A New Way to Play Foreign Markets

There's a saying that the best way to make money during a gold rush is to start selling picks and shovels. In that spirit, investors looking for a play on the international investing boom may want to pick up shares of MSCI Inc.

Shares of the market-index provider have been trading solo since mid-November, when Morgan Stanley began spinning out its ownership position. Since then, the stock (symbol MXB) has already doubled once, and patient investors could see it do so again.

MSCI's indexes are the yardsticks for international investing. The company, originally named for its joint-owners, Morgan Stanley and Capital International, has been crunching numbers since 1969. Today, it calculates 100,000-plus indexes on a daily basis. By the end of May, MSCI will track stocks from 68 different countries. Its well-known EAFE index (for Europe, Australasia, Far East) sets the bar for investing in developed foreign markets.

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MSCI acts like a toll bridge on investment dollars heading overseas. "To invest internationally, you'll often have to pass and pay them in various ways," says William Blair analyst John Neff.

For example, mutual funds or exchange-traded funds (ETFs) linked to an MSCI benchmark pay the company licensing fees of 0.03 to 0.04 percentage point of a fund's assets. At the end of February, ETFs containing $179 billion in assets were linked to MSCI indexes, and that figure has grown at an annualized pace of 68% over the past two years.

In addition, managers of mutual funds, pension funds or hedge funds who want to compare their performance to an MSCI benchmark must pay a subscription fee to access detailed information on indexes. "If I'm an asset manager trying to beat an index, I need to know exactly what's in it on a daily basis, to know how to make my bets," Neff says. More than 2,100 clients subscribe.

MSCI's powerful brand benefits from a virtuous cycle. Because so much money -- roughly $3 trillion -- is already benchmarked against its indexes, MSCI has established itself as the ultimate name for measuring and defining international markets. And new money tends to follow the brand name. "It's very difficult to imagine that brand being displaced," says Andrew Peck, manager of Baron Asset fund, who has been purchasing the stock.

MSCI also offers portfolio-analysis products sold under the Barra name. Barra's software allows portfolio managers to distill the types of risk their portfolios assume -- by quantifying, for example, how a portfolio's returns are affected by price momentum or a market shift in favor of European stocks.

The Barra name doesn't have the same household recognition as MSCI but, Peck says, within the industry "it's known as the pre-eminent risk model that firms should be using." The portfolio-analysis segment has more than 900 subscribers and generates 38% of revenues.

Reflecting the broader international investing boom, growth has been strong and steady. Revenues in fiscal 2007, which ended in November, totaled $370 million, up 19% from 2006, while profits increased 28%, to $81 million.

In the most recent quarter, which ended in February, the company boosted revenues by 21% over the previous year. Profits, at $18 million, came in 17% below those of the first quarter of 2007, but the company says that the figures aren't comparable because of its initial stock offering and related expenses.

MSCI also benefits from low costs. It employs just 652 people. A mere 70-person research staff, which includes 30 PhDs, makes up MSCI's "brain trust." "The company has minimal capital expenditures because the business is based on intellectual property," Peck says. "There's very little in hard assets that it needs to reinvest in each year."

Morgan Stanley offered a small portion of its MSCI stake last November 14 at $18 per share. Morgan Stanley has since sold off additional shares and today owns 53% of MSCI. Leadership at Morgan Stanley has intimated that it will eventually divest itself of its entire MSCI stake, which could put pressure on the shares, but "there's only a certain amount they can sell each year without overwhelming the market," Peck says.

MSCI shares, which peaked on New Year's Eve at $38, closed May 14 at $32.52. Neff, the only analyst currently covering the stock, says MSCI will earn $1.02 per share in fiscal 2008 profits of $1.02 per share, which would give the stock a rich price-earnings ratio of 31 on that forecast.

But Peck, who likes to buy stocks based on their long-term prospects, prefers to value the company on free cash flow (earnings plus depreciation and other non-cash charges plus necessary capital expenditures). By that math, he says MSCI will be worth $60 over the next three to four years.