A great com­pany at a fair price

Rat­ing agency Moody’s is a qual­ity busi­ness and to­gether with Stan­dard & Poor’s it dom­i­nates the credit rat­ings mar­ket with a com­bined mar­ket share of more than 80%. What’s not to like?

Finweek English Edition - - MARKET PLACE -

ratin­ga­gen­cies are an es­sen­tial com­po­nent of cap­i­tal mar­kets and in our view of­fer a com­pelling way of gain­ing ex­po­sure to the fi­nan­cial ser­vices sec­tor. Moody’s, which we be­lieve to be one of the great qual­ity busi­nesses of the world – is one of the top 10 hold­ings in the In­vestec Global Fran­chise port­fo­lio.

The mar­ket for credit rat­ings is a du­op­oly, dom­i­nated by Moody’s and Stan­dard & Poor’s (S&P) (they have a com­bined mar­ket share in ex­cess of 80%, with Fitch a dis­tant third at around 18% mar­ket share). This economic moat means that bar­ri­ers to en­try are ex­tremely high – the brand and net­work ef­fect con­fer a com­pet­i­tive ad­van­tage to the in­cum­bent agen­cies that is in­sur­mount­able bar­ring a struc­tural change to the fi­nan­cial sys­tem or gov­ern­ment or reg­u­la­tory in­ter­ven­tion in the credit rat­ing mar­ket.

Moody’s earns fees from is­suers of debt, but also houses an an­a­lyt­ics busi­ness, which has a num­ber of rev­enue streams in­clud­ing the sale of credit re­search and en­ter­prise risk con­sult­ing to the fi­nan­cial sec­tor. Ap­prox­i­mately half of the com­pany’s credit rat­ing-re­lated rev­enue is gen­er­ated on debt is­suance and half from fre­quent is­suer pro­grammes. Moody’s has phe­nom­e­nal pric­ing power when it comes to credit rat­ings since the cost sav­ing from a Moody’s rat­ing on fi­nanc­ing costs to an is­suer is well below the cost of a rat­ing, on av­er­age 40 ba­sis points ver­sus 5 ba­sis points. It is there­fore in the is­suers’ best in­ter­est to seek a rat­ing.

By far the big­gest po­ten­tial de­trac­tor from the in­vest­ment case would be the volatil­ity of debt is­suance, on which 50% of rat­ings rev­enue re­lies. Is­suance tends to dry up dur­ing a credit con­trac­tion and it can be dif­fi­cult to gauge where one is in the cy­cle, which makes “nor­malised” earn­ings tough to judge. How­ever, we be­lieve there are struc­tural tail­winds for debt is­suance. In Europe, bonds have been ris­ing as a pro­por­tion of cor­po­rate debt and debt cap­i­tal mar­kets are ex­pected to con­tinue grow­ing well above to­tal credit growth.

The other risk to the in­vest­ment case re­lates to reg­u­la­tion. Moody’s has a good track record in this re­gard, with the ma­jor­ity of cases re­lat­ing to the 2008 fi­nan­cial cri­sis hav­ing been dis­missed or set­tled. Looking ahead, a statute of lim­i­ta­tions ap­plies to new cases re­lat­ing to the fi­nan­cial cri­sis pe­riod. The one ex­cep­tion ap­plies to the US de­part­ment of jus­tice in­ves­ti­ga­tion

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