TIVP048: S&P Global (SPGI): The Company behind the Market w/ Daniel Mahncke & Shawn O’Malley

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26:10And for a limited time, you can use code STOCKS15 for a 15 % discount at checkout. Generally, S &P's business model is built around recurring revenue and bundling its products into long-term subscriptions. I think that's sort of a theme that is recurring as you look throughout the company. And so the ratings division is transactional by nature, but even here, revenue is split 50-50 between subscriptions and then one-time transactions. And so the transactional side, just to emphasize it again, comes from rating new issues, whether that's corporate bonds, bank loans, or sovereign debt. And the recurring side, on the other hand, is that annual surveillance fees and the kind of relationship-based pricing programs that keep the agency engaged with clients long after that initial rating is first provided.

26:58And so the beauty of that setup is how it balances stability with cyclicality. And so when capital markets are booming and companies are all rushing to refinance or issue new debt, ratings revenues soars. But even in slower periods like 2022 and 2023, where you have higher interest rates that are kind of cooling demand for issuance, the recurring surveillance fees keep money flowing in. And so that's why ratings remains just such a dependable profit engine for S &P Global for so many years now. And I think it's for similar reasons that, you know, Buffett has loved his investment in Moody's. It just thrives in the good times and it holds up surprisingly well in the bad times.

27:41So there's a real moat and margin of safety around the business. Yeah, we emphasize on it so much because these surveillance fees, of course, they bring in money too. But even more and probably even more important is that they keep you in the ecosystem. So you do not only do a rating once and then maybe next time you choose a different company for it. But because you're still in the ecosystem, it's way more likely the next rating you need will still be done by S &P Global again. And that's just an incredibly good business. And as you can imagine, as you know best as someone who worked there, it's also one of the least capital intensive businesses you can imagine.

28:12Apart from analysts, you only need to set up basically the database and the tech once. And after that, and after it's in place, every additional rating costs almost nothing to produce and goes directly to the bottom line. And with global debt levels continuing to rise, I think the long-term tailwind is as much intact as it ever has been. So kind of finishing that segment and going to the next, the next largest segment would be market intelligence. And that's where you find SMB's Capital IQ platform that we talked about. And as you said before, you can kind of think of it as this Bloomberg effect set competitor, although it's a bit different in its focus.

28:46And it is used pretty much everywhere at banks, at hedge funds, corporates, and even government agencies. So anywhere professionals need to make sense of just financial data, CapIQ is part of that workflow. And what makes this business so strong is just how sticky it is. once a company builds its internal models and its dashboards or its reporting templates around S &P's data, it's almost impossible to switch. It's not just about the direct cost of switching, but as always, with the switching cost mode, it's about the time that you would have to spend just changing the workflows and then also train your employees on the new tools.

29:21I mean, as someone who worked on it, you just said it's so complex, you don't even understand that as someone who works there. Now imagine you've got to train the entire workforce on, let's say, the Bloomberg terminal after that. It's just incredibly difficult to do. And around 84 % of market intelligence revenue, unsurprisingly, comes from subscriptions. So long-term contracts that renew automatically each year. And then another 12 % is what they call recurring but variable revenue, which is basically a usage-based fee tied to things like the number of trades processed or assets under management or positions valued.

29:53So in other words, it's non-subscription part of the business, but it is still mostly recurring and it's keeping people in the ecosystem. And pricing wise, it's a little more flexible than it appears. I think a Bloomberg terminal currently costs about$30 ,000 a year. And I know the fact that it's about$12 ,000. S &P doesn't really publish the exact prices for a cap IQ, but it tends to scale with the client's size. So smaller firms will pay a little less while larger institutions pay much more, depending on just how deeply they integrate the platform into all of the workflows. And I think generally it's fair to argue that CapIQ is probably closer to the Bloomberg pricing than it is to the FactSet pricing.

30:32But even with all of that recurring revenue, I think it's fair to say that CapIQ business isn't quite as protected as something like the ratings business or even the index business. Because Bloomberg is still the number one, and at least from what I've seen in Germany, but I think it will be the same in the US, there's still a certain prestige that just comes with having a Bloomberg terminal on your desk. I mean, when clients come into the office and you see that iconic black and orange screen open, it just looks more impressive than if you open up FactZ and probably also CapIQ. It's kind of like a status symbol for finance people.

31:04I think it actually reminds me a bit of that old debate that we once had about Google Meet versus Zoom. And I was reminded of again a few weeks back in Lisbon at the conference that we were because we love Google Meets. We use it for almost all of our meetings in the intrinsic value community. But apparently, as I was told, Zoom is just a much more respected tool in corporate America. So So I don't know. I don't know a brand is a factor for a video conference tool, but I guess it is. And anyway, I think for a tool like Capacure Bloomberg, Prestige probably is a bit more important. I know that back at the family office, my boss, he still had the Bloomberg keyboard on his desk, despite us using FactSet.

31:42So I think it's kind of important for a lot of people. But S &P just has so much else to offer. I mean, they just have a treasure trove of data that gives you a competitive advantage over any potential entrants in this space. So over 95%, that's what they always say, of the data that CapIQ has and also the other tools, the market intelligence business, all of that data is proprietary. Yeah, well, we definitely have no issue using those Google Meet calls for our purposes. No shame, but maybe we're just value investors who appreciate a good price. But, you know, this part of the business with market intelligence, there has been a lot more noise around it lately.

32:21And the whole data sector, I think, got chickened up pretty badly after FACSET reported earnings. And then they revised down the revenue guidance. And Wall Street always hates to see that. And so even though that had nothing to do with S &P directly, the stock still fell in sympathy, as they say, about 15 % in the days after. And it's kind of wild to have that happen. But a company misses guidance. And then suddenly everybody in the space gets punished. But that is a sort of extrapolation we see all the time in financial markets. And so then again, Faxxed stock dropped around 45%, which is just insane and has me wondering whether maybe we should be looking at them on one of these weekly episodes that we do at some point here in the future.

33:03And so that was actually almost the same kind of drawdown that the company had during the great financial crisis. And so that's a pretty big reaction just because of some trimmed guidance. And you could maybe extrapolate that to make some comments on the overall market at this point in time, which we'll refrain from doing. But yeah, it's pretty astonishing. And so, especially because you look at it and they're still growing, just a bit slower than expected, but the market clearly, clearly freaked out. And it's really just a good reminder of how sensitive these data and analytics companies have become to even small changes in growth expectations.

33:41And so, management at FactSet had this quote where they said, we are taking a conservative approach to our guidance to reflect the current environment of longer sales cycles and more rigorous client approval processes. Apparently, that's all that's needed to spark a crisis, both at FactSet and at S &P. It's kind of funny when you look at an earnings report and you hear that sentence, then you look at the store and sound almost 50%. I mean, I don't think a statement like this should justify a 50 % drop, but I guess it all kind of ties into this this bigger story that's been floating around recently this idea that every company is about to get disrupted at least if it is anywhere near data companies or works with data and it feels like we just can't cover any business anymore without that at least coming up sooner or later in the episode and honestly i know you just said we shouldn't make it and make a comment on the market and i wouldn't do it but every time i see this it does feel a bit like we're in a bubble, at least in this narrative that AI will disrupt everything that has to do with data.

34:43I mean, again, 95 % of S &P's data in this segment is proprietary. You can't just access it or scrape it and then train AI models on it, not unless you would have direct access to S &P's data feed. So the more realistic outcome in my mind isn't that AI replaces S &P, but that S &P uses AI to just make its products significantly better and also more efficient. So kind of like what we expect and to some extent already see with Adobe or with Salesforce. So companies that just integrate AI into their existing tools and their workflows to just make them smarter and then end up having higher margins than they did before.

35:20And I think it's also worth remembering that outside of CapIQ, most of S &P's businesses aren't just selling data. A big part of the value proposition that S &P offers is trust. I mean, credit ratings, benchmarks, and price assessments, all of that just depends highly on the credibility of the company. And no AI startup can just replicate that overnight. So I think that's one of the big differences compared to a company like Fetsad. As you just said, I mean, who knows? Maybe it's just a very good price right now for the valued office, but it's also a way more concentrated business. It's basically a one-product company, and they don't have the same ecosystem.

35:55They definitely do not have the same brand trust. that S &P and also companies like Bloomberg has just built over decades. I think we're probably well overdue to have a call here in our intrinsic value community where we dig into this question of what it even means for there to be an AI bubble in markets and how that impacts different things. And I was reading something in the Wall Street Journal this morning just depicting the massive amount of CapEx going into data centers that will support the cloud computing AI initiatives at companies like Meta and Alphabet and Oracle. And it's just like totally disconnected from reality, it seems, of how much actual construction will have to happen, tying into the grid, the electricity production, balancing all those variables.

36:43The implication is very much that things are a little optimistic about how all that will come together now. And I guess I say that as some context to lead into asking you whether you do believe AI is going to be more likely to be a tailwind than a headwind for S &P's market intelligence division looking forward. Well, I do think it's possible that we will see new AI-driven tools at least compete in the space with the likes of CapIQ, Factor, or Bloomberg. But I think it's more likely that we will see Bloomberg and CapIQ just continue to dominate and just use AI themselves. I mean, where I could have a more direct impact is through S &P's customers.

37:27I think if banks and asset managers just start using AI and automate a lot of things that usually were the task of entry-level analysts, well, then you might simply need fewer people and fewer people also mean fewer capital IQ licenses. But that's probably the most realistic near-term risk. OpenAI, I mean, made headlines just recently about hiring 100 former investment bankers from firms like Goldman Sachs, JP Morgan, Morgan Stanley to train ChetGPT on finance-specific tasks. So it seems to be only a matter of time until automation hits not only tech jobs, which we have seen in the past, but also finance jobs, which, let's be honest, is not too surprising.

38:06But at that point, the real question for S &P will be whether the cost savings from AI internally can offset any slowdown in demand for data subscriptions. So in other words, can the efficiency they gain balance out a potential dip in revenue if some clients simply do not need as many seats anymore? If you'd ask me right now, I do think net they would benefit from the AI tailwind. I think that's a pretty good picture of the data and ratings business, which incredibly, still only a fraction of overall company here, just to emphasize how incredibly diverse it is. I think one of the more fun parts of the company to talk about is the indexes and the S &P 500 itself.

38:50So let's do that. How does that look and factor into things? Yeah, the part of S &P's business that sits behind the S &P 500 and many, many more indexes for that fact is the S &P Dow Jones IndySays segment. So this is the division that manages basically thousands of benchmarks, everything from large cap U.S. stocks to corporate bonds, commodities, and even volatility, which honestly is an index that I like to look at or just keep an eye on because it's a great way to just gouge how jittery or relaxed the market feels at any given time. I mean, just today when we caught this, the volatility index is actually up about 25%.

39:26So there's something going on in the market. But the S &P 500 is obviously the star of the show. And like I said, there are many hundreds or even thousands other indices sitting behind it. And all of them are licensed out to ETF providers. So asset managers and derivative exchanges all over the world. And I won't go too far into the weeds here because we have discussed a lot of this already in our MSCI episode, especially about the risks. But of course, I will still touch on the key points that we have to keep in mind for S &P. So what makes this segment so fascinating and once again, just a high margin business is that it's basically pure royalty income.

40:02All the asset managers like BlackRock or Vanguard pay S &P Global a tiny licensing fee, usually just a few basis points, for the right to use its benchmarks. And when you're talking about trillions of dollars tracking those benchmarks, even a few basis points turn into massive streams of income. And one of the advantages that S &P has over MSCI is that it's just less dependent on any single client. So, for example, you mentioned in your episode that BlackRock accounts for about 10 % of MSCI's total revenue, which is obviously a pretty big concentration risk. And S &P just doesn't have the same issue because it's so diversified across many different businesses.

40:41that no single customer has that kind of leverage, even though realistically, most of the revenue in the index business still comes from giants like Backrock and Vanguard. So in 2024, for example, the indexes division generated about$1.6 billion in revenue and roughly 70 % of that goes straight down to the bottom line. So maintaining an index once, it generally costs next to nothing. So every incremental dollar of revenue is basically pure profit. And that's what makes it such an incredibly and a stable business. Once a fund chooses a benchmark, switching it would mean refiling with regulators, triggering tax consequences even, and potentially confusing a lot of investors.

41:22So these relationships just tend to last for decades. And in practice, the S &P 500 isn't just a benchmark. I mean, if you ask me, it's kind of the market for most people. It's the market. It's as entrenched in the global financial system as the concept of the market itself. Another way to look at this business is that it's basically the ultimate beneficiary of passive investing. Every time someone puts another dollar into an index fund, and whether that's through a 401k, just an ETF and a regular tax bill account, or maybe a robo-advisor, S &P gets a tiny slice of that flow effectively. And over the past 20 years, that shift from active investing to passive investing has been one of the most powerful trends in all of finance.

42:09And so now we've seen pretty clearly S &P has been one of the biggest winners of that shift. It's literally built into the foundation of how people invest today, especially in America. But really, I think it's true to say that globally. And with that said, there are some long-term concerns about where this index business goes that we talked a lot about with MSCI a few weeks ago. And my concern is there could be something of a race to the bottom. If you look at the average fees for index funds, they've been shrinking consistently for years. And in some cases, they've already gone all the way to zero.

42:49And some funds are basically just giving index exposure away for free just to pull investors into their broader ecosystem and try to make money off that relationship in some other way. And so maybe they're not making money on the index fund, but if you're buying insurance from them or have a relationship with that asset manager in some other way, that's how they end up monetizing it. And so while S &P as the index provider still earns that royalty every time money flows into passive products, the question is really how long those unit economics can hold up if the trend toward zero fee index funds keeps accelerating because then there's no pie of revenues to split back to S &P essentially.

43:33I feel like when we talked about MSCI, one of the problems that we saw is we didn't see a thriving ecosystem around the index business. So they had a lot of operations in ESG, but they just didn't really excite us when we thought about other value-adding services. So you made a great comparison to the autonomous vehicle in the Uber bear case, basically. Something that's technically possible, but still pretty unlikely. Yet, if it ever happens, it would be massively disruptive for the business. And I think that's the right framework to think about it here too. I mean, I do think management fees will keep coming down over time.

44:07That's just the direction of where the industry is heading to. And the reality is that S &P and MSCI still have the strongest brands and just the deepest trust in the entire space. So the flagship products, they just aren't as commoditized as most other passive index funds. So people might always be willing to pay a small premium, at least for a premium benchmark like the S &P 500, even if there are cheaper or free options out there. So it is the name everyone recognizes. So the benchmark everyone trusts. So I do believe that this is worth something even 10 years from now. I mean, I have many friends that get confused by the different names in front of the MSCI world, whether it's iShares or Mundi or whatever.

44:47If you now take away MSCI, I think that would almost cause a panic, honestly. And right now, the tailwinds from just rising assets under management are still more than enough to offset those declining fees. And last year alone, the average ETF as standard management, so the AUM, tied to S &P's indexes grew by over 30%. So sometimes it feels like we're near the end of that passive investing boom. But honestly, when I step outside of my investor bubble, basically, and talk to friends and family, I still realize how early we are yet. I mean, sure, most people have heard of ETFs by now, and yet a lot of them are only just starting to invest in them.

45:25And even among those who already have invested in them, it's usually just a small slice of their total net worth or at least the money they have invested in the market. So I would say there's so much runway for inflows left before you're going to see the growth basically hitting a plateau. That said, though, I completely agree that there is at least a terminal value concern. And it's one of the reasons why I would personally prefer S &P over MSCI, because as I just said, the index business is obviously a key piece for S &P as well. But I mean, S &P has many other high margin businesses where segments support each other.

45:57And we just feel that as soon as you have a customer drawn into the ecosystem, there are many ways to make money off of him. So that could be ratings, market intelligence, commodity insights. That's just not as dependent on one driver to keep compounding. So I think another risk we should talk about when we look at the index business here is the rise of direct indexing. and we talked about that a lot in the MSCI episode, but it might even be a bigger threat to S &P since MSCI is so much more focused on international markets and innovations in capital markets tend to flourish in the U.S. first.

46:34So if management fees are going to go to zero on indexes, it'll probably happen in the U.S. first and then everywhere else later. And so direct indexing is an investment strategy in which an investor buys the individual stocks that make up an index, such as the S &P 500, and rather than a mutual fund or ETF that tracks the index. And that might make sense when an investor doesn't want to own specific companies or industries that are otherwise included in the total index, especially for things like ESG concerns. And then there's an argument about making use of tax loss harvesting. So selling losing positions to benefit from write-offs on your taxes?

47:17Well, I'm by no means an expert on direct indexing, and I do not know the most recent trends. But to me, it seems like it is a niche phenomenon when I compare to the general philosophy of just passive investing. I mean, the whole idea is to be passive. People like you and me who see the benefits of this are more likely to invest in individual stocks anyway. And people like my dad, who have no interest in the stock market, they just want to put money into a passive index and forget about it. They likely don't even know whether there is a tobacco or fossil fuels company in the S &P 500. And they're definitely not thinking about anything that's even close to tax loss harvesting.

47:55So I'm personally not really that confident that robo-advisors would make the job so much simpler that then suddenly direct indexing could become a bigger thing. But perhaps the most important thing is that even in a direct indexing world, the underlying platform, let's say you use Schwab or Morgan Stanley, they still need a benchmark to determine which stocks go into the custom portfolio. So instead of the ETF paying S &P, the direct indexing platform now does. Because ultimately, you still need the data and the licensing. And this could cause margin pressure and further take rate declines, though, because the big players like Schwab or Morgan Stanley, for example, they obviously have more negotiating power or negotiating leverage over S &P than millions of individual investors who are currently paying those fees through ETF management fees, for example, when they buy it at BlackRock.

48:45Well, so one division that we haven't talked about yet is commodity insights. And actually, when I worked at S &P, I feel like this was the unit that I had the least insight into and knew the least about. So you'll actually probably teach me a few things here. But I think as any investor knows commodities are a pretty volatile business to be in right prices swing all over the place you don't really have control of your your destiny in that industry but the great thing for S &P is that once again they've managed to turn something that is this really unpredictable difficult business into a highly stable and profitable business for them and so almost 90 percent of the two billion dollars in revenue that this segment generates comes from subscriptions and customers pay for annual or multi-year licenses to access data feeds, dashboards, and real-time analytics on commodities from S &P?

49:39The dynamic kind of reminds me of trendstime. I mean, the airline industry is also volatile, but trendstimes aftermarket sales make it a lot more predictable and highly profitable. And then S &P doesn't deliver any airplane parts, obviously, but it delivers data. And that's at least as doable, probably even more so than aftermarket sales. And every single day, this division basically publishes thousands of price assessments that act as a reference point for physical trades, derivatives, and also long-term contracts basically all around the world. So let's take oil as an example. When an energy company sells a cargo of crude, the contract will often say something like brand platts plus 50 cent.

50:21And then that brand platts reference comes directly from S &P Global. So S &P obviously doesn't decide the price itself, but it collects reported trades between buyers and sellers, then it verifies them, and then it publishes basically a standardized benchmark that everyone else agrees to use. And it's probably not an exaggeration to say that global commodities are literally priced off of S &P's data. And the customer base here is huge. I mean, we're talking about oil and gas producers, refineries, traders, utilities, governments, banks, hedge funds, and even exchanges use it. So a multinational oil company, for example, might use Platts benchmarks, then price the shipments, while a trading house could use it to manage risk or structure derivatives.

51:06Utilities rely on it for electricity and gas procurement contracts and banks and hedge funds, but they feed it into risk models and their trading system. So even regulators, I mean, tax authorities use it for transparency and reporting. So there's really not any part of the financial business that cannot use this data and isn't using S &P for it. And once again, I mean, it's similar to all the other businesses. Once a benchmark like Platt's brand, for example, becomes embedded in contracts, futures market and government policy, replacing it will require both counterparties to agree, regulators to approve and then markets to rebuild liquidity around a new reference point.

51:43I know it sounds all pretty complex and like it's theoretical, but all you need to understand is that something like that almost never happens. It's incredibly high barrier to entry. It's a Modi business. And you see that in the margin because you're talking about 45%. So from$2 billion in revenue that you mentioned before, about$850 million remains as profit. I think this is with a lot of the units at S &P, it's hard to think of a real threat to their operations, but there is maybe one that could be worth looking into. And so right now, the way it works is that S &P's Platts division makes money by collecting trade data, verifying it, and publishing benchmark prices.

52:24I think that's the simplest way to understand what they do. And they do this for things like Brent crude, natural gas, and other refined oil products, basically. And so those benchmarks exist because most commodity markets in terms of trading are still incredibly opaque. These trades can happen privately, between counterparties, and really nobody knows the true market clearing price in the same way that you might on the New York Stock Exchange for shares of Apple. And so that uncertainty and kind of gap in information and data is S &P's value proposition. They collect the bids and the offers and the completed deals, And then they apply their unique methodology and publish a single trusted reference price point that everybody can agree on for contracts and trading purposes.

53:14And then more transparency, though, I think could be a risk for that business in a sense. And from what I've heard, there's a shift in commodity trading toward digital platforms like CME Direct, ICE Connect. And then you have these newer entrants like Vact or Expansive. And these record every trade electronically, price, volume, timestamps, the whole thing. And there are also these blockchain-based settlement systems being tested that log trades in real time on tamper-proof ledgers. I think it's sort of the way to think about it. And so in theory, that could drastically increase transparency. And you add to that the rise of smart contracts and tokenized commodities, especially in things like carbon credits or metals.

54:02and you could eventually end up with these kind of live on-chain price discovery mechanisms for maybe even entire commodity markets. And so, you know, we always have to talk about AI, but with machine learning and large-scale data aggregation, much of what Platts analysts do manually kind of seems like in theory it could be automated. So I don't know, how do you think through that risk for S &P? Well, first of all, and that shouldn't come as a surprise to anyone, I'm not under the illusion that I understand this market well enough to figure out what technology or how exactly they will use technology and what it looked like in 10 years.

54:42I mean, there's still certain dynamics that I would say protect S &P's positioning. They have so in the last decades, and I still think they apply today. I mean, physical commodity markets are messy and fragmented, just as you said, and there are plenty of details you got to account for. So So a single oil trade can vary by grade, by sulfur content, by shipping route, credit terms, and even the delivery window. So it takes a lot of expertise to normalize that data into something comparable. So you cannot just say, well, there's been a certain price, and let's say it has been for gold, and that level of gold or quality of gold, then you know what it actually is worth.

55:17There are a lot of details that you have to figure out, and S &P is very good at collecting all that data and then figuring out what price you should actually pay. And even if all the trade data in the world were public to know, markets would still need someone to then interpret it, to decide what counts as representative, what doesn't count, and what the official numbers should be. And I think that's a big part of what S &P and this business segment is doing. And that's where the trust of this business unit lies. So they're not just a data collector, as it often seems as portrayed when it's about AI disrupting the business.

55:48So yeah, S &P actually has partnerships with most of these companies, like Expansive, for example, where S &P provides the daily benchmark prices for instruments that then traded on Expansive. And on the blockchain front, S &P partners with even JP Morgan, and I think there are two other companies called Kinexis or Vera to help tokenize carbon credit. So unsurprisingly, and I think this has been somewhat of a bigger narrative in most of the companies we cover, S &P doesn't stand still either. And as it is often the case with modern monopolies, it is in a pretty good position to benefit from all these innovations rather than just get replaced by it.

56:23I just continue to be fascinated by, and I remember thinking this the first time I started working at SAP, it was just, maybe as an outsider, it doesn't seem intuitive that a company could exist solely just as a neutral third party kind of validator. And yet in the real world, getting everybody to agree to a standard, right? You have all these different banks and hedge funds and investors all over the world. And sometimes you just need a common language almost. So whether that's with indexes like the S &P 500 index, whether it's benchmarks for crude oil or just with the data that S &P provides or for a stamp of approval on a company's essentially ability to borrow funds.

57:12and be deemed a good credit risk, it's just so important to have a trusted third party. And that's why S &P has been able to capture so much value, not because they have some arbitrary monopoly that's just been granted to them, but because they've genuinely cultivated that trust and become the default over decades. And so looking at this with outside eyes, it just seems bizarre of like, well, why does everybody let S &P just accrue the benefits of these relatively arbitrary things that it seems like anybody could put together and a benchmark for crude oil. But yeah, I think what we're really looking at is the product of decades, if not longer, of accumulating trust and kind of inertia and status quo and kind of a common language around how different things in financial markets are described.

58:02And so now we've touched everything from financial markets to commodities. But I think there's one part of the business that surprises almost everybody who hears about it. And we talked about it a year ago. It was already rumored to be eventually going to be spun off. And it turns out it's still here, though. So let's talk about that a little bit. It is. It is. And it might come as a surprise to you and everyone listening. But the mobility division, which is the segment we're now talking about, is, you can take a guess, all about data. I mean, to precise, it's about data for the global automotive and the transportation industries.

58:36And this segment came over as part of the IHS market acquisition in 2022. And it's generating about$1.6 billion in revenue. And around 312 million of that is operating profit. So that would translate to a 19 % margin. And that makes it the smallest of S &P Global's five main divisions. However, as you heard us say before, they don't have low margin businesses. So once again, 19 % doesn't sound that high. But if you adjust the margin for the amortization costs related to the IHS merger, it is closer to 40%. And the data it owns is exceptionally difficult to replicate. It's becoming increasingly valuable as the auto industry undergoes, I would say, one of the biggest transformations in its history.

59:18I mean, the US database for car ownership records, for example, has about 35 billion entries. So it's pretty much a monopoly as it's used by just every large player that is even remotely operating in the automotive industry. And the business has two main pillars, I would say. The first is it's forecasting and production data. Models that project how many vehicles each manufacturer will build, what components they will use, and where they will be produced. And this information is used by especially automakers, but also by suppliers and logistics firms just to plan inventory, production schedules, and also make investment decisions, right?

59:55I mean, the second, it's vehicle and ownership data best known through the Carfax brand that I mentioned earlier in the episode. And that's where those 35 billion ownership records sit. I mean, I was told that almost everyone or anyone in the US who has ever bought a used car has likely encountered a Carefax report, which shows basically the car's ownership history, maintenance records, and accident data. And it's basically the gold standard for used car transparency. And once again, S &P Global sells this data primarily through subscriptions and enterprise licenses. About 80 % of its revenue is subscription-based, generated from long-term contracts with both dealers, insurers, and even auto lenders that require continuous access to that data.

1:00:37And the rest comes really from just direct-to-consumer sales. I mean, where individuals pay per report when they buy or sell a used car. So it is the same playbook again. It's about recurring revenue. It's high margin and a product that's just deeply integrated and embedded in customer workflows. I think what's interesting about this segment is that the automotive industry is currently going through one of its biggest shifts in a long time. And we discussed it in our Mercedes episode, which was a while back. But more recently, we talked about it in our Copart episode. And as the world transitions toward electric vehicles and also autonomous driving, the value of reliable standardized data on vehicles and its supply chains is just exploding.

1:01:18I mean, modern cars are really more than machines. They are software, basically. So they are producing terabytes of data for automakers, insurers, and charging infrastructure companies to need to interpret them. And S &P Global, through the data that they got from the IHS merger, has decades of historical context, global coverage, no matter in what country you sit, and just deep relationships, especially with the OEMs and their regulators. And that just gives it a unique vantage point to serve as pretty much the data layer of the next generation auto industry. But part of the truth is that the mobility business is just very different from other divisions.

1:01:56So S &P attempted to integrate its mobility data with other parts of the business. For instance, it connected production forecasts and then raw material demand from automakers with pricing data from the commodity insights division. It sounds complicated, but it's really not. I think it's actually pretty cool because you could technically use or see the entire value chain from, let's say, lithium mines to battery plants and then to vehicle assembly lines, let's say at Mercedes. So I think that sounds like there should be a lot of synergy, but I guess it sounds better than it is in practice because as you said, S &P has decided in April of this year to really go with it and just spin off the mobility division.

1:02:33I think that report said it has been valued by private equity firms at around 10 to 12 billion dollars, but they did decide to not sell it, but just spin it off. And I think it could be a pretty good company, even standalone. for shareholders of S &P, it's probably a stock that you would even like to hold after the spinoff. We actually had a call in our private intrinsic value community recently about spinoffs. And there's quite a bit of evidence showing that when they are done right, both sides can win. And the parent company gets to kind of sharpen its focus and the spinoff often unlocks hidden value and grows even faster on its own.

1:03:11And so given the quality of this mobility business, I would not be surprised if that ended up being the case here too, with both S &P and mobility coming out stronger if they ever did decide to go through with it. And in that case, I think shareholders would obviously benefit as well from owning stakes in both companies. That's how the spinoffs typically work. And so, all right, well, I mean, let's put it all together and look at how these five business segments have helped S &P Global just be an absolute monster of a compounder over time and how the company actually uses the capital it earns to create new value for shareholders.

1:03:51And so over the past decade, revenue has grown at roughly 10 % a year, operating profit around 15 % and then earnings per share at about the same pace. And earnings per share did not outgrow profits because S &P's share repurchases over the years were basically offset by this one-time dilution from the IHS market merger, where they issued new shares to essentially fund the acquisition of IHS market, which is what brought that mobility and Carfax unit over along with the IHS market. a whole lot else. And so before that deal, S &P had been steadily reducing its share count though, about 2 % a year on average.

1:04:29And so that's more on par with what we would expect going forward. But that merger really was massive and added 120 million new shares to the total share count, pushing the total from 240 to around 360 million. And so management quickly ramped up buybacks afterwards to try and offset some of that dilution that was concerning investors. And they did so pretty effectively, bringing the share count back down to about 320 million by the end of 2022. And still, that meant shareholders experienced roughly 30 % dilution overall from the transaction, which just shows how big that acquisition really was.

1:05:11And it's not like dilution in the form of stock-based compensation because it did acquire real business assets with intrinsic value, but just dilution in the sense of the share count continuing to expand dramatically. I was actually surprised that when I went back and I checked the stock price, the stock didn't react that negatively. I think if you have so much dilution from a stock that of basically from a company buying another company, usually the stock doesn't really like that because it was definitely a dilutive deal and not exactly cheap either. I mean, I think the company, IHS Market was trading at around 35 times earnings at the time.

1:05:45But to be fair, it did really expand S &P's entire ecosystem significantly and it widened the mode in many of the companies it owns. It's not only about the mobility segment, but there were many, many businesses basically integrated afterwards into S &P. So it does mess up S &P's otherwise excellent return metrics. Return on invested capital or RIC went from consistently achieving high 20s to mid 30s, now being in the single digits. The drop has been due to mostly the increase in S &P's asset base. So if you acquire a company, most likely you will have a huge or ballooned balance of goodwill and intangible assets like software and databases.

1:06:23And that increase in the denominator of the ROIC calculation therefore dilutes ROIC because you can just not grow NOPAD or the net operating profits before amortization and taxes in the same line with the goodwill explosion that you will see. So of course, artificially, returns on invested capital are lower. But obviously, the quality of the business hasn't deteriorated at all since 2022. And the great thing about S &P is those returns are driven just by massive operating leverage, which also explains its incredible margin profile across all the different businesses it owns. So the average operating margin of S &P is about 40%.

1:07:01And prior to the merger, it has been about 55%. I think that's one of the most interesting facts now about looking at S &P that I think there's a pretty good argument to make that the current margin of 40 % will get significantly closer to at least, let's say, 50 % in the near term because you just get all the operating leverage of these new businesses coming in and you just offset a lot of the dilution that you had prior. So I think there's a good case to make that even if the top line isn't going too quickly, you will at least have margin expansion in the next couple of years. And even if you look at gross margins, they're on 70%.

1:07:36Again, that's on par with companies like Microsoft. Generally, if you look at the magnificent seven companies, Microsoft is the only company that can keep up with the margins of S &P. And then a metric where not even Microsoft can compete with S &P is on free cash flow margin. Microsoft, I think, sits around 26 % and S &P is like 10 % of its points higher in the mid-30s. And so a big part of the reason for the great margins is that capital expenditures are typically well below 2 % of revenue for S &P, meaning the business converts nearly all of its profits into cash. And that gives S &P Global just a good amount of financial flexibility on top of the fact that the business is just structurally super profitable.

1:08:20And so, as you said before, S &P has used that flexibility in the past to buy back shares, and especially so after the$44 billion IHS market acquisition. They used a lot of capital to try and reduce the dilutive effect of the deal and then to pay down some of the associated debt. And so now I just want to ask you on capital allocation. I mean, is there anything else that we should know or maybe what their strategy you think will look like in the future? I think it's fair to say that S &P Global has a pretty good track record of just giving back to shareholders. I mean, excluding the merger, it has reduced the share count roughly 20 % since 2012.

1:09:00and even more impressively, and that's what S &P is kind of known for in terms of capital allocation, they've increased their dividend by an average of 10 % per year for 51 consecutive years. And that definitely deserves the sport among the dividend aristocrats. And I got to admit, I was a bit surprised after reading that fact that the dividend year currently is only 0.8%. I think that's a bit underwhelming if you read that they increase it for 10 % over five decades. But then again, that's the price you have to pay for owning a company that has compounded at even higher rates than those 10 % over all those decades.

1:09:32So going forward, I would say the main way to deliver value to shareholders is through buybacks. Since the merger, S &P has repurchased $22.5 billion in shares. While there are no explicitly stated new programs in place, I would expect buybacks to be about $2.5 to$3 billion a year. Again, S &P didn't provide any guidance on that, nor has it issued any new buyback programs since the last one. However, we know that they aim for about 85 % of free cash flow going back to shareholders. And now let's just assume they make$5 billion in free cash flow. We know it aims for 85 % of that going to shareholders.

1:10:08And we also know it pays a dividend, which if we just be conservative, the dividend should be about$1.2 billion. And that would leave us with about$3 billion. And at the current market cap, that would result in a 2 % annual share price decline. That's pretty much in line with what they paid prior to the merger every single year. So that's kind of what I assume would be the most realistic annual share price decline rate for S &P. And beyond dividends and buybacks, S &P also continues to invest strategically, makes more small acquisitions. I mean, they invested into data and analytics companies or specific softwares.

1:10:42So recent examples, for example, are Visible Alpha, which added earnings estimate data. Then you had Pronto NLP, which expanded S &Ps, of course, generative AI capabilities. And you had ChartIQ, which they integrated into CapitalIQ. And it's basically a tool for visualization. Well, we've already touched on some of the risks for each business along the way. But if we just take a step back and look at the big picture, which ones stand out the most to you? And maybe not just like theoretical risks, but the ones that you think really matter to investors right now, what is the market going to be most focused on?

1:11:16yeah again i think the market is is mostly focusing on these on the ai narrative and then facts that we guidance of course and the comments the the company made but as i said earlier i believe that s &p's ecosystem is just much more sticky than fact sets and um i also think that i will be more of a tailwind so i think it's not that easy to pinpoint like really a bear case for the company i think one problem has been that they have been valued relatively high for the last years, which is why basically the company, or at least the stock price, didn't move for quite a while. But I don't see this one big threatening bear case that the market currently sees in the AI narrative.

1:11:53I think the kind of disruption people could be worried about here is maybe similar to what we talked about with Salesforce. And back then we said Salesforce had a real edge because it's so deeply integrated into customers' workflows. And because it's been sitting on decades worth of customer data, there's really no competitor that can just recreate that overnight. But for S &P, I think that advantage is actually arguably even stronger. Its entire moat is built on proprietary data, data it owns, collects and maintains. And the thing with AI models is they're only as good as the data they're trained on.

1:12:27of course. They need information that's clean, labeled, and in the best case, legally licensed. And so, I mean, that's exactly what S &P provides. So if anything, the rise of AI might actually strengthen S &P's position rather than threaten it. By now, I think this whole narrative probably sounds familiar to all our listeners. I mean, we talked about it, especially with Adobe and Salesforce, but almost every second company that we cover. But once again, I would still bet on the incumbent here. I actually think S &P will end up being a beneficiary of AI, not a victim of it. Sure, they might lose a few CapIQ customers if investment banks or asset managers should start cutting the headcount, and eventually that will probably happen.

1:13:06But fewer analysts mean fewer seeds, and that will likely be offset by new revenue streams like licensing data directly to AI developers, or more realistically, just integrating generative AI into CapIQ itself. I mean, management already hinted at this by saying that the company is training its own large language models like Kensho, for example. It's currently their AI subsidiary. And what they want to create is basically an AI co-pilot. So inside S &P's platforms, you will have a tool that can summarize earnings calls, generate peer comparisons, and even surface anomalies in real time. I don't know.

1:13:42I've used JGBT or I've used it every day. I know you do it too. I don't know if I would yet trust it to surface anomalies like that whole lot of data at least with like critical thinking involved but probably that's where I will be going in the next couple of years whether it will be successful or not will be dependent on whether I can do tasks like that and honestly while everyone is expecting AI to reinvent the world just overnight I think in reality at least for a couple of years out it's going to be more of an efficiency driver inside the systems that we already use, at least when it comes to companies like S &P, Salesforce, and Adobe.

1:14:16And again, it's worth emphasizing that when we talk about AI risk, we are really just talking about the market intelligence division. I mean, AI isn't going to disrupt ratings or indices, and those other businesses are just built on both regulation, but also trust and not automation. So even if I should be wrong on this, and AI is more disruptive, we're mainly talking about the market intelligence business. I think it's hard for us to, before we get to the valuation, we really need to appreciate management compensation and talk about the quality of the management team overall as maybe the last thing for today.

1:14:52And since our last look at the company a year ago, the CEO actually has changed in that time. And so I can say I've kept up super closely with S &P. So my question for you is, did that change anything in your mind about the future direction of the company to have that change at the top? And I know that we were both pleased with the track record of the previous CEO and management team, but less so were we impressed by the fact that they had very little skin in the game, unfortunately. Yeah, the skin in the game, unfortunately, hasn't changed. Inside its own about 0.28 % of the company. And in their defense, I must say, it's just not easy to build a meaningful stake in a company worth$150 billion if you're not a founder or at least with the company for many decades.

1:15:36But I'm not a huge fan of the compensation structure either. And that's something that they could change and have in their own hands. I mean, the annual cash bonus is basically based on revenue and margins. And the stock rents are mostly based on EPS growth. Then again, management has given us no reason to really doubt them and their commitment to shareholders. So while it's not the most aligned management team and not the best compensation structure that I have seen, I think it's not a reason for me to not invest in S &P. And just on the new CEO, I mean, do you, is there anything you do differently from her strategy or do you like her for the most part?

1:16:13Well, Martina Chang is an internal hire. So she was the head of the ratings business. And it's very likely always, if you have internal hires, that most things just will continue to basically cruise and be the way they have been before. She was the one, though, with the final decision to spin off the mobility division. So what we might see is just an increased focus on the core business. Well, I think this is as good a time as any to shift gears a bit. Why don't we start talking valuation? When we last covered S &P, I was not totally convinced by the valuation. And since then, the stock has pretty much been flat.

1:16:51So really, the big question now is whether the business itself has improved and what the growth prospects look like going forward and whether they've kind of grown into their multiple a bit. And we actually just talked recently about how the overall market feels more expensive than both of us expected. And so maybe it's time to look at company valuations through a different lens. And, you know, the S &P 500 is at about 30 times earnings, and that's a little cheaper than S &P Global. But if you look at the forward PE, both the market and S &P are about 24 to 25 times. And I think we'd both agree S &P Global is a far better business than maybe the average company in the S &P 500.

1:17:29but it's also a little bit of a straw man argument if you think the S &P 500 itself is dramatically overvalued. And yeah, I don't know. I mean, you're paying a similar multiple for a much higher quality, but I don't know. It's an interesting place to start the discussion. You tell me how you think of it, Daniel. Well, just like you, I've just had hard times accepting that 30 times earnings is supposed to be the new normal. I mean, we've seen plenty of great companies over the past few years that haven't really delivered strong returns. I mean, we talked about some of the businesses on the show.

1:18:01We had Amazon, for example, and honestly, S &P is one of them. Most of the time, it just comes down to valuation. They were just a bit too expensive and basically priced for perfection. That's always a term I like to use because if you're priced for perfection, it's basically the opposite of what we look for, which is asymmetry in the companies that we try to find. And when that's the case, even if the business keeps performing well, it's often just not enough to make investors happy and add in a little uncertainty or perceived disruption like all the AI noise. And that just hits nearly every sector.

1:18:33And then you can get some pretty sharp pullbacks. I mean, we've covered quite a few companies on the show that have seen that, but there are even more that we haven't yet covered. I mean, just look at Constellation Software, which is down almost 40 % from its all-time highs. And it's still one of the best-run companies in the world. But Variation eventually just caught up with it. So, yeah, when I started digging into S &P Global, I was pretty confident, actually, that it looked like a good deal at current prices. I mean, it's trading at a forward free cash flow yield of 4%, which is pretty high.

1:19:02Surprisingly, though, it's not even, it's actually slightly below the average for S &P Global over the last 10 years. So yeah, after running the numbers in my model, I got to admit, it's not as cheap as I hope. I'm modeling revenue growth of around 7.5 % per year, which lines up with S &P's long-term average and reflects steady mid to high single-digit growth across basically all the divisions they have. The ratings and market intelligence businesses are both set to go around 7 % to 8%. Commodity insights and mobility around 6 % to 7%. And yes, mobility will be spun off, but I still included it here.

1:19:37And the indexes business roughly 8%. So yeah, top line growth isn't really something that gets you excited. It's not spectacular, but it's not bad either. It's fine with the company, the size of S &P and the quality it has. What's more interesting, and I mentioned it before, for me personally, is the margin expansion story. I mean, it's totally reasonable to assume that operating margins can climb from about 40 % today to roughly 50 % by the end of the decade. And that will come as the company finishes kind of digesting the IHS merger and continues to benefit from just operating leverage and really starts capturing efficiency gains from, for example, integrating AI across the different business segments.

1:20:14And those improvements should flow right to the net income margins as well. And I'm assuming, as we talked about before, that the share count will keep declining by about 1.5 % per year. You could make a case for 2%. I want to be a bit conservative, but I think that's pretty much in line with what we have seen historically. And if you have all these assumptions and then you use an 8 % discount rate and maybe a 10 % margin of safety, which isn't that large either, this would give you a fair value of around$440 per share. That's roughly 10 % below where the stock is currently trading today. And, well, the most important variable, if you look at the model, is really just the exit multiple.

1:20:52I use an exit multiple of about 27 times, which is not really high, but it's not that low too. It's pretty much in line with the historical averages. And I don't know, I think it's also a fair bit lower than its trailing average, which has been close to 35 times. And if you compare it to the border market, then 27 times is more or less in line with the S &P 500's current valuation. If you use an exit multiple of 35, then suddenly the price you would get is about 570. So what I want to say with this is whether S &P will be a good investment or not mostly depends on how the market will value the company.

1:21:26And that's just not that great of a setup or not the type of opportunity I look for. Typically, we want the story to speak for itself, where, for example, you could assume even pessimistically looking at maybe the growth decelerating or some contraction in the multiple. you could still plausibly underwrite perhaps a double-digit annual return. And as an example of that, when I looked at Ulta earlier this year, I saw a company that had this incredible track record of reinvesting into itself while the stock had hit this period of short-term turbulence. And the returns from incremental new store openings were just so good that especially as they were beginning to expand internationally, I could feel pretty confident that, hey, even coming off a rocky year, Ulta's earnings could not only keep growing steadily, but could really bounce back dramatically, potentially.

1:22:13And then you layer over very aggressive share repurchase programs, driving earnings per share as well. And then the fact that the stock was trading at a 10-year low in PE terms, I mean, you could underwrite pretty satisfactory returns by just betting on the durability of the core business and very attractive returns if you were to expect some mean reversion off of a pretty low PE multiple. So we were thinking about how exit multiples factored in, but more in the sense that we knew we were buying in at a relatively low multiple. And there was good reason to believe that PE expansion could be a tailwind or at least not a headwind going forward.

1:22:50So it was almost like you're looking at it, you're saying, all right, in the base case, we're thinking we're going to get an 8 % to 10 % return or higher. And then there's this call option built in where we think that once we get through this period of fear around the stock, there's pretty good reason to think there'll be much further upside if you get some normalization and how the market is essentially valuing the company. And yeah, that investment ended up working out very well for us. And so in this case, though, it sounds like S &P's core business will continue to do fine. But that's just it's not enough.

1:23:22we're not obviously getting in at an evaluation multiple that we have a margin of safety. And over really the long term, it is true that the entry multiple matters less, but I think it's okay to be a little greedy here too. I mean, S &P is not going anywhere. I don't think we're going to miss out on the chance to ever invest in it. And if it doesn't meet our expected return requirements at current prices, I'm happy to kind of put it at maybe the very top of our watch list and wait till we can put our cash to work when there's a more significant price dislocation in our favor. Nobody is forcing us to swing today.

1:24:01We say that a lot on the show, but I think that's really how you have to think about investing. I mean, if you're looking at a different company every week, most of the time the companies are going to be about fairly valued. And then it's a question of, okay, generally, from a kind of qualitative perspective, is this a business we want to own? And then thinking about, okay, what is the kind of price point where we would start to get very excited about entering it relative to the opportunities that we have elsewhere? Because you always have to consider when you're putting cash into one company, you're not putting it into Alphabet or Reddit or Uber or Nike or Ulta or everything else in the portfolio.

1:24:37So you have to constantly be weighing against the other opportunities in your portfolio and in the market more generally. We just added two positions in the recent weeks to our portfolio, which were Trendstime and Copod. As you just said, there's always an opportunity cost to buy or establish a new position. And then we have just looked at so many companies that I find that building out our watch list is actually one of the big competitive advantages that we have looking at one company each week. And then we now understand how this business works. We know it's a fantastic business. But we also know that there are a lot of cyclical businesses in S &P.

1:25:12And if the market sets off at a certain time, it probably hits S &P even harder than some other companies. So as you said, it's a company that's high up on our watch list. But for now, I think we're holding off owning S &P. We're not yet adding it to the portfolio. And maybe at a later price point, if the market is rewarding our patience, basically. But who knows, maybe next week, you have a company that we can immediately integrate or buy into or for our portfolio. So how about you give us the hints for the next episode so we can try to figure out which company that might be? Yeah, maybe so. In a way, you could say the company is kind of like an inverse of Uber's business models or maybe like something like a mirror reflection.

1:25:53And if you don't know what I mean, you certainly will. It has actually this company that will be pitching has partnered with Uber's most prominent competitor in ride hailing in North America. So that should give you a hint. While they also challenge other parts of Uber's business more directly. I think that's all I'll say. And so the company's name has actually pretty quickly become a verb in everyday parlance too, at least in the US. And yeah, you can leave your guesses in the comments and hopefully it's not too obvious. I don't think it is, but I think we've talked so much now about Uber that some people will probably have an idea of what company it might be.

1:26:28So, all right, I would say I will close it for today with a quote from one of my favorite investors, who is Howard Marks. And he once said that investment success doesn't come from just buying good things, but rather from buying things well. And I think that really sums up S &P Global to some extent. It's certainly a good company, probably it's a great company. But at today's prices, I just don't think the opportunity is as asymmetric as I was hoping for when I first started looking into it. So, again, we hold off. And with that said, thanks so much for listening to everybody who's still here and have a great Sunday.

1:27:00We'll see you all next week.