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

We can go ahead and get started. I'm Patrick O'Shaughnessy, Capital Markets Technology Analyst at Raymond James. Thank you, everybody, for joining us today. Kicking off the day from me, we have Cboe. On Cboe's behalf, we have CEO, Ed Tilly; and we have Dave Howson, President. Guys, thanks for showing up.

Great to be here. Thank you.

So for those in the room who are maybe a little bit less familiar with Cboe, can you maybe just give a 1- or 2-minute overview of how you think of the company?

Sure. At the highest level, we are a global exchange operator. We operate 26 exchanges around the globe. We are in very competitive environments. Any geography that is open for competition is interesting to Cboe. We primarily and usually start in Delta One or equities, and we move up in sophistication into derivatives and clearing and most recently, digital. We do all this with a common technology platform that runs all of our exchanges and various stages of technology migration in our newest acquisitions, but our goal is to operate trusted regulated markets around the globe. And then as a result, we're able to take advantage of those presence with data and access and analytics. And looking at a unique product set that the world is interested in, we are trading the S&P 500 SPX contract here in the U.S. as well as the VIX franchise globally. So that is primarily at the highest level what Cboe is all about.

Terrific. Thank you. What do you think Cboe does better than any other company?

Let me start, David, and you jump in. I think the uniqueness of what we bring to the marketplace is running a common technology platform. So our acquisitions and the presence that we have around the globe, the advantage for us and our customers is knowing how Cboe operates. And that is a huge advantage in a market that has operators that are not always the same, don't always hold regulation in the highest regard. Our trusted operations, really the core to that is a common technology platform, but many other ideas.

And absolutely, and what differentiates us from our peer group is that global securities and derivatives network. We're in every equities market open to competition now, a common technology platform, the data generated from those 26 markets really opens up a myriad of opportunity from data packaging and bundling and delivery by the cloud and also data and analytics capabilities that we can then deploy back to our customers to provide pre-and post trade capabilities. And as we look at the blueprints from around the world, as we've grown on top of that global stack, we can think about how we take that from one region into other regions as we grow out the capability. So really, it's an unrivaled growth trajectory that we've got spanning from that baseline foundation.

And I think the other difference is challenging incumbents around the globe, we have become very, very good listeners. We take advantage of the gaps that investors see around the globe by product and by operation. So listening is one of the keys to our success. It allows us to develop new technologies and new solutions, both product and technology.

And so building off of that point, how does that competitive advantage manifests itself in your strategy and in particular, some of your new product initiatives and acquisitions?

Certainly, when you think about -- I mentioned the blueprint there for growth. So with that global footprint that we have, a little bit of a look back in terms of Europe. And we talk to our investors significantly about the flywheel effect of our businesses that the preview just by going from the cash through the data businesses into derivatives in each region. So in Europe, we started with a single venue, matching buyers and sellers in the central limit order book. And then we combined a variety of organic and M&A initiatives together to grow our footprint there. So we acquired and gain scale in Europe with a second acquisition in Europe. And then from there, we listen to our customers and work with them to add new functionalities and products and services. So we added the BIDS network. We added a periodic auctions in response to regulatory change, all in conjunction with our customers and added data capabilities, taking us to be the largest pan-European stock exchange in Europe through the combination of those initiatives. And then from there, we were able to acquire EuroCCP now Cboe play in Europe, and that allowed us to then step into derivatives in terms of futures and options based off our own indices, based off our own data from our -- the largest pan-European equity exchange operated by Cboe. So that allowed us to step up through that value added. So as we think about that playbook, if you like, that blueprint, we were then able to think about that in other regions around the world where we've now gained scale through organic and M&A initiatives combined.

So you've mentioned a handful of different growth initiatives underway right now. Of those, what are you most excited about, both in terms of the long-term revenue potential as well as your ability to be disruptive?

I'll stick with product. I think the product -- either the continuation or identifying new products, again, it comes from listening to our customers and then observing the data. And I think you'll probably get to questions on the greatest growth that we've seen in quite some time is an extension of the S&P 500 contract, and that is adding daily expiries as well as extending the clock, meaning trading 24 hours a day. So I'd see the potential in the adoption of being able to control an investor's ability to define the outcome of their investments, not married to what has been the standard for years and years in the industry of a 3rd Friday or 30-day exposure, but now down to the day. So we're in the business of watching the customers adapt and embrace the flexibility that we design around our contracts. And that includes then also being mindful of different wallet. Everybody in the room has a different wallet size. Our contracts have to take that into account and dividing and looking and parsing this monster S&P 500 contract [indiscernible] is notional down into bite-size contracts for every wallet. Every investor should have access to the U.S. market. We believe that, that is a program and a view that we can expand, extend in other geographies.

I would take there 2 more, and -- we've got derivatives and we've got data and access solutions. So the data generated by the 26 exchanges around the world is phenomenal, in its own right, of great interest to our customers. But then we're able to package and bundle that in different ways. So we've got our Cboe One family of products with Cboe One Canada, Cboe One U.S. equities and most recently, Cboe One options. So we're able to take that data, package in ways that customers want to receive it and deliver it in a manner in which they want to receive it over the cloud. And we've seen phenomenal growth last year with 72% of the uptake in cloud usage last year from brand-new users. Also in data and access solutions, there's the indices capability that we've got. We've seen and heard a lot about defined outcome investing in the last year, and we've really been the home of the defined outcome index benchmark calculation. And then when we think back to the flywheel is that many of those products have been listed on Cboe exchanges. You have the data -- generates the data for the data product then for the tradable products or trading back on top of Cboe's platform.

So I kind of kick this off and thanks for showing up and a little bit facetious, but I've been a little bit critical to you guys in some of my research of late. And one of the themes in my research was what if you guys had said, "Hey, we're just going to be a cash cow. We're going to milk our SPX franchise. We're going to milk the big franchise. We're not going to invest in European revives. We're not going to invest in global listings and some of these other things. And your EPS trajectory may have looked better, at least in the near term. How do you guys think about the trade-off between, hey, you've got a great core franchise, there's great inherent leverage in that versus investing in some of these initiatives to drive better long-term outcomes for investors?

Well, we obviously, I think you're wrong, which is great. [indiscernible] defensive opinion. But I think you're not wrong in that the opportunity is pretty terrific, and we see that, too. So it really wasn't either or for us. So you don't see us going to sleep on what has been the most incredible growth that we've seen is that, that is the continuation, the expansion of the core of proprietary product set. But it's not instead of, it's [indiscernible]. And we see the opportunity to bring to the world a competitive and dynamic and highly regulated platform where our customers know us. When you see Cboe operating in a market even before technology migration. We've got 2 migrations happening this year, one in about a month in Australia and one at the end of the year in Japan, and that is moving our technology into the region. Before that, market share in Japan doubled and market share in Australia is up. The adoption -- and when we see Cboe coming to the marketplace, we think the opportunity is just beginning. So we're preparing for and getting -- and putting our investors in a position so the growth of the years to come, doesn't rely just on the phenomenal growth that we've had over the last [ 2, 10, 30, ] but rather than we're priming in every geography that allows for competition in the future.

But certainly growth initiatives do take time to seize. So it's not a short-term earnings call to earnings call process. It's a long-term sustained diverse set of opportunities that we have a high conviction for. We've looked at this. We've talked to our customers. And also when we look back on the common technology stack, we can enter and execute on these initiatives with a lower incremental investment when you think about European derivatives. We already have the largest European equity stock exchange, all of the framework there. We had the technology capability, the functionality in the largest options market in the U.S., which we're able to easily bring into Europe. So we're able to execute these things with a lower marginal incremental effort in order that when these platforms and these initiatives get to seed, the growth path and the margin is much more attractive to us. So think [indiscernible].

Got it. So we touched on SPX options a little bit. Volumes have been on a tremendous tear here. Much of the growth has come from 0 day to exploration contracts, which are now roughly half of your SPX volumes. Obviously, pretty notable trend. Zero hedge is right in about it. Everybody is writing about it these days, CNBC is talking about it. What are you hearing as a primary use cases of zero data exploration contracts? And how does that inform your view on whether volumes are sustainable or not?

I think they're sustainable in that -- we go back to defining the outcome of an investment and the sustainability comes around the multi-leg strategy and the liquidity that is found in our case, in SPX contracts that are zero day. Zero day has been around for 50 years in April since Cboe opened its stores in '73. The 3rd Friday actually traded like a zero day once a month from there in 2005, we added Weeklys. So we've had zeros around per bit and the adoption we have been calling out over probably 2 years on our quarterly call was that the move has been into very short dated, very low premium exposure. And that is to take advantage of daily moves. All of us are more certain about what's going to happen tomorrow in any aspect of our lives, what's going to happen in 30 days, 60 days or 90 days. That is not different than the U.S. market. So why not offer a contract that allows us all to take advantage of where we're most certain and that is on the shorter end of the curve. And investors are finding great use case in having an opinion that can be different tomorrow than it was today. And the cash settled nature of that exposure in the S&P 500 for us and SPX means, at the end of the day, there's no physical to deliver or to be taken from you. The position is over. It's settled in cash, and there's an absolute to it. So for example, in physically settled contracts, at the end of the day you're either given more of the underlying or take an underlying fund of you. And cash settlement is simple over. You can have a new opinion tomorrow that doesn't have the tail of a physical settlement. That has resonated really, really well with investors. We think it's sustainable in that -- defining that outcome, limiting the exposure to the downside, but allowing a capped exposure to the upside is a strategy that is available and we think, ready to grow. Reminder, the dailies have been in the aspects since May. We haven't had a year cycle yet. So we love the adoption, started primarily on 2 retail broker platforms and has now grown to higher touch bank desks that are finding the same use case, but in a little larger exposure now. So we've loved the adoption so far. We think back to the wallet side, we talked about a little earlier, XSP, which is 1/10 the size of SPX. We think there's a great case for the wallet that is maybe one 1/10 of size of the users we've seen. So we're going to put a lot of effort and invest in the exposure and marketing around XSP as an alternative for those that may not be ready towards the large notional SPX.

And building off of that commentary on retail, it's not just SPX options, it's -- or XSP. It's also multiple elicit options volumes have been particularly strong. And I think a lot of that coincided with the advent of no commission trading, emergence of retail trading platforms that were geared at a younger demographic. Where do you think retail volumes in general go from here?

When you make a conversion from Delta One and you were taught or you put the time in to learn about derivatives, changing the profit and loss from a 45-degree line and being able to define and limit risk and therefore also eliminate the upside. There's great sustainability in that. Once you make the move from Delta One, into derivatives, we tend not to lose that, tends to be more sticky. And you'll hear that you cover retail platforms. That is the most informed customer. These are not people taking shots anymore and saying, "Gosh, I'm going to buy a bunch of calls, and I hope something is going to happen. This is really educated stuff. I've got a core position. I'm going to overwrite calls. I've got a core position. I want to protect that downside and stay long. I'm not in the position yet, I'm going to enter it with a short put. These are the first level of adoptions that we see in [ derivs ] and we tend not to lose those customers. So we like the trajectory and I like the story and I think there's much more through education and growth.

Another trend that I've seen written about by people much smarter than me is that growth in options volumes can result in the tail wag in a dog in terms of options market maker hedging impact in the underlying cash markets? Do you think there's a risk of options volumes becoming too large for the underlying cash market to efficiently handle?

Not in the -- I'd say take the top 100 multi-list and certainly not -- I don't see that the S&P 500. You can pick -- we can give an example of probably liquidity constrained 1,000 of liquid stack, it might be a different. But I don't -- I can't model it right now. I can't give you an example of one that will see constrained because of derivatives. Market makers kind of scale up and scale down based on their ability to hedge, market makers also don't have concentration in their hedge. Not every liquidity provider will hedge the exact same way, take zeros, for example. We see all of the zero-day, there's a dispersion among the strikes. There's not a concentration of risk. So there's not a concentration issue. So a market maker who is hedging your daily today will be different than Brian's daily, and they will hedge either with a different strike of the same day or any number of days going out across the curve. So liquidity providers are very, very good at laying off risk and rarely do we see that concentrated. Now the gamma hedging that we see as a result of either long or short -- net long or short premium probably shows up a little bit more around the moment of expiry in physical when there's physical to deal with after expiry.

Got it. Interesting. What should investors make of your VIX franchise at this point? VIX futures ADV as still well off the 2018 highs and VIX options ADV peaked in 2017. Has a secular growth story run its course? Or are there reasons to believe that trader adoption of these contracts is going to reaccelerate at some point?

Well, we have seen acceleration in VIX options are coming back in a pretty big way from the last year or so. Volatility is pretty low. So the purpose of having VIX as a hedge, and that is really looking for larger moves in the market that are not strike-specific hedging. So what we mean by that? The at-the-money VIX call trades the same if the level of the S&P 500 is 4,000, 3,000 or 5,000. So non-strike specific hedging of the broad market is really well served with VIX in any environment. So we see a return to VIX options because we're relatively inexpensive for those [indiscernible] that are a little larger than just the daily. As for any moment in time, there is a normal rotation in and out of S&P 500 SPX and/or VIX based on your assumption of what the market is going to do over the next day 30, 60 or 90. And we've seen, right now, realized volatility daily, very, very high that aims the ability to monetize an S&P 500 hedge, it's easier than it is to monetize the VIX hedge. And in this environment, that's very, very friendly for SPX, and in an environment where that realized inverts or spreads, I would anticipate a normal rotation back into VIX. Users are very, very sophisticated. They find what makes the most sense based on their assumption that has [indiscernible].

Got you. Dave, you brought up data and access revenues a handful of times, been a really nice growth story for Cboe and not just in options. How does that growth break down between pricing versus usage? And is increased usage simply function at higher market volumes? Or are there other drivers going on there?

Certainly, if you look back last year, 80% of the growth came from new units and new subscriptions to our data. So predominantly the growth is really about taking more from us. And that is really spread across products. And as I mentioned earlier, we've got those 26 markets generating a humungous amount of data, which we're able to package and strive in different ways for our customers. And when we think about where we're going with Cboe and that global network journey, we're actually seeing a great opportunity to sell our data around the rest of the world. And in numbers, that 62% of incremental growth for our data and risk management and analytics side of the business has come from outside of the U.S., and 38% in EMEA and 24% in the Asia Pacific region. So we see a great runway of data to sell all of our data and data products as we add new capabilities and new data to that stack. So really, our point in the evolution that we curve right now is adoption, is gaining new users. And as a lower price point data offering, that's really where we're looking to sit for some time because we think we've got a really tremendous runway for ourselves as we look to sell more of our data -- our raw data as well as those data products we talked about early.

Are these adopters of your data products typically already trading customers? Or are they getting the data first to develop their trading strategies, which then leads to more volume down the road?

It varies. I think that the same day option is a great example actually is people already in the SPX complex look to take new data strips and data offerings that we've got within the franchise, whether it be the in today open close position data that we've got available on a 15-minute basis. Now people become interested in using that data to then see actually how can I deploy my algorithms, how can I deploy my strategies. So oftentimes, the data and the analytics is the lead point to assess a venue. So being, again, a lower cost option there has tremendous, tremendous power. And then when you think about the analytics capability, we've added to our world-class options analytics suite and European data this year. So this allows us to upsell into the wallet of an existing customer as they begin to think about our European environment as well as the United States.

Got it. One of the nice things historically about the exchange business model is that the incremental margin profile is pretty attractive. Does that also apply to data and access fees? Are the incremental margins there roughly in the same ballpark as the transactional revenues?

I think of it as an ecosystem. When you look at that venue and everything that goes into building an exchange, the core matching engine, the connectivity and the data itself, it's very hard to tease upon kind of a margin calculation for trading versus data. But what I will say, of course, is that once you've got that ecosystem established and going, the kicker for us is the ability, as I managed to package those data products, deliver it the way consumers want to receive it over the cloud and then add value-add data solutions to it, whether it be the analytics at the pre and post trade or whether it be data products like derivative index benchmarks there. So the kicker for us is once you've got the data established and the venue established is really in the data products themselves and the distribution of that data and really back to the start, again, the differentiator for us is having that global network from which to subscribe and actually extend our capability.

Got you. On the capital allocation front, you -- the company indicated during its most recent earnings call that Cboe will likely pivot more towards share repurchases now that you're back to your target balance sheet leverage. Given the number of initiatives you currently have underway, should investors infer that you're not particularly inclined to pursue additional acquisitions at this time?

Let me one small clarifying point. We don't really have a target leverage. We -- Brian has worked us down and the Board, it's like having the flexibility in the balance sheet. So just as a point we didn't really target a leverage ratio. But the core of your question, we are -- there's nothing we need to do tomorrow or in the immediate future. Our eyes are always wide open for scale in the existing business lines or again, geographies that may open to competition. Using the advantage of this technology stack, you see us roll out and upgrade technology after M&A pretty quickly. So that flexibility allows us to have eyes wide open, but nothing that we have to do.

Got you. Well, that -- why don't we pivot and see if there's any questions in the room. All right. Still early. I don't see any hands at this point. Maybe one more for me then. Digital. We haven't really touched on that a whole lot. But can you just explain what is your digital asset strategy? How is that may be differentiated from the other initiatives that are out there? And what's the time frame that you're kind of looking to reach some rewards on this?

Let me start. David, you can jump in. So what we set out to do, and it was the direction that we were very, very transparent when we announced the purchase of ErisX and all the way through the building of the syndication of like-minded go long investors in Cboe Digital was that the customers' experience in a new asset class should not be different because the asset class is new, different or has different characteristics, rather the exchanges and the operators of those markets should still be in trusted operation business that means regulation. There should be transparency in bid-ask and not hidden fees like we see in some other digital platforms. And we were able to build a syndication of and we think the most retail friendly and the most sophisticated liquidity providers that share that vision that the customers' experience in the new asset class should be the same as they have in equities around the world and certainly for Cboe's derivatives. So with that, we set out to do just that. So we are highly regulated. We are very transparent. Our fees will be reflective of that impeditive nature and the view that our customers should have an experience that they're used to with that data, maybe where we are on rollout.

Yes, absolutely. So we're currently engaged in onboarding those 13 equity participation members, along with other new members. And as we've seen the outcome of that on board come through in the volumes and the spreads this year. So when we closed, we were doing about $20 million a day. And earlier this year, we're doing over $100 million a day. And the spreads also in the 2 top line tokens, the BTC and ETH were industry-leading spreads, 1 or 2 basis points wide. So you can see the impact as those customers come on board. And with any ecosystem, any liquidity pools that seeds and found, there will be ebbs and flows as new customers come on and the dynamic changes. So we'll be helping in managing the environment as we go through that. And then we're at the late stages of the margin futures application. And the great thing when and if that comes through is we're able to offer futures and spot on the same platform, which means that we'll be able to offer a collateral efficiencies, basis trading, all [ Merian ] again, of new functionality, which we will look with our customers to enhance and continue to grow as we build out. So really, from this year, expect from us that seeding of the platform and the beginning of that journey of a new traditionally focused digital asset platform.

So final to Dave's point, CFTC needs to improve our margin in the future.

Got it. Terrific. Well, I think that's a good spot to end. Thank you very much.

Thank you.

Appreciate it.