Cboe Global Markets, Inc. (ETF:CBOE) Q4 2022 Earnings Call Transcript

Cboe Global Markets, Inc. (ETF:CBOE) Q4 2022 Earnings Call Transcript February 3, 2023

Operator: Hello, and welcome to the Cboe Global Markets Fourth Quarter 2022 Financial Results Conference Call. All participants will be in a listen-only mode. Please note, today’s event is being recorded. I would now like to turn the conference over to Ken Hill, Vice President of Investor Relations. Mr. Hill, please go ahead.

Ken Hill: Good morning and thank you for joining us for our fourth quarter earnings conference call. On the call today, Ed Tilly, our Chairman and CEO, will discuss our performance for the quarter and provide an update on our strategic initiatives. Then Brian Schell, our Executive Vice President, CFO and Treasurer, will provide an overview of our financial results for the quarter as well as discuss our 2023 financial outlook. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be Chris Isaacson, our Chief Operating Officer; Dave Howson, our President; and our Chief Strategy Officer, John Deters. I would like to point out that this presentation will include the use of slides. We will be showing slides and providing commentary on each.

A downloadable copy of the slide presentation is available on the Investor Relations portion of our website. During our remarks, we will make some forward-looking statements, which represent our current judgment on what the future may hold. And while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. Please refer to our filings with the SEC for a full discussion of the factors that may affect any forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise after this conference call.

During the call this morning, we’ll be referring to non-GAAP measures as defined and reconciled in our earnings materials. Now I’d like to turn the call over to Ed.

Ed Tilly: Thank you, Ken. Good morning, and thanks for joining us today. I’m pleased to report on record fourth quarter and full year results for Cboe Global Markets. During the quarter, we grew net revenue 17% year-over-year to a record $457 million and adjusted diluted EPS by 6% to a record $1.80. These results capped a record year. We saw us grow net revenue 18% to a record $1.7 billion and adjusted diluted EPS 15% to a record $6.93. Our outstanding results were driven by strong volumes across our global network led by Derivatives complex and continued growth in our Data and Access Solutions business. Our Derivatives business delivered another outstanding quarter driven by robust performance in our index options franchise, where average daily volume increased 55% year-over-year while multi-list options trading increased 6% year-over-year to an ADV of 11.2 million contracts.

We saw record volume across our suite of S&P 500 Index options products with fourth quarter ADV and SPX contract increasing 73% year-over-year to 2.7 million contracts. Our Mini-SPX options contract, known by the ticker XSP and 1/10 the size of the SPX options contract, increased 188% year-over-year to an ADV of nearly 66,000 contracts. Additionally, ADV for VIX options increased 7% year-over-year in the fourth quarter. During the quarter, net revenue in our Cash and Spot Markets business decreased 5% while we saw a 13% increase in net revenue for our Data and Access Solutions business, including strong organic net revenue growth of 10% year-over-year. We continue to execute on the transformational opportunities we saw in our business: Derivatives, Data and Access Solutions and Cboe Digital.

I’ll touch on Derivatives and Data and Access Solutions at a moment, but first, I want to provide an update on Cboe Digital. In November, we completed the syndication of minority equity interest with a group of 13 firms announced as investor partners in the Cboe Digital business. Our investor partners include many of the most sophisticated and active participants in fiat and digital asset markets globally and contribute to the momentum of the franchise. We are actively onboarding these partners to the Cboe Digital platform and look forward to working together to bring trust and transparency to the digital asset marketplace. Now more than ever, we believe the experience that established market operators provide with the benefits of their regulated framework is critical to helping enable the opportunities afforded by this asset class.

With the onboarding of new participants and marketplace evolution, we have seen continued volume increase in industry-leading spreads in Cboe Digital to start the year with January average daily notional value topping a record $71 million. Our Derivatives business delivered strong results as we continue to expand access to our unique products to customers around the globe leveraging our extended distribution network. For the year, a record 558.4 million SPX contracts were traded with an ADV of 2.2 million contracts, a 63% increase year-over-year. We continue to see increased demand from our non-U.S. customers and liquidity providers for the ability to trade or hedge broad U.S. market and global equity volatility conveniently across all time zones day and night.

As a result, we have seen a sizable increase in SPX volume during our global trading hour session with ADV increasing 216% year-over-year during the fourth quarter to nearly 55,000 contracts, capping off a record year for global trading hours with total volumes up 3x over the 2021 levels. This year is off to an even stronger start as January volumes ran approximately 55% above 2022 levels. In December, we also added XSP to our global trading hour session, enabling customers to trade this product nearly 24 hours a day, five days a week and providing the ability to adjust positions around the clock with even greater precision and flexibility. With the addition of Tuesday and Thursday expirations late last year for XSP, both SPX and XSP now offer options that expire every weekday.

We continue to see increased demand for same-day trading in SPX with many market participants opening and trading positions on the same day the options expire as they engage in tactical trading strategies around market events. ADV for SPX options open on the same day of expiration increased 83% throughout 2022 and comprised over 43% of overall SPX volumes in the fourth quarter. With the utility and flexibility that options provide in any market environment as well as the varied trading strategies utilized by a diverse customer base, we believe we will continue to see sustained momentum in options trading as customers continue to tap the benefits this product offers. Turning to the VIX products. ADV and VIX options increased 7% year-over-year to over 550,000 contracts traded in the fourth quarter.

During global trading hours, we saw VIX options volumes increase with ADV up 72% year-over-year in the quarter, and we have seen strong momentum to start the year as January volumes ran 56% above 2022 levels. Our Data and Access Solutions business posted strong results during the fourth quarter with the integration of our recent acquisitions continuing to fuel the durability of this business. Through our bundled debt offerings and cloud strategy, we were able to package high-quality data from across our markets and deliver to customers globally in a consistent and cost-effective manner, extending the reach of our content and opportunity for this business. Additionally, we continue to see strong customer uptake of Cboe Global Cloud, a real-time data streaming service to provide simple, efficient access to Cboe’s robust suite of market data.

We now have 25 customers connected to the service with 52% of revenue coming from the Asia Pacific region and 38% from Europe. Additionally, many customers are subscribing to multiple data products offered via Cboe Global Cloud. This diverse customer base reaffirms that our strategy of providing simple, efficient access to our market data is resonating with customers who want access to a global set of market data through a single unified service. Additionally, we have seen solid customer adoption of the Cboe One Canada Feed, a real-time market data feed that provides a comprehensive view of Canadian equities market data since launching last fall. As we integrate Cboe Australia and Cboe Japan post technology migration, we look forward to further expanding our portfolio of market data solutions globally.

Through product innovation, thoughtful integration and superior customer service, we continue to expand our ecosystem as we build one of the world’s largest and most comprehensive derivatives and securities networks. In our Global FX business, net revenues were up 14% year-over-year in the fourth quarter as the business expanded spot market share to a record 18.4% with average daily spot notional value traded of nearly $41 billion. Our non-deliverable forward volumes on Cboe SEF also grew significantly with annual ADNV of $836 million last year compared with $406 million in 2021. In Europe, the Cboe Europe Equities business continued to perform exceptionally well with overall market share reaching 24.9% in the fourth quarter. While we saw increased adoption of our services in Europe, it was our lit order books that predominantly drove our market share gains with lit-only market share rising from 21.9% at the start of the year to 27.3% in December 2022.

Additionally, Cboe BIDS Europe remains the largest block trading platform during the fourth quarter with 34.5% market share of the European block trading market. At the end of 2022, the BIDS Europe platform had over 600 active traders across 243 buy-side firms and 28 sell-side participants. And we expect to have a strong pipeline of new firms this year. The strong foundation of participants utilizing Cboe BIDS Europe will create opportunities as we continue to expand the Cboe BIDS network around the globe. Moving to North America. The power of the BIDS network helped propel Cboe BIDS Canada to another record quarter with 65 million shares traded. Overall equities market share in Canada grew to 13.6% in the fourth quarter while U.S. equities market share was 13.1%.

Turning to Asia Pacific. Cboe Australia market share grew to 17.2% in the fourth quarter, up from 16.1% in the previous year. We remain on track to extend the BIDS network to the region with the launch of Cboe BIDS Australia this month. Our experience bringing BIDS into new markets globally, including Europe and Canada, has enabled us to perfect our approach, and we are very excited about the demand we have seen from local participants for this distinctive block trading platform. We also remain on track to launch Cboe BIDS Japan in the fourth quarter of this year, further extending our reach of the BIDS network into another key global equity market. Additionally, in Japan, we saw our equities market share grow to 3.6% during 2022, up from 2.7% in 2021.

We continue to be in full integration mode since announcing our last acquisition more than 14 months ago. As mentioned, subject to regulatory approvals, we plan to migrate Cboe Australia and Cboe Japan to Cboe technology this year with the Australian migration happening later this month alongside the launch of Cboe BIDS Australia. We’ve been working with our customers closely over the last year in preparation for the migrations. And look forward to the benefits of bringing both of these critical markets on to our technology, creating a seamless and consistent experience for customers and unlocking value for our global market participants. We have also continued to make solid progress enhancing the framework of our global listings business since welcoming NEO, a Canadian exchange last year.

Our goal is to provide issuers with access to an integrated and global network of capital formation and secondary liquidity while working to harmonize our processes and create efficiencies for our customers around the globe. Building on a strong foundation as the second largest ETP listings venue in the U.S., we are enthusiastic about both the near- and long-term opportunities to grow and expand our listing business globally and believe we have the momentum as we kick off 2023. We are excited by the many growth opportunities we see across our ecosystem today. Brian will do a deeper dive on this in a moment, but this excitement is fueling our attractive 2023 revenue growth targets. Specifically, we anticipate total organic net revenues will increase in the range of 7% to 9% in 2023 above our medium-term guidance range of 5% to 7%.

We anticipate that our Data and Access Solutions organic net revenues will grow at a robust 7% to 10% in the year ahead. While we expect to invest behind the meaningful opportunities we see in the market today, we expect that the investments we make this year will help position Cboe to grow in 2023 and beyond. I’ll turn it over to Brian to share more.

Photo by Nick Chong on Unsplash

Brian Schell: Thanks, Ed, and good day to all of you. Let me remind everyone that unless specifically noted, my comments relate to 4Q ’22 as compared to 4Q ’21 and are based on our non-GAAP adjusted results. As Ed highlighted, Cboe posted another incredibly strong quarter to cap off a record year. Adjusted diluted earnings per share for the fourth quarter was up 6% on a year-over-year basis to a record $1.80. The strong performance was again characterized by the continued growth of our Derivatives franchise as well as a steady contribution from our Data and Access Solutions business. Over the course of the year, we made meaningful progress advancing our numerous initiatives, plans that span multiple asset classes and geographies.

We see these investments as driving growth in Cboe as reflected in our 2022 record results and in the healthy outlook we have for our businesses. I want to quickly touch on some of the high-level takeaways from the fourth quarter before delving into the segment performance. Our fourth quarter net revenue increased 17%, setting another quarterly record at $457 million led by the strength in our Derivatives markets category and robust results from our Data and Access Solutions business. Specifically, Derivatives markets produced 33% year-over-year organic net revenue growth in the fourth quarter as innovations like Tuesday, Thursday expirations continue to resonate with customers and fuel same-day trading in our SPX complex. Data and Access Solutions net revenues increased 13%, up 10% on an organic basis, finishing a very strong year where D&A organic revenue increased by a very healthy 12%.

Cash and Spot Markets net revenues decreased 5% during the quarter or 7% on an organic basis. Adjusted operating expenses increased 28% to $177 million. Adjusted EBITDA of $292 million also notched a quarterly high, up 11% from the fourth quarter of 2021. And as noted previously, our adjusted diluted earnings per share was a record $1.80, up 6% compared to last year’s quarterly results. Turning to key drivers by segment. Our press release and the appendix of our slide deck include information detailing the key metrics for each of our business segments. So, I’ll just provide summary thoughts. Our Options segment was a standout for the quarter, again delivering the strongest growth with net revenue increasing 35%. Results were driven by robust volumes in our index business and stronger revenue per contract, given the favorable mix trends.

Total options ADV was up 15% as our higher-priced index options ADV increased 55% over 4Q ’21 levels. RPC moved 25% higher, given a continued positive mix shift to index products and a stronger mix of higher-priced SPX options in our index business. And lastly, we continue to benefit from another quarter of double-digit growth in market data and access and capacity fees, up 34% and 15%, respectively, as compared to 4Q ’21. North American Equities net revenue increased by 5% year-over-year. Results benefited from NEO, which was acquired in June of ’22, contributing $5.5 million in net revenue during the quarter. In addition, access capacity fees increased 10% as compared to 4Q ’21, and market data was up 4%. Net transaction fees fell by 4%, given a mixed volume environment across our businesses, softer market share and capture rates.

The Europe and APAC segment reported a year-over-year decline in net revenue for the fourth quarter of 15%. However, adjusting for a $5.6 million FX impact given the stronger dollar during the quarter, net revenue fell by a more modest 4% on a constant currency basis, impacted by softer industry volumes in Europe. The lower activity levels were partially offset by a 5.1 percentage point increase in market share on a year-over-year basis, making Cboe Europe the largest stock exchange in Europe, again for the quarter. Fourth quarter net revenue decreased 10% in the future segment as transaction fees declined 15% on a year-over-year basis. Lower volumes were the primary driver of the decline, falling 16% in the fourth quarter ’22 as compared to fourth quarter of ’21.

Non-transaction revenues continued to tick higher with access capacity fees up 2% and market data up 25% as compared to 4Q ’21. And finally, net revenues in the FX segment were up a strong 14% as compared to 4Q ’21, capping a very strong year for FX, where net revenues grew an impressive 18%. Net transaction and clearing fees in the fourth quarter benefited from a 21% increase in average daily notional value and higher levels of market share, hitting another quarterly record of 18.4%. Turning now to both Data and Access Solutions business. Organic revenues were up an impressive 12% for the full year. Net revenues were up 13% year-over-year in the fourth quarter, up 10% on an organic basis. As we have seen in past quarters, net revenue growth continues to be driven by additional subscriptions and units, accounting for over 90% of access fee growth and 58% of market data growth.

In our data and access businesses, we saw robust physical and logical port usage in our options and equities businesses driven by increased demand for trading capacity. And on the market data side, the equity’s top of book and options depth of book products continued to perform well. Cboe Global Indices feed also benefited from some pricing enhancements during the quarter. In 2023, we anticipate that trends will remain resilient as we are forecasting 7% to 10% organic net revenue growth for Data and Access Solutions, in line with our medium-term guidance range outlined at our November 2021 Investor Day. Turning to expenses. Total adjusted operating expenses were approximately $177 million for the quarter, up 28% compared to last year. Excluding the impact of acquisitions owned less than a year, adjusted operating expenses were up 21% or $28 million for the quarter, largely reflecting higher headcount as compared to fourth quarter of last year as well as some inflationary comp adjustments and additional incentive compensation in 4Q ’22.

Moving to our expense guidance. We are introducing a full year 2023 expense guidance range of $779 million. This compares to our 2022 expense base of $652 million. There are three basic components to the year-over-year increase outlined on Slide 17 of our earnings presentation that I want to walk through in detail, namely expenses from 2022 acquisitions, revenue-enhancing investments we are making in our business and core expense growth. The first component is the normalization for the two transactions ErisX and NEO, we completed in 2022. We anticipate these deals will add approximately $36 million to $38 million in incremental expenses in 2023. In our expense base, we are again calling out growth-generating investments we are making, given the numerous attractive growth opportunities we see today.

These are costs we expect to drive incremental revenue to our bottom line, furthering the robust growth trends we have enjoyed over the past few years. Specifically, we are investing in global listings, DNA expansion, a more aggressive marketing campaign given our 50-year anniversary as a company and targeted R&D efforts across our ecosystem. In 2023, we expect revenue-enhancing investments to be in the range of $28 million to $30 million accounting for roughly 4.5 percentage points of our 2023 adjusted expense growth. The last component and the largest portion of the year-over-year increase is our core expense growth, showing approximately $53 million to $59 million or 8% to 9% of our expense increase in 2023. I think it’s important to understand the moving pieces within our core expense base.

First, we continue to invest in the infrastructure of our business. As we strengthen our footprint as a multi-asset class global exchange and services provider, we will continue to invest behind a robust technology offering to deliver a best-in-class client experience. Roughly 2% of our expense growth in ’22 was related to core infrastructure. And we would expect a similar contribution this year as we continue to build a cohesive offering around the globe, facilitating the expanded capacity, access and distribution of our products and services globally is important to our success, and we will continue to ensure Cboe can meet the needs of our clients. Unrelated to our infrastructure spend is an incremental two percentage points of expense growth we are attributing to the Consolidated Audit Trail or CAT project.

These costs, which we have limited direct control over, are expected to add an incremental $10 million to $15 million to our 2023 expense base based on our initial estimates. The remaining core piece is related to our day-to-day cost of doing business. In ’22, we talked about some inflationary pressures impacting these expenses. And while we do still feel some of those pressures today, we expect core day-to-day expenses to be up a modest 4% in ’23, down from the 7% growth we saw in ’22. Cboe has enjoyed some of the most consistent and most durable revenue growth, operating margins and earnings generation in the industry. The expense forecast we are providing today highlights the continued investment we are making to sustain those trends moving forward.

To state this more directly, it is because of the investments we have made in our business that we generated record ’22 results and are able to guide to a robust seven to nine percentage point increase in organic total net revenue in the year ahead. We believe that the investments we make in ’23 will position us well to generate attractive return for years to come. Now turning to a summary of full year guidance on the next slide, I want to call out some highlights for ’23 following our record net revenue results in ’22. For Data and Access Solutions, we expect net revenue growth to be in the 7% to 10% range for ’23, in line with the medium-term guidance of 7% to 10% we introduced at our Investor Day a little more than a year ago. We expect acquisitions held less than a year to contribute around 0.5 percentage point to total net revenue growth in ’23.

Most importantly, we are guiding our organic total net revenue growth in the range of 7% to 9% for 2023. This is above our medium-term guidance of 5% to 7% introduced at our Investor Day a little more than a year ago, a function of our confidence in the durable growth of our business and the progress we are seeing behind the investments we have made to increase the access and distribution of our products in markets globally. During this year, we are introducing an expected contribution of $27 million to $33 million for minority investments benefiting our other income line. Cboe has made and we’ll look to continue to make investments in businesses that align with our strategic vision. Our 4Q ’21 investment in 7RIDGE with Cboe becoming a limited partner in the acquisition of Trading Technologies is a great example of how we plan to utilize our network of partners to invest in strategic assets.

We look for the impact of these investments to become a more regular contributor to company earnings and are providing our best estimate of the benefits we anticipate in ’23. We are introducing full year guidance on depreciation and amortization of $48 million to $52 million and expect the effective tax rate on adjusted earnings under the current tax laws to come in at 28.5% to 30.5% in ’23. Outside of our annual guidance, interest expense for the fourth quarter of ’22 was $15.7 million. Moving forward, we expect interest expense to be in the range of $14.5 million to $15.5 million for 1Q ’23. On the capital front, our focus has been and remains maximizing shareholder value through the effective use of our capital. In the fourth quarter, we returned total of $53 million to shareholders in the form of a $0.50 per share quarterly dividend and $15 million in the form of share repurchases.

Year-to-date ’23, we’ve also repurchased $30 million of our shares. We remain well positioned to invest in the business, support our dividend and opportunistically repurchase shares with $188 million in remaining capacity on our share repurchases authorization as of January 31, 2023. Our leverage ratio decreased to 1.5x at the end of the fourth quarter, down from 1.7x at September 30 and from 1.9x from June 30, reflecting our significant growth in earnings as well as the repayment of $120 million of our term loan facility in 4Q ’22. And through prudent debt capital markets transactions, we have also locked in low medium- to longer-term fixed rates averaging below 3% on over 80% of our total debt. Overall, we remain committed to maintaining a flexible balance sheet and striving to put capital to work in the most value-enhancing way possible for shareholders.

Given where we are today in our capital structure, we plan to shift slightly to prioritize opportunistic share repurchases over further debt pay down, given our leverage ratio at 1.5x at the end of 4Q ’22. In summary, 2022 was a tremendous year of record revenue generation and earnings growth. We expect that momentum to continue, fueled by the attractive investments we are making across our ecosystem. We are incredibly pleased with the start to ’23 and look forward to delivering attractive returns to our shareholders in the quarters ahead. Now, I’d like to turn it back over to Ed for some closing comments before we open it up to Q&A.

Ed Tilly: Thanks, Brian. In summary, Cboe delivered a very strong fourth quarter to close the year. And 2022’s record results give us increased confidence that if we continue to invest in high-value growth initiatives that further expand the Cboe ecosystem, we can continue to deliver strong long-term results for our investors. I’m also proud of the work we did to advance our corporate ESG initiatives in 2022. We will continue to look for opportunities to support our communities and associates while driving for a more sustainable future. I would like to thank our team for the incredible results achieved during the fourth quarter to cap off a fantastic year. As we enter our 50th year of business, we are more optimistic than ever about the future.

Our history of innovation, client service and good citizenship will be the foundation for building trusted markets for the next 50 years. I am extremely proud to lead this incredible team and our organization as we continue to push Cboe to new heights.

Ken Hill: At this point, 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.

See also 20 Least Populated States in America and 10 Hot Tech Stocks To Buy Now .

Q&A Session

Operator: Thank you. At this time, we will begin the question-and-answer session. And this morning’s first question comes from Rich Repetto with Piper Sandler.

Rich Repetto: Yes. I guess my question is going to be focused on expenses and expense growth. I guess, Brian, I calculate last year the overall expense increase when you subtract the acquisitions was 13.5%. And I thought we would expect a step down. It looks like 13% ex the acquisitions again this year. So, I guess when you look at just the core — everything beyond the acquisitions, so can you explain, what’s the tangible payback? I know you had something about minority investments, but is this the ongoing — it looks like other exchanges are investing less than half of that, and just trying to understand this 13% growth rate each of the last two years in investments and core expenses.

Brian Schell: Yes, Rich, great question. I think a foundational to probably a lot of folks when they’re looking at the guidance. So, we do want to spend some time kind of continuing to walk through that. So I’ll break it up into a couple of parts here, again, to your thoughts around the core and then the incremental revenue investments and where that was. And honestly, to your last comment about the other exchanges in that profile, I will suggest that our revenue and earnings profile actually is different and actually, I think, has been fairly strong relative to that as well over the last couple of years. So we’ve taken a very explicit, very transparent approach to growing that long-term growth rate. So if we look at behind the core, and this is the — I’ll say the — one of the issues of having, I’ll call it a relatively smaller say some of our peers, but also, I’d say, high-margin, a very efficient exchange in the first place so that if there is a slight uptick, it shows, right?

We’re very transparent about what those expenses are and where they show up. So as we break out the core, as I alluded to in my prepared remarks about looking at the incremental regulatory expenses coming from the consolidated audit trail, right, that’s going to hit us a little bit higher from a pure expense standpoint. We’re laying it out there so we can see that as far as what’s driving that expense base higher, given our history with what we’ve seen where that project is going. With respect to infrastructure, if you look at the incredible amount of volume, and I’ll ask Chris Isaacson to jump in later here about what this exchange operations have been able to do as far as volumes and the ability to actually continue to facilitate that capacity, and our belief that it’s important for us to continue to be a trusted marketplace.

So it was important for us to continue to invest and facilitate that increased capacity, both in the U.S. and the non-U.S. markets, again, which many of those markets saw record peak volumes at some point during ’22. And technology and operations handled that with really no issues. And in the midst of all this also, we’re doing a replatforming in Japan and Australia. Again, all right now, slightly incremental expense as we layer in as we go into 2024 moving forward. And then you look at the overall core of those other incremental I talked about is, again, we’re still, as I mentioned at the end of last year, we still have to incorporate some of the inflationary pressures. We’re seeing that moderate a bit. But again, it’s against a lot of the expense categories, not just comp.