Business Context and Reporting Period
This Form 8-K, filed on December 19, 2023, by Morningstar, Inc., serves as a Regulation FD disclosure containing responses to investor questions received through November 1, 2023. The filing provides management commentary on operational performance, cost management strategies, capital allocation, and specific business segment updates for the period ending September 30, 2023, and the full year 2023.
Key Financial Metrics and Operational Data
- Professional Fees: Declined $13.6 million in the first nine months of 2023 compared to the prior-year period. Excluding M&A and China transition fees, the decline was $8.1 million.
- Debt and Leverage: Consolidated funded indebtedness to EBITDA was approximately 2.0x as of September 30, 2023, down from 2.2x as of December 31, 2022. The company repaid roughly $98 million of debt in the third quarter of 2023.
- PitchBook Growth: Organic revenue growth was 21.7% through the first nine months of 2023. Global private capital raised fell approximately 14% year-over-year in the trailing 12 months ended September 30, 2023.
- Sustainalytics Performance: Organic growth rate was 14.0% in the first nine months of 2023. Market share in second-party opinions (SPOs) stood at 21% for the first half of 2023, down from 27% in 2021.
- Historical Margins: Management cites a historical target for adjusted operating margins between 20% and 25%.
Material Changes and Strategic Shifts
- Cost Reduction Initiatives: The company accelerated expense reduction efforts in the second and third quarters of 2023, including headcount reductions in Morningstar Sustainalytics, DBRS Morningstar, and Morningstar Wealth. Savings from real estate consolidation, travel, and professional fees began impacting earnings in Q2 and Q3 2023.
- Headcount Strategy: Management is taking a cautionary approach to hiring, managing backfills with prudence, and reducing headcount in areas where growth expectations were not met.
- Capital Allocation: The primary focus remains on paying down debt due to variable-rate debt exposure and rising interest rates. Share repurchases and M&A are considered only when returns are attractive relative to debt reduction.
- Cloud Transition: The company is shifting data processes to the cloud, which reduces capital expenditures (CapEx) on hardware but initially increases operating expenses (OpEx) due to cloud service costs.
Guidance, Outlook, and Risks
- Margin Outlook: Management intends to return adjusted operating margins to historical levels (20%-25%). If revenue growth slows, the strategy is to increase margins to drive long-term earnings growth.
- Sustainalytics Challenges: Performance lagged expectations due to reduced demand for ESG products (specifically SPOs) and execution challenges, including sales team turnover and delays in launching the Impact Ratings product. The company is revisiting the Impact Ratings methodology.
- PitchBook Dynamics: Growth deceleration is attributed to a global decline in private capital raised rather than competitive shifts. Revenue growth is increasingly driven by expansion within existing client contracts rather than new client sales.
- Climate Commitments: Morningstar has committed to a 50% reduction in Scope 1 and 2 greenhouse gas emissions by 2030. While targets are science-based, the company has not yet committed to a timeline for formal SBTi validation.
- Risks: Key risks include cybersecurity liabilities, regulatory changes in credit ratings and ESG, geopolitical fragmentation, and the impact of higher interest rates on borrowing costs.
Investor Verification Checklist
- Verify the timeline for the launch of the revised Impact Ratings methodology and its potential revenue impact.
- Monitor the trajectory of Scope 3 emissions accounting and the specific timeline for SBTi certification.
- Track the effectiveness of headcount reductions and real estate consolidations in achieving the targeted 20%-25% adjusted operating margin range.
- Assess the sustainability of PitchBook's growth given the 14% decline in global private capital raised.
- Review the company's progress on integrating Leveraged Commentary & Data (LCD) into the PitchBook platform for private credit market share gains.