TIVP043: MSCI (MSCI): The Financial Giant Enabling Passive Investing w/ Shawn O’Malley & Daniel Mahncke

27:00It seems like much of MSCI's value actually lies in its brand reputation. When people hear MSCI, they just expect a certain level of quality. I noticed that every time I talk to friends and they ask me what to invest in, they always feel that it's more trustworthy and it's kind of more familiar if the index they choose will actually have MSCI in front of them even compared to S &P, which makes sense because as you said, MSCI is more so an international company than S &P is. And even during my time at the family office, I saw a clear difference between products with less well-known names and those from MSCI and also S &P.

27:36And clients tend to feel just much more confident owning those instead of no-name products. And even if it's one of those 300 ,000 indices that have pretty much no volume at all, Speaking of MSCI's products though, and basically their value proposition, how about we zoom in a bit more on the actual structure of MSCI's business? Meaning, I'm talking about what does their competitive positioning look like? What other segments do they have? Just all that sort of thing. We spent all of our focus on it today, but MSCI's crown jewel is the index segment, which makes up about 55 % of overall revenue and 70 % of operating profit.

28:15So not quite as disproportionate as FICO for anyone who listened to that episode, but similar in that you have one segment that's about half the revenues with the vast majority of the profit generated because it's so much more profitable than the other things that the business does. And MSCI monetizes its index in three ways that we've talked a little bit about subscriptions, asset linked fees and transaction royalties on exchange traded futures and options. So active asset managers will pay for index data licensing from MSCI. So you might have a hedge fund paying for access to MSCI's different factor or ESG based indexes or for custom indexes.

28:56Or you might have consultants and financial advisory firms paying for index level data for studies on asset allocation so they can as accurately as possible simulate how different investment strategies would do over time. So if you want to see how the MSCI World Index has done over the last 40 years, you need to pay MSCI for access to the underlying data to conduct that kind of study academically. And even better for them is that once an index becomes dominant in a segment, it tends to stay that way. There's a lot of inertia. And asset manager may prefer to be indexed against maybe an S &P Emerging Markets Index, for example.

29:33But if asset owners and consultants prefer the MSCI Emerging Markets Index, the asset manager would really, they would risk outflows, would be fundamentally damaging to their business by not playing along with what is kind of the accepted standard. And today, and this is an incredible number, there's something like$17 trillion in assets benchmarked to MSCI's indexes. And it's so big, we can't even fathom it. But as we already talked about a little bit, there are different ways for them to profit off these indexes. And about 40 % of MSCI's index segment revenue is those asset-based fees that I mentioned, the largest bucket of which is that which comes from exchange-traded fund products.

30:18So when you hear asset-based fees, think of passive investing and firms like BlackRock sending a fee to MSCI for the right to track their indexes in their mutual fund products. With the expense ratios on ETFs, part of that is going toward paying an index licensing fee to MSCI, assuming they're using an MSCI benchmark. And that fee is a small percentage of the total assets they manage. So bigger funds will pay higher nominal fees to MSCI over time, which is why it's called asset-based fees. The amount of assets under management determines the size of the royalties sent to MSCI. And as financial markets tend to appreciate over time, that ends up just being a win for MSCI.

30:59And that licensing fee that they get is about 0.024%. So a very small number. And that take rate has actually been shrinking over time as fees and investment products generally have come down with the passive investment revolution. But as markets have continued to appreciate and passive investing has brought in hundreds of billions of dollars into index funds on net, often at the expense of actively managed funds, those increases in AUM have more than made up for their commission rate basically declining in percentage terms over time. That's a topic that we've seen with payment companies repeatedly.

31:38But I would think where this might be a bit different is that for these asset-based fee segment in indexes, you'll probably have some really serious customer concentration, right? I mean, I'm thinking about the Vanguard's, BlackRock's, and State Streets of the world. They'll probably hold a pretty disproportionate amount of investing assets, which, of course, also gives them leverage over MSCI. Oh, for sure. BlackRock alone makes up almost half of MSCI's asset-based fees and is 10 % of the company's overall revenues. So the concern there is that BlackRock could use that negotiating power to force MSCI to accept an even lower take rate on licensing fees as fees for ETFs generally decline over time at the same time.

32:22But beyond that, in terms of talking about asset-based fees, there are fees generated by trading of MSCI linked futures and options. And then as about a quarter of revenue is MSCI's analytics segments, which we haven't talked about yet. And basically they offer software subscription for risk in portfolio management analytics. So this might be special data tracking and simulating portfolio construction and returns, liquidity, counterparty risk on large trades, or even trying to project the impact of carbon regulation on different companies, for example, since ESG has been a big focus for MSCI. But I should say that this part of the business has slowed down considerably from political backlash, mostly in the US.

33:10And since 2015, the business has really flexed its operating leverage by cutting overhead costs on top of the steady and profitable business growth, which has driven operating profit margins up from 38 % in 2015 to nearly 54 % today, which is just a massive leap. And we always love to see those patterns where not only is the top line growing, but the amount of every dollar earned dropping to the bottom line as profit is also growing. And that helps profit actually compound faster than sales. You might have sales growing at 15 % a year and earnings per share growing at 20 or 25 % a year because of those kind of dynamics.

33:51That's some serious operating leverage. And since you talked about the ESG part of the business, I still remember going through all the different ESG ratings and rating funds based on MSCI's ESG criteria for some clients back then at the family office who paid more attention to this sort of environmentally friendly investing. And while I generally like the idea of sustainable investments, it sometimes feels or it felt quite arbitrary to consider one business aligned with the principles and another not but both kind of felt like they shouldn't be rated as ESG compliant anyway but as you said I feel like the hype around ESG is largely gone probably more so in the US than than in international markets the clients who cared about it when I did it were mostly churches or charities not necessarily individuals but anyway just going through my notes here on on MSCI, I think we can summarize the picture with a few different points.

34:45So there's something of a network effect to MSCI's business because they only have one competitor of substance. They've been able to boast really attractive and growing margins. And the nature of this business is that you have very recurring customers with relatively high switching costs. So the same asset managers keep coming back to you. And as long as S &P tacitly agrees to not dramatically undercut them on price. There's not a ton to be gained by switching between the two of them. So while you don't have a subscription service with, for example, Adobe has in our portfolio or anything like that, revenues and profits are still very highly recurring.

35:24And on that last point, when you have oligopoly industry dominance like this, some sort of test occlusion is pretty common, I would say, because, you know, all companies involved realize that they have it pretty good and if they keep cutting prices and raise to the bottom to gain slightly more market share they're probably going to wipe out profits for everyone and in the end it will just be a worse industry to be in and as you will see with the chart we are currently sharing right on the screen 80 percent of the index provider industries market share is captured by the top four players which are S &P of course MSCI NASDAQ and FUTSI with the S &P and MSCI being tied for having the largest market share.

36:06And at the same time, you have this tailwind for MSCI from the financialization of basically the entire world. As more companies are listed publicly, more countries build out their financial markets. And as the growing middle class globally finds it easier and easier to invest, that all ripples back to MSCI. What I love about this is that it's not really like a toll booth bet just on the US, but really it's more so a bet on the rest of the world since the US is mostly dominated by S &P. And it seems like this incredibly diverse business that implicitly wins as the world becomes just wealthier in general without them having to do much themselves.

36:48And I would usually say that sounds too good to be true, but evidently we've seen that this has been the case in the recent years and basically the last decades. and then to top it all off and we haven't even gotten to discussing this yet but this is a company with founder-led management which as fans of William Thorndike's book The Outsiders is of course something that we love to see in a company. Yeah, so for anyone not familiar William Thorndike's book The Outsiders it's one of my favorites and it's a study on how a handful of great CEOs that use shareholder returns as the driving metric behind their decisions achieved such great outcomes during their careers And you might be surprised that focusing on shareholder level return metrics is not nearly as common as you would maybe hope or expect in corporate America.

37:37And in general, they ran companies with this focus on profitable cash flow growth per share and value creating capital allocation to complement that underlying business. They didn't manage earnings to quarterly targets or seek the public spotlight in a way that a company like Tesla chronically does. They focused on very boring but pragmatic things like the long-term health of their companies and their stock's performance over time. And it turns out that keeping your head down like this, focused on the right things, does matter a whole lot. And that's my super simplified summary of the book. But I would still say it's worth anyone's time to go pick it up if you haven't read it before.

38:23And to your point, MSCI CEO Henry Fernandez, he's credited with helping found the version of MSCI that exists today. Back when it was a part of Morgan Stanley, with him being at the helm of the business really ever since its IPO in 2007. And what we really like to see is that he owns a substantial amount of shares in MSCI too. several billion dollars worth. So you can't say he doesn't have skin in the game. He does. And what that means is if shareholders do well, he does well too. And that's kind of the incentive structure you want to have. I wish we saw more of that. Almost every time we see a company like that, it turns out that just the entire culture of the company is superior to most of the companies that we look at.

39:08And we, like I said in the beginning, already have a bias toward high quality common bonus. It's just all too common for management to get bonuses based simply on a metric like revenue growth with no consideration for whether that revenue growth is actually profitable and creates value for shareholders. So you might see a CEO to get a multi-million dollar payout for achieving a goal that actually made the company worse or from an intrinsic value perspective. And at this point, there are numerous studies that show that founder-led companies tend to substantially outperform the market. And it seems that MSCI is part of those companies.

39:46There's also plenty of research showing that companies that buy back shares outperform. So between the founder-led management team and their significant buybacks, with a buyback yield of about 2%, it's easy to see why I like the idea of betting on the company so much. I hope it's easy for you to see. And just for context, they have purchased about a third of their shares back in the past decade, which in my book makes them as much of a share cannibal as really anyone. AutoZone and Ulta have been a bit more prolific on that front, but they're certainly in that same realm. And in fact, in the past 11 years, they have purchased$5.8 billion at an average share price of$117 per share.

40:28And for reference, the stock currently trades at almost$600 per share. So the timing of those buybacks looks very, very good in hindsight with just kind of a rudimentary analysis of, hey, on average, they are done at a much lower price than the current stock. We just recently thought about what are the learnings that we have from basically looking at 40 companies for this show now. And we kind of had a presentation hosting for our community where we actually talked about all of those learnings. And one of them was that we want high-quality compounders that are share cannonballs. And it does seem like MSCI would fit into that niche.

41:05And that's always a pretty great thing, especially if you can see that the prices at which they buy back stock is significantly below the current stock prices. As we try to think, though, about the big picture for MSCI going forward, since it's one thing to find a company that was a great investment in hindsight and another thing entirely to find one that will continue to be a great investment, I should mention that the total value of all stocks worldwide is north of$100 trillion. And with emerging markets representing about a third of that market cap, but generating around half of global GDP, I think that implies that even without growth in the value of equity markets globally, MSCI can still be a pretty big winner if the composition of market capitalization shifts in favor of the US to international markets again, as it has done in the past several times.

41:55So you've got this tailwind from the recomposition of global markets and also most likely the continued appreciation of the world's equities and aggregate over time with a third tailwind from just more assets moving into passive funds from active and for more people being able to save more generally. But to use some data to show that trend, according to the Bank of America, about 47 % of assets are actively managed today, which is down from 80 % in 2009. And it seems like this is a trend that seems to continue. So I don't know. I see a white moat. I see major tailwinds for the company. And I see the right type of leadership at the top.

42:34And all that makes me open to, I would say, the bull case here. And Ron Buffett once said, when you find a really good business run by first class people, chances are a price that looks too high isn't actually that high. The combination is rare enough and it's worth a pretty good price. So I would say that leads me to say that this is a stock that by conventional valuation metrics is definitely not cheap at around 38 times earnings, but you're essentially paying more than double the historic PE multiple of the S &P 500. And whenever you pay a premium like that, even for a great company, you should really focus on what can go wrong.

43:10So what are your big concerns with investing in MSCI at this point? I said this a few times when we talked about payments companies, but I'm worried that there's a race to the bottom in fees to financial intermediaries, which for the record is a great thing for consumers. The reality is that every year for decades now, the average fees and mutual funds and ETFs have only gone in one direction. And that direction is down. So now we've literally hit 0 % fees for some funds. And for people who are like, wait, what is 0 %? Yes. There are some Fidelity funds out there that charge nothing and are essentially loss leaders meant for advertising purposes to draw people into the Fidelity ecosystem.

43:50And many of Vanguard's funds are so cheap, honestly, they might as well be considered free. And if a big chunk of MSCI's business is coming from getting a split of these management fees, well, that's very concerning, obviously. And we saw a similar dynamic with stock trading in the US, for example. Commission-free trading is now universal, but not that long ago. I remember paying$10 per trade every time I wanted to buy or sell something on Charles Schwab. on a$200 order on the buy and sell, 10 % of your money was just trading fees. So that was a real hassle. And I'm glad that we've moved past that, but it was a disruption to that industry.

44:32And so I'm pretty sure that fees paid to investment managers in a similar way will get whittled away by competition eventually to that zero bound. And as such, MSCI will also have to lower its licensing fees that it charges funds for, you know, using them as a benchmark in their passive index funds. And, you know, I'm not sure what the terminal value of this could be zero, or maybe it's a negative. Maybe we get to some kind of dynamic where ETFs are actually subsidizing the returns of their funds with a negative management fee to draw in more customers and try to monetize them in some other way.

45:10Obviously, that's completely speculative. But the point being that the lower bound here may not even be zero. We don't necessarily know that for a fact. And 10 years from now, they might make almost nothing from fees tied to passive investments, which we've discussed in most of this episode as being a tailwind. But there is a possibility that if that trend continues in management fees the way it has, no amount of growth in passive AUM can make up for the fall off in the take rate or the fees as a percentage of that AUM that they're able to earn. And to be clear, that's like an uber bear case scenario.

45:46I don't think anyone is really expecting anything like that. But the essence behind the idea gives me some real pause as I think about trying to find a business that we might want to own for the very, very long term. And I think we've already seen this come to fruition a little bit too. The fees generated for MSCI from the iShares Core MSCI IFA ETF, which has an expense ratio of 0.07%, are meaningfully lower than what they earn from a similar fund called the iShares MSCI IFA ETF, which is an expense ratio of 0.32%. And so funds with lower expense ratios are basically by definition going to be less profitable for MSCI because there's just less fee money that can be split with them.

46:33And MSCI's fee rate actually declined 15 % from 2015 to 2019. And bulls are betting that even as fee rates decline, MSCI will still garner enough in fees to keep its business growing. But when I look at this from 30 ,000 feet, and of course, I am trying to make the bear argument right now, I'm not sure that's entirely clear to me why that should happen, honestly. So that's me making a devil's advocate argument against my own pick. But I think it's important to be able to do that. And we saw that pressure on pricing really reared its head in a big way back in 2012 when Vanguard announced plans to transition six of its international stock funds with aggregate assets of hundreds of billions of dollars to FTSE benchmarks, which is a lesser known competitor, but still really the next big one after S &P.

47:18And so these are pretty well-known funds like the Vanguard Emerging Markets Stock Index Fund with the ticker VWO. That's one I've invested in personally in the past. And this came ironically about a decade after Vanguard dumped higher cost indexes provided by S &P in favor of MSCI's benchmark. So Vanguard started using S &P, thought the fees were too high, went to MSCI, thought MSCI's fees were too high comparatively after a while and moved to FTSE. And so that clearly hasn't destroyed the business in any way as we look at things in 2025. This was over 13 years ago, but it's certainly a cautionary tale, an indication that MSCI is by no means infallible or untouchable.

47:57And that draws attention to the relationship with BlackRock, who, as I mentioned, contributes 10 % of MSCI's revenue. So if BlackRock even threatened to take the Vanguard approach, that would be very, very costly to MSCI as a business. Well, as you know, I didn't see the trend of falling take rates and payments as a reason to not own a payments company. I think the market leaders probably have enough or enormous potential to build high margin value adding services that make up for the loss and take rates. But as we talked about with FICO, MSCI has this golden goose business. They've actually diluted it by moving into selling software and analytics packages meant to complement the core business.

48:38And MSCI's analytics segment is, at best, a narrow business based on switching costs, but it is nothing like the kinds of advantages that the index business has. And we haven't had a chance now to really dig into it yet, but the analytics segment provides risk management, performance attribution, and portfolio management applications to investors and asset management companies. And while being embedded in clients' workflows can make your business stickier, financial analytics, and we talked about it before this call, is an extremely competitive space with everyone in it from FactSet to BlackRock's Aladdin, Bloomberg, and S &P's CapIQ business, which you know pretty well.

49:16And unlike in the index business where switch to a competitor's rare, I would guess analytics subscription and cancellations are more common and reflected a mix of competitive defections, but also simply firms shutting down. And if those are the services that should balance out the take rate decline of the core business, I think I am kind of concerned about that. No argument for me there, Daniel. If we were going to do some of the parts valuation with the analytics business being about a quarter of revenues, I would definitely use a much lower valuation multiple for it than the indexes business.

49:51So this isn't a part of the thesis I feel really strongly about, even though it is a chunk of the business. And for anyone who saw our Alphabet episode way, way, way back in the day, there was a similar approach where we broke up each business unit and use a different multiple based on the quality and growth prospects of that unit. And so, you know, I would probably rather pay a higher premium for the YouTube business than, say, you know, their Google Ad Exchange or Ad Manager business, which is getting a lot of scrutiny by regulation and has been in decline in some ways. And another part where you probably wouldn't pay the same multiple, and which is honestly kind of uninspiring, is the sustainability and climate data segment or ESG segment, as some would say.

50:38And setting aside what people think about, say, tracking corporate carbon emissions, it has objectively been a bit of a disappointment for shareholders. As pushback on ESG has mounted, and that has potentially even hurt the MSCI brand if they are being seen as one of those companies pushing ESG changes from behind the scenes. Again, I think this is seen more critically in the US than in most other countries. But still, if we could get the index business at a fair price, that would be great. Unfortunately, though, we'd also be paying for these much less certain business units too if we add the stock to the portfolio.

51:13Yeah, at over 12 % of firm-wide revenue, MSCI's sustainability and climate data segment is a real chunk of the business. And yet it's probably consumed an even bigger share of management's attention because there There's just so much hope that ESG data and metrics would be the next big growth driver for the firm. And MSCI was an early mover and is now a market leader in this, offering ESG coverage for more than 15 ,000 entities with something like over 700 climate change related metrics. And as time goes on, MSCI's advantages get more entrenched here because they can point to a longer history of their metrics potentially being statistically significant to investors.

51:52but there's just been so much hype around how ESG would change investors' habits without as much results as expected. That's why I would say it's sort of been a bit of a disappointment. And this is not me by any means writing off the importance of ESG considerations, but I just don't have much confidence either way that ESG data and metrics will play approximately the same role, a lesser role, or a much bigger role in the financial system over the next decade, at least in the U.S. And I would guess bigger, but I have no idea. I don't have any conviction in that. It's truly just a guess. And so that's why I agree.

52:28I wish it wasn't something that we had to implicitly bet on when we were considering taking a position in MSCI. But at a little over 10 % of the business, it is a significant consideration. And I know Henry Fernandez, the CEO, is a big believer in ESG, naturally, since the company is focused on it so much. But I just wouldn't say that it has really paid off in any way like he had promised years ago. Well, if you're a market leader in a certain segment, I think you're probably prone or biased to say this segment is going to grow in the future. But beyond what we already have discussed, what concerns me is also, and you know that best, the fact that operating leverage cuts both ways.

53:10We've seen MSCI's business scale and become much more profitable over the last decade. But also, we've really been in one big bull market since the great financial crisis. So when we hit another major bear market, there are multiple weak points that I would see in MSCI's business. The AUM and passive funds just get slashed down as stock prices decline and people probably panic sell. And then trading volumes on index options and futures might also fall off. And then you might even see hedge funds or other financial firms go under it, hurting the amount of subscription revenue they get on their data packages and custom index.

53:44So I think I could continue to brainstorm different ways that a downturn in markets would directly or at least indirectly hurt them for another two minutes, which is concerning when you're looking at the stock. While markets are at all time highs and you would still have to pay 38 times earnings. And given that these fees are incremental, any revenue losses could flow to the bottom line, meaning margins could quickly contract to the levels that they were, let's say, at a decade ago. But we haven't even gotten to the big elephant in the room yet, which is direct indexing. And I guess I underestimated this threat prior to this episode, but I believe you think it's an existential threat, right?

54:23Can you maybe just, before we get into it, further define direct indexing again? Direct indexing is an investment strategy where instead of buying a mutual fund or ETF that tracks an index like the S &P 500, an investor directly buys the individual stocks that make up that index in their own account. And the concern is that through robo-advisory services that can automate the whole process, it will become increasingly common to basically sidestep ETFs entirely to do effectively the same thing with none of the management fees and more customization. And for example, if an investor wants exposure to the S &P 500 but doesn't want to hold tobacco companies, they can actually just buy the stocks they do want directly and omit those tobacco firms.

55:06Beyond not paying management fees to ETF assures, there are also some potential tax breaks that can come in from the ability to do tax-offs harvesting yourself. But Henry Fernandez believes that MSCA won't see its role diminished at all either way and has actually said the opportunities for the index business are just beginning and could even accelerate, driven by the increasing demand for non-market cap-based indexes relying on investment themes like AI or reduced exposure to climate change. So it's hard to say, and maybe MSCA won't be as hurt as much as you might think, but there's certainly a looming disruption here that puts a lot of uncertainty around their current business model and what it will look like going into the future.

55:51Maybe just for some more context, direct indexing is still relatively small in scale compared to ETFs and you still need index benchmarks for direct indexing. So if you're omitting tobacco companies from the S &P 500, you are still using data on the S &P 500. And presumably, if you're using some service to enable you to direct indexing, they would have to pay licensing fees to S &P or in other cases to MSCI still. So for smaller retail investors and for anyone using a tax advantage account like an IRA, direct indexing is not really much of an improvement upon just good old-fashioned ETFs, though especially since there is a huge number of ETF options these days.

56:31So I don't think direct indexing is an ETF killer, and I actually have some experience with it from back in the day working at the family office, but it definitely is going to continue to have a big impact on companies like MSCI, which makes it worth at least better understanding or tracking in terms of how it develops. And at the low end, direct indexing products to retail investors could remain a niche of unfulfilled potential, kind of like our robo-advisors haven't really taken over the world as some expected. But at the high end, direct indexing and really just mass personalization of passive investing, which blurs the lines between passive and active further, could restructure the entire investment services ecosystem for wealthy investors hoping to leverage tax breaks outside of their retirement accounts.

57:19I actually came across a direct indexing service that I used a few years ago. And I do have to say it's really compelling. It was really exciting at the time, but I'm not sure that it's really just as simple as picking a couple of ETFs. And even so, direct indexing may not get the same adoption outside of the US. And we know that MSCI primarily dominates non-US equity markets. So direct indexing may be more of a threat to S &B than to MSCI, assuming it's actually a threat. And the bigger issue at present has been the underperformance of international equities relative to the U.S. over the past five to ten years.

57:56And according to Morningstar, if international stock ETFs benchmarked to MSCI had appreciated at the same rate as S &P's U.S.-linked ETFs, then MSCI's earnings per share would be roughly 6 % higher. But that's also a potential opportunity if that dynamic reverses, as it already has to some extent this year, where you have international stocks outperforming the U.S. in 2025 in many different cases. At least for a period of the year. I guess I would prefer owning the company with the most diversified customer base. Although this is more of a gut feeling and ultimately the US markets have been just so dominant for decades now and it has been a while since international markets could outperform them for longer periods than say just one or two years.

58:40So I think MSCI is probably having a lot of tailwinds that you wouldn't necessarily say S &P has but if you just look at the history, S &P benefited enormously from being more US focused. And if we assume that the US will be the mecca of investing still for the years to come, probably that will continue. But let's get into capital allocation somewhere and also how management is compensated. That's also something we look for in pretty much every company. I know the CEO, Henry Fernandez, owns a significant amount of equity. You also said that before, but that only matters so much as his incentive system for future bonuses is properly aligned with the shareholders as well.

59:21So given that there aren't many ways they can reinvest into organically growing the business, it sounds like maybe you can tell us to what extent they've been able to return capital to shareholders and then speak to just a question of management compensation too. One of the things I like most about the company is that MSCI has consistently returned capital to shareholders through dividends and share repurchases on top of it being a great business. And the capital allocation is very good, and that bodes well for intrinsic value. They generally target paying out a third of free cash flow as dividends, while buybacks have shrunk the total number of shares outstanding by almost 2 % a year since 2021, with about 60 % of free cash flow typically going to buybacks.

1:00:03So some simple math there tells you that about 100 % of free cash flow, and even more in some years, is going toward returns of capital in one way or another. And you can also see that over the years, as the stock has been relatively cheaper in PE terms, management has been much more aggressive about buying back shares. When the PE is lower, they tend to spend much more in total on share buybacks and cut back as the valuation gets more stretched. And we have a chart on screen showing that for anyone watching on Spotify or YouTube. It's a very rough way of seeing whether approximately management is being mindful of what price they repurchase stock at, because that can have real serious consequences for intrinsic value.

1:00:41And I do think MSCI has been fairly cognizant of this, even though just structurally, shares in the company almost always trade at a significant premium to the broader market, and understandably so. And I should say that long-term debt has been compounding at almost 10 % a year since 2016. So debt is also very much being used to finance the business as well as the dividend and buybacks to an extent, though it's, I think, pretty sustainable. In my opinion, this is not some super leveraged business by any means. And while stock-based comp as a share of revenue is only about three and a half percent.

1:01:15That number is up by a third since a low point in 2022, which brings us to how management is compensated. And there's a few things to say here. There's a long-term incentive program, which grants options at best over three years. And that's meant to really just discourage people from cashing out and leaving at the first better offer they get. And then there are performance link stock grants that can be unlocked if certain total shareholder return targets are met. And I could go on a rant about this, but I don't love the restricted stock unit payouts that simply vest basically just based on the amount of time you've spent with a company, because I'm not really sure what that optimizes for.

1:01:54In my opinion, your base salary and performance-based bonuses should be enough incentive for you not to leave. So you shouldn't also need stock grants that pay up regardless of how well you do and are really just based on how long you are filling a seat for. To me, that doesn't make a lot of sense. But anyways, going off total shareholder return for the performance-based bonuses is something I like to see. And that is what they do. And I also like that the CEO is required to own a target number of shares with an aggregate value equal to 12 times or more of his annual base salary. And that formally sets a rule that the CEO must have skin in the game.

1:02:30And we've already talked about he does. and that is really not something you see at every company, especially not to that same extent. So to summarize, it's not perfect, the comp structure that MSCI has, but you do have a CEO who's highly aligned with shareholders just by all the skin in the game that he has owning a significant amount of shares. So having said that, I think it's time that we are talking about how all of this plays a role in the evaluation and also decide whether MSCI is a good fit for our intrinsic value portfolio. So how about you walk us through the variation that you did and what you came up with as fair value for a stock that is still pretty expensive?

1:03:12So the two core businesses we've talked about are the indexes and analytics segments. And the indexes is the one that would be worth putting a much higher valuation multiple on, as I've already mentioned. The operating profit margins on it are about 20 percentage points higher than the analytics segment. It's been growing faster with management also being more optimistic about its growth prospects going forward too. And management actually thinks the core index business can grow at low double digits for years to come. So when the core business is still so profitable and growing like that, it's no surprise that MSCI trades at almost 40 times earnings.

1:03:45And then growing quickly, too, are the sustainability and client and private assets segments of their business that have lower margins but have been compounding at 30 % to 40 % a year for the last few years. And I've said this already, but I don't really have a strong opinion on either of those segments. I see them as extensions of the analytics business. So really, at its core, MSCI is still about indexes and analytics. and all this analytics stuff as it grows faster than the index business actually drags down the company's overall profitability. They dilute the index business, which is a really special business on its own.

1:04:23And so there's only a handful of publicly traded companies that can rival the quality of the index business. So as I tried to model this for the company, I created a base case where these lower margin segments continue to outgrow the index business with the company overall mostly growing in line with what management and analysts have projected. And partially that's probably just laziness on my end, but also it's because I don't have a ton of conviction in MSCI's future either way. So it's hard to say what direction to bet on more heavily. I wasn't able to fully wrap my head around how things like direct indexing, for example, will weigh on this business going forward.

1:04:59And so it's hard for me to feel confident predicting a scenario that isn't the status quo. And so we've said this so many times before, but we're not equally confident in every model we build. And this is one of those cases where I went through the exercise of doing evaluation just to see if any insights came out of it, almost like a reverse DCF. But modeling only goes so far if you don't have a fully formed opinion on the business through a more qualitative lens. And with our portfolio holding Uber, I have a lot of confidence in how their competitive advantages compound as their network affects scales, allowing them to have more drivers in more cities offering the cheapest rides that attract more customers.

1:05:35And I can reflect that opinion in a model by showing how that flywheel accelerates. Or even with Nike, we know that their brand status and relationships with the world's top athletes give them some enduring advantages in an industry that isn't going to be disrupted by things like AI. We know people always need clothing for outdoor wear and sports. And Nike has been a leader in providing that apparel for decades. Or just to belabor the points here again, look at Universal Music Group. I know that streaming platforms and the internet are only increasing the amount of music we all stream and the number of people who are able to consume music digitally.

1:06:07And all that goes toward them earning more royalties on their music catalog. And you don't have a unique opinion to express though. There's just not as much that can be gleaned from modeling exercises. And with our portfolio companies, these are all dynamics I can feel like I pretty intuitively grasp. And while I understand why MSCI's indexing business has been so great in the past, I'm just not sure that it will continue to be so good over the next 5, 10, 15 years as the passive investing revolution continues to unfold and as management fees mainly on index funds continue to come down. I think it's very telling that when making long-term projections for the future, MSCI's management doesn't do so for its asset-based fees coming from index funds.

1:06:51If management wants to paint this rosy picture of continued growth going forward, but they caveat that with exceptions for a core part of their indexing business, well then again, I don't know how as an outside investor I could have much faith in their projections. So even if we got the right price, I'm not actually sure I'd want to add MSCI to our intrinsic value portfolio anyways, unless it was just outlandishly cheap. I came into this pitch expecting to really love MSCI, and that's why I thought it would be a good idea. and as I worked through the valuation and I've talked through it a bit with you today I lost some of that faith and long story short at around$460 per share that is where the stock starts to look interesting with something like a 20 % margin of safety relative to my fair value estimate in a base case but yeah rather rather than that being the price where I'd recommend buying it it's more like the price where I'd recommend we revisit it and see if we can get more comfortable with these variables.

1:07:48Otherwise, I think it just goes in the too hard basket and we just set it aside and look at other things for now. I must say I'm pretty surprised to hear that something so big seems to be hanging over MSCI's business, like the take rates and then also the question of will they even be the same need for indexing 10 years from now as it has been in the last 10 years? And when you told me you would pitch it, I thought it would be more about the valuation and less about the sustainability of the business model. But as you said, there's a good argument to make that the core business might just be a melting ice cube.

1:08:22Maybe not in the next 10 years, but if we look out 10, 15, 20 years ahead, I do think there's some risk involved that I didn't even think about before this pitch, honestly. And at least to a certain extent, we own other companies where the take rates generally tend to calm down as well. PayPal is one of the examples there, but you see that as more of a problem than I do because PayPal has transformed, at least in my opinion, from like a really boring company that is arguably losing market share to a real innovator again, pioneering interoperability for global wallets. And with businesses like the ads business that can grow despite a general decline in take rates, I just felt a lot more confident than I would feel with MSCI.

1:09:02And that's what I didn't see in today's pitch. I didn't get the feeling that there's a lot that could make up for the decline in take rates in the core business. And while an ad business for PayPal is improving margins, MSCI's other businesses are all margin dilutive. And if I add the valuation to this uncertainty, I tend to agree that MSCI is probably not a good addition at the current time. And as you argued, perhaps it's not even a good addition if you could get the business at a cheaper price, especially because if we look at the multiple, it is still priced for significant growth and definitely not for a deteriorating core business.

1:09:35So I agree with you. To my surprise, I think MSCI is not one of those companies that we would put on the watch list and be excited about when the market sells off. I think we've both been actually a little disappointed in this one because you always see MSCI talked about in the top tier of quality. And I think looking in the rearview mirror, that's true. But it's just hard to say that in the future, which is what matters for us as investors, it will stay in the same way. So I think it's that time where we say the train keeps going on. And maybe you can give us your hints for what your pitch will be next week.

1:10:16Well, I told you before the call that there are basically three companies that have a pretty bad market sentiment this year, and two of them are PayPal and Adobe, and we own both. So I thought maybe it's time, maybe I'll tackle the third one on the list. I know some of our members in the intrinsic value community own the name, so I'll probably be able to get some good information on the company when I do my research. Anyway, those, I think those are not real hints yet. So I would say the company operates in software and it is supposed to see, or it was supposed to see, significant growth fueled by AI this year.

1:10:48However, the integration didn't go as planned yet and that sent the stock down 25 % year to date. And the CEO, who is also the co-founder of the company, came under criticism as well. And I think I'll leave it at that. That might be enough of a tip for our community here. As always, let me leave you with a quote with today's coming from Seth Klarman. He says, ultimately, nothing should be more important to investors than the ability to sleep soundly at night. MSCI is a company that investors have probably slept very well with for a long time in owning, but at current prices, I'm not sure Daniel and I would feel the same way about being able to sleep easily at night, which is one of those intuitive signals that we should hold off on an investment for now.

1:11:36See you all again next week.

1:12:07Thank you.