Cboe Global Markets, Inc. (CBOE) Earnings Call Transcript & Summary

We think this retail investing growth will endure. There's a new wave of millions of retail investors that had previously not had accounts that we think will stay. They have better access, cheaper to trade. You have stimulus tollers, free commissions. And frankly, a new generation that thinks and now has a better, easier way to trade in the market. Now there is a gap we think that we can help sow with educating those retail investors, as I started out with when I talked about our proprietary products where they may not have access to or may not know how to trade them yet. We want to fill that void, not just about our prop products, but also about all products. We have this great options institute that's been refreshed and has historically been primarily focused on institutional investors, but we also think we have the tools to help educate retail investors in partnership with the retail brokerage community.

Got it. Maybe moving to bids and the opportunities that you see there through the acquisition. Sticking with retail, sort of the greater retail participation is driving more off-exchange volumes, so it kind of makes sense. But at the same time, it seems like if you look at the numbers, more of that is going to either wholesale or internalized sort of volumes with recent ATS share ticking down a bit. Can you talk about some of the dynamics that play over here, and what you're seeing from a market trend standpoint?

Yes. It's a fascinating time to be operating the U.S. equities platform. We talked about this renaissance of retail, a wave of new retail investors. It is driving the highest off-exchange percentage of volume on record. Some days above 50%, I think, on average, about 48% in January. We are benefiting from this wave with nonmarketable retail flow on our EDGX exchange, which was greater than 400 million shares a day in January. It continues to set new highs almost on a daily basis. The other dynamic you have here is that a lot of low-priced securities in U.S. equities are trading an outsized proportion of the overall volume. Some days, up to 0.25 to 0.75 of all volumes happening in stocks that are $5 or below. And certain stocks get very, very hot and they trade tremendous amount of volumes. So that is, in some ways, skewing market share statistics to one venue or off exchange or not depending upon what name was hot at the time. The dynamic around low volume names is -- sorry, low price names is that they tend to trade more off exchange, which is, again, driving things there. But as we talk about off exchange, I will mention bids. We completed our transaction acquisition of bids, which allows us to not compete in retail, but in the off exchange segment of the U.S. equities market. And then we do expect there are congressional hearings around retail activity in January and greater transparency around payment for order flow and other thing in the market as we move forward.

Got it. Moving to your capital and M&A. And maybe Brian has been sitting around. I'd love you to jump in on this one. You still have ample capacity despite your recent deals, plus your track record that you can execute larger transformational sort of deals as you look at opportunities. So maybe starting with one. And let me think of getting this very, very carefully worded. So I get the longest response from the 2 of you. Can you continue to talk about the recent 8-K on amended executive severance, change in control, that's clearly gone at some level of interest from investors. Was there a reason for the update at this point? Or was it more just procedural? And then were you surprised by sort of the stock reaction post filing? It's pretty benign, right?

It -- very benign, and I've never heard this question before. This is shocking. Thank you for that. I would say that it is a normal part of our board governance compensation committee process is that they will routinely go through, whether it's maintenance or whatever of looking at where are we with respect to policies, pay practices, contracts and making sure there's a refresh, if needed. What do those standards look like, like a double trigger on executive severance certain event occur. Requirements for holdings of executives of the stock. Normal things that you see, and this just happened to be one of those updates, refresh, where are we? Where are our peers? Where is the market? Let's put the amendment. Obviously anything applying to executive compensation has to be filed through an 8-K. It happened to be on a Friday, it just happened to be following a scheduled compensation committee meeting. So -- and obviously, we can't comment on one way or the other on any speculation of M&A or anything like that. But I can just assure you that, that was a routine process that our compensation committee and Board goes through on a regular basis, just making sure that, like I said, those policies and those programs are consistent with market standards.

Got it. That's very kind of you to get to that detail and hit that one for me. Just thinking along with sames lines to along M&A and your outlook over the near term. Again, you've clearly positioned for long-term growth through acquisitions, planned investments. So as you think about entering this year with new assets versus your capacity that you have right now. How do you think about that? Is your key priority to perhaps grow the assets that you recently acquired versus more of an upside for more of a transformational deal or something like that over the next 12 months, where is kind of the priority for Cboe?

So -- go ahead, Chris.

So maybe I'll just start, and Brian can take the bulk of this. I'd just say, our view on M&A has not changed, which is we are excited about growing Cboe organically. We laid out many of those growth drivers in the earnings call a few weeks ago, and where we think there may be M&A that could further accelerate that growth, we can and should consider it. So we did that 6 times in 2020. Won't make any predictions about 2021, but we're excited about the growth drivers, and we'll consider M&A if and when it can accelerate. But Brian, why don't you talk about it?

And that's the perfect lead-in, as you think about those priorities that Chris mentioned. And again, just to refresh that is, is that, look, we're most excited about just that increased access, again, which is, if you think back about what all of your questions up to this point of the things that we've announced is that increased access to our existing products. And whether that means geography or whether that means making the contract more bite-size for retail, whether that means access to time frame, all of that is structured around in any incremental investments we have around the existing wonderful set of assets that we have today. That is our #1 priority, and that's where you're seeing those initiatives. The others that we've talked about that we called out on our expense bridge and expense waterfall are things that we've talked about. Hey, we want to continue to grow the nontransaction revenues. You've seen the ISG and the other acquisitions that we've made over time to continue to enhance that data offering because we know that there's an increasing need for data and analytics and a need for that better access. And this is us addressing that demand and that need based on client feedback. So -- and then the third item is European derivatives. We spent time talking about that. Where are we -- what does that look like. And then lastly, we just mentioned bid. So we think we've laid out those priorities. And how do we fund that? How do we prioritize that? Well, we're prioritizing that capital to those priorities to make sure that's happening on an internal now that those inorganic become organic, let's continue to feed those to make sure we grow and that, that creates the secular growth that we want over time and making sure that our investors understand the conviction we have around these projects. Otherwise, we wouldn't necessarily be leading with investment because many times, as you know, investment sometimes need to lead the actual revenue opportunity. And we've been very clear about that and the need to get that there. The thing that I will say is that in balancing what Chris said, we don't need to do M&A. We have done M&A where it enhances our priorities, where enhancements moves to the next level. But you'll see our commitment to returning cash to shareholders, keeping a really strong balance sheet. Should there be something that makes sense that we can leverage the balance sheet for shareholder value, we'll absolutely want to maintain that flexibility given the shape that we're in, but if you look back at our history and our strong cash flow of the business, we've got a commitment to grow the dividend, just like we always have. And opportunistically buy back shares like we did. So we were able to do all of those in 2020. It's a perfect model of how we think about capital allocation and one little formula, I'll leave you with is, and I'll round off some numbers to make the math simple, but adjusted earnings roughly were $570 million. And said, well, okay, you did about $50 million in CapEx. So your kind of after-tax adjusted cash flow as proxy of $520 million. We sent back $520 million back to shareholders in the form of dividends and share repurchases. So again, that's a perfect reflection of how we think about capital allocation and how we want to deploy it to what we think is helping to grow shareholder value.

That makes sense. Moving maybe to the competitive landscape. Another key topic that's top of mind for investors and analysts as well. When I think about -- maybe just start so with the competitive landscape. And then are you seeing any kind of uptick in concessions or pressure from any of your customers just as they exit a pretty tough year where maybe their profits shrink, maybe their resources have as well. Anything from that standpoint where you're seeing an uptick in pressure from the client side?

I would say not really, Ari. We've seen -- I think a lot of our customers had tremendous years in 2020. Some of them had difficulties right around the pandemic onset. But really, a lot of them had great years, navigated the year well. Volumes were very, very strong as you know, and that has continued through 2020. So we have not seen customer attrition to speak of. In effect, great engagement not just on our existing businesses but on new launches like European derivatives.

Got it. And then maybe just moving to 2 specific of the new inference kind of play in your space, 1 in cash equities, 1 across auctions. Talk maybe on members' exchange, they're fully live right now, sort of with that 1% model market share, yes, at the same time, with the inverted pricing structure that they have. What are your thoughts around, one, MEMEX sort of being in the space and sort of disrupting it as a result of this pricing structure kind of in a longer-than-expected manner. And then on the other name, too, I would love to get your thoughts on the new spikes are really relaunched from mix? And then is this a viable product and a threat to sort of Cboe's volatility management offering?

Yes, first line U.S. equities. We've said all along, we welcome competition. We're built for it. We fiercely compete in U.S. equities. And U.S. equity has grown. We're benefiting from that with retail priority on EDGX. And we have said all along, we're going to optimize net revenue over time, adjusting to gain market share, but ultimately optimizing for net revenue. So we're pleased with our progress in U.S. equities and how we're using a data driven approach. Not much to say on MEMEX, they'll be inverted for us as long as they want to be inverted. We know their ownership base. We have good relationships with them, but we're offering we a lot of value-add in U.S. equities. And that's proved out by the recent tremendous growth in GX at retail priority. Then on the spike, I'd just say, very, very small volume to date. It's just the fact history has shown when "competitive" products come into the space, if you think back, way back when the first ETPs that were based on volatility came out, there was this big concern about whether it was going to cannibalize VIX. And in fact, what happened was, it grew the overall volatility space, and it actually helped grow our products as well. So we will have competition in this area. And -- but again that volume has been very small for that specific product you mentioned.

Got it. And then no change basically on the cash equity side also, no real change to the way you think about automizing revenues, yes. There's not a shift in strategy there over the near term or something like that. Got it.

It's data-driven, and it's about execution quality. And that's what's driving growth and retail priority. That's why we're bringing out other things like depletion protection and other new order types and functionality because our customers demand transparency and execution quality, and that's what we need to provide them as proven by data.

I think you said, which I think is important for investors to understand is it's not a what's your last week or next week. It's literally a medium to longer-term optimization of that net revenue mark, which includes a value to the shareholders of that revenue optimization. Because it's going to fluctuate. Competition is going to do different things. And like I said, so it's not a next month issue. It's a longer term. And like I said, this hey this -- the way this is played out, this market environment is very, very different than where it was when Bats was launched when it took an inverted each for a short period of time to capture market share. So again, it's a very different dynamic. We've talked about that before in the past. But again, strong competitive base, strong consortium behind these exchanges. Again, we welcome the competition. And again, we just remind people that this is a longer-term approach that we're managing the overall dynamics of the business.

And I think the entire industry is embracing the new wave of retail investors. I'll say there's millions of new accounts of people that never had brokerage accounts before. And those accounts, they need to see data in order to make wise decisions. And so there's we think we have market data products that are very competitively priced where there's opportunity for non transactional revenue as well.

Got it. Now we're pushing up on time, too. So let me hit a couple more. Real quick on the evolving sort of landscape around on digital assets as well. You got the early movers in the space when Invest app site, arguably, it was a little more . But recently, you excuse with , positions you both in the way to leverage the market data side as well doing some interesting things on the index creation cycle. So likely your thoughts on the outlook for the broader sort of trip to market in your position positioning. And do you think 2020 was perhaps like a tipping point for broader institutional interest, which might drive this ahead?

It's a very interesting time in crypto. I think we were probably early to the market with our first futures contract it's not uncommon for us to retool and then come back to the market, what we think is a refined product. We saw our announcement with coin routes. We're very excited about the data and the partnership with coin routes, and how that brings more transparency to the crypto market. I'm sure you've seen good news about ETPs in Canada that are crypto based. And there are many ETP listing issuers that are seeking similar approval in the U.S., and that will be a question for the SEC to take up on this next administration, but we're -- it is a different time. I think the first wave was primarily retail and you now see publicly a lot of institutions entering the crypto space and deciding they're going to fully support it. So we think it's really natural maturation of this asset class that we plan to be engaged in.

Got it. And then just on a similar vein over there. There's been some please on conversations that we've been having around asset organizations and the implications for the industry. What are your thoughts on it moving from your more tokenized assets away from esoteric sort of assets like points and art and things like that to more of the traditional type of cash equities, bonds, things like that. Do you view the organization of assets as the broader threat to the exchange business model? Or is it more of a nifty solution given all considered?

No, I don't think we view it as a threat. I think we actually view it there an opportunity and tokenization, the digitizing of assets over time, likely we have a part to play in that. And so that would be a multiyear effort. But I know it may seem a little bit far afield. But even as we -- the debate in congressional hearings from last week around real-time settlement and things like that are -- I think it actually intersects with your question that we're for real-time settlement probably would be difficult to get to in the near term, but T plus 1 is something that we -- it's probably possible with some effort, but the digitization of assets is going to come over some period of time, we have a part to play there, and there's opportunities for us.

Got it. And you think about the overall infrastructure of the existing exchanges, it's not -- you don't view it as more of an overhaul and a disruptive development may be additive to the overall way you think about technology?

Yes. I think that there could be a technical overhaul of how, especially the back office and CCPs and but I think at the time of the match, there may be changes there as well. But it's primarily post-trade and back office that needs to be reformed and probably will be, and there'll be a lot of efficiencies that come from them. But the regulators are not going to let things right -- you're not going to let things completely go outside of their purview. So even as assets are digitized, regulators will be embracing.

Got it. Now that's been fascinating conversation. Before we know it, we pushed up on time. So thank I think we're out of time now. But Chris, Brian, thank you so much for the time today. It was a real pleasure, again, and thank you, everyone, for dialing in virtually. Have a great day. Thanks, everyone.