Buying binge signals new dawn for Morningstar?

Joe Mansueto is stepping up deal-making at Morningstar Inc. as the financial information provider comes off a rare decline in annual revenue.

In the past four months, Morningstar’s CEO and majority shareholder reeled off five acquisitions, mostly smaller firms that expand the Chicago-based company’s investment research business.

In March, Morningstar bought Aegis Equities Research, an Australian firm, and Realpoint LLC, a Horsham, Pa.-based structured finance research ratings company. In February, it acquired Peekskill, N.Y.-based Footnoted.

“It’s a brilliant strategy, particularly to go in when the market is pretty distressed,” says Philip Tasho, CEO of Alexandria, Va.-based Tamro Capital Partners LLC, which manages two mutual funds that hold Morningstar shares. “When the economy is improving, you want to accelerate that pace because you’re probably at the inflection point.”

Morningstar builds revenue through the acquisitions by cutting duplicative costs and selling the new products to its bigger base of 7 million individual, 250,000 financial-adviser and 4,200 institutional customers, says Mr. Mansueto, 53. The acquisitions strengthen Morningstar’s competitive position and give the smaller companies resources they need to expand, he says.

“We’d like to be able to track, really, any investable asset,” Mr. Mansueto says. “We’re still filling in the mosaic.”

The deals come as Morningstar works to reignite growth in revenue, which fell last year for only the second time in the company’s 26-year history. Revenue slipped 4.7% to $479 million from 2008, and consolidated net income fell 11% to $82.3 million as the recession sapped demand for financial information and research services.

Morningstar has acquired 15 companies and taken stakes in three others since the economy slowed in late 2007. If the company can acquire a business faster and cheaper than it can build one, it will make the purchase, Mr. Mansueto says.

The billionaire founder says the buying spree wasn’t brought on by bargains in the marketplace, but rather by increased opportunities because of sellers’ anticipation of an upcoming increase in the capital gains tax rate.

Morningstar wants to step in wherever investors want more data and analytical information, whether that’s in a new region or a new investment area, Mr. Mansueto says. Entering the Brazil market and expanding a toehold in India, as well as adding coverage of fixed-income assets, are all attractive options for future growth, he says. Later this year, Morningstar will add “buy-sell” ratings on corporate bonds, he says.

“We have a pretty simple strategy — it’s to follow the investable assets,” Mr. Mansueto says. “Wherever there’s a mutual fund market, a stock market, that’s sizable, I think Morningstar should be there.”

Morningstar’s ability to pay cash for acquisitions lets it move fast on opportunities, Chief Financial Officer Scott Cooley says. The company still had $342.6 million at the end of last year, up from $297.6 million at the end of 2008. Still, Mr. Cooley insists the company isn’t under pressure to keep up its current pace of purchases.

Morningstar doesn’t disclose the price of every deal, but most have been for $52 million or less. The company spent $74.2 million on six acquisitions last year, according to its annual regulatory filing.

“It’s all about cash flow and paying a fair price for what that acquisition can generate over time,” Mr. Cooley says.

Revenue would have fallen even more last year without the benefit of acquisitions, which brought in $29.6 million more, the company said in the regulatory filing.

Last year, Morningstar missed out on $9.4 million in annual revenue it had received the previous five years because of the end of a legal settlement that had forced six investment banks to buy equity research from the company. Two major clients also declined to renew investment consulting contracts, and Web ad revenue dropped off.

For Mr. Tasho, who says Tamro bought its shares gradually last year, the investment has paid off. While he wouldn’t say at what prices he bought it, the stock has risen over the past year by about 41%, to $47.76 a share from $35. Tamro had 490,575 shares at the end of last year, Securities and Exchange Commission filings show.

Still, the earnings drop led some to question the lofty valuation of Morningstar shares, which trade at 27 times trailing 12-month earnings. Eva Dimensions LLC, a Locust Valley, N.Y.-based valuation modeling and investment research firm, slapped a “sell” rating on the stock, and one investor, who requested anonymity, sold all of his 800,000-plus shares in the past month for the same reason.

While some stockholders might clamor for a share-buyback or dividend with so much cash on reserve, they can’t exert much pressure on Morningstar, where Mr. Mansueto owns 52% of the shares.

Chip Reed, a portfolio manager at Eaton Vance sub-adviser Atlanta Capital Management Co., which owned 1.3 million shares at the end of last year, according to SEC filings, backs using the capital for acquisitions, especially smaller ones because they are easier to integrate. Also, Mr. Reed likes that, as a shareholder, Mr. Mansueto is “on the same side of the table as we are.”

“So far, if you look at their track record (on acquisitions), it’s been pretty good,” Mr. Reed says.

[This story, which was written by Lynne Marek, first appeared in Crain’s Chicago Business, a sister publication of InvestmentNews.]

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