* MSCI seemed immune to price war until Vanguard fled
* MSCI's acquisitions less profitable than index business
* Investors turn attention to BlackRock's next move
By Aaron Pressman
Oct 5 Just four weeks ago, an MSCI (MSCI.N)
executive was crowing about his company's near-monopoly on
providing critical benchmark stock market indexes which are
licensed by fund companies around the world.
"It's the only part of our business in which we have a
committed strategy of trying to utilize a little bit of pricing
power and raise prices a little bit every year," Edings
Thibault, MSCI's head of investor relations, told investors at
UBS's Best of Americas conference in London on Sept. 7.
How fast times have changed for MSCI, a leading provider of
indexes, risk management advice and other investment analysis
On Tuesday, the largest U.S. fund manager Vanguard Group,
MSCI's second largest index licensing customer, said it was
defecting to cheaper rivals. MSCI's stock went into free fall,
dropping 27 percent and cutting $1 billion off the company's
Until Vanguard's move, investors seemed to think MSCI, known
for its all-world and emerging market stock indices, would be
immune from the price war being fought in the $1.5 trillion
global exchange-traded fund market. Now it has become clear that
the drive for lower ETF fees will hit index providers as well.
With the loss of a big customer to MSCI's still-lucrative
index business, analysts and investors are taking a hard look at
the rest of the company's operations. Some are coming away
"Their bread and butter business is the indexing," said
Steven Roge, a portfolio manager at R.W. Roge & Co in Beverly,
Massachusetts. "All the acquisitions they've made to diversify
have been a very poor move."
None of the recently acquired companies, such as
RiskMetrics, boast the sky-high profit margins of the indexing
business, Roge said. Many of the new units often require
substantial additional investments to service new clients.
In contrast, revenue from new index-licensing customers is
nearly all profit, and revenue from asset percentages increases
naturally as markets rise.
Still, Roge said the sell-off in MSCI shares was "overdone"
after they hit the lowest price in more than three years at
under $25. He was a buyer on Tuesday and the position likely
already shows a profit as MSCI shares had recovered some of the
losses, quoted at $27.03 early afternoon on Thursday.
Investors fear BlackRock (BLK.N), the top ETF manager and
MSCI's single biggest licensing customer, will use the Vanguard
defection as leverage to demand lower fees. On Tuesday,
BlackRock called MSCI the "gold standard" of indexing and said
it planned to "deepen our partnership." But the New York-based
firm has since declined to comment on pricing issues.
Last month, BlackRock CEO Laurence Fink said his firm
planned to cut some ETF fees to better compete with Vanguard,
possibly increasing pressure for concessions from MSCI. While
BlackRock's plan is still forthcoming, Charles Schwab (SCHW.N)
on Sept. 21 slashed its ETF fees to as little as four hundredths
of a percentage point.
Analysts who follow MSCI at Credit Suisse, Raymond James and
other firms sliced earnings estimates and price targets soon
after the Vanguard news. Most said they expected BlackRock would
get fee concessions but would not switch index providers.
MSCI CEO Henry Fernandez did little to staunch the wound in
a 45-minute conference call with analysts on Tuesday morning.
Asked repeatedly about the company's prior assertions of
strength, Fernandez repeatedly backed down.
For example, MSCI had previously touted the long-term
contracts signed by ETF customers like Vanguard.
But Fernandez conceded that the length of the contracts was
almost meaningless since an ETF manager could switch to a new
index provider without technically cancelling. ETF managers
could switch indexes in "relatively short periods of time," he
told the analysts, adding assets "may not be as sticky as we all
The fee in MSCI's contracts is calculated as a small
percentage of the amount of assets tracking a particular index,
so while a contract stays in force, no more fees are due when an
ETF manager switches to a new benchmark, he explained.
The risk was disclosed in MSCI's lengthy, annual 10-K
filings with the Securities and Exchange Commission. "Clients
that have licensed our indices to serve as the basis of
index-linked investment products are generally not required to
continue to use our indices," the 2011 filing warned. If a
client changed, "our asset-based fees could dramatically
More questions arose after analysts noted that the head of
MSCI's indexing business, C.D. Baer Pettit, sold $2.4 million
worth of MSCI shares on Sept. 7. Before that, Pettit had not
sold shares since 2010, according to securities filings. MSCI
declined to comment on the sale or when it first learned
Vanguard might defect. Attempts to reach Pettit were
MSCI's share price may not recover much more in the short
term. It has probably lost allure for managers who pick growth
stocks without yet falling enough to attract value investors,
said Christopher Shutler, an analyst at William Blair & Co.
"Trading at nine times its EBITDA (earnings before interest,
tax, depreciation and amortization), it's not exactly a value
stock," Shutler said. Shutler trimmed his 2013 earnings per
share estimate 6 percent to $2.05.
None of MSCI's five largest shareholders has been willing to
talk about the situation.
T. Rowe Price Group (TROW.O), whose funds owned 13.6 percent
of MSCI shares at the end of June, and Morgan Stanley Investment
Management, with a 12.2 percent stake, both declined to comment
as did hedge fund manager Eric Mindich's Eton Park Capital
Management, which owned 5.8 percent. Ron Baron, whose firm BAMCO
Inc held 7.6 percent, did not return a call. Janus Capital Group
(JNS.N), whose funds owned 5.1 percent, declined to comment.
MSCI's crown jewel has always been indexing, its core
business when brokerage firm Morgan Stanley (MS.N) and Capital
Group International, an affiliate of the firm that manages
American Funds, came together to create the MSCI brand in 1986.
An aggressive acquisition spree over the past decade, fueled
in part by going public in 2007, has added several other lines
of business including Barra, an investment analytics firm, and
RiskMetrics, a risk management and proxy research specialist.
But the additions, which analysts say are significantly less
profitable than indexing, face their own issues.
Even at Tuesday's low closing price, MSCI was not a "buy,"
analyst William Warmington at Raymond James said. "We continue
to remain on the sidelines given the challenges MSCI is facing
across business lines," Warmington wrote in a report on Tuesday
The portfolio management analytics division saw revenue drop
over the past three years. Despite several acquisitions,
analysts said, MSCI has not spent enough to improve its software
offerings. This has created opportunities for rivals to pick off
large clients. In the second quarter, the unit reported an
annualized customer retention rate of only 84 percent, down from
91 percent a year earlier.
Revenue at MSCI's ISS proxy research unit, acquired in 2010,
has not grown much in 2012, even as big shareholders have grown
assertive at underperforming companies.
ISS's reputation with clients could also be at risk from an
investigation by the Securities and Exchange Commission into a
former employee who was found to have leaked confidential voting
data in return for meals and tickets to various events.
MSCI said on Tuesday that the U.S. Securities and Exchange
Commission had sent a so-called Wells notice, indicating the SEC
may recommend a public administrative proceeding against ISS for
violations under the Investment Advisers Act. MSCI said it was
cooperating and did not expect the outcome of the matter to have
an adverse affect on its business.[ID:nL3E8L26X9]
(Reporting by Aaron Pressman; Editing by Martin Howell and
Keywords: MSCI VANGUARD/
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