MarketAxess Holdings Inc. (NASDAQ:MKTX) Q4 2022 Earnings Call Transcript

MarketAxess Holdings Inc. (NASDAQ:MKTX) Q4 2022 Earnings Call Transcript January 25, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. As a reminder, this conference call is being recorded on January 25, 2023. I’d now like to turn the call over to Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Stephen Davidson: Thank you, Chris. Good morning, and welcome to the MarketAxess fourth quarter and full year 2022 earnings conference call. For the call, Rick McVey, Chairman and Chief Executive Officer, will provide a strategic update for the company. Chris Concannon, President and COO, will review key business trends and then Chris Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter. Before I turn the call over to Rick, let me remind you that today’s call may include forward-looking statements. These statements represent the company’s belief 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.

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, 2021. I would also direct you to read the forward-looking statement 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 Rick.

Richard McVey: Good morning and thank you for joining us to review our fourth quarter and full year results. We continued to execute our growth strategy and delivered the third consecutive quarter of record market share gains across nearly all our product areas. Strong increases in trading volumes and significant price improvement for clients through our unique all-to-all trading protocol, Open Trading. Our underlying revenue growth trends improved materially in the quarter despite near-term bond duration and FX revenue headwinds. We delivered 8% revenue growth, 10% adjusted for currency, EBITDA growth of 10% and EPS growth of 15%. With this strong finish to the year, we delivered our 14 straight year of record annual revenue.

Slide 4 highlights the key areas of our growth strategy. Our leadership position in global credit continues to expand beyond just U.S. high-grade with record estimated market share in high-yield in municipals, record share in Eurobonds and accelerating share gains of almost 300 basis points in emerging markets, reflecting our increasing global diversification. The deep pool of liquidity on our platform continues to expand with a record of nearly 2,100 active client firms and a record number of active traders. We have seen especially strong growth in our international business with over 1000 active client firms and nearly 6,000 active traders. As traditional sources of liquidity have become scarce, the importance of our all-to-all liquidity increases and a record 38% of our credit volume was executed through Open Trading.

This has been a key driver of our estimated market share gains and a source of valuable price improvement for our clients. For the full year 2022, an astonishing 1,300 client firms provided liquidity on the MarketAxess platform. In summary, the foundation of our business has never been better with accelerating growth in trading volume, new market share records, increasing momentum in new product areas, and a substantial addressable market opportunity. With this strong financial performance as backdrop, earlier this month we announced that Chris Concannon, a proven leader, deeply experienced in electronic markets will assume the CEO role in April and I will take on the new role of Executive Chairman. I would like to congratulate Chris on the promotion as CEO.

It is well deserved and given his strengths in automation, e-trading protocols, data, product delivery, and ETFs, Chris is the right person to lead the company. And now is the right time to make this transition because we have never been in a better position. I am excited about my new role as Executive Chairman where I will continue to work with Chris and our Board of Directors on long-term strategy, key client relationships, regulatory affairs, and investor communications. We will continue to invest actively in our business by developing new trading and data capabilities, adding new product areas, and expanding internationally. We believe we have an outstanding opportunity set for the next decade and beyond, and many reasons to believe the fixed income market environment will be favorable for e-trading and data revenue growth.

Slide 5 provides an update on market conditions and U.S. credit. In 2022, the Fed raised the Fed funds rate a total of 425 basis points, making it the fastest rate hike cycle since 1980 to 1981. This shock to the fixed income markets, especially with the initial moves in the first half of the year, drove an unprecedented 14% decline in investment grade indices for the year, the largest negative return I have seen in my career. Along with these price declines duration declined approximately 20% from year end 2021 levels to the lows in October, directly impacting high-grade fee capture for institutional client e-trading activity.

TRACE: Slide 6 shows the strong multi-year gains in estimated market share from the pre-pandemic period in 2019. This is the third consecutive quarter of top quartile market share gains for the company. In Q4 2022, all but one of our primary products were in the top quartile of historical data for year-over-year quarterly growth versus the past 10 years. Strong market share gains across our global product set combined with improving market volume and bond duration trends positioned the company well for revenue growth in 2023. Now let me turn the call over to Chris for more details on business trends.

Chris Concannon: Thank you, Rick, and thank you for the kind remarks. The last several years have been an incredible experience leveraging your deep fixed income market knowledge and working with you as a trusted partner and executive. The track record that you have established is unparalleled and I am deeply grateful to you and the Board for having their confidence to pass the CEO reins to me for the next phase of the growth trajectory for MarketAxess. This is truly an honor, so thank you for all your support and I’m looking forward to working with our clients, with you and with the Board on our many strategic initiatives that we will continue to unlock shareholder value for years to come. The team that we have assembled here is world-class and we are well positioned to capitalize on the growth opportunities ahead.

Slide 8 illustrates some of those tremendous growth opportunities. As we begin 2020, the strength of our franchise in terms of product and geographic breadth has never been stronger. Our leadership in global credit is expanding reflected in the strong market share gains that we achieved over the last several quarters. These gains only serve to reinforce the sizable revenue opportunity that we have ahead of us. We believe the product opportunities that we have are further enhanced by the current market conditions. Higher yields typically lead to higher velocity of trading, which will increase the demand for electronic trading solutions. January month-to-date has seen strong new issue activity, which reduces market share in the short-term, but increases outstanding debt.

Our total credit ADV month-to-date is showing solid double digit growth year-over-year and sequentially. Slide 9 provides an update on Open Trading. The diversity of our liquidity pool has made a significant difference in the quality of execution for our clients. We delivered price improvement of $945 million in Open Trading for the full year, well in excess of our annual revenue of $718 million. We believe that the price improvement opportunity we deliver to clients provides us with additional flexibility to fine tune our pricing over time, particularly when we are delivering such high levels of execution quality to the client transactions. Open Trading is able to deliver these levels of price improvement because it increases market participation by bringing a multitude of investment banks, systematic and alternative funds, ETF market makers and institutional investor clients into one unique pool of liquidity.

This unique liquidity pool is good for market participants and more recently regulators have become more focused on these types of protocols that support liquidity and market resiliency. This is a particular focus in the rate space where we believe our all-to-all solution in and U.S. treasuries is very well positioned with a record 244 active client firms now on the treasury platform up from 192 in the prior year. Slide 10 highlights the increasing momentum we are seeing with automation and credit trading. Automation tools are critical to solving for the pain points facing our clients. Clients are facing increasing cost constraints and need to find more efficient workflow solutions. Our automation suite of tools will be critical to helping our clients solve for these cost pressures while delivering high quality execution.

Automated trading increased to a record $62 billion in volume and a record 383,000 no-touch trades reflecting continued strong adoption. Today, Auto-X represents 20% of total trade count and 8% of our credit trading volume. We also saw increased adoption of our Auto-X Responder solution during the fourth quarter. Additionally, the use of dealer algorithms continues to grow across our platform. Clients are increasingly facing higher ticket counts and smaller trade sizes while trying to manage their technology costs. Our automation tools are increasingly in demand to help address these growing challenges. Lastly, in the first half of this year, we will have an initial launch of our Adaptive Auto-X solution, which will provide algorithmic workflows for clients to systematically access broader liquidity across multiple trading protocols.

This new service is expected to unlock additional cost savings for clients while simplifying client workflow. Slide 11 illustrates the growth we are continuing to drive in portfolio trading. The fourth quarter was another record for portfolio trading with total volume of $31 billion up 135% year-over-year. Estimated high-grade and high-yield portfolio trading market volumes have remained relatively flat at around 5% to 6% of secondary TRACE volume over the last several quarters. We believe approximately 65% to 70% of our portfolio trading activity is currently using electronic trading venues. And based on that, we estimate that we had an estimated 31% share of the electronic portfolio trading market, up from 17% in the prior year. Now let me turn the call over to Chris Gerosa to provide an update on our financials.

Chris Gerosa: Thank you, Chris. On Slide 13, we provide a summary of our quarterly financials. For the quarter, we delivered revenue of $178 million up 8%, which was our best fourth quarter ever driven by record market share gains across most products. Excluding the impact of FX, revenue would have increased approximately 10%. These strong results include the negative impact of a 9% decline in total credit fee capture, driven principally by the lower duration of U.S. high-grade bonds traded over the platform. Record information services revenue was up 9% or 17% excluding the impact of FX. The full year effect of the contract signed in the fourth quarter is a positive driver as we move into 2023. Fourth quarter post-trade revenue included the negative impact of approximately $1.1 million on the strengthening U.S. dollar compared to the prior year quarter.

Excluding the impact of FX, the year-over-year growth rate would have been approximately 8%. The increase in was principally due to a higher interest income of $3.2 million driven by higher rates. The effective tax rate was 25.4%, slightly below the prior year period, which included the negative impact of return to provision adjustments. On Slide 14, we provide more detail on our commission revenue and fee capture. Total commission revenue increased 9%. Our growth in total credit commission revenue was driven by record increases in estimated market share and healthy increases in our trading volume, but was partially offset by lower fee capture across U.S. high-grade. The lower high grade fee capture was driven principally by higher bond yields and slightly lower years to maturity of bonds traded on the platform.

All-in-all assuming the same level of trading volume, we estimate that the change in U.S. high-grade duration lowered our fourth quarter commission revenue by approximately $10 million. While the U.S. high-grade fee capture declined year-over-year and was down slightly from 3Q 2022 levels, duration did move higher intra-quarter as reflected in the Corporate Bond Index duration, which is well below those set in October, 2022. On Slide 15, we provide you with our expense detail. Fourth quarter expenses increased 8%, driven principally by invest investments to enhance the trading system and our data product offering. Excluding the impact of FX, expenses would have increased 12%. Employee compensation and benefits increased $3 million on an increase in headcount, mainly in technology and customer facing roles to support revenue growth initiatives.

The increase in clearing fees was due to the strong increase in credit open trading volume. On Slide 16, we provide an update on cash flow and capital management. As of December 31, our cash and investments were $515 million and we had no outstanding debt. Our trailing 12-month free cash flow came in at $261 million. During the year, we paid out $106 million in quarterly dividends to our shareholders and for 2022 we repurchased 280,000 shares for a total of $88 million, $100 million remains on the outstanding repurchase authorization. Our Board of Directors declared a regular quarterly cash dividend of $0.72, which was based on the financial performance of the company. On Slide 17, we have our 2023 guidance for expenses, the effective tax rate, and CapEx. We expect that total 2023 expenses will be in a range of $418 million to $446 million.

Approximately 65% of the increase is due to our continued investments in trading system and personnel to support our product and geographical expansion. We expect that the effective tax rate for full year 2023 will be in the range of 25% to 26% and 2023 CapEx is expected to range from $52 million to $58 million of which the majority relates to capitalized software development costs, resulting from the investments we are making in new protocols and trading platform enhancements. Our full year expense and CapEx guidance is based on foreign currency exchange rates as of December 31, 2022. Now let me turn the call back to Rick.

Richard McVey: Thank you, Chris. In summary, we continue to execute very well against our growth strategy. We delivered record levels of market share and enhanced our competitive position in the institutional client e-trading space, both in the U.S. and on the international front. Our global footprint continues to broaden and deepen as we diversify our product offering and achieve record growth in active clients. The market is increasingly turning to our unique Open Trading solution for liquidity and significant price improvement. Market volumes have improved and we are currently seeing positive trends in fee capture and FX. And lastly, the improved macro backdrop for fixed income markets is creating a very attractive operating environment for MarketAxess in 2023. Now, I would be happy to open the line for your questions.

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Q&A Session

Operator: Thank you. The first question is from Rich Repetto with Piper Sandler. Your line is open.

Richard Repetto: Yes. Good morning Rick and Chris and Chris. First Rick, congratulations on the transition to the Chairman role. It’s very well deserved and we thank you very much for mentoring that proven leader in the new asset class, Mr. Concannon.

Richard McVey: Thanks, Rich.

Chris Concannon: Yes, I needed some extra mentoring Rich.

Richard Repetto: But no, true, you stuck with it and congrats Rick. So you’re very bullish on the outlook for volumes. You know U.S. high-grade I think is already standing at a record level in January and appears that the stars are lining up. I guess my question, Rick, is there anything that we should be, like, how can this get derailed the outlook on volumes? Because we’ve seen it happen in commodity volumes when you — people expected energy, oil, but financial products generally have performed as expected I guess, but is there anything that you’re watching that could potentially be unexpected and impact volumes?

Richard McVey: You know what, not probably, but of course it’s a full year ahead and markets are full of surprises. I will say it’s encouraging to see that the mutual fund outflows that took place most of 2022 have started to turn into inflows, which is opening up the new issue calendar for the high-grade market as we start the year. And who knows that the expectation right now is that we could have a soft landing and the inflation numbers will continue to come down, but nothing is certain and there is the possibility that we get a negative surprise on inflation and the Fed has to continue to move rates higher in the near-term, but that’s not the expectation right now. And I will say, while the high-grade market is wide open, we are still not seeing anywhere near normal levels of activity in markets like high-yield and emerging markets in even euros.

So it’s a good sign that high-grade is leading the way and we’re having robust levels of new issue activity this month. But what I would expect to happen is this improving environment will work its way into the high-yield in emerging markets as well. And EM in particular volumes were greatly depressed in 2022 with some of the market challenges and FX challenges throughout the course of last year. So there’s a huge opportunity there that is the market environment does continue to improve and we have China reopening that EM market volumes may follow the path of high-grade and improved. They have not done that yet, but that would be something to watch, I think, in the quarters ahead.

Richard Repetto: Got it. Got it. And I was just looking at the, this is for Chris Gerosa, the cash, excuse me, the cash levels seem like they went up substantially like over $150 million quarter-to-quarter cash and cash equivalents. Any explanation or color behind that?

Chris Gerosa: Yes, Rich, it’s a seasonality effect with our clearing operations. We have to put capital into DTC to support our failed activity. So at the end of September, you have elevated fails, which takes on some of the cash and the seasonality impact as you get into December, there’s less trading volume lower fails, which reduces in more cash on the balance sheet that we don’t have to hold at DTC.

Richard Repetto: Got it. Got it. And, one last thing, Rick, the seasonality here usually, and you mentioned the higher new issuance, so just so I guess we can, I don’t know what is braced, but people won’t be, I guess is it fair to expect that the market share numbers in January are likely to come down? They seasonally seem like they do that all the time because low issue — our issuance is low in December, then higher in January, so that they had to assume that market share is likely to come down, do that, that seasonal effect?

Richard McVey: That is the norm. That is, you’re exactly right, Rich. That is the normal month-to-month seasonal pattern because new issue is at the lowest level in December and often the highest in January. But we’re taking a holistic view of our credit market opportunity and the guidance that Chris gave in credit ADV month-to-date in January puts us at or around record credit ADV levels. So we see robust trading activity when we look more broadly across all products that we’re involved in, in credit.

Richard Repetto: Got it. Thanks guys and looking forward to the transition.

Operator: The next question is from Chris Allen with Citi. Your line is open.

Christopher Allen: I wanted to followup a little bit on the high-grade side. One of the — basically the one pushback we’re getting on the stock now is just that the market share of high-grade has been pretty static if you kind of look at it over the last three years, right around 20%, 22%. I was wondering if you could provide any color there, particularly in the context of recent quarters you see in the average trade size coming down, which should be helpful for your market share of high-grade. I’m just wondering if there’s any dealer activity in terms of balancing share on high-grade versus high-yield where you’re seeing good gains there, or there’s some other factors apply?