MSCI Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; compared with the corresponding 2016 periods. Amounts are in U.S. dollars. Interim financial statements are unaudited; PwC performed a review, not an audit.
Business context
MSCI provides indexes, investment analytics, ESG ratings and analysis, and real-estate analytics to institutional investors. Its revenue model is primarily recurring subscriptions, supplemented by asset-based index fees and non-recurring products and services. The company reported approximately 6,900 clients across 88 countries.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Operating revenue | $322.1 million | $288.4 million | $939.4 million | $857.9 million |
| Operating income | $148.7 million | $123.3 million | $425.2 million | $362.1 million |
| Operating margin | 46.2% | 42.7% | 45.3% | 42.2% |
| Net income | $85.2 million | $65.3 million | $239.4 million | $192.6 million |
| Diluted EPS | $0.93 | $0.68 | $2.61 | $1.98 |
| Adjusted EBITDA | $168.6 million | $143.3 million | $485.5 million | $422.5 million |
| Adjusted EBITDA margin | 52.3% | 49.7% | 51.7% | 49.3% |
For Q3, revenue rose 11.7%, operating income 20.6%, and net income 30.4% year over year. For the first nine months, revenue rose 9.5% and net income 24.3%. Adjusted EBITDA and its margin are non-GAAP measures as defined by MSCI.
- Revenue mix: Q3 recurring subscriptions increased 7.5% to $243.4 million; asset-based fees increased 29.8% to $72.9 million, primarily reflecting growth in index-linked products; non-recurring revenue was nearly unchanged at $5.8 million. Nine-month recurring subscriptions rose 5.8%, asset-based fees rose 27.9%, and non-recurring revenue fell 5.2%.
- Segments: Q3 Index revenue increased 17.0% to $184.6 million; Analytics increased 3.3% to $115.0 million; All Other increased 16.2% to $22.5 million. For nine months, Index revenue rose 15.6%, Analytics 2.0%, and All Other 5.8%. Nine-month Analytics Adjusted EBITDA declined 0.9% to $94.3 million.
- Cash flow: Nine-month operating cash flow was $261.0 million, down from $303.5 million. Investing cash outflow was $27.4 million; financing cash outflow was $233.9 million, including $150.4 million of treasury-share repurchases and $85.3 million of dividends paid. Cash increased by $7.2 million to $799.0 million.
- Liquidity and debt: Cash and cash equivalents were $799.0 million; current assets were $1,153.1 million and current liabilities $563.5 million. Long-term debt was $2,077.4 million, net of deferred financing fees. MSCI had $2.1 billion principal amount of senior notes and an undrawn $220 million revolving facility. At quarter-end, the consolidated leverage ratio was 3.12:1.00 versus a 4.25:1.00 maximum; interest coverage was 5.97:1.00 versus a 4.00:1.00 minimum.
- Capital returns: MSCI repurchased $136.9 million of shares in the first nine months, compared with $483.8 million in 2016, and declared dividends of $0.94 per share versus $0.72. The board subsequently declared a fourth-quarter dividend of $0.38 per share.
Material changes and management commentary
- Growth was led by index-linked asset-based fees. Average AUM in ETFs linked to MSCI indexes rose 40.0% in Q3 year over year; quarter-end AUM was $674.3 billion, up 42.0% from September 2016.
- Management attributed higher margins to revenue growing faster than Adjusted EBITDA expenses, particularly because of Index asset-based fees. Expenses rose 5.0% in Q3 and 3.7% for the first nine months.
- Nine-month operating cash flow fell despite higher earnings, reflecting higher operating, tax and interest payments and working-capital movements, including an $87.2 million use of cash from accounts receivable.
- The effective tax rate declined to 29.5% for Q3 and 29.6% for the first nine months, from 33.1% and 33.3%, respectively. MSCI cited geographic profit mix and discrete items, including share-based compensation tax benefits.
- Total Run Rate was $1.305 billion at September 30, up 13.8% year over year; recurring-subscription Run Rate grew 8.6%. Q3 net new recurring subscription sales were $21.0 million, up 68.2% year over year. Aggregate Retention Rate was 94.0% for Q3, compared with 92.7% in Q3 2016.
Outlook, risks and unusual items
- MSCI gave no specific earnings or revenue guidance in the supplied filing text. Management stated that domestic and foreign cash flows, cash balances, revolving capacity and potential capital-market access were expected to be sufficient for operating needs and commitments for at least the next 12 months. It expected foreign cash to continue growing in line with foreign-operations earnings.
- Revenue and fees are exposed to market movements, investment-product AUM and flows, trading volumes, product mix and foreign exchange. Approximately two-thirds of securities in index-linked product AUM are denominated in currencies other than the U.S. dollar. Foreign-currency exposure affected 13.9% of nine-month 2017 revenue; MSCI reported $1.8 million of foreign-exchange losses versus $0.6 million of gains in 2016.
- Cash held by foreign subsidiaries increased to $425.3 million from $208.2 million at year-end 2016; repatriation may incur U.S. or local taxes and some funds are subject to local restrictions.
- BlackRock accounted for 11.1% of consolidated revenue for the first nine months of 2017, versus no customer reaching 10% in the comparable 2016 period.
- MSCI said Real Estate revenue had been below management expectations. Its July 2017 goodwill impairment tests found no impairment; the Real Estate reporting unit’s fair value substantially exceeded carrying value.
- Pending legal matters were not expected by management to have a material effect based on currently available facts, though outcomes remain uncertain. Tax examinations cover multiple jurisdictions and years; MSCI said it had adequate reserves but could not estimate possible changes in unrecognized tax benefits over the next 12 months.
- MSCI planned to adopt the new revenue-recognition standard on January 1, 2018 using the modified retrospective method. It expected changes to affect timing for implementation services, desktop licenses and multi-year deals, but had not determined the quantitative impact. Adoption of the new lease standard was still under evaluation.
Key facts for investors to verify
- Whether ETF AUM, flows and market appreciation sustain asset-based fee growth, and how much of that growth is market-driven versus recurring business gains.
- Whether subscription Run Rate and retention translate into recognized revenue, particularly given the relatively slower Analytics growth.
- Whether operating cash flow recovers and receivables convert to cash; assess the impact of tax, interest, dividends and repurchases on available liquidity.
- Debt covenant headroom, interest costs and the availability and terms of the undrawn revolving facility.
- The eventual quantitative effect of the revenue-recognition standard, as well as developments in tax examinations, foreign-cash repatriation and legal contingencies.
- The durability of reported earnings growth in light of lower tax rates, share repurchases and the contribution of market-sensitive fees.