UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported):
July 2, 2010
MORNINGSTAR, INC.
(Exact name of registrant as specified in its charter)
Illinois
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000-51280
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36-3297908
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(State or other jurisdiction
of incorporation)
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(Commission
File Number)
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(I.R.S. Employer
Identification No.)
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22 West Washington Street
Chicago, Illinois 60602
(Address of principal executive offices)
(312) 696-6000
(Registrants telephone number, including area code)
N/A
(Former name or former address, if changed since last
report)
Check the
appropriate box below if the Form 8-K filing is intended to simultaneously
satisfy the filing obligation of the registrant under any of the following
provisions:
o
Written communications pursuant to Rule 425 under the Securities
Act (17 CFR 230.425)
o
Soliciting material pursuant to Rule 14a-12 under the Exchange Act
(17 CFR 240.14a-12)
o
Pre-commencement communications pursuant to
Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
o
Pre-commencement communications pursuant to
Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
Item 7.01. Regulation FD Disclosure.
The
following information is included in this Current Report on Form 8-K as a
result of Morningstar, Inc.s policy regarding public disclosure of
corporate information. Answers to additional inquiries, if any, that comply
with this policy are scheduled to become available on August 6, 2010.
Caution Concerning Forward-Looking Statements
This
current report on Form 8-K contains forward-looking statements as that
term is used in the Private Securities Litigation Reform Act of 1995. These
statements are based on our current expectations about future events or future
financial performance. Forward-looking statements by their nature address
matters that are, to different degrees, uncertain, and often contain words such
as may, could, expect, intend, plan, seek, anticipate, believe,
estimate, predict, potential, or continue. These statements involve
known and unknown risks and uncertainties that may cause the events we discuss
not to occur or to differ significantly from what we expect. For us, these
risks and uncertainties include, among others, general industry conditions and
competition, including current global financial uncertainty; the impact of
market volatility on revenue from asset-based fees; damage to our reputation
resulting from claims made about possible conflicts of interest; liability for
any losses that result from an actual or claimed breach of our fiduciary
duties; financial services industry consolidation; a prolonged outage of our
database and network facilities; challenges faced by our non-U.S. operations;
and the availability of free or low-cost investment information.
A more
complete description of these risks and uncertainties can be found in our
Annual Report on Form 10-K for the year ended December 31, 2009. If
any of these risks and uncertainties materialize, our actual future results may
vary significantly from what we expected. We do not undertake to update our
forward-looking statements as a result of new information or future events.
Investor Questions and Answers: July 2010
We plan to
make written responses available addressing investor questions about our
business on the first Friday of every month. The following answers respond to
selected questions received through June 30, 2010. We intend to answer as
many questions as time allows, although we will not answer product support
questions through this channel. We may wait to respond to a given question
until the following month if we need more time to research the answer.
If you would
like to submit a question, please send an e-mail to investors@morningstar.com,
contact us via fax at 312-696-6009, or write to us at the following address:
Morningstar, Inc.
Investor
Relations
22 W.
Washington
Chicago, IL
60602
Investment
Management Segment
1.
Regarding Funds of Funds first I am going
to state some observations and then ask questions related to those
observations:
During the annual meeting presentation, Mr. Mansueto
emphasized the importance of the fund of funds business as part of Morningstars
growth strategy. However, Morningstars
2
fund of funds business consists of three
very different products. The largest product, investment consulting, competes
in a relatively mature industry with many strong competitors. It is also an
industry that is largely invisible to individual investors. The other two
businesses (managed portfolios and retirement accounts) are much smaller, but
are more visible to individual investors. Given the strength of the Morningstar
brand among individual investors, these product lines appear to represent a
unique opportunity to leverage the Morningstar brand and research capability.
We agree
with you about the unique opportunity to leverage our research and brand
through Morningstar Managed Portfolios and managed retirement advice, but we
also see ample opportunities for our Investment Consulting business. While
there are other strong competitors in this area, we believe we have several
strengths that set us apart, including our expertise in analyzing managed
investment products, our capabilities in asset allocation and portfolio
construction, and our access to Morningstars extensive holding-based database.
Also, the
majority of our Investment Consulting revenue stems from our work as a
portfolio construction manager or subadvisor to mutual fund or variable annuity
firms. Many of the portfolios we work on are available to individual investors
and therefore visible to that audience.
2.
Most of the retirement account AUM is
managed by the Ibbotson division. Given my observations above, I would
think that Morningstar could generate more strategic value by focusing on
Morningstar Retirement Manager. Can you describe the marketing strategy for
this product? Has Morningstar considered re-branding the Ibbotson product or
combining the two products?
Ibbotson
Associates had a well-established managed retirement account business when we
acquired it in 2006, and assets under management have continued to expand since
then. For the past several years, we have operated Morningstar Associates and
Ibbotson Associates as separate units. However, were working to find more ways
to leverage their combined expertise to better support clients. At the same
time, we believe Ibbotson has a well-respected brand among institutions, and we
expect the brand to continue in the marketplace.
Regarding
our marketing strategy for Morningstar Retirement Manager, we market these
services mainly through our relationships with retirement plan providers and
plan sponsors. Morningstar Associates has relationships with 16 plan providers,
and we work with these providers to expand the number of plan sponsors using
our services. Our marketing efforts also include financial advisors, who can
contact their plan sponsors with requests to use Morningstar Retirement Managers
services. Finally, we provide a variety of communication materials to
retirement plan participants to increase awareness of our services. Our focus
is on helping people create a retirement strategy that establishes long-term
savings, contributions, and income goals. Once a strategy is established, our
investment professionals create and manage an investment portfolio designed to
meet those long-term objectives and help move investors closer to a successful
retirement. We also offer a new In Retirement service for participants in
retirement or approaching retirement that helps determine how best to turn
participants accumulated 401(k) savings into a sustainable paycheck.
3.
I am a Morningstar shareholder. I have
recently reviewed public information regarding Financial Engines. It appears
they are a direct competitor and are growing much more quickly compared to your
retirement account management business. I recently read your responses [from
the 8-K published April 5, 2010] regarding your market position but Im
not clear how effectively you are competing with them.
·
Does Morningstar have data connections to
the large 401(k) recordkeepers?
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Are you target[ing] Fortune 500 companies and/or
large 401(k) plans for your services?
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Are you planning to build or add to
recordkeeper data connections to sell into this market?
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·
Does your retirement account portfolio
management software meet the requirements of the new Department of Labor
guidelines?
We believe
were one of the largest players in managed retirement accounts, and were
doing a number of things to compete against other companies in this market. Well
address your specific questions below.
Yes, we
have data relationships with the large 401(k) recordkeepers. We work with
approximately 25 recordkeepers (aka plan providers) through Morningstar
Associates and Ibbotson Associates. When we create a relationship with a plan
provider, we go through an integration process with the provider. That
technical integration allows for data to flow from the provider to us. The data
set would include things like participant name, account balance, contribution
rate, current funds, salary, etc.
We do
target large 401(k) plans with our services and currently work with
several larger plan sponsors, including a couple of Dow 30 companies.
Were
always looking to expand our relationships with recordkeepers.
Regarding
the last part of your question, yes, our managed retirement accounts do meet
the new Department of Labor guidelines concerning qualified default investment
alternatives.
4.
My understanding is that an employer can
reduce its exposure as a fiduciary if employees choose to have their 401(k) managed
by a third party advisor such as Morningstar [Associates] or Ibbotson. Is this
accurate? If so, do you expect this to be a major driver of the retirement
account product?
Yes, this
is accurate. Under ERISA, employers are generally fiduciaries of their
retirement plans and are required, among other things, to operate the plan
solely in the best interests of participants, prudently select investments,
avoid conflicts of interest, and monitor investment options on an ongoing
basis. One of the hurdles facing plan sponsors in addressing the above
liabilities is that they often dont have the investment expertise to make prudent
decisions, properly benchmark fees and investment lineups, or the time to
document every decision they make.
Plan
sponsors who want to address these limitations and manage their legal
liabilities have the option of outsourcing some of their fiduciary
responsibilities by working with Morningstar Associates or Ibbotson Associates.
We believe plan sponsors choose our services not only to assist them in meeting
their fiduciary obligations, but also because they find value in our services,
which can improve the odds of their employees reaching their retirement goals.
5.
In the Investment Consulting business, who
sells the product, what is the sales process, how many sales professionals are
involved, who do they report to?
We have
approximately 15 people involved in sales, business development, and product
management for our Investment Consulting business globally. These individuals report
either to Morningstar Associates or Ibbotson Associates (or, in some cases, to
local country managers outside the United States). In addition, we have a team
of about 10 strategic account managers who are responsible for managing our
largest client relationships across Morningstar and report to our national
sales director.
Our
Investment Consulting work is largely a solution-oriented process, as opposed
to a product-oriented process. The sales process, therefore, is highly
customized to solving the specific investment issues facing our prospective
clients. We generally start by working with the client in a collaborative
manner to understand their needs and how our asset allocation, portfolio
construction, or other consulting services can help their clients achieve
better outcomes. In many
4
cases, we
already have established relationships with potential Investment Consulting
clients through our data and software areas, so were starting from an existing
client relationship rather than prospecting for completely new clients.
6.
Managed portfolio AUM has grown from $1.4
billion in 2005 to $2.3 billion at the end of Q1 2010. While that is a
respectable growth rate, AUM of $2.3 billion is very small relative to the
opportunity and too small to have a meaningful impact on Morningstars overall
results. What is the growth strategy for this product? How is the current
strategy different from previous years?
Our
Morningstar Managed Portfolios business is still relatively small compared with
the total market opportunity. Were continuing to build scale in this area and
see many opportunities to expand.
Our vision
for the business is to create a well-rounded, modular platform that delivers
strong investment outcomes to clients at a lower cost than similar investment
programs. Were focusing on broadening our solution set to include additional
programs such as unified managed accounts, partial discretion portfolios,
separately managed accounts, insurance-plus, and lifetime income offerings.
We recently renegotiated our custodial contract, creating lower costs for
account holders. Were also modularizing the business to unbundle our core
investment management, technology, and distribution capabilities so they can be
used in different configurations by different types of advisor clients.
Equity
and Credit Research
7.
Is the equity research distributed through
Morningstar.com and the Advisor Workstation written by the same analysts that
work on the institutional product? If so, how much time does an analyst
typically devote to each channel and how similar is the material distributed to
retail investors to reports distributed to institutional clients?
We
distribute our equity research through multiple platforms, including
Morningstar.com, Morningstar Advisor Workstation, Morningstar Direct,
and Institutional Equity Research Services. The
core research reports distributed to the individual and advisor
channels are the same (i.e., the investment thesis and Morningstar Rating), but
institutional clients receive additional content that encompasses not only
the analysts conclusions but also their assumptions and background
research. This additional content includes the discounted cash-flow
model underlying the analysts fair value estimate for each company, thematic
sector research and updates, invitations to events such as the annual Stocks
Forum, conference calls discussing market events or investment ideas,
company visit notes, and more. Our institutional clients can also contact
analysts directly via phone or e-mail with detailed questions about
their coverage.
Its
difficult to quantify a percentage of time that our analysts spend on research
for different channels. Our research process focuses on company- and industry-specific
analysis that we distribute to various audiences depending on their needs. In
addition, while our analysts spend some of their time working on research that
we only deliver to institutions, we believe this research ultimately benefits
all of our audiences because it enhances the quality of our research and
knowledge of the stocks and industries we cover.
8.
What is the average AUM of your
institutional equity research customers?
We havent
calculated an average AUM for our institutional equity research business, but
we can shed some light on the relative size of our client base. Approximately
half of our institutional equity research business is with mid-size asset
managers, which we define as those with between $1 and $10 billion in equity assets
under management. We also serve a growing number of larger asset managers
(greater than $10 billion in equity assets under management), which account for
about a fourth of institutional equity research revenue. Our clients also
include smaller
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firms
(managing between $100 million and $1 billion in equities), which represent
approximately another one-fourth of our revenue.
9.
How did Morningstar determine that the
addressable market for fundamental research is $3 billion?
We
triangulated this estimate using a couple of different methods. We looked at
the number of firms in each market segment that purchases research and
estimated a dollar amount for research spending per firm. As a cross-reference,
we also looked at third-party estimates of commission payments by asset
managers to brokers and/or third parties for equity research in the United
States. Finally, we evaluated the global picture and estimated what percentage
of the market resides inside and outside of the United States. As a rule of
thumb, we believe equity research needs correlate with equity assets under
management, and we see approximately half of these managed in the United States
and half elsewhere. Overall, we believe $3 billion is a fairly conservative
estimate of the addressable market for fundamental equity research.
10.
Does
Morningstar hope to compete directly with S&P/Moodys/Fitch in supplying
credit ratings used for various regulatory or fiduciary purposes (i.e., do you
intend for a Morningstar AAA to satisfy the requirement that some institutions
and portfolios hold a certain percentage of assets with investment grade
ratings)? Alternatively, is the more appropriate comparison the model employed
by Credit Sights and the fixed income research efforts of investment banks
(i.e., research for investors that supplements but does not replace the rating
agencies)?
Our
corporate credit ratings business does not compete directly with the first
three firms you mentioned under the current regulatory framework (which has
been under much debate and is still subject to uncertainty until the financial
regulatory reform bill is finalized). Under current laws, a small number of
government-sanctioned ratings agencies (those designated Nationally Recognized
Statistical Ratings Organization) are authorized to supply credit ratings for
the regulatory purposes you mentioned. Many asset managers also have language
requiring ratings from NRSROs in their investment policy statements.
That said,
our corporate credit ratings measure the same thing that the NRSRO corporate
credit ratings attempt to measure: probability of default. We believe we have a
unique viewpoint to offer on company default risk that leverages our cash-flow
modeling expertise, proprietary measures like Economic Moat, and in-depth
knowledge of the companies and industries we cover. Morningstars equity
analysts produce detailed five-year forecasts of cash flows to evaluate stocks,
and are able to compare those forecasts with liabilities coming due to provide
insight into companies creditworthiness. Another distinction of Morningstars
credit rating methodology is its emphasis on its Economic Moat calculation of
competitive advantage when evaluating both a companys financial prospects as
well as its business risk.
Our credit
ratings are available on Morningstar.com and other Morningstar products. Were
also offering a data feed of our credit ratings for free so other websites or
publishers can use or display them.
Regarding
the second part of your question, yes, we compete in the research space against
other independent credit researchers as well as the sell-side. We make our
underlying research, credit models, and analysts available to our institutional
buy-side clients. We also have an advisor version of our credit research that
we make available to firms with captive advisor forces as well as platforms
that serve independent advisors.
As a
Nationally Recognized Statistical Ratings Organization, our Realpoint unit,
which we acquired in May 2010, does compete with the NRSROs you mentioned
for its ratings of collateralized mortgage-backed securities in the new-issue
CMBS (Commercial Mortgage-Backed Securities) space. Realpoints main business
to date, though, has been in the surveillance and
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ratings of
existing CMBS, which it sells to institutional investors under a
subscription-based model.
11.
Will
Realpoint expand to cover other structured products (RMBS, cards, autos,
student loans, etc)?
We are
exploring the possibility of moving into other structured finance asset
classes.
12.
Will
Realpoint be rebranded as Morningstar at some point?
Yes, we expect to rebrand Realpoint under the Morningstar name by the
end of 2010.
13.
How is revenue
relating to equity research reflected in your financial statements? Would Institutional
Equity Research be reported as a distinct product line in the 10-K, assuming
it became a top five product?
We report
institutional equity research as a separate product (labeled Morningstar Equity
Research) within our Investment Information segment. If it became one of our
five largest products, we would disclose revenue for this product in the 10-K
table you referred to.
14.
Where
does the credit rating business appear in your results? Will it be
separated from equity if it is combined currently?
We
classify the credit rating business as a separate product from Morningstar
Equity Research for financial reporting purposes. Both services are part of our
Investment Information segment.
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.
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MORNINGSTAR, INC.
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Date:
July 2, 2010
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By:
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/s/
Scott Cooley
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Name:
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Scott
Cooley
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Title:
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Chief
Financial Officer
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