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

This is Craig Siegenthaler from Bank of America. And we have a crowded stage today, and we're lucky to be joined by 3 senior members of Cboe's leadership team. We have CEO, Fred Tomczyk; CFO, Jill Griebenow; and COO, Chris Isaacson. Before taking the reins as CEO last year, Fred was CEO of TD Ameritrade for almost a decade, and he's also been on Cboe's Board since 2019. Jill has been at Cboe since 2011 and was elevated to the CFO role late -- last year, which -- prior to which she was Chief Accounting Officer and also CFO of Cboe Europe. Chris has been COO -- in the COO role since 2019 and was previously Cboe's Chief Information Officer. Before that, he was a founding employee at Bats, which was acquired by Cboe in 2017. We also have Treasurer and Head of IR, Ken Hill, joining us here on the front row, too. So Fred and team, thank you all for joining us at the BofA Financial Services Conference. Cboe is a leading options in cash equities marketplace with a footprint across North America, Europe and Asia. It is also the exclusive home to the SPX options contract, which is one of America's fastest-growing financial products with volumes having doubled in just 3 years. Cboe is also the home of the VIX contracts, too. The company celebrated its 50th anniversary late last year. And during this period, it hit several key milestones. It was the first marketplace to trade options in 1973 and was the first to create options on the S&P 500 Index in 1983.

So maybe we could start with a little background. Fred, how are you enjoying the day-to-day responsibilities of being CEO again? It was my understanding that despite being on the Board, you were pseudo-retired. Maybe you found it a little boring. I'm curious.

Well, I don't know if it was boring because I just sit on 3 Boards. And I have a bunch of grandchildren. So they're all over in Naples right now, so this is a bit of a break from chasing a bunch of little kids around with runny nose and so. So actually, I'm enjoying it quite a bit. It's nice to get back into it. I see a lot of familiar faces wherever I go, whether it's in conferences like this, in investment banks. So it's been quite enjoyable actually.

Great. So in terms of strategy, I was curious on what you think the biggest changes from the former leadership was until now. And from my seat, it seems like there's a lot more focus on lowering expense growth, concentrating on fewer but higher-conviction themes. Maybe Jill have some to add on this too.

Yes, I think that's right. So when I was on the Board, I mean, the strategy used to come from the Board and I would always give my constructive feedback, which was it was too broad. So when you just say more asset classes, more geographies and you're doing as many M&A transactions as Cboe had done over the last 3 or 4 years. But the focus of the organization needed to be, a, more focused on making some choices and theme -- what you would call high-conviction themes, so areas we want to focus our scarce resources. That's the first. Second was to slow down all the M&A. It became a -- you faltered at the Board, but when you came in to management, you really felt that there was a bit of M&A fatigue. I don't mean the M&A, the deal, as much as the integration of all those assets and businesses. So we're just consuming a lot of technology resources. Chris led the effort. And now that I had built out this sort of global footprint, which I wouldn't call complete, but it's a good start, that it was time for the organization to take a breather, slow down the M&A. And it had grown expenses quite rapidly the last 3 years. It was time to moderate that and get back to an organic growth strategy with organic investments and organic growth and in technology, and get back to our roots of what we do and prove out that we can make this global securities and derivatives network really work. And with the technology all migrated now other than Canada, we can see now if we can push things out in different parts of the world and really leverage up the platform.

Great. I have a question for Jill. Given that Cboe beats its targets almost every year and the current midpoint of your guidance assumes modest negative operating leverage, can you help us with the conservatism that's actually built into your revenue and expense targets? My own estimates actually currently assume you'd beat both of them.

Thank you. And fair question, and I'm happy to be on this side of it, to be honest with you. But just to give some background, we did introduce the organic -- the net revenue growth range of 5% to 7% back in November of 2021. And we did that because at the time we did not feel we were getting fair credit from The Street community for the durability of the revenue that we consistently generated year after year. So again really wanted to target that 5% to 7% growth range on top of that. Our data and analytics business has consistently returned somewhere in the area of 7% to 10% net revenue growth each year. So that was the guidance that we introduced early here in 2024. Continue to stand behind it, though. We do see a very strong start to the year from an index options perspective. And to the extent that momentum continues over the course of the year, I'm happy to update guidance. But again, with what we introduced early in 2024, feel good with. From an expense perspective, as Fred alluded to and in your earlier question, we did have a few years that were marked with very, very high, elevated growth rates. But it was really a function of the various M&A integrations that we did. With that comes increased headcount, increased technology support services. But really, what that allowed us to do is layer footprint and foundation globally. We now have a good base in many geographies we weren't in previously. Now we are looking to really optimize and tap into that value while doing it at a 6% to 8% operating expense growth rate compared to the double digits that you saw in prior years.

So just a follow-up on that. Is it an important goal of Cboe now to improve its operating margin and demonstrate positive operating leverage in most years, not every year? And can you also do this while not impacting your strong revenue growth?

I think we're -- I'd say for 2024, we are absolutely looking to stabilize that operating margin. So again, few years marked with very high expense growth while we were laying that foundation. 2024 is really the year that we want to stabilize it and in time, potentially expand that. But very importantly, continuing to invest in the business from an expense perspective to be able to consistently grow that top line.

Yes. I mean I do think our revenue growth rate will moderate somewhat from what it's been in the last couple of years because it's been quite high. But it will still grow. And we're continuing to make investments in that. But we want that operating leverage. If you get the revenue growth up in the upper single digits, it's much easier to have operating leverage than when it's down in the low single digits. And so we're trying to keep the revenue growth up, sort of stabilize that margin and then start to slowly increase it.

Great. Let's move on to capital return. Cboe has the lowest amount of financial leverage in my exchange coverage. Should we see more buybacks?

Yes. Another fair question. We ended the year '23 with a leverage ratio of 1.2x, which is very, very comfortable. We like the positioning of our balance sheet at the moment. What that allows us to do now that we've paid off all of our floating rate debt is effectively redeploy our capital elsewhere. So we have a history of paying a quarterly dividend in the past. We've increased that during the third quarter. We'll definitely reevaluate that again this year. But then to your point, share repurchases are definitely on the docket. We have a history of being heavier with those during the first quarter each year. And then we'll definitely be opportunistic to the extent that we sense any weakness in the share price, we'd absolutely get behind that.

Great. Within the capital return conversation, let's just talk about M&A for a moment. Chris, I know you were heavily involved with the Asia integrations, and you're now very focused on Canada, and this must be keeping you quite busy. But given this workload, do you have the capacity today to integrate more acquisitions?

Yes. I mean we definitely have the capacity to integrate the NEO acquisition that's in Canada as we bring that together. We're very pleased with the way the APAC integrations went in Australia and Japan. And we're seeing pull-through of market share and nontransaction revenue as we expect. As the global platform bears it out, we unlock value there. So we have capacity to invest in these organic growth initiatives while completing the final integration in Canada. I'm actually quite excited about it. As Fred mentioned, getting back to our knitting -- leading-edge technology, which underpins all of our markets and all of our growth initiatives. So we couldn't be more excited, frankly, than right now, reinvesting a lot in technology.

Yes, yes. So to me, I mean, we're very much a technology firm. We process a lot of transactions every day. And in fact, the messages into the options platform is like, what, 70 billion a day. So it's huge, huge volumes. And so you need really good, strong, robust technology. And one of the secular trends that we see is, there's no question, technology is important. Also, you have a number of emerging technologies being used in the business. So we want to make sure we're at the leading edge of that.

Great. Let's move the conversation now on to the macroeconomic backdrop. It's shaping up to be a year of inflections. Rates were going up. Now they may be going down. Hopefully, markets go up with that with more financial market liquidity. I mean this sounds like the formula to encourage more retail engagement. So what are your thoughts on this evolving backdrop? And do you view it as a tailwind for your business?

We see a number of what I'd call secular trends that are going on. There's no question there's been the rise of the retail investor, and that's been going on through the retail brokerage platforms like Ameritrade and Charles Schwab for 20 years. And what's interesting about that is a lot more adoption of the use of options by these retail traders, and everybody comes to the conclusion you're just making single-leg bets. Our analysis would say otherwise, that over half the trading volume in the retail investor on those platforms today are making what we call multi-leg or complex trades. So they're actually defining the outcome, they're willing to tolerate and putting those trades on. So they're using a lot of vertical spreads, as an example. So we definitely see that trend. And so that continues to go. You've got good markets. That always helps. We've got markets that have been -- it was a very strong year last year. We've got a good start to this year so far. And we're starting -- and right now, you're in a year where you've got a lot of geopolitical uncertainty on top, so now going to more cyclical trends. You got geopolitical uncertainty. You have 2 wars going on. You've got the Russia-Ukraine or the Russia -- or I'm sorry, the U.S. and China kind of standoffishness here. You've got a U.S. election. You got the -- every time the Fed has a [ ship ] pivot like we did last week, you see not the Fed so much as CPI print, you see volumes just pop. So you're having an environment where there's good secular trends, and it should be good from a cyclical perspective. So we're quite positive on that.

So back to retail engagement. If you look at the data inside the retail brokers, it arguably peaked in 2021 and arguably troughed last year. We're probably not likely going back to '21 anytime soon, maybe not ever, but there's a lot of upside from '23 levels. Are you looking for retail activity to broadly increase? And when you think of the strategies the investors that use your products, are you thinking that there'll be more of a shift to offensive versus hedging strategies?

It's -- people always go to 0DTE, but the analysis that we have is that a first 0DTE started -- it started -- we've always had it. It was 20% prior to May of '22 before we started introducing Tuesdays and Thursday expiries. And then since then, it's grown and -- where it's half of our SPX volumes today. And when you look at it today, you were to sell those mostly retail, it's actually not anymore. It's actually over, I think, 60%, 65% institutional. And it's very balanced across hedging strategies, income generation and making speculative trades. So it's actually a very robust -- it's very unlikely the meme stock craze. It's -- you're basically seeing a pretty robust series of volumes and trades in that platform, which is good for the 0DTE product.

And Craig, I just might mention, we just -- we really like the mix of both retail and institutional. And even some that comes in through retail brokerage platforms is quite professional looking with complex orders, as Fred was mentioning. I mean we're very pleased with that. There's also some major retail brokerage platforms that are yet to offer index options which we're quite excited about here later this year.

Yes, yes. We definitely see Robinhood going there. We're also seeing more of the clients that we have in the U.S. going to different parts of the world. XSP, if we can get protected options, so we can -- you can actually offset the margin offset against SPY trades. All those things should help. And global trading hours are still rather small in the book relative to what we think they could be.

Robinhood seems like a big one, huge user of options. Are there any other platforms to think about or most of the other big retail platforms rolled out at this point?

I think most of the rest have rolled out. Robinhood is the big one that comes to mind this year. Now having said that, some of those platforms, whether you take IG and tastytrade, are going to start to go more global. So there is opportunities behind Robinhood. And with our global platform now, wherever we've gone in the world, we have big clients with us, and that's important.

And when you said institutional client, I think that's hedge fund market maker but also wealthy active traders, which aren't really retail. Is that a good way to describe that bucket?

It's hard to define. It depends what you mean by wealthy retail trader because a lot of them will be on the retail platforms. So if you went back to my old firm, which had the thinkorswim platform, yes, you have a lot of what you and I might call semi-professional traders. And they're pretty good at what they do, and they use a lot of complex strategies.

Got it. So you have 2 very large products at Cboe, SPX and VIX. How do you see these -- the volumes in these products impacted by potentially lower volatility and lower interest rates? Not that we're there yet, but this is one of the likely economic scenarios we're looking for. Because normalized volatility is good, but not low volatility.

Yes. It's interesting. In the fourth quarter, what we saw is you would have expected that to be a low trading quarter because you didn't see a lot of volatility, and the VIX was -- I don't know what it was...

15.

15. And you would have said that wouldn't be a great trading quarter, but it turned out to be a very strong trading quarter as we saw people -- and you particularly saw an asset manager starting to use call options as they went through the end of the year to try and improve their performance against benchmark. So you're seeing a lot of that. You saw a lot of people use trades in VIX to -- particularly around convexity trades. So we saw a very strong fourth quarter. So I mean it used to be -- your theory of -- my theory always was you only see trading go with volatility, whether it's implied or real. But it doesn't seem like that's quite true anymore. But volatility will help. And you saw the CPI print last week. There's no question, we had a pop in volumes. And a lot of them was in the longer-dated options.

Very interesting from the fourth quarter, we actually saw record SPX market days from volume on market updates. Usually, people think about market-down days when we see the greatest volume, but it was market-up days when we saw multiple SPX records.

Do you have any perspective on that trend, why that happened?

I think as Fred mentioned, people are changing their positions -- continuously repositioning because they have 0DTE if they need to, and also some of them probably trying to catch up with yield enhancement for toward the end of the year.

Yes.

All right. Let's go a little deeper on SPX with 0DTE. We know the share within SPX of 0DTE can fluctuate up or down. But what would you consider normal SPX volumes for 0DTE given that it was around 50% in January and it keeps climbing higher?

We don't have a target or anything like that. It was just -- what we tried to do was create a variety of products around the SPX complex that allow people to trade in any environment in any size. So XSP is clearly designed for a retail investor. We still think there's lots of room for that to get better volume. And SPX -- not SPX, I'm sorry, XSP for the retail investor, SPX is a larger contract. So -- and we try to make sure we have products, whether you want to have short-duration or long-duration positions. We're just trying to make sure there's all use cases whatever you want to do, you can do that, whether you want to reduce risk or hedge risk, generate income or take a speculative position.

So we all know Robinhood is a huge options platform. They're planning to launch index options this summer. That could mean the second half could be good for someone in your position. But the Robinhood client, while being very active, the characteristics are very different than the client inside of Ameritrade or Interactive Brokers. Do you think younger active traders will gravitate towards this product, too?

Well, I think so. I mean there's no question. If you're an active trader, once you get comfortable with options, you will want to trade options a lot more. You just -- for the capital you put up and the positioning you can do, if you really want to trade, it's a much better product than just a straight equity.

Great. So we've noticed that the SPX contract and with 0DTE was -- has been able to gain market share versus a competitive product around ETF options. So I wanted your perspective on why this is happening, what are the key advantages to your product and do you think this is sustainable?

I think so. I mean the advantages of the index is that it's cash-settled. And the European style story don't get called away. You have favorable tax advantages. There's a number of advantages to the index products as opposed to SPY, as an example. So if you really want to trade and you want to trade options on that, it's a better product from my point of view. If you're a retail trader, if it's cash-settled, I've made my bet, I got a time duration on it, it settles, I don't wind up with an open position or a position I got being called away on me.

I think one element of the Cboe story versus other exchanges that gets misunderstood is the revenue stability and the reoccurring nature of options trading. So investors can pivot from offensive to hedging strategies as the market evolves, and options are expiring every day now. So traders must keep reopening position [indiscernible] basis. Do you think your index options business is more predictable given the migration to short contracts like 0DTE?

So far, I would say, absolutely. We think that's true. And you're on a very good point, which has always been my view on options versus equities, which is that options expire. And so you have more resiliency to the trading revenue, it's more recurring in nature than an equity trade. An equity trade doesn't expire. And as we've gone to shorter-duration option trades and actually just picks that all up, and that's one of the reasons our revenue is growing so quickly. And in the environment we're in, it's hard for me to see an -- this year that changing just because of all the, what I call the secular trends, but also the cyclical trends are all kind of lining up at the right place for that type of trading.

Great. I think product innovation may be another element of your story or your model that's misunderstood, especially with the VIX and SPX zero days. When do you plan to launch daily contracts for the VIX? And do you think this could have the same type of interest that we saw with SPX?

Yes. So I'll take that one. So obviously, we're very, very pleased with the way 0DTEs work with SPX since we launched Tuesday, Thursday, a couple of years ago. The way the VIX contract is currently constructed, launching 0DTE for VIX would be challenging. So we have a 1-day -- VIX 1-day index. And we've launched -- the teams in the lab working on a potential 1-day contract, but that's going to -- that's still to be coming. I will mention, though, that we have other products where we are -- we have launched Tuesday, Thursday just in January. We did that for the Russell 2000 W options. And we're seeing some nice growth even to start 2024. So this just speaks to -- we're constantly thinking about product innovation. If you think about Cboe, we're a markets technology company with tremendous product innovation -- technology, product innovation and being the largest securities derivatives network. So RUTW is the latest. We also have some -- a lot of other products that are in the hopper that we plan to bring out over the next couple of years.

Yes. We just introduced Credit VIX, a dispersion index. We've also -- we've got a bunch of them going out with MSCI. So we continue to innovate.

Yes. With MSCI, I'll mention there's 3 products we're actually launching on March 18, ACWI, USA and Global. So what's great about it is now we'll have index options products on, obviously, large-cap SPX, small-cap Russell and then international exposure with MSCI, really rounding out the product suite.

So I wanted to stick with the dispersion index. So you recently launched S&P 500 Dispersion Index. And I want to hear how has interest and feedback from your business partners fared for the new dispersion products?

The reception of the dispersion index has been fantastic. I think it shone a light on what is a very large portion of the market and looking at what is the value of diversification portfolio versus purely in the index. We're still on the lab, again, on making that a tradable product, working with our partners like the OCC, Options Clearing Corporation, about how that tradable product would trade and settle. So more to come on that, no firm date on the launch, but very pleased with the traction and the attention the index itself is getting.

I wanted to hit on one of the long-term risk. So I put one of the risks at reliance on third-party index providers like S&P Global. So how should we think about the risk of Cboe losing the S&P index in the future despite being -- I know the next renewal date is quite a long ways off, I think it's 2033. So it's not tomorrow, but how should we think about that?

The way I would think about it is -- and keep in mind, we've had a partnership with S&P for over 40 years, number one. No one's been able to develop tradable products and build a complex around an index like we have with them. And the reality is they're -- we're dependent on them. They're dependent on us, which is great because we own the VIX complex that goes hand and hand with it. And I would say if you're winning and both sides are winning with revenue growth, which we are, and we have a good partnership, which we have, I mean -- so like I talk to Dan Draper regularly. The teams talk regularly. And I think the 2 teams are gelling very well. So to me, partnerships rarely end when they're working. It's when -- they end when they're not working and it's one partner is not happy. But our relationship with S&P has been -- since I've gone in the CEO chair, have been very positive.

A second risk I wanted to cover was the intensifying competition in multi-listed options. There was a new exchange that just launched this quarter. We're seeing pricing pressure from some of your competitors. Maybe just review with us the revenue growth prospects in multi-listed options.

Yes. Multi-list, it's obviously a competitive market, and we think this competition makes the market better in the long term. We always try to -- as Jill and Fred and I talk about quite a bit with Dave, we're always trying to manage market share versus net revenue in these multi-list highly competitive markets, which we've done. When a new market comes out, a competitive market, they tend to take market share that's frankly lower net revenue or sometimes even net negative. So we like the competition. If you look at our history across the globe in competitive markets, we've done very well and growing market share actually in those highly competitive markets. A reminder that we're built on a very efficient technology platform, which allows us to compete in the most competitive markets, while helping us grow in the proprietary products as well.

Great. At this moment, I want to see if there's any questions in the audience. So please raise your hand, and we'll get you a microphone. On the front here.

Retail is a really important part of your coalition in the U.S. Now you guys are expanding into Europe, where retail engagement has historically been very, very subdued. I guess, is the thesis there that like options can be more of an institutional product? Or do you think that maybe retail in Europe could be at an inflection point?

There's a little bit of both, and it depends where you're going around the world. Europe is one market. Asia is another market. So it does depend somewhat on that. But where we're introducing the products is likely -- it's always because we have a big client in that market that we're also dealing with in the U.S. and say, we think this is a good opportunity. Having said that, we have no -- we don't have blinders on. When you think about Europe, it has to be developed. That has to be sold. It's not going to be just put it out there and they will come. You have to really work it. You have to educate people on how to use it. You have to work with the various market makers to bring liquidity into it. And you have to work with the brokers to make sure they bring it to their clients and work with us on the options to actually help people. You don't want to introduce people to options that don't know what they're doing. You want them to learn how to trade options properly. And that was always the secret at Ameritrade is you had different tiers, but you educated people on how to do it. And if you saw people doing what we would call dumb things, you would call them and say, what are you trying to do and can I help you here and educate you on how to do it better. But no question, Europe to us is a long bet. It's not a short bet. Is it going to pay off in '24? No, I don't -- I'd be surprised. It would be a nice surprise. But in the long term, we think there's an opportunity there. But it has to be developed and sold into the market.

Any other questions? Please raise your hand. So I think that may be it, guys. So on behalf of all of us at Bank of America, Fred, Chris, Jill, thank you very much for joining us. Appreciate it.

Thank you.

Thank you.