[CBOE stock] Cboe Global Markets Q4 2020 Earnings Call (2/5/21)

Thank you, Debbie. Good morning, and thank you for joining us today. I hope 2021 is off to a great start for everyone and you're keeping safe and well as we continue to navigate this pandemic. I'm pleased to report that Cboe posted solid fourth quarter and record full year results, highlighting the strength and diversification of our global business. For the year, we grew net revenue by 10 percent and adjusted earnings per share by 11 percent despite an unprecedented macro environment that for much of the year did not favor index trading. Our results were driven by record trading volumes in U.S. cash equities and multi-listed options fueled by strong retail trading, growth in recurring non-transactional revenues, and increased efficiency enabled by our fully integrated superior technology. Importantly, while achieving strong growth, we continue to successfully execute key growth initiatives to advance our strategy to leverage product innovation and superior technology, expand our customer base and diversify our business mix with recurring revenue. We also maintained our commitment to operational excellence in 2020, as evidenced by the continuity and resiliency of our markets despite the year's unrelenting challenges. Our ability to provide reliable and continuous markets in that environment while continuing to execute key strategic initiatives and post strong growth is a testament to the dedication and expertise of our entire global team. Additionally, our record results and strong cash flow generation enabled us to return $520 million to shareholders in 2020, a new all-time high and a 69 percent increase compared to 2019. Our commitment to returning capital to shareholders will continue in 2021 and beyond, reinforced by today's announcement regarding the board's authorization of additional share buyback capacity. Turning to our targets and expectations for this year, we plan to leverage the deals we closed in 2020 to accelerate organic growth in 2021. Brian will do a deeper dive on this, but we plan to invest approximately $25 million in organic growth initiatives in 2021, which we expect to contribute to our incremental top-line compounded average organic growth target of four to six percent over the mid-term. As you've seen since our IPO, we have also allocated capital inorganically to help accelerate our strategy while returning capital to shareholders. Over the past four years, we have delivered five percent compound annual net revenue growth while growing adjusted EPS by 19 percent on a pro forma basis, which reflects the strength of our strategy and our ability to perform in the most challenging cycles. The success of our ongoing diversification reinforces our confidence in continued growth. Additionally, while we're only five weeks into the new year, we are beginning to see institutional investors re-engage in trading our index options and volatility products. In January, month-over-month volume increased by 77 percent in VIX futures, 68 percent in VIX options, and 15 percent in SPX options. As we've noted in previous calls, we expected to see re-engagement in these products once there was more clarity around the political and pandemic uncertainty that clouded investors' views on where the market was headed. Although much uncertainty remains around the COVID-19 pandemic, the vaccine rollout has begun, the new U.S. administration is in place, and the Brexit deal has been executed. We believe we will continue to see increased trading on our index products as the uncertainty of these and other previous market unknowns come into focus. Additionally, in response to customer demand, similar to these futures, we are planning to extend the 24/5 trading model to VIX and SPX options in the fourth quarter of this year, subject to regulatory review. Over 15 percent of trading in VIX futures, which already trade 24/5, took place in non-U.S. trading hours last year, up from 13 percent in 2019. Naturally, we believe 24/5 trading in VIX and SPX options will result in increased trading outside of U.S. hours as well. We began the year with a considerable amount of momentum from strategic progress made in 2020. We are excited about both near and long-term opportunities to grow and expand our business, driven in part by increases in proprietary product trading, recurring revenue, and retail engagement, while continuing to invest in long-term growth. Our ongoing strategy, which has reinforced the value of our unique platform and fueled our strong year-over-year growth, remains consistent: further strengthen our core proprietary products, leverage our superior technology, increase recurring revenue, broaden our geographic footprint, and expand our product line by asset class. We have exciting initiatives underway within each of these strategic pillars, but today I'd like to focus on four incremental growth drivers: the opportunity to grow non-transactional revenue through Cboe Information Solutions, our plans to launch Cboe Europe Derivatives, expand BIDS Trading, and grow our retail trading base. We're excited about our prospects to further increase recurring revenue through expanding and enhancing Cboe Information Solutions, our comprehensive suite of data solutions, analytics and indices. These products generate recurring revenue by providing market participants with value-added trading resources and support transactional growth in our proprietary products with tools that draw users to our markets and drive volume as they re-establish trading positions. As discussed in previous calls, last year's expansion of our information solutions offering through key acquisitions accelerated our ability to grow our recurring non-transactional revenue. In 2020, we reported 12 percent growth in recurring non-transactional revenue and 9 percent organic growth, and we expect to see incremental sustainable long-term growth as we continue to optimize these integrations in 2021. Importantly, our expansion of information solutions now allows us to interact with and add value to market participants at every step of the trade process. We are looking to enhance these customer support opportunities in 2021 with additional portfolio and risk analytics offered through various delivery mechanisms, including Cboe STE, our proprietary order execution management system, and through our APIs. Additionally, we plan to expand our market intelligence analytics and alerts to many market segments, including retail traders. We also plan to expand our global indices platform, which provides index calculation, development and services with real-time distribution channels. Finally, we expect to further expand our offering of unique historical data sets and add high-demand data sets like cryptocurrencies to the information solutions data suite. Turning now to the upcoming planned launch of Cboe Europe Derivatives, I'm pleased to say we are on track to launch in the second quarter of this year, pending regulatory approval, bringing to fruition our vision to unlock the potential we see for considerable growth in this market. Our highly successful European equities business, global derivatives expertise, and ownership of EuroCCP uniquely position us to simplify and bring new efficiencies to pan-European derivatives trading and clearing. We've worked closely with market participants in shaping our plans and have received very positive customer feedback and support. During the fourth quarter, we made strong progress on the technical build-out of the exchange and clearing platform and toward achieving the necessary regulatory approvals. Customer testing and optimization is ongoing, and we have commitments from clearing firms, order flow providers and market makers to be there on day one. As we've said before, we think this market is ripe for significant structural growth. We are not aiming simply to take market share from incumbent exchanges; we intend to shape and grow overall derivatives trading in Europe with a novel market structure designed to attract both new and existing participants. While our revenue expectations for European derivatives in 2021 are modest, we are investing for long-term growth and looking for a gradual revenue build as we gain traction and expand our product offering to realize what we view as a paradigm shift in European derivatives trading. Our new Amsterdam exchange, which we launched in 2019 in advance of Brexit, will serve as home to our derivatives business in the region. I'll also note here that the flawless implementation of our Brexit strategy enabled us to seamlessly transition trading from our UK venue to Amsterdam at the start of the year. Also, as a result of Brexit, we were excited to welcome back trading of Swiss shares on our UK venue yesterday. We are working with customers to re-establish our market share in Swiss equities trading, which was approximately eight percent of Cboe's notional value traded in June of 2019 when Swiss trading was last available on our market. Turning now to our acquisition of BIDS Trading, which we completed at the end of the fourth quarter, we're pleased to welcome Tim Mahoney to the team and the Cboe family. We have a successful track record of working with BIDS, which powers Cboe LIS, one of the largest block trading platforms in Europe. While BIDS will continue to operate as an independently managed venue, the acquisition helps us to expand BIDS' block trading capabilities and services to other products and geographies, including Canada, as we look to further expand our presence in North American equities. We are well underway with our integration of MATCHNow, the Canadian ATS we acquired last year, and the BIDS acquisition provides additional features that we believe will help us disrupt the electronic block market in Canada and other markets in the future. BIDS has an extensive global network of more than 460 buy-side investment managers and sell-side constituents, which differentiates the platform and provides a strong foundation from which to expand into new markets. BIDS also provides us with a foothold in the off-exchange segment of the U.S. equity market, which now accounts for over 45 percent of overall U.S. equities trading. Moving on to retail trading, we believe the resurgence of the retail investor we saw in 2020 is here to stay. We are well equipped to deliver tailored products and services to meet the needs of this growing customer base and to evolve our education programs with retail-centric content to empower these new investors. Product innovation remains a core focus of the Cboe franchise. We plan to continue to expand our proprietary product offering with smaller contract sizes that appeal to both sophisticated retail traders and institutional investors. This includes mini-VIX futures and mini-SPX options, our recently announced mini-Russell 2000 index options, as well as additional retail-focused products in our pipeline which will extend our value-add to a broader universe of investors. Our strategy to nurture growth in these products, which is driven by cross-functional team focus and dedicated client services, targeted marketing initiatives and robust investor education, is well underway. Additionally, we continue to see increased retail trading in U.S. equities and record volume in our Retail Priority program, which helps improve execution quality and trading outcomes for individual investors and firms that facilitate their orders. Volume in Retail Priority orders represented over 31 percent of total volume on Cboe EDGX, with the exchange reaching record market share of 7.3 percent in the fourth quarter. In January, trading on EDGX set a new monthly average daily volume record, as did Retail Priority orders, which are up 56 percent over December of 2020. We're excited to see growing retail engagement in the marketplace and are well positioned to invest in and leverage our core strengths—product and market innovation, technology, strong customer relationships and investor education—to support this growing user base. We believe our investments in this area will benefit retail investors and create another sustainable long-term growth opportunity for Cboe. With that, I'll turn it over to Brian to walk through our 2020 performance and 2021 outlook in greater detail and then provide some closing remarks.

Thanks, Brian. In closing, we are extremely proud of the results we delivered last year and are optimistic about opportunities to leverage our recent acquisitions to grow our business. Our operating results highlight the strength of our diversified business and our team's consistent execution of our strategy. By further strengthening our core proprietary products, leveraging our superior technology, increasing recurring revenue, broadening our geographic footprint, and expanding our product line by asset class, we will be well positioned to achieve our mission to build one of the world's largest global securities and derivatives trading networks. The investments we plan to make this year are expected to contribute to our long-term growth in 2022 and beyond. We also plan to continue to exercise disciplined expense management and efficient allocation of capital to create long-term shareholder value, and believe we have the people, technology and expertise to continue to define markets in a very powerful way. With that, we'd be happy to take questions. We ask that you please limit your questions to one per person to allow time to get to everyone. Feel free to get back in the queue, and if time permits, we'll take a second question.

Good, Dan. It's Ed Tilly. Let me start and invite Chris to jump in. But sustainable, I think we've just seen an incredible demand that began last year. It continues. It tends to be in single-name options, so our education will be focused on the basics first. You know, the educated investor is the one that's in day in, day out, year in, year out, and that's really what we will be targeting. So the responsibleness, the suitability, what derivatives and how derivatives can change the risk profile for investors is really what we'll be concentrating on. And I think just even recently we had 730 participants in our series of 21 for '21, which is 21 investment strategies for 2021. It's an incredible amount of turnout early on. So we're gauging the continuation by the interest in education. We're committed to it, so the investment we make is for the long term. And that conversion from straight delta-one trading into derivatives is really where Cboe's effort will be most concentrated. And then Chris, maybe a little bit on the mix and what we see coming in on various products and how that's different across the uniqueness of our product set.

Boy, I love the way you frame that. The ecosystem is really what we were after when we launched, albeit probably a bit early, a few years ago. We too saw the potential and the interest. And while not a huge asset class as measured by AUM, certainly by turnover and trade, so we know there's a great deal of interest from the trading community and growing interest, as you point out, institutionally for some exposure. So when I warm up like that, you can tell that we are planning how to re-enter the space, very measured and cautiously. But I could not describe it any better, the importance of the ecosystem, what we see by vibrant derivatives markets, cash-settled markets, retail-accessible markets. You mentioned ETPs and ETNs, all very important for a successful exposure to crypto. So in the planning stages, but we plan on re-entering that market over time and it's just a matter of us right now on prioritization. So stay tuned, in development, and want to get back into the space.

Thanks, Ari. Great question. I'll start with the first and then invite John and Chris on the ISG in particular. There's a prop product segment. I think if you just take a half a step back and what we discussed primarily for the three quarters of last year, after the huge volumes and volatility spike in the first quarter, was institutions told us that they're on the sidelines, there's too much uncertainty out there. Right? If you think about this pandemic just being defined, U.S. elections on the map, an uncertainty there led to a runoff election, Brexit coming, going, closing, not closing. And told us once some of those uncertainties were passed, that there'd be re-engagement, that there needs to be and there's a demand for exposure broadly in the U.S. market. And that's what we're seeing in January. So just basically feeding back directly from those institutional users in their plans and moving forward, and we're seeing that engagement. So that's really not surprising to us. Stressed, I think maybe your word, probably a little bit too much of a reach. I think we're seeing a more broadly interest in short-term moves and volatility. A lot of that led by the volatility in single names raising volatility overall. And then if we look at fixed options, we see interest in buying puts when people realize, gosh, that spike, don't think that's sustainable. We saw that last week and we saw put buying and sure enough, investors in this cycle tended to be right. So we see engagement across now a variety of macro trading cycles and I like it. The engagement is up and down. Our proprietary products led by institutions re-engagement. So I don't think I'd call any segment out on not re-engaging. Maybe some slower than others, but it's engagement each and every day and we like to see what we're seeing in January. Love to see that continue. Chris and John, maybe on the ISG question.

So let me see if I can just summarize it a bit. What we see happening in January, as predicted, is re-engagement at the institutional level, that it's eliminating last quarter's headwind when institutions were on the sideline waiting for uncertainty to pass. Separate and apart from the investment we're making for the future, and Brian laid them out, I think 24x5, the extension of BIDS, our continued investment in ISG, and obviously our mid-year launch of European derivatives, all in queue and ready to make an impact for us in 2022 and beyond. That's the way we're looking at it.

Let me start with more broadly the SEC and the long-term view and relationship we've had. I would sum it up as an incredibly healthy attention where both the SEC and Cboe put the investor, the retail investor, first and foremost in our thinking. It's in our day-to-day, it's in our operations, it's in new product development, it's in order handling, it's in all our comment letters. We both have been aligned with trying to do what is best for a market structure-wise, the investing public. I think that will continue. Our expectation of the new chair as he's putting together his team will be a very healthy relationship with his front line, the listed exchanges. We are where price discovery happens. I'm sure this chairman and his team will understand that and I'm looking forward to just some incredibly healthy dialogue. So very optimistic going into the change. Chris, operationally, I think what I hope continues is the engagement we've seen in the SEC primarily this year about the lit exchanges and how what an incredible role they've played in maintaining stability in the most uncertain of times. I hope that continues. I think it will. But Chris, I think the amount of time the team at the SEC has spent with us in regular calls, updates, and communication is a model for the future. But a couple words from you, I think operationally, is important.

Rich, I don't think that you need a solution. Yeah, a great way to put it. I think I don't know, I don't know that I'd categorize as solution. Transparency, education. What is the hunger? Why, what is the motivating factor on some of these investment decisions? What is the duration? What's the goal? I think my reference to investing in retail is understanding the exposure that retail is looking for, understanding the strategies and being able to bring to market contracts and exposures that are directly focused on what the retail investor of today is looking for, which is different perhaps than the retail investor of yesterday. So for us, as I've said, we continue to say, Rich, and I love the question because it's a great way to wrap this up, we can solve everything with education and transparency. We truly can. And our Options Institute is armed and ready to engage with new retail. Our research and development team are engaged with, and we tease that we're looking at contracts to bring to the market that address the needs of the new retail investor. That's what we're going to be focused on. I don't think there's a fixing that needs to be done out there, but education certainly does provide for a day-in, day-out, year-in, year-out investor who's engaged, trading suitable contracts, and ones that we will help them with the basics. As I say, sophisticated strategies will then follow.