Morningstar

Moat: 3.5/5

Understandability: 3/5

Balance Sheet Health: 5/5

Morningstar is a leading global provider of independent investment insights, offering data, analytics, and research to investors, financial advisors, asset managers, and other financial professionals.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Morningstar’s moat rating is 3.5 out of 5.

  • Intangible Assets (Brand and Data): Morningstar has built a strong brand over the years, known for its independent research and ratings. This provides some competitive advantage by making it a trusted source. It also has a vast amount of proprietary data and analytics, which also gives it some moat. These are difficult to replicate.
  • Switching Costs: While the basic financial data itself is somewhat of a commodity, the tools, analytics, and workflows that Morningstar provides create stickiness. Financial professionals may be reluctant to learn a new system or recreate the custom work built on existing platforms, making switching to a competitor costly and time consuming.
  • Network Effects: Morningstar does not have a network effect in their core business. But Morningstar Workplace, our investment management platform, is starting to see some of the characteristics of a network effect because it includes the investment managers, the advisor, and the clients all as users in the same platform.
  • Cost Advantage: Morningstar has no real cost advantage.

The moat has these drivers: Intangible assets (brand, data), switching costs, and network effects (in a small niche).

The moat is not very wide or extremely defensible, therefore a 3.5 rating is appropriate. It lacks one of the major moats, a cost advantage.

Legitimate Risks Affecting the Moat and Business Resilience:

  1. Technological Disruption: Fast-paced technological changes in data analysis and financial software could lead to new or improved offerings that may supplant Morningstar’s current products.
  2. Data Privacy and Security: Recent regulatory pressure on data privacy and growing cyber security threats could potentially impact operations and incur significant costs for compliance and data protection infrastructure.
  3. Increased Competition: Low-cost, automated data providers and alternative research platforms can compete on price and commoditize a big part of Morningstar’s business.
  4. Regulatory Changes: Increasing government regulation or oversight of the financial services industry could increase costs, restrict some of the company’s business practices, or limit its product offerings.
  5. Reputational Damage: Incidents of biased research, data leaks, or unethical conduct could harm Morningstar’s brand name and its reputation as a trusted authority.
  6. Market Volatility: Since revenues can depend on the amount of activity, and fees generated from financial services, increased downturns in the stock market and economies may result in a negative effect on revenue.
  7. Talent Acquisition and Retention: Competitor firms may be better positioned to hire or retain talent.

Despite these risks, Morningstar has shown resilience over its long history, and its focus on a value-driven approach helps it to build relationships and continue to innovate and develop new product offerings.

Detailed Business Explanation:

  • Revenue Distribution:
    • License-Based Revenue: This is the largest component, generated from recurring subscriptions to Morningstar’s data and analytics platforms, as well as various advisory, and wealth management software platforms, and contributes 65%.
  • Asset-Based Revenue: Represents fees from asset-based investment management, solutions for investment mandates, and advisory services. They also include fees paid on assets held in Morningstar portfolios, and contributes around 15-20%.
  • Transaction-Based Revenue: This comes from transactions or a fee derived from it through the PitchBook platform, where venture capitalists find new investments, and contributes around 10-15%.
  • Major Products and Services:
  • Morningstar Data: Provides proprietary data on securities, funds, and financial markets, as well as sustainability data
  • Morningstar Analytics: Includes software platforms and tools for financial analytics, portfolio analysis, research and reporting, including Morningstar Direct, Morningstar Advisor Workstation, and Morningstar Credit Lens.
  • Morningstar Investment Management: Through its managed portfolios, the firm provides services that cover a wide range of investment strategies and approaches.
  • Morningstar Sustainalytics: Provides ESG research and rating data and research to investors and other financial professionals.
  • PitchBook: A financial platform used by venture capitalists to analyze different financial data.

  • DCRBS a credit rating agency.

  • Industry Trends:
    • Increased Demand for Data and Analytics: Investors are relying on more sophisticated tools and data to make decisions. This is an advantage for Morningstar because it positions itself to meet that demand.
      • The increased use of data-driven insights for more sophisticated management and analysis techniques, has led to growing demand for analytics, data, and software.
    • Growing Importance of ESG: Investors are becoming more focused on the environmental, social and governance aspects of companies. This area remains difficult to accurately measure, so companies that have been reporting in this aspect have an edge.
    • Increased Automation and Efficiency: In a world of technological advancements, companies who are able to automate their workflows and improve efficiency will have an advantage.
    • Globalization: Increase of foreign investors who are looking for insights for companies not based in the U.S.
    • Regulatory Complexity: Banks, insurers, and other companies in regulated industries are facing increasing regulations and requirements, including those regarding financial reporting and data analysis, which translates into more complicated workflows and needs for information.
  • Competitive Landscape: *The industry is extremely fragmented and does not have strong barriers to entry. It is very easy to create a new rating agency or an investment advice firm. But as the company explains, barriers to success are very high. That is, it is easy to enter the industry but very hard to actually become successful.
  • Morningstar’s primary competition includes Bloomberg, Thomson Reuters, S&P Global, Moody’s, Factset, and private research firms, each with their own niches and competencies.
  • They also compete with specialized providers and individual consultants, depending on the segment.
  • The competition also comes from new data companies that are focusing on AI and machine learning to provide superior insights.
  • What Makes Morningstar Different:
    • Independence and Objectivity: Provides independent, unbiased research and data, which has created a strong brand.
    • Global Coverage: They operate in North America, Europe, Asia, and Australia.
    • Comprehensive Data and Analytics: They offer a wide range of data and tools covering various asset classes and types of analysis.
    • Integration of Proprietary Technology: Their research capabilities are supported by proprietary software, which they continue to develop and improve.
    • Commitment to Transparency: They provide a lot of public information about their company and business.

Morningstar operates across a lot of different fields, but they all lead to the same thing: helping investors make smart decisions. With the increasing demand for analytics and high quality, transparent data, the company is well positioned for future growth. The company’s brand also plays a key role in increasing adoption, but it needs to continually evolve and stay ahead of competitors who might attempt to copy and displace the company.

Financials:

  • Revenues: Morningstar generates revenue from a combination of subscription fees for its platforms (particularly Morningstar Direct, and Morningstar Advisor Workstation), fees for its asset management and advisory services, and fees from its PitchBook platform.
  • In the Q1 2024 report, Morningstar had 10.7% yoy revenue growth, driven by the data/analytics platform and recurring revenues, with a total quarterly revenue of $124.4M, which has grown from 1.1 billion (2020) to almost 1.8 billion in 2022.
  • They had seen a 13% year over year growth in revenue from 2022 to 2023.
  • Profitability: The company maintains robust profit margins.
    • In Q1 2024, operating income and operating margin were $24.6 million and 19.8% respectively, which are down from the previous year.
    • Their free cash flow in Q1 2024 was $113.5 million, also down from the previous year.
  • The company has 18.8% average net margin over the past few years.
  • Balance Sheet: The balance sheet is exceptionally strong and has the following characteristics:
    • Low financial debt ($350M long term debt and liabilities out of $3.5B assets).
    • Good and stable current ratios (current assets of 1.12B and current liabilities of 830M).
    • A great cash balance that ensures continued investment in organic growth.
  • Cashflows: The company has great positive cash flows due to its subscription-based model. The CFO in Q1 2024 was $59.3 million.

It is worth noting that a huge portion of Morningstar’s revenues are recurring, which gives them a high degree of certainty when it comes to future revenues. They also generate a considerable amount of free cash flow, which helps them grow their existing businesses, and acquire new ones. They also have very healthy operating margins and an extremely strong balance sheet, which makes them quite resilient to any headwinds in their industry. Controversies and Recent Problems:

  1. Market Share Loss: While Morningstar’s brand name remains strong, a few large investment and consulting companies have created their own proprietary investment platforms and tools. This has increased competition in Morningstar’s core industry.
  2. Overestimation of the Value of Credit Ratings and their inherent conflicts of interest: This is a very well known problem in the industry. It was exposed during the 2008 financial crisis and continues to be an issue that creates challenges for the business, since they are a part of such a sensitive sector. This has been an issue for DBRS (a credit rating agency owned by Morningstar), particularly.
  3. Integration Challenges: They had a recent acquisition of PitchBook, which has brought new customers, but also brought about some integration issues because those clients were not familiar with the existing Morningstar platforms.
  4. Unstable Economic Environment: As the company mentioned in their earnings calls, economic turmoil is a constant source of potential problems for revenue growth.

The management, as explained in the earning call, is focused on integrating the new acquisitions, growing their organic growth, maintaining their margins, and delivering on financial guidance. They have also been focusing on the integration of ESG into all their segments. They have been focusing on managing expenses to maintain the healthy operating margins, and are focused on returning free cash to shareholders. The management also commented that new regulations have not greatly affected their business, and that the company has very strong client retentions.

Understandability Rating: 3 / 5

  • Morningstar’s core business is not inherently hard to understand. However, its sprawling business model across different industries, and complicated financial analysis, and data makes it fairly complicated for new people to quickly grasp its business model. While what they do and their services might be understandable to an investor, the intricacies of the different market segments, and the complexity of their financial analysis can make them confusing, requiring a deep knowledge of financial markets.

Balance Sheet Health: 5 / 5

  • Morningstar has an extremely strong balance sheet. They have almost no debt compared to their cash balance and revenues.
  • They are extremely resilient to economic conditions.
  • They are generating a lot of free cash, which allows them to continue innovating, creating new solutions, acquiring competitors and returning money to shareholders.