In 2013, the company promoted a CEO from outside the McGraw family, and Douglas L. Peterson has managed to elevate what was already a great profit margin to new, impressive heights. S&P Global has an impressive market dominance not found in many other industries or companies globally.
Debt is often regarded as an attractive way of financing business expansions or parts of daily operations, and just like individuals, businesses try to secure the best possible terms. for that to happen, it is virtually a necessity for companies to get a credit rating from either S&P Global or Moody’s, another company that we are co-owners of.
S&P Global’s story began in 1860, where Henry Varnum Poor started to provide investment guides on US railroads for investors. Through several mergers and acquisitions, Standard & Poors ended up as part of McGraw-Hill in 1966. This changed in 2013 when parts of McGraw-Hill were sold. McGraw-Hill was turned into a separate entity, becoming what has been known as S&P Global since 2016. Together with Moody’s, S&P Global dominates the credit ratings market. In the past, the business also consisted of a – in our view – less attractive activity, namely publishing educational material and other books.
S&P Global’s history is filled with acquisitions, divestments and mergers. These are still a large part, but in a different way. When companies undertake acquisitions, they most likely turn to S&P Global to get a credit rating from S&P Ratings, which is S&P Global’s credit rating agency. Even though credit ratings in connection with
company transactions make up a big part of revenue in Ratings, the majority
relates to the issuance of debt for financing of normal business operations in the issuers. In 2017, Ratings had revenues of just under three billion US dollars, equivalent to about half of S&P Global’s total revenue. Ratings is a very profit-
able division which in the past five years has managed to increase its operating margin from 40 to nearly 54 percent. As is the case with Moody’s, S&P Ratings’ high profitability is partially thanks to the savings achieved through lower financing costs that a credit rating gives a bond issuer, as this allows the agency to continually raise prices by three to four percent each year. The scale benefits in S&P Ratings are significant when the same debt issuer needs to issue more bonds, thus contributing to the impressive margins.
Externally recruited CEO has delivered stellar results
An expected increase in the issuance of bonds as an alternative to bank loans outside North America will have a positive effect on S&P Global Ratings, which has a 40 percent share of the total credit ratings market. This particularly applies to outside the US, as issuing corporate bonds is not particularly common. In Europe, corporate bonds make up a little over 20 percent of the total European debt market, compared to a 70-80 percent share in the US debt market. The conversion from bank debt to corporate bonds is progressing slowly in Europe, but that is not a decisive factor for S&P Global, as even without this expected long-term trend, it remains an extremely attractive business. The amount of outstanding debt growths in line with the nominal growth in global economic activity, and when linked with annual price increases, this provides a wealth of opportunities for further growth and value creation going forward.
S&P Ratings’ (and Moody’s) credit ratings have become the industry standard, and the same applies to most of the company’s other divisions, which set the standard within each their respective business area.
Their market position in their respective business areas are strong contributors to making S&P Global as profitable as it is today, with a roughly 40 percent return on invested capital. It’s an impressive level of value creation that we as co-owners are benefiting greatly from. With free cash flows corresponding to 4.3 percent of the company’s market value, we still see S&P Global as being attractively priced in relation to future potential returns.
The focusing of the business can to a great extent be attributed to CEO Douglas L. Peterson, who has managed to turn an already amazing company into something even better. Peterson has been CEO of S&P Global since 2013 and is the first one outside the McGraw family to ever hold that position. Prior to that, he was head of the ratings division for two years. He has played a major role in the transformation of the company, which among other things has resulted in the divestment of J.D. Power in 2016 and the acquisition of SNL Financial LLC in 2015.
Both transactions were within S&P Global’s Market Intelligence business, which is part of their Market & Commodities Intelligence division, which had revenues of 2.5 billion US dollars in 2017. Market Intelligence consists of platforms that gather industry-specific information, which allows customers to get access to better information for their decision making.
The transactions were made to focus on areas that S&P Global excel in, and they have resulted in increased sales thanks to – among other things – cross-selling of services to S&P Global Capital IQ and SNL Financial’s customers. The aim is to merge the two platforms into a single large platform in the near future. The merging of the two platforms has already improved the division’s margins, and there is more in store thanks to additional cost synergies as well as increased sales.
Energy division nearing valuable status in the industry
The other half of Market & Commodities Intelligence consists of the S&P Global Platts platform (Commodities Intelligence). Platts is the leading provider of information and pricing on energy and other commodity markets. Whatever the future of energy turns out to be – or the dominance of renewables or conventional energy – energy will still need to be sold, making it difficult to work around S&P Global. S&P Global Platts’ prices are often used as reference points when deals in the various commodity markets are being made. Thus, the division has for all intents and purposes achieved the same ‘industry standard’ status that the credit rating agency has. The Market and Commodities Intelligence division is a long-term, attractive division with high stability, as over 85 percent of its revenue comes from subscription payments.
Operating margins in Market & Commodities Intelligence have improved significantly over the past few years, from around 20 percent in 2012 to over 32 percent in 2017. The reason for this improvement is the focusing of the business as it is a scalable business area where cost efficiency along with lower discounts for clients has increased earnings levels.
The proceeds from the divestments that S&P Global has executed over the past couple years will not be retained within the company, but instead channelled back to the shareholders in the form of dividends and share buybacks. In 2017, the company distributed 1.4 billion US dollars to its shareholders, equivalent to more than four percent of its market value at the start of the year.
S&P Global has increased its dividend payments on an annual basis for the past 44 years, making it part of the S&P 500 Dividend Aristocrats index, which is an index of companies that have increased their dividends each annually for a minimum of 25 years. Since 1974, the annual dividend has increased by nearly 10 percent a year. The current dividend of two dollars per share corresponds to a dividend yield of around one percent. Added to that is the company’s attractive share buyback program.
Being part of this index has no real significance, but it indicates how prevalent S&P Global’s index business is; there is an index for everything. In fact, S&P Global Indices, as the division is called, has over a million indices. Over 11.7 trillion US dollars are either benchmarked or indexed to S&P Dow Jones Indices.
Earnings rise in line with assets under management
The king is the S&P 500 index, where 8.7 trillion US dollars are either benchmarked or indexed to. A large share of that money comes from the increasingly popular passive investments, which base their portfolios on an index. The issuers of the fund pay a fee to S&P Global for permission to use the index. The same goes for investment managers seeking to benchmark their returns to a recognised and widely recognized market return. Most of these fees come in the form of payments that depend on the size of the amount of assets under management. In that way, S&P Global ensures that its earnings increase in line with the value of the funds being managed. This simultaneously gives the business a major degree of stability and predictability, which we highly value.
S&P Global Indices had revenues of 730 million US dollars in 2017, making it the smallest of the three divisions. However, it is also the division with the highest operating margin at 65 percent. S&P Global Indices is an extremely scalable division where an extra dollar in revenue essentially equals an extra dollar in operating income. Once an index is created, there are almost no costs associated with the flow of new clients.
S&P Global has come far since its separation in 2013, and we look forward to continuing our journey with the company and taking part in the impressive value creation which it has shown itself capable of.