Nolan Hoffmeyer: «How to Achieve Returns in the Subscription Economy»

While we have become accustomed to subscribing to consumer services and products in the recent past, companies have also seen some of their spendings move to subscriptions for IT services or software, Nolan Hoffmeyer says. His focus is on information providers.

By Nolan Hoffmeyer, Senior Portfolio Manager at Natixis subsidiary Thematics AM

Many industries depend on crucial information, crucial data so that they can do their job efficiently. The finance industry for instance relies on real-time pricing data and economic news. Lawyers need access to the latest legislation and the latest judgments.

Doctors rely on databases that list the best medicines and treatments. Real estate agents subscribe to services that provide the price of real estate based on the latest transactions. Accountants use databases that list the different tax treatments that may apply in different countries. And the list goes on.

Critical Information

These are only examples of critical information that some industries need to consume to perform their daily activities. Most of us working in finance already know how dependent we are on «Bloomberg» or «FactSet», without which, we couldn’t even work.

These companies offer up to date and often real-time data that is accessible any time from anywhere. Given the recurring nature of the offering, subscriptions are the way of monetization chosen by most providers, if not all.

High Renewal Rates

As said above, these companies provide data that is critical for daily operations in many industries. So, while many of them are showing high-single or low double-digit revenue growth, they also benefit from very high renewal rates. It is not unusual for such companies to see more than 90 percent of their customers renewing their subscription each year. Companies simply cannot afford to cancel their subscription, which would put their own business at risk.

High visibility around future revenues is therefore one of the distinguishing features that we like so much. Another is «subscription inelasticity». While subscription-based businesses prove resilient in weaker economic environments, or even during recessions, they also demonstrate strong pricing power when the economy is expanding.

Competitive Advantages

Again, who would cancel their subscription even if the price was to increase a few percentage points each year. This often results in high-margin businesses: for example, a sample of information service providers that we invest in have operating margins of 30 percent.

Most of the time, information service providers enjoy strong competitive advantages that create high barriers to entry. They have all specialized in one particular field, have collected related data, have hired data analysts, and have strong relationships with their clients.

Pricing Power

This makes it almost impossible to replicate for newcomers. Costar has been collecting data on U.S. commercial real estate for more than 20 years and employs more than 3,000 specialized analysts. Markit, part of the company IHS Markit, is the de facto standard when it comes to economic data such as PMIs. Resiliency, pricing power, and strong competitive advantages are the characteristics that make this subsegment an attractive investment opportunity.

To best illustrate the dynamic of these companies, we dive a little deeper into one of them, MSCI Inc.

Data Subscriptions

MSCI is a leading provider of financial information to asset managers and asset owners. About a third of its revenue comes from asset managers subscribing to its benchmarks used to compare the performance of its own products and show it to investors.

Another third of its revenue comes from analytics tools such as RiskMetrics and Barra. A quarter of its revenue is generated by MSCI index-based ETFs. MSCI collects a few basis points on assets invested in such ETFs. Finally, the rest of the business comes from different data subscriptions, the largest being ESG data where MSCI, along with Sustainalytics, is a leading provider.

Business Resiliency

Despite the exposure to asset managers and financial markets, MSCI’s business is highly resilient with more than 70 percent of revenue coming from subscriptions which asset managers have to pay if they show MSCI indices as benchmarks. The company last reported a more than 95 percent retention rate in its benchmark subscription business. As an illustration of the business resiliency, MSCI was able to grow its revenue in 2008 and 2009.

In addition to the resiliency of its business, we believe MSCI is positioned to perform well. We identify two major growth drivers. First, with the increasing market share of passive investing, revenue coming from its asset-based fees should continue to grow. Second, while ESG investing becomes more mainstream, its ESG data business is benefiting from a strong boost. It is now growing at close to 30 percent per year.

With proven financial resiliency and attractive opportunities to grow the business further, we consider MSCI to be a compelling investment case.