Morningstar Inc. is tapping a senior executive from Toronto-based DBRS Ltd. to run its credit ratings arm, as the investment research company tries to use its new acquisition to take on the debt industry’s two ratings titans.
In May, Chicago-based Morningstar announced a deal to acquire DBRS for US$669-million. The transaction marked the second sale of the Canadian debt-rating agency in five years, and in such transactions, acquirers have a history of installing their own people as leaders.
Instead, Morningstar has named Detlef Scholz, the head of Europe for DBRS, as the new head of its credit ratings group. The division will combine DBRS and the small debt ratings business that Morningstar had been building on its own.
Mr. Scholz has two key attributes: He is intimately familiar with DBRS’s culture, which should help to integrate the two businesses now that the takeover has closed, and he has executive experience at one of the industry’s top rivals. Before joining DBRS in 2015, Mr. Detlef spent two decades in increasingly senior positions at Moody’s Investors Service in Frankfurt, London and New York. Moody’s is the major rival to industry leader S&P Global Ratings.
Because Mr. Scholz will be based in London, his promotion suggests Morningstar is most interested in growing DBRS beyond Canada’s borders. But Morningstar chief executive Kunal Kapoor stressed in an interview that the rating agency’s Canadian operations are crucial to its bottom line – and to its growth.
“I don’t personally view Canada as a place where we draw a dividend from,” Mr. Kapoor said in the interview. “There are plenty of growth opportunities.”
Mr. Scholz said in the same interview that credit markets have many layers beyond the debt issued by publicly traded companies. For one, the Canadian government has emphasized infrastructure investments and set up the Canada Infrastructure Bank, and these types of projects almost always need debt financing.
DBRS’s strength in Canada also gave Morningstar comfort that the rating agency would remain profitable even if there is an economic downturn in the near future, which could force it to temporarily scale back its global growth plans.
DBRS “has durability and staying power regardless of the environment,” Mr. Kapoor said. “It’s natural there will be ups and downs. … The strong presence in Canada gave us a lot of comfort that we could withstand any negative economic environment in the short run.”
Morningstar disclosed that in fiscal 2018, privately-held DBRS had revenues of US$167-million and that its operating margins were “consistent with Morningstar’s overall business.” In fiscal 2018, Morningstar reported an operating margin of 21 per cent.
While Canada will remain important, Morningstar is certainly interested in global growth for credit ratings – particularly in the United States and Europe. One of the deal’s major selling points was Morningstar’s calculation that the global credit-rating market has grown at a compounded annual rate of about 7 per cent over the past 10 years, and this is expected to continue because new types of debt products continue to launch.
The growth itself is important, but crucially, fixed-income investments can be much more complex than equities and Morningstar clients want to understand this market better. “Credit is complicated," Mr. Scholz said.
Almost all of Morningstar’s revenue from rating debt in 2018 came from the United States, while the bulk the DBRS’s revenue came from Canada and Europe. Just 4 per cent of Morningstar’s revenue last year came from debt-rating services; had it owned the Canadian company, that figure would have been 17 per cent.
As for Morningstar’s bottom line, acquiring a credit business will help to diversify from its traditional strength in equities and mutual funds. Asked if this played a role in the acquisition, Mr. Kapoor said DBRS’s strength and the underlying growth in credit markets were the key drivers, but added that the diversification was a nice kicker.
“Nobody today should assume that anything they do isn’t worthy of disruption in some form," he said.
DBRS, once known as the Dominion Bond Rating Service, was founded by Canadian Walter Schroeder in 1976 and was first sold to Carlyle Group and Warburg Pincus for a reported US$500-million in 2014. Under Morningstar’s ownership, the business will remain based in Toronto.
In an e-mail, Mr. Schroeder said he is no longer involved in the business in any form but gives the deal his blessing. “I spent forty years of my life creating and expanding DBRS, and believe that it is falling into good hands," he wrote.
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