with Calpers appealing the first portion or expected to and the rating agency is appealing the second decision. That appeal we would expect would be heard sometime in the second half of this year but I’m not aware that a date has been set on that yet I don’t think it has. And then depending on what the decision on that appeal is we would move back either the case would be dismissed or we would move back to a discovery process and potentially than the other defenses and claims would be looked at in the case I suppose to just this anti-SLAPP issue.

On Abu Dhabi, the most recent decision was an effort by Planus to introduce four additional claims in New York, there was the Abu Dhabi case was preceding on a fraud claim and there was a change in New York Court of Appeals ruling, which permitted additional claims to be raised. So Planus argued for four additional claims. Three of those were rejected. One for negligent misrepresentation was allowed to move forward surviving emotion to dismiss, which would lead it to a discovery phase.

And the timing on both of these in terms of their ultimate conclusion is very uncertain and probably very protracted based on everything that’s going on so far.

David Lewis – JPMorgan Chase & Co.

You can talk about non-financial corporate issuers and it doesn’t reach excuse me the disintermediation trends in Europe. How long do you think that that they’re going to feel do you have a view on how long that pressure in that interest in diversified buying sources, could go on there?

Raymond McDaniel Jr.

Yeah. I think that is a very long-term trend. I think even with the movement we’ve seen, much more of Europe is banked. Particularly as you look at, move out of investment grade and into the speculative grade bond sector and the bank loan sector, the rated bank loan sector where the bank loans would be syndicated or sold or packaged into CLOs something in that sort. That is a much, much more nascent market. and actually what we’re seeing and this is more of a cyclical phenomenon, but we have seen in the U.S. market, a lot of European activities. So European corporate coming over to the dollar market and borrowing here, much more selling we saw for example last year, the year before.

But one of these short-term casualties of the financial crisis in Europe is that the speculative grade market, speculative grade bond market was really beginning to get some traction in Europe. As I’ve talked about these markets historically, the spec rate market in the U.S. was quite large compared to what we saw in Europe and until the last couple of years, the European spec rate market really wasn’t even large enough that it had much of an impact on our business. That changed pretty rapidly and it’s only with the cyclical downturn in issuance activity coming out of Europe that I think that’s been reset, but I would expect to see that come back again.

And we still haven’t gotten to where Europe is an active market for rated bank loans. So that’s another direction I would expect to see our business move as we work our way through the financial crisis. But we’ve got to get a point where there is enough market access, market confidence that these firms are going to start thinking more aggressively about business expansion as opposed to just holding cash and hunkering down, which is I think psychology for an awful lot of firms at this point.

David Lewis – JPMorgan Chase & Co.

Could you talk about the current ranking for European rating agencies and is there the competition is changing?

Raymond McDaniel Jr.

There’s been a lot to talk about creating a European rating agency or creating a public sector rating agency to offer opinions on sovereign debt and that talk has not resulted in anything concrete yet. And as long as the playing field is leveled and we’re not in someway discriminated against, I’m happy to compete against to European rating agency or a public sector rating agency.

I mean the challenge will for any new voice, new entrant will be how to position their credit analysis as against the incumbent rating agencies. And broadly speaking, they can take an attitude that our ratings are too harsh on European names and they should rate higher and we can consider whether that would have introduced credibility problems. They could decide that we are too liberal and rate lower and I’m not sure that’s what Europe wants right now, or they could have broadly the same ratings and then I think it’s going to be a question of what’s being contributed to the debate about credit worthiness.

So if some one can do whether it’s public sector or another private sector firm, if they can do a better job than we can they should, and that would serve markets. And if they can do a better job than we can, I would like them to stop criticizing from the bleacher seats.

David Lewis – JPMorgan Chase & Co.

Let me open up the questions?

Question-and-Answer Session

Unidentified Analyst

(Inaudible)

Raymond McDaniel Jr.

Yeah, sure. Sure question about the Asian markets and in particular the Chinese market for bond issuance and then ratings. We this requires looking at things through from a couple of different perspectives. We rate through a joint venture in China domestic Chinese debt. We are 49% investor in a joint venture called CCXI. We have been involved with them since 2006 and it has been a very successful venture financially. There had been very few defaults of rated entities in China, so it’s difficult to talk about ratings quality until we can see how well we have ranked those credits as against any potential credit problems that emerge.

So it’s in early days, but it has been a good joint venture for us, in terms of its early performance. And we are not permitted to rate domestic Chinese debt through Moody’s Investor Service in China. We can certainly do anything we wanted from offshore, but we think it’s a better avenue for us to have this joint venture and participate in the market from on shore.

We do rate cross border issuance out of China through Moody’s Investor Service and this is dim-sum bonds and bonds in the U.S. and Euro markets, and we’ve done that for many years. But it is not a large market and yeah, we would be looking for growth in the business really associated with a couple of big drivers coming out of China, and I think these are long-term.

One is that the Chinese economy, we think is likely to continue to grow at a good pace maybe not at the pace, it has been growing out, but that is going to cause firms seeking capital to outstrip the banking system capacity. And so it’s another – it’s a disintermediation story, but not one like Europe whereas the banks pulling back, but rather where the economy is just outgrowing banking capacity, which should encourage bond issuance.

And the second driver and that should encourage cross-border bond issuance. Then there are some drivers like the effort to internationalize Renminbi and that in some market and the fact that introduces ratable debt through some other policy objectives that are going on. So part of this is associated with economic growth and part of it is associated with the future structure and profile of the Chinese currency and the Chinese financial services, financial institutions market. So I hope that’s…

David Lewis – JPMorgan Chase & Co.

Any questions?

Raymond W. McDaniel Jr.

Yeah. The question is we expect Moody’s Analytics to increase its revenue throughout the year ramping up, and two things; one is the acquisitions that we had in the fourth quarter last year, neither one were at the beginning of the fourth quarter. So, we do still get some lift in the fourth quarter of this year from those acquisitions. But also, we have been selling our risk management software and we expect that we are going to have customer acceptances from the increased sales we’ve had over the last 12 months in risk management software, which allows us to recognize revenue in that business.

So it’s partly the acquired revenue story and it’s partly the fact that sales in the risk software business are a leading indicator by 12 to 18 months of where revenue will be going for that business.

Unidentified Analyst

(Inaudible)

Raymond W. McDaniel Jr.

No, no, I don’t think it is. I’m saying the dollars of revenue, we’ll be growing throughout the year although last year they did as well, so the rate of growth is not going to be increasing through the year that’s going to continue to be somewhat lumpy particularly because of the software business, but if we look at it through the year-end, we expect to have increases in revenue throughout the year, quarter-on-quarter.

Unidentified Analyst

Just quick question on the Basel III, I mean how do you see that impacting your risk software business analytics. And the second question just (inaudible) also with software it’s just you’ve some competitive advantages I think for some of your peer’s technology focused, peers in that business. How is that played out over the course of last couple of years?

Raymond W. McDaniel Jr.

Sure. Well, Basel III has been very beneficial and really not in for the developed markets. It’s been more helpful to us as financial institutions in the emerging markets are looking to operate to a global standard, and looking at Basel III as that standard. And so they are interested in raising their risk management and internal control environments in accordance with these global standards. And so that has been a big benefit for us in financial institutions.

Frankly, we would expect to see some similar halo effects on Solvency II for the insurance sector and how that affects European insurance companies in particular. The growth that we expect to get out of Moody’s Analytics is largely and the software part of analytics is largely associated with regulation, but not driven by regulation requiring exactly what we have on offer, but rather what we have on offer aligning well with enhanced risk management processes. And I’m sorry there was a second part of your question, which I answered.

Unidentified Analyst

Yeah. In terms of your competitive position in risk software, have you thought about that today versus a couple of years ago?

Raymond McDaniel Jr.

Yes. Against some of the more technology, purely technology based firms. Moody’s Analytics competes against some very large technology oriented companies. everyone from, yeah, IBM to Sungard, Accenture to Oracle, so it’s a competitive field and the competitors are often large. We do think we have best-in-class risk software. We acquired KMV at the beginning of decade and we acquired Fermat a couple of years ago, which are both top quality risk software firms.

The other thing that we have though that the technology-oriented firms don’t have the same capacity around is the content that goes with this. We have a vast content capacity that feeds or is available to feed the models and the product that we are installing at these financial institutions. So both in terms of training the models, validating, what we’re doing and having the ability to allow firms to run their own scenarios, off of very robust databases is and proprietary databases, as we think is very significant competitive advantage. So we’re building engines and we’re supplying fuel to those engines both and we think that’s how we had been able to punch up our weight as against some of these very large competitors? Yes.

Unidentified Analyst

(Inaudible)

Raymond W. McDaniel Jr.

Yeah. The question about whether some of the new credit-rating agency entrance to the market have been succeeding, and I guess in particular, at our expense. And I think the – I know the answer to that is at our expense no. our ratings coverage is as high or higher overall as it’s ever been. But there have been ratings assigned by new entrance in some areas, particularly in the securitization area, particularly where there are no investors, so an issuer is doing something for balance sheet purposes and he is not planning on transferring the security and that’s where there might be interested more sensitive to price and who offers the most optimistic opinion about the security.

Unidentified Analyst

(Inaudible)

Raymond W. McDaniel Jr.

Yeah, certainly on the financial institution side, issuance has been sluggish and 800 or so banks have access the CDS LTRO facility and that’s where they’ve been going. They’re eventually going to have to find market access again from the private sector, but that’s eventual.

So the financial institutions sector has been impacted, less so on the investment grade corporate sector and more so, on the speculative grade corporate sector. There is not a lot of risk appetite, right now that’s hardly surprising. And there is not a lot of so that’s on the investor side and on the issuer side; there is not a lot of attention to business expansion.

And so to the extent that that firms don’t need to refinance. They are largely sitting on the sidelines at this point. So most of the activity we’re seeing is refinancing activity. And there is just a better market access the higher, the credit worthiness at this point, certainly compared to the U.S. where access is still broadly available.

Andrew Simon – JPMorgan Chase & Co.

That’s a great one and then thank you for joining for our quite side chat.

Raymond McDaniel Jr.

Absolutely, thank you very much, I appreciate your participation.

Andrew Simon – JPMorgan Chase & Co.

Any of them wants to be on a research list you could drop off your business card this is after the lunch break now Bill Green the Chairman of Accenture speaking in the main ballroom.

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