buy moody's
TRANSCRIPT
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Buy Recommendation
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Business Model
• Investor Services (rating agency)
• Perform comprehensive analysis of debt products
• Inexpensive to issuers (~50bps)
• Continuing expansion into rating project finance and bank loans
• Analytics
• Developing products to aid effective fixed income valuation
• Not related to credit turmoil
• 8 year CAGR of 22% (2000-2007)
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Business Model
• Core business line is credit rating
• Much more focused than competitor S&P
• More downside in bad times, more upside in good times
• A managerial tradition of little to no long term debt
• Capital Expenditures
• Growth is not funded by continued capex investments
• Constant operating margins
• All products have similar margins
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Business Model• International
• 45% of 2007 revenues are international
• Emerging markets
• Revenues are growing at 30% CAGR
• Revenues generated by the rating agency are:
• Recurring – 42% of revenues
• Monitoring outstanding issuances
• Frequent users (CP, MTN)
• Transaction – 58% of revenues
• Responsible for most of the decline in earnings
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Internal Analysis
•Moody’s adopted a new structure Jan 1st 2008
• Moody’s Investor Services
• 2007 Revenue of $1,780M
• 79% of MCO revenues
• Moody’s Analytics
• 2007 Revenue of $479M
• 21% of MCO revenues
• Effective cost control to combat shrinking margins
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Financial Performance
• Analysis of last five years
• Revenue growth – 16% CAGR
• Operating Margins – Steady between 54% - 52%
• Net Income – 18% CAGR
• A main component in the steady growth has been the credit boom
• The prevalence of structured finance over the past 3 years has been a major factor in Moody’s increasing margins
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Economic Moat
• Duopoly with S&P
• Sustainable – more than one rating is desired
• Perceived by the market as being the “top” bond rating agency
• Reputation is everything
• Act as gatekeepers
• Credit products need ratings to attract investors
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Related Industries
• Investment Banking
• Steep decline in CDO and high yield bond origination
• In the business of creating new structured products
• Investment funds
• May have strategies designed around ratings
• Bond/Security ratings have become institutionalized
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Recent Events
• Decline is share price tied to reduced earnings and forward credit fears
• The credit markets have dried up
• A majority of Moody’s revenues are tied to the creation of new debt securities
• Fears that credit crunch will drag on
• Short term impact only?
• Investment bankers create debt products
• Credit crunch will not last forever
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Structured Products
• Growth in structured products has contributed to revenue growth
• Collateralized Debt Obligations ect.
• Complex structures make them harder to rate
• Fees for rating structured products are higher
• Future outlook
• Again, investment banks are in the business of creating securities
• The majority of these securities need to be rated
• Many structured products continue to be created
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Investment Thesis
• Variable cost business
• Low overhead
• Labour force is non-unionized
• Will cut costs when necessary
• Sustainable Duopoly
• Almost zero capital expenditures
• Credit markets will improve
• Only short term earnings will be effected (1-3y)
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Investment Thesis
• Will continue to effectively cut costs
• Variable cost model allows for quick turnaround
• Analytics business will continue to grow
• Not tied to global credit cycle
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Investment Risks
• SEC regulation
• Reputational Damage
• They were wrong on CDO’s and didn't recognize the risk
• Increased competition
• The market has peaked and will now decline
• Their “issuer-pay” model might be banned
• Perceived key investor risk
• If Buffet sells his stake
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
P/E Multiple Analysis
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
• Historical price to earnings ratios
Five Year Average P/E 25.33x
Pre-Credit Crunch P/E 27.07x
Seven Year Average P/E 26.05x
• Without the credit crunch, where it would be trading
Forward EPS $2.119 for 2008
Five Year Average P/E $53.67Pre-Credit Crunch P/E $57.36Seven Year Average P/E $55.21
P/E Multiple Analysis
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Stage One Stage TwoGrowth Rate (U.S) 9% 6%Growth Rate (Intl) 18% 14%
Cost of Equity 9%Terminal Growth Rate 4.5%Tax Rate 40%Long-Term Margins 52%
LTM Stage One Stage Two2007 2008 E 2009 E 2010 E 2011 E 2012 E 2013 E 2014 E 2015 E 2016 E 2017 E
Revenue 2,259$ 2,003$ 2,264$ 2,564$ 2,907$ 3,302$ 3,640$ 4,018$ 4,441$ 4,914$ 5,445$ U.S. 1,355$ 1,102$ 1,201$ 1,309$ 1,427$ 1,555$ 1,648$ 1,747$ 1,852$ 1,963$ 2,081$ Intl 904$ 901$ 1,064$ 1,255$ 1,481$ 1,747$ 1,992$ 2,271$ 2,589$ 2,951$ 3,365$
Net Income 718$ 450$ 532$ 628$ 714$ 813$ 897$ 991$ 1,097$ 1,215$ 1,348$ Cash Investment $52 ($29) $89 $99 $110 $123 $112 $123 $135 $149 $164
Owner's Income 665$ 479$ 443$ 530$ 604$ 689$ 785$ 868$ 962$ 1,067$ 1,184$ Discount Factor 92% 84% 77% 71% 65% 60% 55% 50% 46% 42%PV of Income 440$ 373$ 409$ 428$ 448$ 468$ 475$ 483$ 491$ 500$
PV of Projections 4,514$ PV of Terminal Value 10,656$
Equity Value 15,170$
Intrinsic Valuation Analysis
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Sensitivity Analysis
Cost of Equity Versus Terminal Growth Rate15,170$ 3.5% 4.0% 4.5% 5.0%8.0% $16,440 $17,963 $19,922 $22,5348.5% $14,626 $15,790 $17,244 $19,1159.0% $13,149 $14,059 $15,170 $16,5599.5% $11,925 $12,649 $13,517 $14,579
10.0% $10,894 $11,480 $12,171 $13,001
Cost of Equity Versus Stage One Intl Growth15,170$ 16.0% 17.0% 18.0% 19.0%8.0% $19,161 $19,537 $19,922 $20,3178.5% $16,594 $16,915 $17,244 $17,5829.0% $14,605 $14,884 $15,170 $15,4639.5% $13,021 $13,266 $13,517 $13,775
10.0% $11,730 $11,948 $12,171 $12,400
Cost of Equity Versus Stage Two Intl Growth15,170$ 12.0% 13.0% 14.0% 15.0%8.0% $19,191 $19,552 $19,922 $20,3028.5% $16,629 $16,933 $17,244 $17,5649.0% $14,644 $14,903 $15,170 $15,4449.5% $13,061 $13,286 $13,517 $13,755
10.0% $11,772 $11,969 $12,171 $12,379
Presentation by Dylan Haggart & Dave Gregory 03/05/2008
Conclusion
• An investment in Moody’s is a bet that the fixed income market will continue to grow
• A P/E of 12 isn't justified
• Earnings will drop, but share price shouldn't drop faster
• Valuation ranging from 13.29B to 14.21B from multiples
• Discounted cash flow valuation places MCO between 13.57B and 15.17B
• Currently valued at 9.31B
Business Model
Internal Analysis
Financial Analysis
Economic Moat
Investment Thesis
Industry Analysis
Valuation Analysis
Investment Conclusion