S&P Global is the most interesting "boring" business in the world. It boasts a fixed-cost structure unlike any other to unleash the power of operating leverage as its core "boring" credit ratings business grows alongside faster-growing segments.
SPGI penetrates capital markets from all angles – data, information, pricing, indices, and credit ratings. It owns mass amounts of data that it can use to expand product offerings and stay on top of new trends.
The global credit boom, ESG (i.e., environmental, social, and governance) investing craze, and growing amounts of passive investing vehicles and assets under management ("AUM") present astonishingly large markets in which SPGI can grow organically for years to come.
SPGI has grown free cash flow ("FCF") per diluted share at a compounded annual growth rate ("CAGR") of 20% over the last decade. Its businesses are resilient, and its operating leverage is unmatched. Shareholders benefit tremendously.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
Good Luck Avoiding S&P Global
Debt issuers need S&P Global to rate their debt to bring it to market, sell it to investors, and obtain their sought-after capital. Budgeting, planning, and investing in operations and society is made easier with a highly recognizable SPGI credit rating.
Investors benchmark against the myriad of indices SPGI compiles and maintains, especially the S&P 500 and DJIA. These are the most important indices in the world which set the tone for risk markets everywhere else in the world.
Finance professionals turn to Market Intelligence to help them gain an edge over markets by accessing SPGI's deep network of data sources, analysis, and research. It may not be the most popular service, but it sure is growing at rapid rates.
Perhaps what is most remarkable is the examples above are a non-exhaustive list of everything SPGI is capable of, not to mention what is still to come. They are also the source of incredibly high pricing power.
Everywhere you look in the world of finance and capital markets, SPGI has a product or solution to help individuals and institutions get money. Good luck trying to get around S&P Global if you live in a capitalist region.
As noted earlier, SPGI's operating and net margins have been expanding at high rates over the past decade. However, the magnitude of SPGI's operating leverage cannot be fully understood without looking at the specific pieces impacting operating income (except depreciation and amortization).
SPGI's expenditures were around $2.9 billion in 2011. While revenues almost doubled, total expenditures increased at a much smaller pace to $3.7 billion in 2020, led by cost of revenues while other costs and expenditures remained roughly the same. SPGI was able to pull this off while maintaining its duopoly position, meaning it simply does not have to spend aggressively to protect its moat.
SPGI's fixed-cost structure is best-in-class and is the source of its rapid margin expansion.
If SPGI can maintain this cost structure while revenues grow at high-single digits or low-double digits, we would not be surprised if we see margins continue to increase for a long period of time. Virtually every marginal dollar of revenue generated would fall directly to operating income.
SPGI's operating leverage stemming from its fixed-cost structure, productivity improvements, and process automation efforts form a powerful recipe for financial strength, growth, and ability to exercise optionality through reinvestments and business acquisitions.
The Ultimate Finance Data Package
SPGI serves a wide array of customers that use plenty of services, ranging from credit ratings to data management solutions, and finance data interfaces to commodity price data. The data SPGI collects is highly interconnected between its various product offerings and subscription solutions.
For example, SPGI's data management solutions use over 200 datasets that are compiled from other aspects of SPGI's business – GICS, credit ratings, Capital IQ estimates, indices, and others. Another example is SPGI's subscription-based credit risk solutions which tap into SPGI's enormous bank of credit ratings, analysis, and proprietary research and rating methodologies.
SPGI can use this proprietary data from its clients and customers to create new products and stay on top of new innovations and trends, such as ESG, passive investing, and many others. In other words, data is optionality.
SPGI competes in a highly consolidated industry with only three major players – MCO itself, SPGI, and Fitch. SPGI owns about 40% of the global credit ratings industry and has maintained a duopoly position for a long time.
SPGI's unique competitive advantages led to its leading position in the credit ratings market. In turn, its leading position and reputable brand name also give it exclusive access to the biggest credit deals on the planet.
Many debt issuers seek credit ratings from at least two CRAs (mainly SPGI and MCO). Despite strong competition in this consolidated industry with Moody's and Fitch, SPGI will usually be engaged by a debt issuer alongside either of its main competitors.
Global bond issuances have been rising at rapid rates since 2019. This massive secular trend was triggered by record-low interest rates, pervasive global fiscal and monetary financial easing and stimulus, and loads of cash sloshing around in financial markets. Following many years of consistent bond issuances, the number of issuances in 2020 hit a record of about $27 trillion globally. The more debt there is in the world, the harder it is for organizations and governments to get out of it. It also makes it difficult for central banks to tighten monetary conditions too far. We expect interest rates to remain low over time, despite strong inflationary pressures that exist today. Debt refinancing and new issuances, as well as credit rating monitoring will all keep SPGI busy for years to come.
Unlike its largest competitor, Moody’s, SPGI has operations related to various equity and fixed-income market indices. As a large operator and leader in this space, SPGI is set to benefit from an incredibly large and growing trend: passive investing. AUM for passive index fund and ETF investing have grown from a round zero in 1990 to over $15 trillion in 2020. As the world is deprived of investment yields in "safe" assets like bonds, investors are increasingly turning to equity markets and other alternative public market funds based on certain indices to fill up their portfolios. Additionally, the average global investor is warming up to the idea of passive investing as equity markets have performed well for several decades.
SPGI has a strong balance sheet and income profile, and it's not afraid to use it. In November 2020, SPGI announced a massive merger proposal to join forces with IHS Markit ("IHSM"), a British business, finance, and government information provider, as part of a $44 billion all-stock deal to acquire almost 68% of the business. SPGI sees IHSM as a highly complementary company that operates in attractive markets and has "cutting-edge innovation and technology capability" to boost the value proposition for Intelligence customers.
ESG (i.e., environmental, social & governance) is a stratospheric opportunity for the company. ESG is a nascent industry that is attracting money inflows by the billions. SPGI is launching new products in the space to meet high demand. ESG products in particular are experiencing stratospheric growth rates from which SPGI benefits. Additionally, the SEC proposed mandatory climate disclosures for registered public companies. The world is clearly moving in a direction where ESG is a key to success. SPGI will be there with its robust ESG solutions to rate, evaluate, provide analytics, and consult on all-things ESG.
SPGI's capital-light business model allows for financial optionality. The company's operating leverage and extremely low capital expenditure requirements enable SPGI to gush cash. With all this cash, SPGI can pay dividends, buy back shares, or conduct huge acquisitions. Whatever the best opportunity is at the time, SPGI will do. This level of financial flexibility is indicative of a company with a monopoly (or near-monopoly in this case) position. Shareholders have been, and will undoubtedly continue to be rewarded in such a manner.
Approximately 30% of SPGI's revenues are derived from transactional sources (i.e., volumes as opposed to contractual recurring revenue). Debt issuances are highly sensitive to fluctuations in the broader economy and other geopolitical events. In the case of adverse economic events, debt issuance could drop off substantially, harming the transaction portion of SPGI's revenue mix to a great extent.
Stimulus – What if it Ends?
Financial markets have been flooded with tons of cheap money over the last 1-2 years. If central banks taper their monetary stimulus efforts or if governments hold back on fiscal spending to bring down their debt amounts as a percentage of GDP, this may negatively impact the number and size of M&A deals and reduce organizational appetite for debt as interest rates rise.
SPGI is watched closely by regulators for their role in the stability of financial markets and as a member of a highly consolidated industry.
In 2014, SPGI reached a $1.6 billion settlement with the US government, 19 states, and the California Public Employees’ Retirement System over its ratings on mortgage securities that ultimately led to the housing collapse in the 2008 financial crisis. SPGI will be watched closely by governments around the world and may be the scapegoats of future financial collapses. This could sour investor sentiment towards SPGI.
Additionally, SPGI is a large market player and will face antitrust concerns when acquiring companies. However, SPGI's merger with IHSM was fully approved and closed. Major regulatory risks do not appear to exist today, but could change.
Acquisition and Integration Risks
SPGI may not be able to integrate all targets according to plan, which could hurt M&A deals and the expected accretion to SPGI. Also, the lack of acquisition targets could hurt SPGI’s ability to grow inorganically.