Sunday, 7 July 2013

Rating the Rating Agencies - We've Rated Moody's.

Moody's is the largest of the Big Three rating agencies. It employs 4500 people worldwide and has reported a revenue of $2 billion in 2010. Since rating agencies have been under heavy fire since the start of the financial meltdown - in January 2011 the Financial Crisis Inquiry Committee claimed that "The three credit rating agencies were key enablers of the financial meltdown" - we have decided to actually rate one of them. We have chosen Moody's because today it is the largest rating agency.
However, in rating Moody's we have not rated its financial performance or its capacity to honor its financial obligations or its Probability of Default. In other words, we have not performed a conventional rating which, as we claim, is not relevant in a turbulent economy. What is more relevant in turbulent times is resilience - the capacity of a business to withstand and survive sudden and extreme events. In fact, our ratings actually measure the resilience of a business based on the structure of its financials.

For the analysis we have used our on-line self-rating system. Anybody can use this system to rate any company.

We have used information from Moody's Investor Relations page, available here. If anyone wishes to verify the results of our rating it is possible to do so by simply downloading the financial information and processing it using our mentioned self-rating system.  The process, in other words, is fully transparent.

Since it is not the scope of this short blog to provide a thorough and detailed analysis, we will illustrate only on the results based on the Balance Sheet data. We have, however, analyzed also the Consolidated Income and the Cash Flow statements.

The following Balance Sheet entries have been used:

  • Cash and cash equivalents
  • Short term investments
  • Accounts receivable  net of allowances of  
  • Deferred tax assets  net
  • Other current assets
  • Total current assets
  • Property and equipment  net
  • Prepaid pension costs
  • Computer Software  Net                                     
  • Goodwill
  • Intangible assets  net
  • Deferred tax assets  net
  • Other assets
  • Total assets
  • Notes payable
  • Accounts payable and accrued liabilities
  • Commercial paper
  • Revolving credit facility
  • Current portion of long term debt
  • Bank borrowings
  • Deferred revenue
  • Total current liabilities
  • Non current portion of deferred revenue
  • Long term debt
  • Notes payable
  • Deferred tax liabilities  net
  • Unrecognized tax benefits
  • Accrued Income Taxes                                       
  • Other Accrued and Current Liabilities                      
  • Unearned Subscription Income                               
  • Other liabilities
  • Total liabilities
  • Shareholders' deficit: Preferred stock  par value  
  • Shareholders' deficit: Series common stock  par value   
  • Shareholders' deficit: Common stock  par value  
  • Capital surplus
  • Accumulated deficit
  • Retained earnings
  • Treasury stock  at cost       shares of common stock at December 31
  • Accumulated other comprehensive loss
  • Cumulative translation adjustment
  • Total Moody's shareholders' deficit
  • Noncontrolling interests
  • Minimum Pension Liability                                  
  • Total shareholders' deficit
  • Total liabilities and shareholders' deficit

The corresponding Business Structure Map - which may be obtained here and examined interactively using MAPVIEW - is indicated below.

As the name suggests, the map represents the structure of the business as reflected, in this case, by its Balance Sheet. In the map one may identify dependencies between the various Balance Sheet entries. An intricate and inter-connected map points to a business that is difficult to manage and to understand. Information on how to interpret such maps may be found here.

If the structure of this map is resilient then also the business is resilient. But let us see how resilient the structure of Moody's business really is:

On a scale of one to five stars, a two-star rating is obtained. This is because the business is highly complex - 18.01 - which is quite close to the maximum sustainable complexity of 21.95. This means that the business cannot become much more complex than it already is today and, if it does, it will be unmanageable. In other words, the business is not well prepared to face sudden and extreme events as it is approaching high levels of fragility. Furthermore, since the business is very close to reaching its maximum sustainable complexity threshold, with the current business model Moody's cannot grow much more.

Using Moody's rating scale, two stars corresponds to A3.

When a business functions in the proximity of its critical complexity (think of your cholesterol being close to the limited suggested by your cardiologist) it is important to know what is making the business complex. This information is portrayed by the Corporate Complexity Profile which you may also examine using MAPVIEW. The Complexity Profile of Moody's is illustrated below:

The entries at the top of the chart are those that are responsible for the high complexity and hence for the low resilience of the business. Values are expressed in percentage terms. The fact that numerous entries have similar contribution (6-8%) points to a situation that is quite intricate and difficult to modify.

The above result poses the question: shouldn't raters have high ratings? Isn't someone who has the power to judge others supposed to give a good example? Would you trust a cardiologist who smokes while he examines your ECG?

DISCLAIMER: Structural resilience ratings do not constitute buy or sell advice.