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

Good morning. We will go ahead and get started. I'm Patrick O'Shaughnessy, capital markets analyst here at Raymond James. And for the next session, we have Cboe. And on their behalf, we have CEO, Ed Tilly; and COO, Chris Isaacson. Format for this is just going to be a fireside chat, Q&A. And then towards the end, we'll open it up to audience questions. So with that, I'll get it underway. Gentlemen, thank you for joining me today.

Great to be with you. Thank you.

So I think apropos of current events, maybe I'll just kick it off with a question on what's going on in the global macro and how people are managing their risk and otherwise using your tools to engage with the current environment?

It's a great place to start. And I would say across geographies and across asset class, the engagement has been pretty terrific. We probably would never have started a conference in acknowledging the flow in FX, which has just been incredible for us. European equities, as busy as they've been. And then not surprising, in the U.S., the focus on not just -- and maybe pivoting out of individual management were all the rage over the last 20, 24 months into macro hedging. And for us, that's primarily the S&P 500 and the volatility complex. So we see engagement across our most busy and visible product sets. And depending on the [ investment ], whether it's retail or institutional, the engagement has been [ lately ] nonstop. You want us to move?

Would you like me to move further away from the speaker?

I was going to go out there.

That's better.

Yes.

Not so much feedback now. Terrific. Well, thank you for that first question. And then just kind of tying in with some of your corporate actions of late, Cboe has been very active on the tuck-in acquisition front over the past year or so. How would you describe the overarching strategy behind that effort?

So I think, more broadly, if you can look at it, we believe that we have an advantage using the technology stack that we've built first in the U.S. and really expanded quite successfully in Europe more broadly, and I'll ask Chris to weigh in. But with that advantage, we're able to go into jurisdictions that allow for competition. We think we have something special to add for our customers, an experience that is consistent across geography and asset class. We embrace regulatory first, and the technology allows us that -- the transparency and the reliability that our customers have grown to know us in the U.S. market. But I think the technology, the integration, the philosophy around we don't buy a business and let it exist over there, but rather the integration and migration of technology is very important to our predicting and counting on success when we look at M&A. But I think it's important to call that out, Chris.

Yes. We're talking about we're building the largest global security and derivatives network. We have 23 markets today around the world, but I think that we've got [Technical Difficulty]. So if you think about maybe kind of, say, Europe, we started with organically [Technical Difficulty] how we grow the value [Technical Difficulty]. And we bought Chi-X Europe that got us to scale about 20%. Then we brought BIDS to the region. So we have a block trading network now that came in 2016. Then we bought EuroCCP. So we have a clearing network. We have -- sorry, have a clearing organization. And then we launched European Derivatives last year. So we have -- if we think about that life cycle where you have cash equities, some of the most competitive markets, our common technology platform allows us to compete very effectively there. That generates a bunch of data. And then we're able to launch derivatives. Now that's what's happened in Europe. We just migrated in Canada, MATCHNow, the largest ATS in Canada to our Cboe technology in February. At the same time, we added BIDS as a block trading network there in Canada. We'll do the same thing when we go to Australia a year from -- about a year from today, when we migrate Cboe Australia to our technology. We'll introduce BIDS. And then we'll do the same thing when we get there in Japan in the second half of 2023. So we have a well-known playbook here. And that's how we want to operate all these 23 markets, in a globally consistent way, but locally optimized to the nuances of that market because we are a customer-driven business. We want to meet the customer demands of that local jurisdiction.

How do you define success for these acquisitions, whether that's Canada or Japan or Australia? Is it a certain market share threshold? Is it financial metrics returning to Cboe? Is it client engagement? What determines whether these deals are ultimately successful for you?

It has to be all of those. And I think importantly, and Chris pointed it out, it's the network and flywheel effect, right? So the successful business that we had in Europe being the largest pan-European exchange allowed us to create indices using our own data. So that in itself is a success that you wouldn't necessarily jump to. But in the exchange business, being able to create your own indices, that's very important and, from there then, launch derivatives on that index, launch the options on that index. What would be more successful? When there's a vibrant market in the derivatives that we can launch a volatility benchmark. So if we look out into the future, this is a step function. And in various phases, we have successes that we measure. But how those businesses -- the ecosystem feeds on themselves, spins off other benefits for us in the non-transactional area of Cboe's revenue. So we are really holistic in the view. And when we evaluate M&A, it's really on a much different level than just that business makes a heck of a lot of sense, we should go there, but how does it feed into the greater experience for our customers and Cboe Global.

And I would just add we have an M&A scorecard where we try to be very difficult on ourselves and say, how are we doing on each of these integrations and how are they working together. So clearly, we have financial metrics we look at that Ed has mentioned: revenue, cost synergies, revenue synergies, expenses. And we have how are we doing on any platform migrations that are happening, any corporate integration like nonfinancial metrics we might have there? And then how are we doing with integrating people? Because any great M&A integration starts and ends with people. And so how are we treating the people? How is our retention? How are they coming -- becoming part of the broader Cboe and contributing to the success of Cboe? So we try to use that same playbook regardless of the M&A transaction.

Does that imply maybe an elevated level of patience with some of your acquisitions? It's not, hey, this needs to pay off in a year. It's this is a 3-year play, a 5-year play, a 10-year play?

It's a great question, and I think your analogy earlier is one of my favorites. So I'll rest for a minute and let you take over. I loved it.

So when you think about it, we have different investments that have different growing seasons, natural growing seasons. So if you think about...

Chris is a farmer.

So I grew up on a farm in Nebraska. My brother still farms there. So sorry, I'm giving you some farming analogy here. So when you plant corn, you -- they have different growing seasons. Some is 90-day corn, some is 115-day corn. So the point is, we have different seeds that we're planting that will come to maturity at a different time. So the stuff that's the shortest season is you think about new products on existing platforms. And we've done a lot of that recently with 24x5 launch, 24x5 options trading in SPX and VIX last November, already paying for itself. Next week, our target is to launch Nanos, a new retail-focused product on the S&P 500 that's really going after those 150 million retail accounts. Then you have SPX W -- Tuesday and Thursday weekly options expiring. So those are relatively light lifts somewhat to -- on existing platforms. And then you have totally organic efforts, but a new platform or a new asset class such as U.S. treasuries. We've launched that. We'll spend a relatively small amount of money to access a new asset class. And then the longest season would be things like EuroCCP or European derivs, where we realized we need to do an acquisition to get a clearing agency, clearing organization. And then we need to launch a new market using our own indices and creating it. So creating a new clearing entity, new indices, new products to build a new market.

Where does crypto fit into that different time horizon landscape that you laid out? Because obviously, there are a lot of companies making a lot of money on crypto right now. But doing it in a regulated fashion -- the approach that you guys are taking seems like it's thoughtful. It might take a little bit longer. So what's your thought process on time line for that?

I think important to recognize what it is we get with the ErisX acquisition. And then timing, I think, will flow depending on your perception of how engaged the regulators are. Regulatory first, super important for us, and a consistency, we think, because -- just because this is a new asset class for many doesn't mean that the experience should be different. It should be trusted. There should be a bid-ask that you can rely on, that you can point, click and trade. But I think for what we get in an instant and understanding that time line is important.

Yes. So with the ErisX transaction, which is one we plan to close in the next month or 2 at the latest because we have to receive CFTC and all the state approvals, which we're getting close on. With ErisX, we get a spot trading platform that trades physical coins. Well, it produces data. It's a derivatives trading platform that's licensed with the CFTC. So there's fully funded cash and physically settled futures. And there's also a designated clearing organization that's licensed with the CFTC. So spot, derivatives and clearing in a single transaction. If you think about what is our flywheel, it's spot or cash trading, derivatives -- data, derivatives and then clearing, where we can get clearing. One thing, I think, that's maybe underappreciated about this asset that's unique is the clearing organization, which allows us to clear both spot and derivatives and, over time, to allow capital efficiencies in the trading of crypto for both spot and derivatives in the same clearinghouse.

We spent a little time also on building the customer base and how we're looking at that.

Yes. So the customer base -- a lot of the existing crypto exchanges have been primarily focused direct to retail and not embraced intermediaries. We believe intermediaries have a strong place to play here. And so we're bringing together a Digital Advisory Committee together and syndicating a significant minority percentage of Cboe Digital to embrace those intermediaries, which we think, through them, we'll be able to access even more customers that will want to trade crypto, if they aren't already, as crypto matures in a trusted, regulated framework within the U.S. We want to operate this as much like the rest of our markets as we can, understanding the nuances of crypto but in a trusted, regulated way as crypto grows from maybe adolescence to maturity.

And on the crypto regulation front, what are you guys hearing right now? How do you think it's going to -- how is it going to evolve? Like right now, it's just a vastly different marketplace than securities or futures. The broker-dealer is often an exchange. There is no best execution requirements. There's very little transparency. How do you think that's going to evolve over the next couple of years? And then how are you guys going to be positioned to benefit from how it evolves?

Knowing the market and knowing -- and having grown up in highly regulated markets and the experience -- we've watched the growth of retail throughout the last 20 months or so, so we know that trusted and reliable are key. Transaction fees. Customers aren't used to paying them. They're seeing them now. It's very confusing. Your point of execution, what's embedded in the bid-ask, what is not. Gosh, it looked like I traded for free. You didn't. And so that kind of transparency that we bring to crypto more broadly is really our focus. We think we will excel there. And not to be lost is what we repeat with Chris. The model with working with known introducing brokers. Every retail broker that you know, we think we can make the experience better for their customers because you will have a bid-ask that is tradable. The fees will be transparent. The experience will be no different when you pivot from trading your favorite macro contract, Nano, over to your favorite coin. The experience should not be different. And that's what we're after, that consistency. So I find -- we find ourselves way ahead on being regulatory first and trusted first. So I think we have an advantage there.

And maybe just to give a magnitude of where crypto is at today for the average, say, retail customer. If you go trade on some platform, you're going to see 200 basis point spreads, if you do the math, and as a comparison to single basis point spreads or even less on more mature markets. So it's two orders of magnitude wider spreads at this point. There's only one direction for those to come down as the markets become more efficient, more transparent and more regulated. And we think overall -- the overall crypto market will grow, the one that we'll have access to 25% a year for the next 3 to 5 years, the overall crypto market, we think, is going to grow.

And so pivoting to another area of elevated retail investor engagement right now. It's just equity options. If you look back at the industry volumes around the Internet bubble, they were actually really resilient. They grew 42% in 2000, another 9% 2001, and they only dipped 2% in 2002. So there was no up and then right back down. Do you think that's a good model for maybe what we've seen in the last couple of years and what we should expect going forward where we had this surge of new interest, but it is sustainable at this level?

I -- the pattern is going to be -- I can see as similar, meaning once you teach a payout that is different than a straight line -- you're long and something goes up, you make money; you're short, something goes down, you make money; you're long, you're short, you lose. When you change the payout scheme and teach hedging leverage, limited downside, that's sticky. And we're in a market environment now that is really friendly for us to teach. This market doesn't go straight up. And taking risk into consideration in your exposure, that's what derivatives allows you to do. There is an outcome, a predictable outcome, in any environment that derivatives allows you to achieve that Delta One just does not. So the stickiness, I think, comes from awareness and in a market that we're able to teach. We've -- we're revamping our Options Institute that was primarily institutionally focused to include retail now, because there's so much to learn. And that's when the lifetime investor is borne out of education, and that's the focus. Always been a focus for Cboe. But in this environment, teaching retail, we see an incredible opportunity to make this experience sticky.

And I'll only add to that that all these new retail brokers as well as the traditional retail brokers have their own education arms as well. And so the level of information and education that's available to that retail investor is unprecedented. And I think there's potentially a misconception that this new retail investor is not as sophisticated as we might think, and I think there is a higher level of sophistication than we give them credit for. I'm sure there's a spectrum amongst them, but there's incredible information and education there, and we want to do our part to add even further education.

To that point, I think also, the movement out of single name -- and you've seen incredible growth and we've shared with you our super short-dated, lower-premium weekly contracts in the SPX. We look at retail platforms, and that growth is phenomenal. So even teaching macro hedging principles and away from single name, it's got to be a full range of education and awareness.

And as you're working with these retail brokers on education, what do they also do from the marketing standpoint? So if you launch something like Nanos, how aggressively are they out in front of their clients saying, hey, here's this new risk management tool, this is something that you should take a look at?

I think that the best example is Webull has been very visible with enabling our cash settled weekly contract already. That's a good example of a newer retail really embracing for their customers an awareness that there's the single stock strategies, which are great, but this -- right now, in this environment, the U.S. economy is reflected in the S&P 500. So it varies depending on the introducing broker, but we've done ventures with just about every traditional retail vendor that you can think of over time. White labeled education, awareness and campaign and this -- and the Nano will be really no different.

How much room is left for innovation within your proprietary product set? Obviously, you talk about Tuesdays and Thursdays. There's only 7 days of the week. There's only so many different variations that you can come out with. But I think you continue to churn out new variants and new adaptations of existing products. Do you see a long tail to what you can do in that dimension?

Yes, I think the lowest-hanging fruit, we're in that phase now of Tuesday, Thursday and smaller, bite-size contract. I think the level of sophistication is still there, and that's in dispersion and correlation. So for the institutional investor, we've got plenty of runway. And a lot of that will rely on, for us, OCC and their ability to recognize offset in margin, recognize that replicating strategy using our derivatives is the same as what you might see trading OTC. But we think there's great runway in more sophisticated, next-level derivs. And I'll pick on dispersion because it's one of my favorites.

Okay. 2021 and now 2022 are both expected to be investment years for Cboe in terms of elevated spending growth relative to your historical baseline. Some of this was acquisition related, but some was organic as well. Does this signal a structural change? Or is it just a relatively unique confluence of events for Cboe?

It's not a structural change. I think we've been very consistent. When we see opportunity in our business, we're going to invest. And many times, that investment comes before realizing the revenues associated. EuroCCP is a perfect example of that. We announced that acquisition and said we've got to spend. First of all, we have to buy EuroCCP. That's an expense. We have to build out the capability for derivatives in Europe. Get ready, that's going to come before we trade contract one. And we try to be very transparent in that. And now we see a very successful EuroCCP, the launch of derivatives in Europe, the extension now and the announcement of going in further country-specific risk, and then in the single name. So we'll ramp up and be totally transparent with what we see coming, but sometimes that investment comes first. And so no, I don't think it's necessarily a change. We've been very aggressive lately, and we see great opportunity. And to Chris' illustration, there are various timing and payouts on our investments. Your great example of 24x5 was an investment we made last year. And we ramped up that spend in order to deliver 24x5. We did. It's very successful, but that expense came before the first contract that was traded near around the clock in global trading hours. So the philosophy is not different. I think the visibility we're able to give you is probably greater, but we are really consistent in spending for the future and the future of growth.

All I would add is just there is some -- Brian Schell, our CFO, went through this last earnings call really, really well on the whole bridge. But there's a lot of acquisitions closed and now at full run rate we're bringing into the cost base. For this year, there are some prospective acquisitions with ErisX and NEO that will be added to the expense base. And then there's high-conviction growth initiatives that we want to invest in, similar to 24x5, but the next thing. And then we're going to invest as we have conviction over high-growth opportunities.

I want to touch on your European Derivatives initiative. I think there's a long track record of broker-dealers encouraging exchanges, "Hey, launch this product. We're going to be there. We're going to support you." And then, for whatever reason, it doesn't necessarily work out. Are you getting the support that you expected right now from the broker-dealer community as it pertains to European Derivatives?

We looked at it a little differently. So we weren't promised anything specifically by broker-dealer. Rather, this is global customer demand who are not benchmarked to the current European indices. This is -- think of a U.S. investor who wants or has exposure more broadly in Europe and today needs to clear that exposure in 3 different CCPs, 3 different pricing schemes. Very inefficient, not necessarily the offset that one CCP can offer. And again I'll repeat, not benchmarked to the existing indices. That is the customer that worked with us to bring this model forward. This is a -- very friendly to liquidity providers. Liquidity providers who post accessible bid-asks are rewarded by trading. This is not a call-up, a dial-up, meet me at a certain time crossing network. This is engaged, committed liquidity providers from bell to bell. Those have showed up. That market quality, very good already and will only, we believe, build with time. So a little different scheme. We're not after the market share that exists today. We've been very clear with that when we laid this all out for all of our investors and our customers. There is a world that wants exposure to Europe. It's inefficient today. We're bringing that efficiency. If you are benchmarked to a country-specific index, you're likely not going to look at us. But the world will have access to a much more efficient, liquid, transparent platform.

Yes. I might just remind you that the turnover of derivatives, even though the economies are largely -- are basically the same size, U.S. versus Europe, it's 1/7 the size in Europe. And so we're -- as Ed mentioned, we're trying to grow the market, not take share.

Chris, I should take advantage of you being up here by asking about the cloud. And I think of the public trade exchanges, there's a number of different strategies out there right now. NASDAQ and CME announced big partnerships. ICE -- seems like they're kind of going in the other direction. They like to own their own data centers. Can you talk about Cboe's cloud strategy and why it's the right fit for your exchange?

Yes. Let me start with one of our guiding principles is that we are a customer-driven company. And so where our customers are at or where we think we want to add new customers, that's -- we're going to use the right way to touch that customer. So we launched Cboe Global Cloud in the fall of last year because there are customers that we think can benefit from our data that don't have access to our data today. And that's played out. Most of those new customers are coming outside the U.S., in places where they don't have access to our existing data centers. And we're continuing to add data to the Cboe Global Cloud as a distribution tool, start out with primarily U.S. data, indices data. And we'll be adding more data from around the world because, as I mentioned, we have 23 markets. We're in a unique spot. We have basically -- any market around the world that's open -- in the top 10 that's open to competition, we have equity -- raw equity market data that we'll be adding to the Cboe Global cloud. So cloud is ready for great use for data distribution. The cloud is ready for most applications that are not highly latency sensitive. Clearing is not latency sensitive. So when we close the acquisition of ErisX, they have a clearing platform. It already runs on AWS. That works great there. Matching of buyers and sellers, the cloud is not quite ready yet. Will it be there? Eventually someday it might be, and we're analyzing that ourselves. But right now, the precision around latencies is nanoseconds, single-digit nanoseconds, which involves cable links within a very, very tight precision. That's hard to do in the cloud today. That requires a lot of investment, a lot of local zoning by these cloud providers. And if they want to do that and if our customers -- I'll bring it back to the customer. If our customers, who have invested hundreds of millions of dollars in different data centers around the world want us, the exchange provider, to move our platforms into the cloud, we'll be there. But if they don't want to, we're not going to force them to go there just so we can do a press release.

Makes sense. I think we have time for maybe a question from the audience, if anybody has one. I don't see any hands up. We're more or less at the end of the allotted time, but we do have a breakout session downstairs.

Awesome. Great.

So we'll wrap it up, up here. Thank you very much.

Thank you.

Thank you so much. Thank you.

Thanks for being here. Thank you.