MSCI (NYSE:MSCI) provides investment products and financial data to some of the largest asset managers in the world. You might be more familiar with it for its exchange-traded funds (ETFs) than for its own business. But its business is a strong one, and it's been a big winner for investors, up almost 500% over the past five years.
The company has built up years of experience in the industry and an extensive collection of historical data, proprietary equity index data, risk algorithms, and environmental, social, and governance (ESG) data, along with strong intellectual property protection on its indexes. As a result, it has been able to effectively leverage this data and expertise to continually improve the index and ETF products it provides for its clients.
MSCI capitalizes on this domain knowledge through a subscription-based revenue model. In fact, subscription-based revenues make up 74% of its $1.6 billion in total revenue since June 30, 2019. Not only that, but the company is able to keep clients satisfied, as seen by its 90%-plus retention rate over the past five years. All of these factors make MSCI a great company to consider adding to your portfolio.
A staple in the financial community
MSCI's global reach attracts many big-name clients, most notably BlackRock. The company provides support tools and services for the global investment community including indexes, portfolio construction, and risk management analytics. MSCI's goal is to help clients understand key drivers of risk and return, which in turn help them build better portfolios.
MSCI's stock market indexes make up about 60% of the company's total business. An index can focus on a general basket of stocks, such as the S&P 500, or on investments that fit a very specific criteria such as ESG stocks. MSCI uses its expertise to continuously innovate its ETF and index products. For example, it offers indexes that target systemic style factors, including volatility, size, momentum, and value. It also offers newer indexes for clients that will track ESG companies as well as ETFs based on on-trend factors, such as smart cities, the digital economy, and other disruptive technologies.
In total, MSCI calculates 226,000 indexes daily and 12,000 indexes in real time, and serves 7,800 clients across 90 countries.
Subscription-based revenues are a key growth driver
MSCI's principal business model is to license annual, recurring subscriptions for the majority of its index, analytics, and ESG products and services for a fee due in advance of the service period. For its index segment specifically, the company sells index data subscriptions that give clients access to MSCI index-linked investment products on a contractual basis, rather than on a usage basis.
In its most recent quarterly earnings report, MSCI reported total 12-month revenue of $1.6 billion, 74% of which came from recurring subscription services. Since the end of 2015, it has seen revenues growth at a compounded annual growth rate of 10% During that same time period, adjusted earnings per share grew even faster, at a compounded annual rate of 28%.
Recurring subscription revenues continue growing, as well. In the second quarter of this year, the company reported recurring subscription revenue of $309.9 million, a 7.2% increase over the same period last year. This increase was driven thanks to 10% growth in recurring revenue from index products and a 22.7% increase in ESG products. Subscription revenue has continued to grow despite the challenges the economy has faced with COVID-19.
A look at the competition
MSCI has a number of competitors, depending on which operating segment you're looking at. In its index segment, the company competes with S&P Dow Jones Indices -- which is jointly owned by S&P Global and the CME Group -- as well as with FTSE Russell, a subsidiary of the London Stock Exchange Group. In analytics, the company finds competition from Qontigo, BlackRock Solutions, Bloomberg Finance L.P., and FactSet Research Systems.
What sets MSCI apart from its competitors is its extensive database on global markets, proprietary equity indexes, risk algorithms, and ESG. The company relies strongly on intellectual property rights to keep many aspects of its products and services proprietary. Also, its strong relationships with its clients gives it an advantage over competitors, especially since happy clients stay with MSCI for years.
A happy client base
MSCI's retention rate, a metric that tracks the company's ability to retain its customers over time, is consistently 90% and higher over the past five years.
MSCI also continues to grow its subscription run rate. This metric provides an estimate at a particular point in time of the annualized value of the company's recurring revenues under its client contracts for the next 12 months, assuming all contracts are renewed. The subscription run rate is a key operating metric for MSCI because a change in its run rate would ultimately impact its operating revenue over time. New subscription sales have an effect of increasing the company's run rate and operating revenues over time. In the past five years, the subscription run rate has consistently grown between 7% and 10%, and its subscription run rate has actually grown over 10% in each of the past three quarters.
MSCI does a good job of maintaining clientele, a sign that its customers are clearly satisfied with its services and products. Maintaining a high retention rate is essential for its subscription-based revenue model to work.
Is MSCI a buy at today's valuation?
Investors may be concerned that MSCI is too expensive for its current share price. The company has a price-to-earnings (P/E) ratio of 56, which is much above its recent norm between 30 and 40. But its consistent sales and earnings growth and customer loyalty make a strong argument that it deserves its premium.
MSCI is a great company that continues to thrive -- even in the face of the COVID-19 pandemic -- thanks to its subscription-based business model, which makes it a steady and stable investment choice despite its high valuation.