MarketAxess Holdings Inc. (NASDAQ:MKTX) Q3 2023 Earnings Call Transcript

MarketAxess Holdings Inc. (NASDAQ:MKTX) Q3 2023 Earnings Call Transcript October 25, 2023

MarketAxess Holdings Inc. misses on earnings expectations. Reported EPS is $1.46 EPS, expectations were $1.7.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session. [Operator Instructions]. As a reminder, this conference call is being recorded on October 25, 2023. I would now like to turn the call over to Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Stephen Davidson: Thank you, Christa. Good morning, and welcome to the MarketAxess third quarter 2023 earnings conference call. For the call, Chris Concannon, Chief Executive Officer, will provide you with a strategic update on the company. Rick Schiffman, Global Head of Trading Solutions, will update you on how we executed this quarter and then Chris Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter. Before I turn the call over to Chris Concannon, let me remind you that today’s call may include forward-looking statements. These statements represent the company’s beliefs regarding future events that by their nature are uncertain. The company’s actual results and financial condition may differ materially from what is indicated in those forward-looking statements.

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For a discussion of some of the risks and factors that could affect the company’s future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31, 2022. I would also direct you to read the forward-looking statements disclaimer in our quarterly earnings release, which was issued earlier this morning and is now available on our website. Now let me turn the call over to Chris Concannon.

Chris Concannon: Good morning. I’m very pleased to update you on the significant progress we made in the third quarter to enhance our franchise and drive long-term growth. First, in terms of the quarter, we generated revenue of $172 million, earnings per share was $1.46 on net income of $55 million. Our quarterly results were impacted by unusually low levels of credit spread volatility during the seasonally slower summer period. But we are seeing some early positive signs of higher volatility in October. We are not happy with our growth rates in U.S. credit, but we believe we are taking the right steps to improve our growth rates in our business in the years ahead. Turning to my strategic update on Slide 3. We continue to innovate through the launch of our new trading platform, X-Pro.

X-Pro delivers our proprietary data for pre-trade analytics and protocol selection. We specifically targeted portfolio trading solutions in X-Pro to address our U.S. high-grade market share challenges. In low volatility market environments, protocols like portfolio trading become more prevalent with portfolio trading rising to 7% of trades during the quarter. Activity on dealer-centric protocols also increases in low volatility markets and we are continuing to focus our growing — on growing our Mid-X and dealer RFQ protocols. We believe that we have a superior dealer RFQ solution because of our comprehensive Open Trading liquidity. We are pleased to see our portfolio trading clients increasingly leveraging, our unique pre-trade analytics like tradability, only available through X-Pro.

35% of our portfolio trades were executed on X-Pro in October month to date, up from 18% in the third quarter. We continue to deliver unique data and functionality enhancements to our portfolio trading offering in X-Pro. X-Pro integrates our real-time data, our pre-trade analytics, and our trading protocols into a simple trader cockpit that allows the user to seamlessly manage more line items and being more productive. Adaptive Auto-X, a fully automated trader solution provides a suite of sophisticated AI-driven trading algorithms that integrate all of our trading protocols to programmatically improve execution outcomes while reducing market impact. Execution solutions like X-Pro and Adaptive Auto-X allow traders to fully leverage the power of MarketAxess, operating in a far more efficient manner while accessing the best possible liquidity and pricing available in the market.

These products answer our clients’ growing demand to help them do more with less. Although Adaptive Auto-X was still in pilot phase during the quarter, early results show promising transaction cost savings and reduced market impact in U.S. high grade. Our client franchise has never been stronger with a record of over 2,000 active clients across 67 countries. We delivered strong growth in our international businesses and in municipals. As well as record data revenue as our investments to broaden our geographical and product footprint pay off. We closed the acquisition of Pragma, we integrated the muni-broker platform, and we rolled out Open Trading to several emerging local markets, further solidifying our global leadership in emerging markets e-trading.

Slide 4 illustrates how we are integrating our next-gen proprietary data with X-Pro to help traders do more with less. Our unique proprietary data helps clients with their portfolio construction objectives by leveraging liquidity scores, tradability data and our soon-to-be launched matchability data. These data tools can help clients predict the price of a bond, the depth of the market and the likelihood of finding another matching buyer seller on the platform. Our data tools also help clients optimize their protocol selection across RFQ, Open Trading, portfolio trading or automation. Last, with the launch of our AI dealer select data, we can now help inform our clients about their optimal dealer selection based on the bond they are trading.

Slide 5 highlights the expansion of our addressable market. Acquisitions totaling approximately $360 million and significant organic investments in new products and protocols over the past several years have expanded our addressable market by an estimated $3 billion across credit, rates, data and post trade. We believe that our acquisition of Pragma will be a key accelerant of our ability to capture this opportunity while enhancing our technology footprint. An expanding market, higher trading velocity, new product expansion and new protocols and workflows are all additional levers of growth that could enhance our addressable market. Slide 6 provides an update on market conditions. Since the end of the third quarter, volatility has continued to move higher, which has benefited ETF market maker activity and U.S. high-yield estimated share.

High-yield ETF market maker ADD on our platform is up 94% from the third quarter. With over $7 trillion in global corporate debt set to mature in the next three years, borrowers will have to refinance their debt at much higher rates, creating the potential for higher levels of turnover in the secondary markets. Proposed new additional bank capital requirements could lead to further constraints on bank balance sheets for market making, highlighting the importance of a diverse liquidity pool like Open Trading. Before I turn the call over to Rich Schiffman, I wanted to provide an update on October. Current October trends show high-grade estimated market share and market volumes slightly above September levels. While high-yield estimated share and market volumes are both above September levels.

We have five important trading days remaining in the month, and both high-grade and high-yield market share normally show increases in the last week of the month. Additionally, global portfolio trading ADV in October is approximately $770 million, up 77% from Q3 levels. Now let me turn the call over to Rich to provide you with an update on our market.

Richard Schiffman: Thanks, Chris. We made significant progress this quarter advancing our trading business. Slide 8 highlights the strong expansion of our client network. We had a record 2,093 active client firms trading on our platforms in the third quarter, which included a record 1,625 client firms active in U.S. credit. Trading volume from hedge fund and private bank clients increased 35% year-over-year and represented 17% of total credit market volume in the quarter, up from 13% in the prior year period. A record 1,151 active client firms are trading three or more products on our platforms, reflecting the deep partnership that we have with our clients and the power of our liquidity. We had a record 366 active firms on our municipal bond platform, and we are continuing to integrate muni brokers with Open Trading to expand sources of liquidity for investors and dealers.

On Slide 9, we highlight the growing international diversification of our trading business. Third quarter growth in international average daily trade volume and trade count was 15% and 21%, respectively. This was driven by strong Eurobond trading volume up 18% and emerging local markets trading volume up 27%. The launch of enhancements like U.S. high-grade trading on price has been very well received by our private bank clients, particularly in Europe. Trading volume on Axess IQ, our front end for private banking clients increased 130% in Q3 compared to the prior year. Adoption of our automation suite of products continues to grow, as shown on Slide 10. In the third quarter, there were a record 8 million algo responses from dealers, an increase of 41% year-over-year with a three-year CAGR of 30%.

Adoption of automated tools continues to increase with our investor clients. We experienced record Auto-X trade volume and count in the quarter with three-year CAGRs of 35% and 41% respectively, and a record 167 active client firms. Auto-X trade volume now represents a record 11% of total credit volume, and trade count was a record 24% of total credit rates. With Adaptive Auto-X, our new suite of client algorithms, we are leveraging our new Open Trading protocols like Live Markets and Auto-Responder to reduce execution costs while increasing the liquidity across our platforms. Historically, traders are responsible for selecting how to engage our comprehensive trading ecosystem. Now they have the ability to use a sophisticated AI-driven algorithm that helps make the decision on the size of the order, the protocol, the counterparty and when to trade.

Slide 11 provides an update on Open Trading, our market-leading all-to-all liquidity pool. Open Trading ADV is running at $3.8 billion compared to $3.2 billion in Q3, up 19%, reflecting some early positive signs of an increase in volatility. Open Trading share of total credit volume is running well above the 33% reported in the third quarter of 2023. We continue to expand available liquidity by increasing the number of alternative providers. A record 201 hedge funds provided liquidity on Open Trading in the quarter, a 13% increase from the prior year. Open Trading is consistently the largest single source of secondary liquidity in the U.S. credit markets. While price improvement has ticked lower, we have delivered approximately $530 million in cost savings year-to-date.

In U.S. high grade, no touch trades executed between Auto-X and a dealer algo represented 21% of trade count on Open Trading. We recently announced the expansion of Open Trading to select emerging local markets, including Poland, Czech Republic, Hungary and South Africa. This is a powerful next step in the evolution of our EM franchise, providing global dealers and institutional investors with access to unique onshore liquidity providers. Now let me turn the call over to Chris Gerosa to review our financial performance.

Christopher Gerosa: Thank you, Rich. On Slide 13, we provide a summary of our quarterly financials. For the quarter, we delivered revenue of $172 million, in line with prior year. Record Information Services revenue of $12 million was up 22%, this strong performance was driven by the healthy pipeline of new contracts as we continue to experience strong adoption across our data product suite. The favorable interest rate environment contributed to $6.6 million of interest income, up from $1.4 million. The effective tax rate was 23.4%, and we reported diluted EPS of $1.46 per share. On Slide 14, we provide more detail on our commission revenue and our fee capture. Total commission revenue decreased 2% in the quarter, but year-to-date is running 2% above prior year.

The decline in credit commission revenue was due to lower estimated U.S. credit market share and lower total credit fee capture partially offset by revenue generated from strong international trading volumes. The lower levels of credit spread volatility during the quarter contributed to a decrease in ETF market making maker activity, which had a negative impact on our U.S. high-yield market share. The reduction in total credit fee capture from prior year was driven principally by the lower duration of U.S. high-grade bonds traded over our platforms and a product mix shift in other credit products, primarily in U.S. high yield. On Slide 15, we provide a summary of our operating expenses. Third quarter operating expenses increased 10%, mainly driven by the continued investments in trading system enhancements and our data product offering.

Approximately 42% of the increase in operating expenses is due to employee compensation and benefits as we increased headcount 17% to support our revenue growth initiatives. The 15% increase in depreciation and amortization expense was due to higher software development costs and acquired intangible amortization expense. Professional and consulting expenses related to M&A were $1.1 million during the quarter and $2.1 million year-to-date. Our operating expense growth rate would have been 7%, if you exclude the impact of foreign exchange and M&A. On Slide 16, we provide you with our updated full-year 2023 expense guidance. Based on the progress operating expenses and the acquisition of Pragma, the company is refining its previously stated full-year 2023 expense guidance range of $418 million to $446 million to a new range of $432 million to $438 million.

Lower variable cost savings from incentive compensation expense and clearing costs was mostly offset by $12.5 million of incremental M&A-related expenses. Excluding M&A-related expenses, our core expense growth rate is expected to be approximately 8%. Our estimated Q4 direct operating expense for Pragma is $8.5 million, which includes acquired intangible amortization expense. For modeling purposes, Pragma’s third quarter 2023 total revenue was $6.9 million. On Slide 17, we provide an update on our balance sheet, cash flow and capital management. Our balance sheet continues to be solid with cash and investments totaling $553 million as of September 30 and we had no outstanding borrowings under the credit facilities. On October 2, we purchased Pragma for approximately $129 million, consisting of $81 million in cash and $48 million of stock.

We continue to actively invest our cash to take advantage of the favorable interest rate environment to continue to deliver strong net interest income in the coming quarters. During the past 12 months, we paid out approximately $108 million in quarterly dividends to our shareholders, and our Board of Directors declared a regular quarterly cash dividend of $0.72 based on the financial performance of the company. Now let me turn the call back to Chris for his closing comments.

Chris Concannon: Thanks, Chris. In summary, on Slide 18, we continue to execute very well against our growth strategy. We are pleased to see some early positive signs of increased volatility, driving higher levels of ETF market maker activity in U.S. high yield and higher levels of Open Trading activity month-to-date. Our client franchise and network has never been stronger with continued diversification across client segments, regions and products. We are making excellent progress with the rollout of X-Pro, powered by our proprietary data, which is increasing trader efficiency while driving better trading outcomes. Portfolio trading on X-Pro is increasing as more clients leverage our enhanced functionality and tradability data.

We are not happy with current growth rates in U.S. credit. But as we continue to execute our strategy and the macro backdrop improves, we believe we will be well positioned to deliver higher levels of growth in the quarters ahead. Finally, I would like to welcome Carlos Hernandez back to our Board of Directors. Throughout his career at JPMorgan, Carlos has been forward-thinking about electronic trading and market structure, and we are delighted to have them back on the board. Now we would be happy to open the line for your questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question comes from the line of Chris Allen from Citi. Please go ahead.

Christopher Allen: Yes, good morning. Getting a lot of questions myself, just on kind of the October update. Maybe you can help clarify a couple of things. Can you give us some color just in terms of how much of high-yield activities has historically been driven by ETFs. And then from a portfolio trading perspective, it sounds like you’re making nice advancements there, particularly into October. But from an overall industry perspective, how is portfolio trading tracking? And what is clearly a more volatile environment?

Chris Concannon: Great. Good morning, Chris. Thanks for the questions. Just with regard to the current activity, I think it’s important to look at credit spread volatility. Obviously, we do see higher levels of VIX volatility in the market, which has been driving high-yield ETF activity. But when it comes to the credit spread volatility, it remains fairly unchanged from September, high-yield credit volatility is only slightly up. So we’re encouraged by the increase in volatility, as I mentioned, high-grade market share is running just slightly above September. Obviously, we have the five remaining days in the month which is a critical part of the month where volumes do increase. And high yield, given that slight increase in volatility is above September levels.

And then with regard to portfolio trading, we are seeing our clients leveraging portfolio trading as a protocol. We’ve seen that grow this year, certainly in the lower ball months that we saw in Q3. We continue to see demand for portfolio trading solutions. And we’re continuing to enhance our X-Pro as we roll it out to users. We specifically built X-Pro to target portfolio trading and rolled that out in August. So it’s still very early days of our X-Pro for portfolio trading, and we’re encouraged by where we stand today. And as I mentioned in the month of October, 35% of our global PTs have been on X-Pro, and that’s up from just Q3. But again X-Pro right now it’s still early days as we roll out additional enhancements.

Christopher Allen: Thanks. I’ll be back in queue.

Operator: Your next question comes from the line of Patrick Moley from Piper Sandler. Please go ahead.

Patrick Moley: Yes, good morning. Thanks for taking my questions. I just had one on expenses. You mentioned in the guide, the $8.5 million of that was related to Pragma. So just wondering if that is maybe a good quarterly run rate to assume in ’24 or whether there could potentially be some opportunity for expense synergies or reductions there going forward? Thanks.

Christopher Gerosa: Yes. This is Chris. It’s a good run rate for 2024. We’re still finalizing the purchase price accounting around that. But the current estimate is roughly $1.5 million of that $8.5 million represents the acquired intangible amortization expense. And so I would expect that to be a decent run rate with modest growth consistent with our core growth for planning a 2024 budget. We’re still working through our budget process for ’24. But in terms of layering on top of your models, I would assume that’s a good run rate for you.

Patrick Moley: All right, thanks a lot.

Operator: Your next question comes from the line of Alex Kramm from UBS. Please go ahead.

Alex Kramm: Yes, hi, good morning everyone. Just following up on the discussion about the operating environment. You made that comment in your September volume release and you’ve repeated it today that the last week of September was the second best week ever for the company. So maybe you can just remind us what was so good in that week and how that environment has changed so far in October, so we can kind of compare and contrast a little bit here.

Christopher Gerosa: Sure, Alex. Well, obviously, we were pretty excited about that last week of September because we were coming off a quarter of fairly low vol and low volumes. The month was, if you recall, a very large new issue month both in high grade and high yield, and we typically see higher closing monthly — month end closing activity with regard to the new issue. So there’s a higher level of turnover going into that month end of people repositioning some of that new issue bond activity. So there was — we did see that in September and October. Obviously, new issue is slightly lower. But we typically, in the last five days of the month, the last four days of the month around month end see higher levels of volume in the market, but also MarketAxess experiences slightly higher market share during those periods as well.

Chris Concannon: And I’ll just add to that, if you go to the market condition slides, you track the VIX in the upper right, the VIX was really suppressed for most of Q3, and we saw that return of volatility that Chris alluded to, which was a good tailwind for the high-yield volume coming through the platform, and we continue to see that into October. And from a credit fee capture perspective, just reminding everybody that high yield is our highest fee capture product. So the more high-yield volume that comes through, it will naturally elevate our fee capture the bottoms that we experienced in the month of September, where that was trading at roughly $150 per million. And what we’re seeing so far in the month of October puts to the $155 million that we had seen for the entirety of Q3.

Alex Kramm: Excellent. Thanks for the color.

Operator: Your next question comes from the line of Benjamin Budish from Barclays Capital. Please go ahead.

Benjamin Budish: Hi, thanks for taking the question. I wanted to follow-up on the prior question on Pragma. Chris, you said in your prepared remarks, you think it’s going to be a key accelerant of your ability to capture the expanded TAM. I wonder if you could expand on that. And then maybe for Chris, just on terms of modeling for next year, where the revenue is going to be reported? And how should we think about sort of the growth rate of the Q3 number you alluded to earlier? Thanks.

Chris Concannon: Great. Thanks, Ben. And obviously, we’re pretty excited about the addition of Pragma. We were able to announce and close quite quickly. Pragma is a technology company. That’s how most people should think about it. So we are enhancing our tech footprint with very new technology and obviously an algo-driven solution that Pragma brings to us. They have an equity business as well as an FX algo business. So two areas of interest. More importantly, there, we’re helping — they’re helping us to enhance our algo offering, Adaptive Auto-X, which we launched this year. So that technology is quite helpful. The other piece of Pragma that we are exploring, we find could be synergistic is their EMS functionality. They have an EMS platform that they license to the NYC and it’s quite attractive across multi-assets solution.

So we are looking to leverage that EMS platform as well. And then we do think — given the excitement that we see from our clients around Adaptive Auto-X, and then given some of the excitement from our clients on unique order types that we’ve been rolling out in our rates platform, we do anticipate higher levels of demand for both automation and algo solutions in both credit and rates growing in the years ahead. So we’re excited to have kind of technology, that kind of expertise in-house at MarketAxess as we see just the excitement around our first-ever algo in credit. And obviously, we’re seeing levels of demand for algos in rates as well.

Christopher Gerosa: And then on the revenue projections, we’re still working through, as I mentioned earlier, the budgeting process for ’24. But I called out, the quarterly revenue is roughly around $7 million. So there is that slight drag when you layer in the intangible amortization expense on the total $8.5 million. But I think those two numbers are good numbers used for run rate with a modest growth rate in each line item.

Benjamin Budish: Got it. Very helpful. Thank you.

Operator: Your next question comes from the line of Dan Fannon from Jefferies. Please go ahead.