November was a bit of a difficult month for IPOs with over 1/3 of the issues trading below the offering price on the first day. MSCI Inc. (MXB) was one of the issues that bucked the negative trend and traded sharply its first day and so far has held its gains nicely. The company provides support tools to investment institutions and is one of the primary distributors of index information for a number of different investment vehicles. According to the prospectus that was filed with the offering, MCSI currently calculates daily values on over 1,000 indices.

The company has two flagship product categories. The first is its international equity indices (falling under the brand name MSCI). These products basically manufacture and track indices for many different investment vehicles. The indices can be geographically specific such as an index on the China, Turkish, or European exchanges. Indices may fall under sector categories such as shipping, manufacturing or retail categories. There are also categories for different asset classes such as large or small cap equity, various bond indices, and indices on alternative investments such as hedge funds. All of the data for these vehicles are available to sell to clients who use them to construct portfolios, benchmark investment approaches, or disseminate to the public.

The second product category is called Equity Portfolio Analytics and falls under the brand name Barra. Clients use these products as tools in portfolio construction and maintenance. Statistics such as “value at risk” and volatility measures are employed to enable managers to efficiently track a benchmark, estimate exposure to certain events, or analyze the extent to which a manager’s skill will play into total returns.

MCSI boasts of a client list that includes the top 25 global asset managers in 2007 (as measured by assets under management – AUM). The geographic spread is very diversified with 51% of revenue coming from the Americas, 34% from Europe, Middle East & Africa (EMEA), 9% from Japan and 6% from the rest of Asia. While there is still room for the company to increase offerings in emerging markets, most existing financial exchanges are covered by some product or service offered by MCSI.

MSCI is actually an acronym for Morgan Stanley Capital International. As the name implies, MCSI has been a division of Morgan Stanley (MS) and will continue to remain a “controlled company” with Morgan Stanley owning 83% of the economic value. While the IPO was priced with the agreement that MS will not sell any more shares for 180 days, the ultimate plan will likely include a spin off of the entire company to MS shareholders. Historically, a transaction of this type would depress the shares of the spin off company as excessive new supply would hit the market and many owners of MS would likely dispose of their interest in MXB.

The actual IPO offering consisted of 14 million shares priced at $18.00. After deducting underwriting expenses and fees, the company cleared roughly $230 million. The capital was used to partially repay a note due to the parent company for $626m. At the same time of the equity offering, the company initiated a $500 million dollar credit facility which it immediately borrowed $425m to pay the remainder of the note and for working capital. So the new company while cash flow positive, is off and running with a significant amount of debt on its books. The burden does not pose an initial problem, but may make it more difficult for the company to acquire new technologies or companies to bolster its product offerings.

External events could have a significant impression on the company and its operations. A declining market would likely cause many clients to have smaller AUM balances. Lower balances would cut down on fees the company could charge and would reduce the number of new products or modules existing customers would invest in. During 2006, 12% of revenues were paid in the form of soft dollars. This is a practice where an investment manager will pay a premium for execution of trades with the expectation that the broker who receives the premium will pay for certain research products. This practice has come under congressional scrutiny and if it were restricted, it could have a negative effect on revenues generated.

The business is highly competitive with Dow Jones, FTSE International (a joint venture of the Financial Times and the London Stock Exchange), and Standard & Poors listed as the primary competitors. While many customers are “locked in” to MCSI products due to their need to index to or replicate a MCSI benchmark, the acquisition of new clients can be difficult if the competition is courting the same institutions. Distancing oneself from the competition in this market can be a difficult task and MCSI may not be able to continue to develop products that effectively compete against these firms.

While the MXB deal traded very well, I have my concerns as to how the stock is priced. The stock carries a significant premium and likely reflects the market’s expectation that the company will grow quickly. I believe the overall environment is very challenging and will likely face more fear before it improves. Furthermore, the potential for additional stock to come to market should help to cap the price appreciation. While I do not currently have a position, I am watching the pattern evolve and if I see confirmation that the stock is breaking down I will look to begin building a short position.

MXB Notes

FD: author does not have a position in MXB