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

Great. Okay. Thanks, everybody, for joining us for our next session. I'd like to welcome management team from Cboe. With us today are Fred Tomczyk, CEO; Dave Howson, President; and Jill Griebenow, CFO and CAO. Cboe remains one of the fastest-growing exchanges in the space, powered by its proprietary index options, complex as well as its robust data and access revenues. After taking over as CEO, just this September, Fred and his team remain focused on driving the firm's profitable organic growth, improving margins and being more selective when it comes to capital deployment. So we'll get to talk to you guys about all of this. So looking forward to it. Thank you for being here. Why don't we get started?

Look, Fred, so first question for you. I kind of want to go back to the sort of top of the highest priorities that you outlined on the last earnings call, which was sharpened strategic focus, allocate capital more effectively, develop management succession. So all makes sense. So why don't we double click on a couple of those? Let's start with strategic focus. Cboe has several pretty well-established and scaled products across both cash and derivative markets, but also kind of a handful of new or maybe less profitable initiatives. So what are the key areas you expect to continue to invest behind versus what are some things that you're likely to deemphasize?

Well, just to stand back, I mean, I have been on the Board for 4 years, so I'm not coming in totally green. And so I've watched the company evolve over the years. And I've always -- I was at -- and about -- the strategy was too broad. It needed to be tightened up to provide greater focus and clarity in the organization into the Street. So now that I'm the CEO, I'm going to do that. So I kind of ignored my advice when I was a director. But when you sharpen that strategic focus and where we're going to focus now, it seems to me that now that we've built this global securities platform, and we've now converted all but Canada onto the Cboe technology platform. So we have one global securities platform. That's a tremendous advantage. So we should stand back now and say, as a management team, what do we do now? Now that we've gone through the pain of building all that and the expense of doing that, then basically, where should we focus our time and attention? And when you think about that, the way I start with my process, we're going to go through that with the management team. But in the cash equities markets, I mean, we've got that presence in each of those markets. That's -- we make a lot of money at it, but at the same time, it's not a high-growth business. And it has its ups and downs, and it's a bit of a hand-to-hand contact business. But on top of that, now that we've got it, we have lots of opportunities in the Data and Access Solutions business. I do believe that technology and data is a secular trend that basically is worth investing into. All the clients that I talked to, particularly the bigger ones, would say, Fred, it's about we want to -- we're with you in these markets that you've gone into. We haven't gotten into one where we don't have at least 1, if not 2, big clients that are there saying, we think there's lots of opportunity there for you. And I'd say -- they always say it's about technology. It's about access. It's about data. So that will be an investment area for sure. Secondly, we obviously -- we're known for derivatives, and in particular, we're known for our index options. And we do quite well financially on our index options. So how do we roll up in each of these countries that we're now in? And once you've got the cash equities business, you've got the Data and Access Solutions business, now you roll up into Derivatives, that may mean different things in different markets. That's something the management team and I need to work through. But obviously, when I go out to those markets and talk to people, they always say liquidity is moving to the U.S. So that's perfect for us because we can bring the U.S. securities network and our index options to those markets. And that's easier for us to do now that we have this global securities platform that cost us a lot less to take it out through the world. So those 2 areas will be a focus. I think everybody today asked about Digital. The reality is, yes, we bought that at the wrong time. We could have bought it 6 months later. It would have been a lot less expensive. But having said that, and we've had all of a follow-up here from the industry, but everyone I've talked to would just say, there is still an asset class that people are interested in. That's not going to grow the way we thought it might have grown, but it is an asset class people are interested in. And everybody I talked to would basically say, what we need in that asset class is a trusted, transparent and liquid market, which is really the reason we bought it, was to bring that to that asset class. And so I think on that one, yes, it's an earnings drag right now, but I think we ought to give it some time to look through. We're going to introduce margin futures early in the new year. We'll look to some more things on the Derivatives side for that space. I do think you'll see a Bitcoin ETF, which will bring more liquidity into that asset class. But if we can bring our network in that transparent, robust and sort of liquid way that is trusted, then I do think you'll see more interest come into that asset class. So I think we have to give it some time to see if we can make that work because it's clearly -- it's something unique that we've got.

Yes. Well -- and you already have it, to your point. Jill, why don't we talk a little bit about expenses? So that's another kind of key strategic pillar. And really building on the strategic sharpening focus, I would love to kind of get your perspective on what does it mean for trajectory for the firm's margins and expenses perhaps into 2024? But also, as you think about the building blocks, you talked about kind of core expense growth 8 to 9 and then growth investments, 3 to 4. That's kind of what it's been over the last 2 years. Is that still the framework or there is room to dial down on both of those things?

Yes. I guess I'll start by saying that we won't be sharing 2024 expense guidance until early February. But to your point, we have seen the past several years marked with double-digit percentage-wise growth rate. And really, that's been a function largely of the acquisitions and integrations that we've done that with those have come increased costs. As Fred talked about, we really have laid a nice foundation. A lot of that infrastructure is built, whereas when we look to 2024, really looking to stabilize the margin. So the way we'll go about stabilizing margin is, one, to moderate the expense growth. So again, given we don't have any large acquisitions, integrations looming, it's fair to expect that you wouldn't see the high double-digit percentage growth rate that we've seen in the past. And then we'll also still be focused on the top line revenue growth. The combination of those 2 factors, again, striving to really stabilize that margin.

Got it. Great. Why don't we get into some of the specific product? Dave, on to you for the next couple of these questions. Not surprisingly, let's start with SPX and 0DTE. It was topic du jour really all year. And I think you guys continue to surprise the market with the volumes that product suite has been delivering. Lots of discussion about who is the customer. Where is it coming from? And I feel us and you guys kind of learned more along the way, but talk a little bit about how the customer base has evolved and your kind of confidence level that you can continue to build off of this robust base that you've established in 0DTEs.

Yes. Certainly, with Q3, seeing an average ADV of 2.9 million contracts a day, they are really great, great progress. So since introducing the Tuesday and Thursday expiration in Q2 of last year, we've seen that ecosystem evolve and really create what we think is a brand-new ecosystem, intraday risk, that trading capability there, sucking some OTC flows on exchange and also those retail brokerage platforms, those end users that are really finding great utility in the precision and flexibility. Since the start, we've been looking at that 90-plus percent that comes from those retail brokerage platforms and trying to define who the origin of that order is. And obviously, as you say, we don't see all way through to the origin of the order, but we have a few calculations and heuristics we've put on to the data that we have knowing the origin of the platform that sends the order. And we've kept that constant over time. And about this time last year, we saw nonretail being around about 55%. So nonretail usage, 55%. That includes institutional, [indiscernible] and the like. Fast forward to this year, we're seeing that growth -- that grew to about 65%, but that's not in the absence of growth on the retail side. Retail has also grown, but institutional has outclipped that in terms of growth rate. And that's really borne out. The lead indicators we talked about last year was institutional customers looking at data, looking at open and closed data set that they're able to get from Cboe now and really train and look at their models. And what we've seen in the feedback from customers is that more strategies and more funds are now deploying capital into a short-dated options strategy. So that growth has been really sustained and sustainable. And we get asked about the sustainability of what we see there. And we've looked at it from a number of lenses, but really the baseline if you take a further step back is just look at the market cycle in vol regime over the last 18 months, SPX down 20%, revolving 20 to 30 in 2022. This year, SPX up, down, up, vol down at 15. So different market cycles, different vol regimes that the utility that customers are gaining from that trading capability and that exposure has really persisted throughout that period.

I got you. Let's talk a little bit about some of the other products. XSP is the another one that, I think, generates a decent amount of interest. There's not a ton of volume as of yet in that product, but the addressable market and the opportunity set seems to be pretty substantial. Talk to us maybe a little bit around how you view the addressable market for that product. What are some milestones we need to hit for us to actually start to see a bigger contribution from this contract?

Yes. And just to level set there, the XSP product is the 1/10 size contract of the SPX -- traditional larger SPX contract. It's the same size as the SPY. So think about the use cases and exposure and the wallet size that might trade this instrument. You can think about the SPY user base there. If you look at quarter-to-date, XSP versus last year quarter-to-date, volumes are up 30%, as you say, from a low base but still growing and showing the early fruits of liquidity schemes we're putting in place as well as the joint marketing schemes that we've got deployed and deploying out into next year. We're partnering with customers like Robinhood as they look towards introducing cash-settled index options in the middle of next year as we understand it. And that's the 10 million active users on a monthly basis that particular online retail broker seats. The interesting thing about XSP is it's a cash-settled index option. It's got a European exercise. There's no chance of early exercise or assignment. And then you've got the potentiality for 60-40 capital gains treatment. And when you combine all of those attendant benefits with the expected approval, we hope to see an approval from the SEC of the protected options filing, which will allow margin offsets between an XSP-type index product and the ETF itself. We see a great opportunity there for overwriting strategies for example. And when you look -- we look to try and size what is the overwriting market that might be more beneficially deployed in an XSP product where you're not going to have capital gain event, you're not going to have the underlying stock called away from you. We look at the sell call to open percentages in SPY that we see today. We see about 7% to 10% of SPY ETF options volume being sell call to open. So think about it in those terms is a substantial amount, just on the overwriting capability itself, let alone the attendant benefits of the index options contract, the fact that it's trading only in one place at Cboe, and you can trade it 24 hours a day.

How big of a catalyst do you think the margin approval is ultimately going to be? I know it's been kind of lingering for a little while. And I guess, a, any idea on timing? And then how material do you think is that in terms of the use case for folks?

It's not the single and sole catalyst. It's an additional accoutrement that allows you for that capitally efficient deployment for the 102 level options trade to avail themselves of. In the meantime, it's got great scope and scale for it in itself. The next stage of the SEC, I think, comes on the end of January, January 27. A comment period on that has lapsed, no substantial comments. So looking forward to hearing what we'll hear in January.

Yes. Okay. Great. Let's talk a little bit about innovation in the proprietary product suite. And we've seen Cboe expand the utility of both SPX and VIX products over the years, whether it's the dailies, the weeklies, the global trading hours, et cetera. What else is in the lab? What else can you think really expand the utility function of these proprietary products through additional innovation?

Yes. Whatever we do is always customer-led. We always talk to our customers about what exposures they would like to have and how they would like to deploy that capital more efficiently, what challenges they're facing. We look at how we can bring sophisticated or potentially OTC trading interactions and bring them into a listed, standardized, tradable, cleared environment. And the most recent example is the Dispersion Index we launched in September of this year, really simplifying and distilling down to a single number, what is a high maintenance, highly sophisticated strategy that's challenging to deploy. To be able to have that index now published allows our customers to investigate how they might use it in a live tradable product, which we hope to bring to market in the form of an index future later on in 2024. So that's a great example of building on top of the S&P 500 Index options liquidity pool that we already have. It's about bringing incremental transparency to the marketplace. So you can tell what's going on underneath the service of a low VIX. Actually, there's really high dispersion right now, signals that actually there's opportunity for active management. But actually, it also signals -- it shows an evidence of that sector rotation we're -- going on right now. So it brings transparency further to what's going on underneath the service, and then you can trade up. You can trade it in 2024.

How do you think clients and customers will treat this new product potentially against what's already available, which is obviously the -- in Mini futures on CME?

It's a trading strategy deployed to really take advantage of the pricing differences between single names versus the index itself. So it doesn't really have a direct read across to any Mini that particularly.

I got you. Okay. Talk about the cash products a little bit. Fred, you mentioned it's a fairly mature part of the business where you guys. Very profitable and scalable when the volumes are there. But as we all know, pretty competitive. You guys have done a great job getting all of your markets on a single platform, really creating kind of a global ecosystem around cash equities. What are some of the other organic growth initiatives you see across the cash equity market? Is it getting Canada on the same platform? Is that kind of the next big step? Or anything else that could generate organic growth in this business?

Yes. Certainly, that uniform technology platform is a real differentiator for that single uniform access, the uniform way in which you interact with our markets and the way that you ingest data is really critical to us. Getting Canada onto the platform is certainly an important focus for us. And the beauty of the single technology platform, including the attendant benefits of being able to package and bundle the data that comes from those 27 markets around the world, is that we can lift and shift functionality and capability with a low effort on our part but a low effort also on our customers' part. So there, think about periodic auctions. We launched periodic auctions around MiFID II. It got to be about 5% of the European market. We've got 78% of that 5%. We've brought it to the United States and launched it in the United States. We could do that in Australia, Japan and Canada as well if the market was amenable to it. Low lift for us, but importantly, a low lift for our customers, who can then go to their own buy-side customers and introduce new capability to them with a low-friction effort. So that core uniform platform has a variety of low incremental cost and effort, gross benefits to it as we think on a go-forward basis.

I got you. Let's shift gears a little bit to access and data of -- Data and Access Services. That's actually an area where you said you would like to continue to invest more as the demand there continues to be pretty good. And the growth, to be fair, is also there. You see it in your results. 7% to 10% growth in 2023, in line with your kind of medium-term targets. Notably, I think you said half of the growth continues to come from new subscriptions and incremental units, which obviously is very important. But you also benefited from the first kind of pricing increase that you've done in this business, I think, in over 5 years. How do you think about the building blocks for growth from here? Is there room for additional pricing increases or to remain in this kind of 7% to 10% range will really have to come from new sales?

Yes. The 7% to 10% medium-term goal, we remain comfortable with that. In terms of the growth algo and how we think about things, it's certainly continue to package and bundle that data from those 27 venues that we have and actually get that deployed, the access broadened out for customers around the world. Q3 growth in D&A was 39% from outside the Americas. And we think we've got a good runway. So that's our focus, is getting our data to more customers. 78% of the customers that take data from the cloud are international as well. So we've got a great growth trajectory there. So pricing for us is something we look at where if we've drifted a call into the competitive landscape or whether it's unextracted value, but it's not a strategy for us. It's not a growth strategy in its own right for us. We've grown from pricing constituting around about 20% of growth at this earlier part of this year and last year to really go forward. We think about 1/3 of our growth is probably going to come from pricing. And as you say, there are less frequent kind of catch-up pricing moves that we think about there.

I got you. I got you. What about pricing with the rest of the business, right? So when we think about the competitive advantage you guys have created in a number of proprietary products, arguably, there is pricing power. Have you sort of tested the market on your ability to raise prices there without impacting volumes and kind of how you think about the pricing dynamics in the trading businesses?

Yes. And similarly there, if we think about the products to start with, pricing is not a growth strategy for us at this point. We think there's a really great runway still in terms of new -- accessing new users, and there's new users finding new use cases for what is a phenomenal liquidity pool we've got there with that volatility complex. I talk it -- remember, it's SPX options, VIX options, VIX futures with more products to come. We think there's more use cases and more users to be addressed. And that's really our short -- our medium-term focus, is to really grow that price without that incremental pricing be a core element of that strategy. We do adjust prices in the complex where there's an underappreciated value in certain corners and functionality sets because we have a deep and rich functionality set between below the surface there on the platform. We do adjust pricing, but it's not the core strategy. It's about the new user. It's about the increased distribution for us in the proprietary products. Multi-list products is about optimizing capture share and revenue and those SIP revenues that come with the market share.

Yes, I got you. Okay. Great. Let's talk about capital allocations. Fred, maybe we'll pivot back to you for a minute. You talked about allocating capital more effectively. And it sounds like acquisitions are not super high on the priority list. But are they on the list at all? Are there things that might be still interesting inorganically? And on the flip side, are there things you'd be willing to part with? And is there room for divestitures?

So there's a few questions there. So I mean obviously, when you look back at how we've allocated capital the last 3 years, there's been a fair bit to go to M&A. We've done a number of transactions, mostly smaller. And so I think my message is we've done a lot of them. When you're on the Board, you continue to say when you do these small acquisitions, the integration work is bigger than you think. And so I think that's turned out to be true that they took more work than we thought. And so I think the organization has a bit of an integration fatigue. So that weighs into your thinking, and you want to call us back around what you've built. But when you're running a business that has 65% EBITDA margins and there's no real -- it's a capital-light business model, so you don't have a lot of need for the capital to fund the balance sheet or anything that I think it's important and prudent to spend attention to how you're allocating that. So obviously, we're going to have a dividend. Obviously, we'll look at share buybacks on an opportune basis. I think given that we've built this geographic platform now, it's time for us to redouble down on an organic strategy that builds off that and leverages off the platform we built and the capabilities that we've got. So that's, again, going to go back to data and access and derivatives, which is our sweet spot. So we're going to see more of that. The M&A will be brought down. That doesn't mean there's no M&A. So I want to be clear about that, but we'll be much more deliberate that we work through as a team about our strategy that's laid out an organic growth strategy and where does the inorganic fit and why. There's going to be perhaps scale acquisition, which would be getting a bigger share in a certain market, which will be about cost synergies, maybe some new synergies. And then I think about the second category, which is about capabilities. And now that you've got this global platform, you just got more distribution to -- you can buy an interesting capability. We can scale it into the market. And that's something we focus on. So I think about it that way. So there'll be less M&A, but it will be more deliberate and thoughtful and to fill in behind the organic strategy. Is there anything we're planning to divest on? Not right now. I think we're very focused on putting our strategy together with the management team to optimize what we've got. Obviously, people ask me about Digital. We've talked about that earlier. I think we've got to give it a chance to see if we could make it what we thought it was. And again, it's trading at 41,000 again. And so it got there quickly. So -- but I think there is interest in it, and they're interested in what we're trying to do with it. So we can bring liquidity to that. Then I think maybe we can make something out of it.

Great. Jill, maybe just to build on that with respect to capital allocation. That's not obviously M&A-related. I would love to just get your perspective on kind of use of cash flow. I mean obviously, high-margin business. Balance sheet is delevered naturally quite well over the last couple of years. So the preference towards additional day paydowns versus dividend growth versus repurchases. And I really do want to click on -- double-click on share repurchase here where in the past, it's been a little bit more episodic. So is there desire to make it a little more systematic and sort of less opportunistic and just part of the overall ongoing capital return framework?

I think I'll start by saying our leverage ratio was 1.3x as of September 30. So again, really do enjoy the balance sheet flexibility that we do have. To your point, we have been more opportunistic in the past when it comes to share repurchases. I would say for the foreseeable future, likely a little bit more opportunistic. And then as it relates to the dividend rate, we do have a history of increasing that rate, typically do it in the third quarter of each year. Again, I would anticipate that, that practice would continue. But really, the balance sheet flexibility that we have is a good position to be in. We've touched on the organic growth initiatives. Dave commented on periodic auctions being a success story that came out a few years ago. Having just those small pockets of capital, being able to deploy those and reinvest it in the business, they can, in turn, then generate net revenue for years to come. That's really what I'm looking forward to. But then also to Fred's point, it's -- if we do some M&A, it may be something very, very deliberate, very targeted. And it's good to have some dry powder on hand to put towards something like that. So again, multiple uses for how we'll deploy the capital, but really enjoying the balance sheet flexibility we have right now.

Got it. And when you say opportunistic when it comes to share buybacks, should I think of that as on the pullback? So share price does not reflect the growth, and that's where you kind of step it up or opportunistically, you'll just do actually more in the next several quarters or years than you did in the past?

I think if you look at our past few years on a quarterly basis of when we've been more active in the share repurchase market than others, it's typically towards the front half of the year. So again, if there's a buying opportunity and we will be opportunistic, we will go in. Otherwise, I would again expect it to kind of tally with how the quarters that we've been a little bit more active as we have in the past, but something that we're definitely monitoring.

I got you. Okay. That makes sense. Okay. I want to hit on 1 or 2 new initiatives. Not sure if we have time for 2, so at least one. I do want to go back, Dave, to you and talk about Cboe Europe. Lots of questions on this as well. You guys made a pretty big push into the derivative expansion in that market with an upcoming launch, I guess, of single stock options in the first quarter of 2024. I guess based on the commitments you're getting from various market participants, what are your expectations for perhaps revenue contribution from this business into '24? And sort of what kind of measurable progress do you need to see to continue to sort of move ahead with further investments in this venture?

Yes, absolutely. This is a good example of an organic investment really when you think about the existing footprint we have in Europe, largest cash equities exchange, largest cash equities clearinghouse to build on top of that existing infrastructure and capability with a marginal incremental effort for us from a cost basis. The team that have deployed it is a very big effort to go into equity derivatives, of course. But in terms of the dollar amount, it was incremental in terms of size. For us, the key elements and when we assess any of the new initiatives, we look at the value proposition. We look at the customer demand and engagement and the core elements. And we assess those over time to make sure that they persist, and then we measure certain KPIs as we go along. So for us, a rounded offering in European derivatives needed to have single stock options as well as those index options and futures. We've got that now technically, and we see our liquidity provision schemes kicking in throughout Q1. And the readiness of those customers that we put out in a press release there showing really good solid breadth of the marketplace, that from retail brokerage platforms and liquidity providers to banks, really being engaged there. We see that coming through into and through Q1. And the same as the rest of the brand-new markets we look at. We look at spreads on screen. We look at trading levels. We look at OI as we see that progress and develop throughout the year. And we continue to listen to our customers as we go to make sure that we remain on track, and we can assess what we do as we go through 2024. So 2024 really is the year where we'll begin to measure the early trajectory there as we kind of get version 1.0 instantiated.

Great. Well, I think we have a couple of minutes left. If anybody has any questions in the audience, just raise your hand, we'll get a mic to come around. All right. No questions.

One of the benefits of being late in the day.

Well, perhaps, but you guys get a couple of minutes back. So thank you very much for your time. I appreciate you guys being here.

Thanks, Alex.

Thank you.