Moody’s sells credit ratings to corporations, governments, and banks so that they can raise debt from the capital markets. The industry in which they participate, debt capital markets, possesses favorable long-term growth prospects. Debt issuance has historically grown at least as fast as GDP, and capital market bond issuance has grown even faster as it has taken share from banking loans. Over the long term, we believe this GDP-or-better growth is likely to continue. Moody’s serves as a key information filter in this industry. Moody’s charges corporations approximately 7 basis points1 to rate their bonds yet likely saves them 30 to 50 basis points2 in annual borrowing costs. Moody’s benefits from both protocol and data network effects. Because crowded information marketplaces are generally quite inefficient, requiring participants to maintain background knowledge on numerous providers and analytical methodologies, industries such as credit ratings tend to coalesce around one or two standards (i.e. protocols). Moody’s and its main competitor, Standard & Poor’s, are the globally-recognized credit rating standards with far larger networks and far more data than any of their competitors. Additionally, the scope of their networks is unmatched. They provide corporate, government, and structured product credit data going back, in some cases, over a hundred years, and they provide analytical support and software that increases the use-cases for the data. Moreover, most corporations and governments, along with most large endowments, pension plans, and sovereign wealth funds, are run by employees instead of owners, further solidifying Moody’s competitive position because employees are incentivized to make the “safe” choice (in this case, by hiring an industry leader like Moody’s for their credit rating needs instead of an upstart). Finally, for much of Moody’s history, the U.S. government and its various regulatory bodies made Moody’s and a few other specially-designated rating agencies so important to banks’ bond purchases that it made their ratings almost mandatory for most corporations and governments, which led to Moody’s becoming one of the entrenched, global “languages” in the ratings business today. As a result of these industry and competitive dynamics, we believe Moody’s is likely to grow volume and pricing at attractive rates for years to come. Remarkably, it is likely that very little capital will need to be reinvested to achieve this growth, increasing the earnings multiple investors should be willing to pay for the business.
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1 See https://www.standardandpoors.com/en_US/delegate/getPDF?articleId=2148688&type=COMMENTS&subType=REGULATORY. Given the duopolistic nature of the industry, we believe Standard & Poor’s pricing is a good proxy for Moody’s.
2 In 2012, for the first time in its history, Heineken decided to get its debt rated. Based on Heineken’s post-mortem analysis, getting its debt rated saved the company 30 to 50 basis points of yearly interest cost. See http://treasurytoday.com/2013/02/do-companies-need-to-be-rated-to-issue-bonds.