It seems they create a new way to lose money every day. From options in the 80's to futures in the 90's to the proliferation of asset backed securities this decade, there are always new variations of investment vehicles to speculate on.
Moody's Corp. (NYSE:MCO) has risen with the tide as the premier ratings firm for many of the new issues being brought to investors. While the company does not have direct liability to the leveraged debt vehicles that have filled the news headlines lately, it does make much of its revenue by researching and rating these securities. In 2006, over half of MCO's revenue has come from global structured finance products which includes both residential and corporate Mortgage Backed Securities [MBS].
The global economy has been characterized by low interest rates in much of the developed world over the last 3-5 years. This has paved the way for corporations and individuals alike to take on new debt and increase leverage. This has been a definite positive for MCO as the securities are usually bundled by the originators and sold as packaged deals to investors. In order to get a good price for the debt obligations, originators hire Moody's or Standard & Poors (or both) to rate the debt and conduct due diligence on the structured product. So the low interest rate environment has benefited Moody's tremendously.
Another positive trend in the industry revolves around the Leveraged Buyout [LBO] boom. As private investment companies issue debt to finance new purchases, Moody's is called upon to research these deals as well. It is easy to see how MCO has been able to string together so many quarters of increasing sales and earnings.
While the macro picture has been rosy for quite some time, it now appears that Moody's will face more challenges than it has had to deal with recently. Interest rates have begun to push higher as inflation concerns stubbornly refuse to go away. This is making debt issuance less and less attractive both for corporations, and individuals (think about fewer people re-financing because of higher rates). Furthermore, we have seen less and less LBO activity in the last few weeks which may not be a trend yet but is definitely noticeable. Finally, since the company is having to look overseas more and more for growth potential, it is learning that price is of more importance to emerging market customers than to US customers who are interested in the blue chip name that Moody's has to offer.
Moody's hosted an analyst day at the beginning of the month and during that time modestly raised guidance for 2007. However, it seemed the tone was much more on dispelling rumors of economic trouble than outlining growth potential for the company. Shortly after the meeting, rates began ratcheting up higher and the Bear Stearns hedge fund crisis began. All of this has pushed the stock lower which should get chart readers attention as well as fundamental investors.
All of that is to say I am concerned with the prospects for this company. MCO is using free cash flow to buy back shares which should help boost EPS to some degree on an individual share basis, but I'm not sure if it is enough. With the company spending capital to expand and the global economy potentially hitting the brakes, it seems the risks outweigh the rewards at this time.
MCO 1-yr chart
Disclosure: Author does not have a position in MCO