Textbook example of a wonderful business

[jawn619]

Buffett owned it. Greenblatt owned it. Here is a short case study of one of the great businesses/investments in past 20 years.

 

http://raritancapital.com/casestudies/MCO

[Jurgis]

Wonderful business that could and possibly should have died during the Great Recession.

 

I'm somewhat surprised when MCO is quoted as an example of company to put into concentrated portfolios. What if US regulators had more teeth?

[premfan]

Wonderful business that could and possibly should have died during the Great Recession.

 

I'm somewhat surprised when MCO is quoted as an example of company to put into concentrated portfolios. What if US regulators had more teeth?

 

+1

[jawn619]

Wonderful business that could and possibly should have died during the Great Recession.

 

I'm somewhat surprised when MCO is quoted as an example of company to put into concentrated portfolios. What if US regulators had more teeth?

 

I think it's extremely difficult to foresee that regulatory risk. You have the benefit of hindsight, but I don't think it's possible or prudent to care about that risk if investing in 2000-2001. The case study was more about how to identify businesses that are capital light, have a competitive advantage, and using excess capital to buy back shares.

[Graham Osborn]

Wonderful business that could and possibly should have died during the Great Recession.

 

I'm somewhat surprised when MCO is quoted as an example of company to put into concentrated portfolios. What if US regulators had more teeth?

 

+1

 

+1.  The very timing of this post is bearish for the stock IMO.  The ratings agencies suck just as much now as they did before, it's just now their idiocy is being applied to "investment grade" corporate bonds rather than "investment grade" mortgage-backed or municipal securities.  It's like hiring sell side analysts to value stocks.  But the OP is right that if despite being so stupid these companies have endured so long, they must have a certain degree of staying power ;)

[DavidVY]

Disney is the ultimate good business with amazing pricing power

 

People will take their kids to Disneyland for the holidays instead of paying for rent (overheard this on the radio station)

 

Pablo Escobar took his kids to DisneyWorld @ the time he was being hunted by the US govt (Cocaine Cowboys)

 

A movie soundtrack from Frozen becomes a US best-seller because of the branding power.

 

The some of the biggest musical stars got started with Disney.

 

And don't even start with how iconic cultural icons have lasted over 40+ years.

[Travis Wiedower]

I feel like rating agencies may be better off nationalized. The current setup has the incentives ass backwards.

[APG12]

I feel like rating agencies may be better off nationalized. The current setup has the incentives ass backwards.

 

The market should be privatized not nationalized. The government restricts competition by providing licenses, and then it provides a captive market by requiring firms to use these licensees through an array of statutes and regulations. It doesn't matter whether rating agencies are subscriber pay or issuer pay. A natural duopoly plus government restricted competition and a forced customer base is going to have serious problems.

[HJ]

To the extent banking / insurance need to be regulated businesses, there's simply no way around rating agencies.  It's impossible to ask the regulators to re-underwrite every single private credit that is extended.  Someone has to play that role.  Another way of saying these companies have huge pricing power if they chose to exercise it.

 

That said, whether these agencies should be structured as non-profit in nature, to strip out any incentive to skew rating one way or another, is a different story. 

 

Regulatory risk is indeed high, but one can also take the view that this particular risk is only going down every day we step away from the '08-'09.

 

[Guest Schwab711]

I really don't think Congress was ever close to stripping NRSRO designation during the crisis. The folks in Congress involved in the financial industry are well aware of the importance of the CRAs. The only people calling for banishment of specific CRAs or the industry as a whole are average Joe's that aren't customers of the CRAs and don't understand why they exist.

 

HJ hit the nail on the head in his first sentence. Why do we have the NRSRO designation in the first place? Well, prior to 1975, any idiot with access to paper and a pencil (possibly pen for final copies) could provide a "valuation" or review of credit, hired by the issuers. The company requests the credit rating, tells John Doe what to put in the report, and viola!, major companies could create legally admissible evidence that contains whatever they want it to say. Limitations and regulations are beyond essential for this industry. There is simply no way to cut out conflict of interest (the US has been trying for 100+ years). That's why I don't think anyone really considered any kind of non-monetary punishment (S&P was banned from rating certain securitized products for 5 years that will end in 1-2 years; that's pretty harsh).

 

These businesses cannot be non-profit for so many reasons. Most importantly, a non-profit monopoly providing an essential service is guaranteed to be massively inefficient and inaccurate over time.

 

There actually is quite a bit of competition in the industry! There are 8 NRSROs based in the US last time I checked. There's more NRSROs then cell phone carriers and eyeglass retailers...

 

I also don't think there's anything to fix:

Issuer-paid >>> subscriber (investor) paid

License to operate >>>>>>>>>>>>>>> No license to operate

Both S&P and Moody's faced or will face >$1b fines for their actions and S&P faced a 5-year banishment due to regulators not trusting them (reputation and accuracy are the only differentiation between NRSROs!)

S&P and Moody's ultimately didn't originate the loans or create the structured products. They were asked to rate products of exceptional complexity that were either relatively new or brand new financial products. This wasn't/isn't an easy task.

 

I'm no idiot. I do realize there was some wrongdoing. However, it was relatively small and now that the dust has settled, can we all admit that the US used the financial system as a scape-goat to explain the recession and nearly every related problem? The blame should and could have been spread around to everyone. Sometimes, recessions and downturns happen...

 

Examples include, folks buying houses and not understanding what they're signing, predatory originators, banks offering bank checks for new loan originations, investors offering blank checks to invest in securitized mortgage (and non-mortgage) products that they don't understand, legislation that encouraged all of this behavior, lack of regulator oversight, and I could go on and on.

 

I agree with HJ that time will help folks forget the problem that never really was. I think the MCO/MHFI business model limits COI as much as possible and we have regulation in place to watch for COI where it is most likely to occur (blame regulators for COI - that's their job is to tell MCO/MHFI when they pushed the envelope too far!). The MCO/MHFI business model is completely safe and in no danger (and arguably never was in danger).

 

Just my two cents

[rpadebet]

How about paying these rating agencies differently?

 

Why not pay them using the bonds they rate?  And force them to hold those bonds until maturity or at least a fixed period of time.

That should align their incentives with the buyers right? They certainly would have been more careful with aaa ratings on some CDOs

[merkhet]

How about paying these rating agencies differently?

 

Why not pay them using the bonds they rate?  And force them to hold those bonds until maturity or at least a fixed period of time.

That should align their incentives with the buyers right? They certainly would have been more careful with aaa ratings on some CDOs

 

I actually am quite fond of this idea. I wonder to what extent there might be some gaming though. It's hard to take all the gaming off a system that includes human nature. So maybe rating certain AAA bonds as B+ to get extra interest from the bond, etc.

[Eye4Valu]

What gets me is that ratings agencies always appear to be looking in the rear view mirror. They change their ratings after any given crises, but usually not before. Investors who look at ratings likely do so before they invest. The ratings agencies need to look through the windshield more often and give investors adequate warning of trouble ahead. After the fact, it is too late. I feel the same way about sell side analysts. Look at VRX for example. 9 out of 10 had high price targets pre-crises, then lower them post-crises. It soon becomes abundantly apparent that you cannot trust ratings agencies or sell side analysts opinions one way or the other.

[kfh227]

Disney is the ultimate good business with amazing pricing power

 

People will take their kids to Disneyland for the holidays instead of paying for rent (overheard this on the radio station)

 

Pablo Escobar took his kids to DisneyWorld @ the time he was being hunted by the US govt (Cocaine Cowboys)

 

A movie soundtrack from Frozen becomes a US best-seller because of the branding power.

 

The some of the biggest musical stars got started with Disney.

 

And don't even start with how iconic cultural icons have lasted over 40+ years.

 

Go to the Disney (trip planning) forums.  People are starting to get VERY pissed at pricing models that Disney is putting out for Disney World.  They are heading towards micro transactions for everything.  Some laugh that they will start charging for popular rides in park soon.

 

They already screwed up fast pass to where it is pointless.  All it really does is force you to walk through the park more (in sun and heat usually).  But all that walking in the heat makes you more thirsty and the $3 Coke bottles are waiting for you.

 

I question their purchase of the Star Wars franchise.  Light sabers going through bodies and blood on storm trooper masks.  It's a along shoot admittedly but if Disney starts going after the ten market aggressively, they could destroy their "parent friendly" brand.

 

Storm troopers walking through hotels may scare and confuse 5 year olds.  They show this in a commercial of them going through the Grand Floridian.

 

I used to love Disney but these days, I am caring much less about it.  Some of the magic is gone.

 

I am just worried about direction.  My fear is that if the direction is maintained, that the brand will be destroyed.

[Guest Schwab711]

How about paying these rating agencies differently?

 

Why not pay them using the bonds they rate?  And force them to hold those bonds until maturity or at least a fixed period of time.

That should align their incentives with the buyers right? They certainly would have been more careful with aaa ratings on some CDOs

 

They are paid to be independent and uninterested. Providing them bonds gives them incentive to game the system (I probably agree with all of you that the incentive is not very large compared to losing their ongoing business if caught but...). More importantly, they would no longer be independent or uninterested.

 

I understand folks are generally upset about the ratings of the securitized products but no more than a few handfuls of people saw this whole collapse coming and even they thought it was just a higher probability than other market participants were assuming. Maybe just as valid of a question, why should we blow up a business model that has been tested and refined over and over for 100+ years because of one recession? Why didn't the regulators do their jobs? In my opinion, that's where the COI focus should be placed.

 

 

What gets me is that ratings agencies always appear to be looking in the rear view mirror. They change their ratings after any given crises, but usually not before. Investors who look at ratings likely do so before they invest. The ratings agencies need to look through the windshield more often and give investors adequate warning of trouble ahead. After the fact, it is too late. I feel the same way about sell side analysts. Look at VRX for example. 9 out of 10 had high price targets pre-crises, then lower them post-crises. It soon becomes abundantly apparent that you cannot trust ratings agencies or sell side analysts opinions one way or the other.

 

Sell-side analysts are another story. I turned down a job as a sell-side analyst when I found out that they wanted to sell reports. They didn't give a hoot about accuracy or value. I couldn't do it. Blame the HFs and institutional investors that buy/use these reports. There are some fantastic equity analysts in these positions that are trying to 'do good', but it's a drop in the bucket from what I understand. Would be great to hear from someone that works in this field.

 

As to rating agencies looking back... that's what their ratings are. It's similar to baseball-reference's similar player scores. B-Ref isn't trying to say that Player A will turn out to be exactly like Player B. They are just showing you how players have turned out that had similar starts to their career. Every player (and company/point in time is different).

 

I'm sure they are capable of predictive analysis but it's really not fair to the borrower. Similar to FICO (and why I think the "new" consumer rating companies are going to hit a regulatory wall if they catch on - denying someone a loan because they surf a certain website or something similar is going to be a PR nightmare). For the CRAs, the situation is magnified by a magnitude. If they did predict solvency or liquidity to a greater then they could control the market by predicting a company will go bankrupt before it actually happens. It's a bit like the quantum mechanics conundrum where the very act of measuring the photon alters the physical properties of the photon, ruining your experiment. Same thing for companies. What if MCO/MHFI predict bankruptcy because their model says 100% chance of occurrence but the actual odds were 99.9999%? What if company survives anyway and sues MCO/MHFI for excess interest they were forced to pay because of MCO/MHFI's opinion? This is a slippery slope.

 

Their ratings are only meant to give generalized PD and LGD analysis based on historic results of companies with similar financials/operations/ect as the subject company. Any disappoint with CRAs may be due to unrealistically high expectations of them. I'm all for improving the financial system but just explaining why things are as they are based on what I know and what people have told me.

 

Also, both MCO/MHFI had junk ratings on VRX for years. They really are extremely accurate. If anyone was better then them they would win business.

[LC]

Just get rid of the rating agencies. Force people to be held accountable for the investing decisions they make.

[Guest Schwab711]

Just get rid of the rating agencies. Force people to be held accountable for the investing decisions they make.

 

That's not really necessary for credit markets. They are so liquid because the credit ratings work so well. Your suggestion would increase the cost of capital across the board and shut certain parties out. Why do folks think the credit ratings are unnecessary or need to be tinkered with?

[Picasso]

What gets me is that ratings agencies always appear to be looking in the rear view mirror. They change their ratings after any given crises, but usually not before. Investors who look at ratings likely do so before they invest. The ratings agencies need to look through the windshield more often and give investors adequate warning of trouble ahead. After the fact, it is too late. I feel the same way about sell side analysts. Look at VRX for example. 9 out of 10 had high price targets pre-crises, then lower them post-crises. It soon becomes abundantly apparent that you cannot trust ratings agencies or sell side analysts opinions one way or the other.

 

Totes Magotes. For investment purposes their ratings are backward looking and a joke.

[jawn619]

http://fcic.law.stanford.edu/interviews/view/19

 

Buffett talks about Moody's in the beginning of the interview

[ZenaidaMacroura]

I feel like rating agencies may be better off nationalized. The current setup has the incentives ass backwards.

 

The market should be privatized not nationalized. The government restricts competition by providing licenses, and then it provides a captive market by requiring firms to use these licensees through an array of statutes and regulations. It doesn't matter whether rating agencies are subscriber pay or issuer pay. A natural duopoly plus government restricted competition and a forced customer base is going to have serious problems.

 

Not to be adversarial (I have no opinion really, just curious) but why is a government restricted duopoly different from a natural one?  Doesn't the government face the same pressure to do something to reign in the natural duopoly as it does to unrestrict the license induced one?

[APG12]

I feel like rating agencies may be better off nationalized. The current setup has the incentives ass backwards.

 

The market should be privatized not nationalized. The government restricts competition by providing licenses, and then it provides a captive market by requiring firms to use these licensees through an array of statutes and regulations. It doesn't matter whether rating agencies are subscriber pay or issuer pay. A natural duopoly plus government restricted competition and a forced customer base is going to have serious problems.

 

Not to be adversarial (I have no opinion really, just curious) but why is a government restricted duopoly different from a natural one?  Doesn't the government face the same pressure to do something to reign in the natural duopoly as it does to unrestrict the license induced one?

 

Sure, the difference between a natural duopoly and a government restricted duopoly is the difference between voluntary interactions and physical coercion. If you want to compete with a natural duopoly, you open up shop and provide a better product. In the case of rating agencies, which have substantial competitive moats, your product needs to be much much better. If you want to compete with a government restricted duopoly, your product doesn't matter- nothing matters- because you are prevented from competing by threat of force.