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

Good morning.

So Fred, you joined Cboe's Board in 2019. Can you describe Cboe's evolution over that 5-year period and how you see your role in guiding the firm going forward?

So first off, when I joined Cboe's Board, I think it was just after the Bats transaction, not long afterwards. And I joined Cboe's Board because, my past of Ameritrade, I've been involved with them both in the equity side but also on the options side, obviously. So when I joined the Board, and when we came into COVID, we were very much as a Board, encouraging management to take advantage of the environment and to try to make some moves and change Cboe. And so if you look back 5 years later, you see an organization that now has established a footprint in 7 of the top 10 developed markets that are open for competition. So it's got a good global footprint. It's also got a good Securities and Derivatives and growing Data and Access Solutions business. So it's changed quite a bit because it used to be pretty much all about options and just equities. And so it's got some emerging businesses and a global footprint. And I think the opportunity for the organization right now is, okay, now how do we take advantage of that now that we've got all the technology migrated on to Cboe technology other than Canada, you have -- the cost to sort of implement things in different parts of the world becomes much less expensive.

Got it. So prior to joining the Board of Cboe, you were the long-time CEO of TD Ameritrade. How would you compare leading Cboe to the task of leading the online brokerage firm?

Well, they're related, and obviously, they knew each other, and similar businesses, except they're very different situations. And so I'm very big on situational leadership. So Ameritrade, I took over just as The Great Recession hit. My first day as the CEO, which is the same as [ Walt Bettinger's ], was when the world blew up and Lehman and Merrill Lynch went down. So that was day 1. And at the time, Ameritrade, which is a retail organization, so a heavy marketing, also had -- all of the revenue was basically tied up in equity trading commissions and interest-sensitive assets. And so all your revenue was tied to those 2 things. And what happened, equity traders pull in when you have that type of environment and interest rates were falling. So basically, Ameritrade was in trouble then because, basically, it was -- in the absence of action, it was headed to a loss, and it would take me a hard time to sort of pull it out. So luckily, I was in management for a year, so I was able to roll out what I really wanted to do and have worked through strategically what to do in that year. And so that was one of the things that led us to buy thinkorswim and move into the options franchise and become an asset gatherer. So those 2 main things. But we saw in options something that I think we can talk later about at Cboe, which is, a, the commission per trade was higher. An equity trader, when a market falls off, freezes. At the retail side, I'm saying. And -- but an option trader can trade through any environment. That's the first point. Second point is there was a higher commission per trade. Third was that option traders can trade through any environment. So no matter whether the market is going, up or down or whatever, you can find ways to trade on the options. And we saw options as much more of a recurring revenue stream than equities because options expire. If you think about that in today's world with 0 DTE, that makes it a much more recurring in nature. If you think about Cboe, unlike Ameritrade, it's not in trouble. The company is doing well. Its earnings are doing well. Its revenue growth is doing well. It's much more of an institutional business or a business-to-business business. And we have things -- so we have a situation where we can afford to take a bit of time to really think through things. And with an option -- both Ameritrade and with Cboe, the reality is, is you have 2 firms that kick off a lot of free cash flow. So how do you allocate that excess capital is important.

So since becoming CEO, you guys have done a lot of investor meetings. I think this is the fourth week in a row you guys are in an investor conference of one sort or another. What are you hearing from your shareholders, in particular, your long-term shareholders? What are they asking Cboe to do? And what are they asking Cboe to not do?

Well, I don't think they get that specific. But you can tell from their questions what they're focused on. And I'd say the first one is, where is all the M&A going? And so we have pulled that in and basically sort of consolidated things that we've done, get the technology all integrated. And now we're investing in organic growth and technology because this business is a lot about technology and data and access. Secondly, as you kick off all that free cash flow, we want to make sure you're spending more time on how you allocate the capital. And when you go back to the M&A, how are you making sure -- where is it heading? How are you ensuring that you're getting a return on those? Those are the 2 main questions. And then the third one is, okay, how are you going to continue to grow the organization? That usually starts with, is 0 DTE sustainable? Which we believe it is. We have seen no reason why it isn't. And then how are you going to continue to grow the organization?

What are some of the key metrics by which investors should evaluate your success as a company and the management team? And over what time horizon do you think is appropriate?

The ultimate metric is obviously total shareholder return in my point of view. So it's about that. But I think when you look at it from a management perspective, it's about driving growth. And basically, when you have 65% EBITDA margins and you have a capital-light business, it's about how you find ways to drive growth. How you allocate your capital, are you being disciplined? Are you thinking about that? Those are the kind of things that I think shareholders over time will pay attention to.

So specifically, we're thinking about, Jill and I and Fred have been talking about this a lot, is that margin. So thinking about margin, think about having that in a healthy range. We're not looking for a 90% margin business. But we're, at the same time is that healthy margin range, we're thinking about revenue growth. So that would be margin, it would be revenue growth. And thirdly, of course, is expenses. That revenue -- the expense growth rate is something we've been looking to moderate. And Jill has been talking a lot about that. But then we will invest in high-conviction, high-confidence opportunity sets. So you will still see that happen. And then when you look down to the initiative-by-initiative, they will have their own unique margin profiles, revenue profiles and time horizons that we look at, whether that be extending the trading hours, moving into European derivatives, digital assets, all the new product and innovation, the new tradable products that we bring to market around that core ecosystem. And with those, we can look to manage that expense profile in line with the revenue profile as it unfolds, as we lean into those initiatives.

I think that's the other question I think investors have been asking us, is because our expense growth has been high, ignoring all the M&A, and the margins have been falling. So how are you going to bring the expense growth down and stabilize the margins? Which is one of our objectives right now.

And that's what we've committed to in our 2024 guidance that we rolled out. So if you look back to 2022, our expenses were up 23%. A year ago, they were up 15% compared to prior year. This year, we went out there with a range of 6% to 8% net revenue growth -- or sorry, operating expense growth range. So again, just really looking to stabilize that margin.

What do you think investors that are new to the Cboe story don't appreciate about the company in a way that your most informed investors do?

So when we look at that, and we have new investors coming in, they appreciate the global platform. They recognize what's been built that Fred was talking about earlier. But what is less appreciated when they look at the profile of the revenue, they look at nontransaction revenue, which we report through the Data and Access Solutions business with that 7% to 10% guide. Then they look at the transaction revenue. And that transaction revenue is heavily weighted towards derivatives, and in particular, options. And so what new investors often miss is the piece that Fred was talking about, is that options that mechanically can allow you to define your risk/reward profile, which means they have utility in any market environment if you're educated on how to use them. And once you use them, you put on that option trade, you manage it and you finesse it as time goes through, and then it expires. And so if you want to have a new exposure, you have to put that back on again. So it's a constant repositioning and management of those positions which makes actually that transaction revenue stream much more durable than when you look at a pure, say, equities business that might have transaction and nontransaction revenue. That derivatives business is a piece that is often underappreciated, but we've been telling the story now. And certainly that drive to shorter-duration tenors has really reinforced that as a durable, more recurring like in terms of revenue stream.

And then kind of, I guess, building off of that a little bit. What is impossible for competitors, either an existing firm or a start-up, to try to replicate about the Cboe model?

It's the global platform. It's the 7 of the top 10 developed economies that we are in. We're in every market open to competition. We run equities venues around the world. So we have a global securities and derivatives network. We operate 27 venues around the world across equities, futures, options, FX and digital assets and now U.S. treasurers, that kicks off a lot of data, our data that we can then monetize and package and bundle. But if you were to try and replicate that to compete with Cboe today, there aren't many assets you can buy and it would take decades to establish a footprint and a good number of dollars to actually get to the footprint that we have been able to put together today over the past 5 years, as Fred was outlining at the beginning. So really, that global footprint, that meaningful market share in those jurisdictions and that trajectory which is unique to Cboe.

And just to layer on to that, that is what I was speaking to the expense growth that we saw in 2021, '22, into 2023. We were making that investment to build that global footprint, that global foundation. Now we have it built. We are out there with the 6% to 8% expense range. But now we're looking in the now to unlock the value from that global footprint that we've now laid.

And I would add that I think Cboe does better than any other exchange that I've seen, is to take index options and build out a whole ecosystem around it with tradable products and whatnot. I haven't seen anybody else been able to do that in the option space. People try it in the futures space and things like that, but Cboe's very good at building out the index option business around an instrument in a way that I haven't seen anyone else do.

If I could just maybe do a follow-up question to the commentary on the global platform. It sounds like the argument is the whole is greater than the sum of the parts. Is there maybe an example that you can provide of the fact that you have all these global exchanges and the data that goes with that, that makes it more valuable because you own all the assets as opposed to somebody just owning this one and then somebody else owning that other one?

Yes, absolutely. And the other underlying point here is that with the exception of Canada, all of those equity platforms are on the same technology stuff. That creates great operating leverage, great scale. It means that we can look across our markets around the world and say, "Hey, that piece of functionality over there really suits this market structure very well," whether it be, for example, periodic options in Europe, where we're 78% of the 5% that it is available for the overall European market and bring it to the United States. Or say, "Hey, look at it in Australia," and bring it to Australia. We can also bring the data and analytics which we use to gain 600 basis points market share advantage in Europe and do that same analysis in Australia. So that's great for us. That's great for us in terms of the cost for us to do that. But really importantly, it's also good for our customers. Our customers are global. Our customers are deployed everywhere. They have the same opportunity cost and cost efficiency challenges to look at when they think about what to do each year. And if for a small marginal incremental investment, just like us, they can add a new capability in a new jurisdiction or be more effective in their engagement in a new jurisdiction. They'll do that alongside us because it makes sense for them and it makes sense to their customers as well. And so you can't compare that to the incumbents around the world, makes it much more agile, much more compelling and lower friction. And then on the other side of the data, the example you were looking for there is it's a uniform platform. You can get the data in the same way from every single market around the world that we operate. And we're doing that really effectively through the deployment of Cboe Cloud right now, where we can deliver the data to anyone anywhere around the world over an Internet connection. And it's interesting that about 80% of our customers of cloud are internationally based outside of the U.S. So that runway for data is very real for us and we see people, CFD providers, for example, taking 1 set of the data and then find themselves in the e-commerce stage shoppers, and say "Oh, European equities. Thank you." Canada, U.S. and it's all in 1 place, all in 1 package, all in 1 format.

That's helpful. You touched on 0 day to expiration options a little bit earlier, so maybe we can tie it into this question. How do you differentiate between cyclical trends driving trading volumes versus secular trends? And is that something you can even really know in real time?

Certainly an interesting one. Our objective is obviously long-term shareholder value, but long-term customer value. And at Cboe, across that technology platform and across that product innovation, our aspiration, our drive, is to create functionality and tradable products that are useful in any market environment, whether that be a block trading mechanism for equities when liquidity and volatility is low and you don't want to signal your messaging; or whether that be a new dispersion tradable product to allow people to enact a highly sophisticated sometimes OTC strategy in a listed, cleared environment. So for us, we almost don't mind what the environment is and don't need to call it. But when we do look at today, and we see the cyclical trends, obviously the increased and elevated uncertainty this year against the backdrop of, I would say, kind of 4 cyclical trends, being the broadened access of the usage of options in general, for which we're using The Options Institute to drive education, it's to drive to the shorter-dated tenors, that utility found there, that we're leaning into that cyclical change that we've seen over the recent years. It's a global expansion. You hear that from other online retail brokers in forums like these about them pushing globally, and that's really where we see the opportunity to push the utility of options globally, both for the local market, but also pulling into the U.S. And then the final one I would mention is really capital efficiency or cost, the cost focus I mentioned before. Regulation, Basel III, Basel IV is pushing firms to be more capital-efficient. So that means really a listed, cleared environment where you can gain from capital efficiency and counterparty risk management. And also then, we lean into that with the product development I talked about, whether it be a new variant futures product, which is taking an OTC interaction, capitally intensive, on exchange, or those dispersing futures we're looking to launch in 2025.

Yes. And I think if you think of the secular trends, I mean, you're just seeing adoption of options globally. Not in every country, but it's really, it's a growing product category. Technology, data, access, all important, emerging technologies is changing the world, all those things I would consider secular trends. I think what Dave got into some of the stuff in the short term, and you try to position your firm to be able to go through any environment. But there's a lot of uncertainty in the short term which is causing a lot of people to change positions on a regular basis.

Amongst the publicly traded U.S. exchange companies, Cboe is unique in providing full year revenue guidance. Given the inherent unpredictability of trading volumes, which still represent around 2/3 of the company's revenue, how is your team comfortable in providing that full year revenue outlook?

I can take this one. I think if you step back and look at why we initially went out there with that medium-term guidance of 5% to 7% organic net revenue growth, we introduced that in late 2021 because what we found at the time was that we weren't really getting credit from The Street and the analyst community for the durable net revenue that we continue to put forward year-over-year. So I would say in any given year, we continue to feel comfortable with that 5% to 7% net revenue growth range. That's really underpinned by the Data and Access Solutions business. So Dave alluded to that earlier, our guide to that is 7% to 10%. And then also just foundationally the product innovation that we continue to put forward. So the combination of those things, again, continue to give us comfort with that 5% to 7% organic net revenue growth figure. Obviously, it's something that we continue to evaluate over the course of the year, update the guidance quarterly. But again, continue to stand by that medium-term guide.

You touched on innovation in that response, Jill. When you guys think of some of Cboe's biggest innovations, were they generated internally? Or were they kind of client-driven?

Ultimately, everything we bring to market at the end of it is always customer-driven and customer-partnered. We partner with our index providers and we partner with our customers to really try to drive long-term value proposition for them there. Whether it's internally initiated, that might us seeing patterns in the data, patterns in the trading and then going to customers to discuss those. It might be us looking together with customers at regulatory change and saying, "Well, how do we navigate this in partnership as a market infrastructure provider with other intermediaries to serve the customers and navigate regulatory change?" Or sometimes it's together. We have an annual risk management conference, a big conference for us, where we bring all of the brightest minds from derivatives into one place to discuss how to navigate the upcoming environment as the community sees. And many of Cboe's product innovations were born at risk management conferences and then iterate it from there. So really, it has to be a partnership. We're lean. So we need to be as focused and effective as we possibly can be. So it really comes down to ultimately being a partnership. And when we think about those things, whether it be global trading hours, the new products that I mentioned earlier, from that volatility toolkit that we're expanding dramatically; or to going into new asset classes, regions; extending trading hours, all of those were done on a base of customer demand and a partnership in the delivery of those.

And then maybe a question that ties into something that we were talking about earlier. So you guys have a broad array of kind of franchises underneath the broad Cboe umbrella. Some of them are maybe a little bit more mature in nature, some of them are a little bit more nascent. How do you think about allocating capital resources to those initiatives, whether it's European derivatives or Asian equities, in terms of the broad construct of the financial results you guys are trying to achieve?

Yes. And one of the things that hopefully has come through in the discussion today is that we've now got a scaled infrastructure. We've spent the last year integrating and scaling the infrastructure. So what's often misunderstood is that now we're able to efficiently invest in growth initiatives on top of that already scaled architecture. So the investment required, for example, to go into European derivatives, expand trading hours, launch new tradable products, is relatively small according to a comparable if you were to start from scratch. When you have an exchange and a clearinghouse, already the largest in equities in Europe, it's marginal to take that great exchange technology that runs options, bringing it to Europe on top of that infrastructure that you've already got. So we're able to scale from a general perspective. And then when you think about resources, we've recently more aligned along global lines. We've got Cathy Clay running Global Derivatives, who can efficiently deploy resources on a global scale and cover our clients in a more efficient way. We brought together North American, European equities under one umbrella with Listings. So again, serving those same clients to the point earlier about moving functionality around the world in a more uniform way. And then as I said earlier, we think about being able to scale expenses or dial expenses in line with the revenue profile of each of those as they unfold, and make adjustments as we go.

But it's going to be about growth. I mean -- and it's leveraging the network that we've got. Because, as Dave said, the incremental cost for us to leverage that network and try to push things out with basically customer demand is where we will drive growth at economical cost and keep the margins up.

I think we have about 5 minutes left. So now I'll just quickly pause, see if there's any questions in the audience.

Going to be easy on us today.

No hands have been raised, so I will keep going.

Might I ask a question?

Please go ahead.

So it seems like that you said that EBITDA is 65% when have making of -- have been making a lot of investments. So is there a target for EBITDA margin that you want to get to since you have [ finished ] transactions? And -- yes.

I wouldn't say there's a target. Like, I mean, when you're making 65% EBITDA margins and you have a capital-light model, that's pretty good returns. So I think you don't want it falling. We also don't -- we're not focused on driving it to 90%. We'd much rather say, if we can grow it 5% to 10% at 65% or more, that's -- we'll take that all day long. And if you have growth rates up there, then it's much easier to have operating leverage, which the margins will naturally drift up over time if you can keep that growth level.

In the back of the room?

You say you have a lot of [ big pricing ] compared to some of your peers [indiscernible] from a customer standpoint [indiscernible] and pricing right there [indiscernible] compared to something that [indiscernible] do you think you have more [indiscernible].

Thank you very much for the question. That was not a plant, by the way. I don't know the gentleman who asked the question. To the point of the question that the objective is to offer high-value, cost-effective data and data feeds. And so that's what we're striving to do. For us, when we look at the Data and Access Solutions in terms of pricing, about 1/3 of the growth has come from pricing last year. And we expect about 1/3 this year. What we're really looking to do is what I was talking about earlier, and hopefully we're achieving, is that new customer, new use case. That's really where we see the drive because we do see there is runway in pricing, but actually, our drive is really to get more customers viewing and using customer data, our data, and then actually for us to create new data products and new insights on top of that existing ecosystem that we've already got and pushed that out. So pricing is not a growth strategy for us. It's really about new customers, new use cases.

All right. Maybe one last question for me before we wrap it up. So Fred, you kind of talked about hitting the brakes a little bit on the M&A strategy. Is there anything out there that's still kind of strategically you feel like there are gaps to plug? And then maybe on the other side of the coin. Is there anything that Cboe currently owns that you think maybe this just doesn't fit? Maybe we took a wrong step, and it's a potential divestiture down the road?

Well, I mean, there's -- I think the way that you should think about M&A for us is that we'll be much more disciplined in terms of it fitting strategically, being financially attractive and actually making a difference. And I understand why we did some of the -- many of the transactions we've done in the past. If you think back to the data and access ones we did, and there was 3 or 4 of them there, they actually kick-started our Data and Access Solutions revenue growth. So there are some of those up there. But I think if you think about where we are around the world, we would say we're still under-penetrated. While we have a position in Japan, we're still fairly small. But we want to get our equities franchises up in different markets up into the 15%, 20%, 25%. Then you can get a Data and Access Solutions business, and then you can build your Derivatives on top. So I think that would be one logical spot even though we don't -- I wouldn't say there's any specific target or anything like that. But that would be when you look at it strategically, the one market that we're in, it's a big market, it's not a growing market, but it is changing, although change in Japan takes time. So that's one. And then I think -- we'll look at the different things, but I wanted to be much more deliberate that when we stand back and go through our strategic review, you stand back and say, "Okay, now that we thought about it, we've looked at it, these are the places where we think we would like to do something, and why." As opposed to, I'll call it, reacting to what's on the market. You're always going to react because you want to be opportunistic, but you want to be much more deliberate. And in my experience anyway, deliberate, strategic M&A actually works much better and has a higher chance of success. In terms of divestitures, that's not where we're focused right now. I mean, I think we're very much focused on, yes, we look at each of our businesses, how they fit into the network, can they leverage each other, and are they providing good returns to us? Then we'll make decisions accordingly as we move forward. People always ask about digital, but the reality is I think you're seeing bitcoin prices rise here. You're seeing interest in everybody we talk to in the market. There's some interest in that asset class. And everybody is looking for what we've got. And I think we just have to give it some time and push it and see how we make out, and then we'll make decisions accordingly.

All right. Terrific. I think that's a good spot to end. So thank you guys very much.