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

Okay. Good afternoon, everybody. Thank you for joining us for our next session. I cannot speak anymore. It's been a long day. Okay. I'd like to welcome management team from Cboe. With us today are Dave Howson, Global President; and Jill Griebenow, the company's CFO. Cboe remains one of the faster-growing exchanges in the space, powered by its proprietary index options complex as well as robust data and access suite of solutions. We'll spend time with the team here on the progress Cboe's making this year and how are you thinking about '25. Welcome both. Happy for you guys to make it this year.

Thanks for having us.

Great. So why don't we start with a question on some of the strategic priorities and really looking back at sort of the progress you guys made this year. Remember, when Fred took over, and he was sitting on the stage with us last year, there's a couple of things that he wanted to accomplish, and you as a team wanted to accomplish, a number of things, but more targeted approach to M&A, stabilizing operating margins, shifting capital returns and allocation and reallocating resources kind of towards more core competency areas for Cboe, right? So it feels like a lot of that has been accomplished. So talk to us a little bit about what's next, what's on the priority list for '25.

Yes. Thanks, Alex. Great coverage there of all the key pieces you talked about...

I read that, sorry.

And really, what you've seen to do broadly there is leading to really creating operating efficiency and working out how we lean into our strengths. And as we look across the businesses, we like all of our businesses, we like the cash and spot markets, the FX markets, they've done nicely this year. And of course, the derivatives in the Data and Access Solutions business as well, which spoiler alert we've announced is now going to be called Data Vantage. So we've got a new name. We can all say incorrectly including myself for about a year's time.

There we go.

But really, when we look forward, the growth algorithm for us is really the growth businesses are the derivatives business and that Data Vantage that data business. And then when you break that down somewhat. You look at the derivatives business, it's 3 or 4 key pillars to that growth. It's a growth in retail utilization of options. And that includes, of course, the onboarding, gradual onboarding of Robinhood, 4% of our users use options today. If you compare that to other retail brokerages out there, it can be up to about 10% on the 24 million funded accounts that is a great runway of opportunity for us. Also thinking about the -- what we've been calling the import business in the same vein as well as bringing that exposure, that need and desire for exposure and managing that expansion to the U.S. economy. That comes in the form of retail brokers internationally, institutional players internationally as well as around Europe and Asia Pacific as we think about the 2 specific regions. So bringing that import flow. And then finally, it's about exporting our IP and capability and market structure when we think about the European derivatives initiative, which is another longer view, longer burn. And then you think about the data of Data Vantage business, we think about data everyone internationally wants access to the U.S. market, the U.S. equity market data that a real big growth driver for us as we think about Data Vantage into the future. And then as we deploy our technology capabilities, if you think about the strategic review, technology underpins everything we do, and we've been able to redeploy our skill, our horsepower back into the core technology platform, including a variety of access layer improvements in the equities business where we get to build ones and then deploy many around each one of our markets, and we're deploying, for example, dedicated calls into the U.K., Europe and Australia after having a resoundingly solid uptake in the United States.

I got you. I got you. Okay. That was very comprehensive and a lot to cover, so let's unpack some of the areas. I wanted to start with retail. The rise of retail has been kind of a continuous and very powerful theme in trading markets. You mentioned that as well. It feels like after the U.S. election, it got another boost, which may continue into 2025. People feel pretty enthusiastic about the state of the market. How is Cboe positioned to capitalize on this trend? I know you talked about Robinhood and that's maybe somewhat of a low-hanging what else do you do want to capitalize in retail? And aside from trading, there are other ways you guys could incrementally monetize this, whether, again, it is data or access or something like that.

Yes. Indeed, when you think about retail really, 3 core strands. It's about access, it's about education, and it's about product and product and marketing. So firstly, on Access, you mentioned Robinhood, as I did that's really about accessing and penetrating more of that user base. That's new users and the use cases within that. And then when we think about international retail brokers, we brought on 3 retail brokers from South Korea, for example, this year. So it's new users in new geographies. So expanding the access to retail brokers and their customers around the world. When we think about education, it's a lot about joint marketing, joint education with the likes of Robinhood and our other retail brokerage partners around the world. And we're investing in our own education platform quite heavily to bring that internationally, and we're looking at ways of using new technologies, AI to bring natural language, local language capabilities to our Evergreen options education content, which is tremendously important as people begin to understand how to utilize options as part of their portfolio management strategies. And then coupled with that, it's the marketing of the product and really allowing folks to understand the benefit of a cash-settled European exercise product with -- if you're in the U.S., potential 60-40 tax benefits as well.

Is there a way to frame the addressable market when it comes to non-U.S. retail using some of your proprietary products. I'm assuming you're talking about SPX options largely maybe more. But just to start with that, if you kind of were to draw power between what's available and what's happening in the U.S. but expanding outside the U.S. how much more material could that be in terms of the overall contribution of the business?

Certainly, a solid demand. it's SPX, it's XSP and to a lesser extent, VIX options for the retail internationally with our key sweet spot of target customers. We've got 6 top priority countries in Asia Pacific, that's South Korea, Japan, Australia, Hong Kong, Singapore and Taiwan. A variety of levels of sophistication and user base in those countries requiring a bespoke method of engaging and breaking down those pathway barriers that exist to bring in flow back to the U.S. So we don't really put out a target addressable market that we're going for that. But certainly, when you look at markets like South Korea and Taiwan, there's an active base of customers, Singapore equally there that we're really looking to tap into that don't necessarily have access to the core proprietary products complex today.

Got you. Okay. Let's talk about some of the products, starting with SPX. An enormous growth driver for you guys over the years. really powered by 0DTE options over the last 2 years or so. It does look like the rate of growth is starting to moderate for 0DTE to some extent. And some of that may be the market maker adoption or the broker-dealer adoption that's been largely mature, but it does sound like you guys still see runway on the retail side of things. So help us understand like where is 0DTE in the maturity of its product and what would be sort of the next leg of growth would all of that be largely retail? Or is there still some kind of institutional demand that you guys could drive into that product?

Yes, we certainly see momentum and opportunity in both retail and in the institutional categories there, in particular the institutional, international institutional participants. When looking at the retail brokerage platform flow that we see coming through, we see anecdotal evidence of customers being more sustainable and actually honing and refining and expanding their strategies they're deploying. So for brokerages where we can see it, we see actually users expanding and growing their engagement with the core complex of products. That's new use cases within that -- you mentioned retail, you've mentioned it before, the growth of new users within Robinhood's addressable market and internationally is also a key growth opportunity for us there as we think about that. And you mentioned data and insights from those activities. That's also something we think about as well in the previous question. When it comes to institutional, we see market makers coming into the complex that might have specialization outside of options, growing their activity on the complex. We see international institutional customers coming through as well. Institutional growth and adoption is takes more time because of the breaking down what we call pathway barriers, whether that be clearing access or market data distribution to those customers. That takes a little bit more time. But between the 2, we see a really quite a rich mix within the complex, and we see them both continuing to grow.

Got it. On Robinhood, do you guys have any data from them so far? How the contract has been working, how they're adopting it since it was launched only, I guess, a couple of months ago?

Yes, a month or so ago. It's a slow role in that Robinhood rolling out to their customers gradually and rolling out gradually on the legacy platforms, the mobile platform and the legacy desk. It will be added to the new Legend platform, which has tremendously rich and diverse functionality within it, that's later on into next year. So it's an early start and a slow role, but encouraging signs with the index options products we hope would be utilized. We're seeing some flow coming through there, but too early to give proportions or think about that.

Okay. And that platform obviously is going to be a lot more user-friendly for active traders who are more likely to use this product to begin with.

Absolutely, the cash settling option right in the sweet spot of the users that they're going for. And more interestingly, taking a step back from this movement, it's a new leg of competition for the retail brokers. And so they're going to be competing on price. Robinhood lowered their price for index options, they're going to be competing on functionality, education and compelling -- providing compelling cases in smoother ability to trade, and that will -- just as we see with exchanges or other areas of the financial services market a continual evolution with the longer-standing players. And so ultimately, we could see that as a longer term path of creating more active -- more active traders, more actively trading because of that functionality.

I got you. I got you. Okay. Great. You mentioned XSP, so the smaller SPX contract, also an important factor in the retail story. So let's maybe dig into that a little bit. I think you said that, that product has grown about 18% in the third quarter. So pretty healthy growth. Where are you seeing the customer uptake in that product how would you frame the addressable market within that. We've talked in the past about an alternative to SPY options. Is that still the typical kind of user case that you're going after? Or is there something else?

Yes. there's certainly leading to the mission to bring every investment strategy to every wallet size. XSP is that 1/10 size exposure of SPX. We do see retail actually trading SPX only risking, say, $4,000 or $10,000 if they utilize various spread strategy. So it is still possible to access the bigger contract, but you're right, the XSP contract, we think, is really in the sweet spot of that onboarding the maturation of say, a Robinhood style user base. The trends have been good. As you point out, we've been working on the market structure. We've been talking to our liquidity provider. It's about improving the prices on screen so that when you pull up that screen, you see a tighter spread. We've been working on rebate structures and other pricing structures to make it more attractive and more amenable to trade the product. And when you couple that with the potential 60-40 tax benefit, it opens up a whole new set of use cases. And you said -- talked about SPY there, you could overwrite a long-standing SPY position with an XSP call option and then have no risk of having a capital gains event on your SPY underlying position. So strategies like that become interesting. Over this year, we've seen an increase in 0DTE trading as well as we brought on new customers started the year about 30% and trading on the day of exploration in XSP now coming towards the end of , it's around about 40%. So all these things coupled together, the product, the users, the customers and the growth with Robinhood coming together nicely to really have an interesting setup for XSP going into 2025.

Yes, definitely a nice complement to the franchise. Let's hit on the VIX, just shifting gears a little bit. You announced 2 new strategies, 2 new products there, 1 being Variance Futures and then options on VIX Futures, which I believe were launched in October. Talk to us a little bit about the uptake so far. What are you hearing from the customer base, what the reception has been? And ultimately, what would you define as a successful outcome for these kind of 12 to 18 months from now, just to give us some guidepost.

Yes. Yes, a quick recap on the products themselves and the intention. These are complementary and additive products around that core S&P 500 Index complex. They add new hedging tools to the toolbox to the overall volatility tool kit that we have there. Variance Futures providing an interesting new exposure with the ability to capture realized volatility throughout time, whereas you look at the, the VIX products, that's forward implied volatility that you're trading through the VIX options and VIX futures. So really the Variance Future, which is effectively the on-exchange equivalent of a Variance swap allows you to avoid the need for market timing through time and allows you to hold the position and gain the benefit of those fluctuations and realized volatility. Really interesting for the Tier 2, Tier 3 hedge funds that might not have the capital to trade OTC, really interesting to liquidity providers who want to take part in this market, whereas if it's offered OTC, there's no place for the liquidity provider to play to provide active transparency and pricing in the product. So lots of interest from the buy side, good interest from the market makers. The way points for both of these products are quite similar. One of them will be vendor adoption. We launched this just before the election, Thanksgiving, Christmas and the holiday sorry. And the freeze periods that come with that -- and so it's out there. We've only just had one of the clearing brokers add support for Variance Futures, and we're seeing a few hundred contracts a day coming through there. So that product is going to mature throughout the -- throughout next year into the middle of the year as time goes on. VIX options on futures, the value proposition there is to bring VIX optionality to non-securities based users. So international users, for example, broadening out the addressable market, the distribution VIX optionality and then allowing the ability to trade 5 days in a row, expires 5 days in a row to bring that shorter-dated exposure into the complex. As these products mature, we think about the market structure as well as we learn from customer feedback. So back on Variance Futures where adjusting our LMM schemes adjusting the block sizes. So you need to learn and go with your customers on the journeys, you look exactly how you optimize these products. So that's going to take us through into the new year. But really bullish with the feedback we get from the buy side and the appetite, the liquidity providers to support that incoming flow.

Got it. All right. Well, we'll stay tuned on both of those. Let's talk about pricing a little bit. You guys obviously run a proprietary suite of products. How are you thinking about your pricing power within those 2? It doesn't feel like you've done a whole lot there in the last couple of years. But every time we see a couple of years go by and exchanges don't take pricing up on some of the proprietary product. It means it there for some level of pricing increase, maybe, maybe not. But how are you thinking about pricing for both the VIX and the SPX?

Yes, we've certainly been very intentional about price increase, a very cognizant of that push-pull effect of pricing that could have on a product. It's not our growth strategy. It's worth saying that for a start, lowering pricing, might increase some of the lower edge activities, increasing pricing might reduce some of it but result in a greater P&L. Our real focus right now is growing that user base, more users, more use cases and stability in the pricing at this point is really important there. If you think about the Robinhood rollout, that competition we're going to get in the retail brokerage space. If we think with pricing at this point, it might destabilize some of that ramp-up in the first part of next year. I'm not saying for 10 years, but I'm saying as we think about next year's ramp-up and we think about those international users, that pricing stability is something that's appreciated by customers as we think about it because we think we've got a solid runway to be able to penetrate. And so we're not out of ideas, and we're not out of a runway to help build that ecosystem.

I got you. Okay. Great. Let's shift gears, I want to talk about maybe some of the more competitive products. In the Cboe ecosystem. U.S. equities and options, the multi-listed options business, it looks like the market share kind of continue to slip over the course of the year, not by a lot, but it's been coming down. At the same time, you did talk about bringing in non-U.S. customers into your markets, which should theoretically at least improve the market share. What's the disconnect there? And I guess how are you thinking about the trade-off between market share and pricing because there's obviously some flexibility out there as well.

Yes, definitely. So U.S. equities and multi-list options as well? Okay. So the P&L optimization is the goal. Market share and RPC are the dials in a blunt kind of description of what we do every day in those 2 markets. Starting with U.S. cash equities first, over the year, that proportion of the total market that is trading off exchange, that TRF and the close has just grown. And it's well -- it's been -- the TRF alone has been over 50% in recent times. So that squeezes the addressable market that we have to play in as an on-exchange, primarily a on-exchange player outside of the bid business that we have. In on-exchange space, we've maintained broadly our share of that addressable market around about 25%, 26% of that addressable remaining market. We did change one of our venues in November this year, the EDGA equities venue to a make at a price model from an inverted price model based upon some of our customer feedback. That change has gone well. And then more broadly, as we think about the parameters that we compete upon, it's pricing, the month-to-month pricing changes we make, it's features and functionality, think about ordinary order types we've got across the exchange landscape there and that it's technology. And that technology came this year in the form of dedicated calls, which was an access layer innovation which had some really strong uptake from our customer base and allow them to interact more precisely with our core exchange venue as well as allowed us to generate new data insights, which we could then provide back to our customers. So that technology investment is twofold. One, the direct value and then the value from follow-on data and insights we can have to bring back to customers, which then allows them to optimize engagement in the core platform. That statement holds true for multi-list options as well in terms of those technology advancements. Multi-list options, we've been around about 24%, just a little bit above. It's going to be a focus for us coming into 2025. We've got some new highs coming on. That technology resource, again, freeing up from those M&A integrations and migrations, focusing its mind on the data, those insights and working with customers to work how to improve the interactions. The early example would be BZX options in September, I believe it was this year. We changed the access layer architecture to our -- it's our price time options market. That's actually changed quite fundamentally some of the dynamics in the market and allowed customers to be more efficient at how they interact with BZX options. It's that type of thing that we'll be doing more of as we think about rollout -- rolling out new capabilities into 2025 to really bring a back of focus to our competitive position in multi-list options.

I got you. Great. I wanted to pivot to a couple of newer things you announced recently as well. Securities financing transactions being one of them. It sounded like you have several firms expected to join the platform over the next couple of months, a couple of quarters, I forget exactly the time frame. But can you talk about just framing what this opportunity could look like? And I know from a regulatory perspective, Basel III endgame was viewed as a potential tailwind to maybe more platforms and more firms joining the platform to an extent regulation gets rolled back or Basel III endgame may not even happen. How does that impact the opportunity set for you guys?

The need for capital efficiency remains the Basel III, Basel IV endgame and framework were a catalyst to focus minds. But when you look at pension funds, use it, the risk weight, the RWA calculation for those firms and those pools is still 100%. If you clear it, it's 2%. So the value proposition holds irrespective of the timing or the forcefulness of the Basel III as Basel IV piece there. So U.S. banks and European banks alike have the same set of challenges and the need to be more efficient with balance sheet. The size of the opportunity to frame it is there's EUR 3 trillion of lendable assets available in Europe. EUR 200 billion of those are actually on loan now within the scope of the securities financing transactions, the stock [indiscernible] loan clearing initiative we're putting out there. We've got access to 10,000 ISINs across ETFs and equities as well as the direct Texas to the 19 CSDs around Europe. So for us, it's a brand-new white space opportunity, but in an adjacency where we already have the connectivity. So alongside the capital efficiency, you also get the workflow simplicity of having a CCP in the middle rather than 5, 6, however, many different plus counter policy you might have as you're lending out your inventory clearing house brings that single point of simplicity to the workflows as well. There's a number of other advantages. Right about 9 so far last count of early adopters. We're looking to come on board as we go into new year, same story there, testing systems need to come through as we go through there. We have regulatory approval, so we're good to go from that perspective. So that will be a ramp-up in the first half of next year.

What is the economic model to Cboe look like? Is it clearing fee on a transaction basis, what are those fees if you're going to help us frame like, I don't know, $1 billion of notional comes across like what is that?

Mostly is clearing fees. We also get the net interest income from the custody piece as well and any settlement that needs to happen as well, but most of it is from the clearing fees, activity levels.

Got it. All right. Let's talk about Data Vantage.

Data Vantage.

Data Vantage [indiscernible]. Okay. So the target is 7% to 10%. You guys will be at the lower end of that this year, as we talked about, maybe unpack kind of the reasons why some of the slippage, not outside of the guidance but towards the lower end of the guidance. But again, more importantly, what does it mean for 2025 to an extent there's any sort of pent-up demand that did not come through this year? Are you thinking about next year? Any early thoughts on how that could look like?

Yes. It's kind of 3 or 4 core factors. First one coming into the year, we had some exits and consolidation in the market, being a global offer of Data and Access, that hit us starting the year. We talked about some of the sales cycles being longer than expected. That came through throughout the year with some portions of the Data Vantage product set. And then the third piece is really the timing of the index business of those cash collections, not always coming in, in kind of a smooth nature. And then you hit September where we have a 10% year-over-year growth in September. And so then that's really the story for 2024, a number of pricing changes and solid sales in between that keep us up towards the bottom end of that 7% to 10% guide for the year. Then when we think about 2025, it's a number of things that we've kind of mentioned already, but really thinking about that sale of data globally. People around the world want access to the U.S. market or have access to the U.S. market and want the exposure there. So global sales of our U.S. data has been key. Each quarter this year, we've reported that 40% of incremental growth in Data Vantage has come from international sales. So we're going to be leaning into that. That's also cloud sales and deploying more data and insights over the cloud to get to more users. So data forms a critical part and a part that we remain confident with into 2025. Then there's the access layer investments that we talked about, the builder [ wants ] deploy many dedicated calls due to go to the U.K., Europe and Australia out into next year. And then there's also, in general, the freeing up of technology resources from those integrations really coming back to put the horsepower into what's the next access layer innovation rollout for the options market, what's the new instrumentation and the data we can create in terms of the core, the data insights we can give to our customers how can we produce them and derive value from them.

So into next year thinking closer to the middle of the range? Or kind of how are you thinking about the magnitude of that improvement as you're thinking about 2025?

We'll be talking about ranges and guidance in February.

Fair enough. Fair enough. I think I'll try. So I might now get a better answer on the expenses, which is my next topic, but we'll try there as well. I guess the way I would want to frame it, you guys have done a really nice job sort of moderating the pace of expense growth and really pivoting and redirecting investments into areas where you could see the most organic revenue growth, which was obviously a welcome move. All that said, it feels like you're talking about the margin opportunity business from more of a margin stability perspective as opposed to much of a margin improvement perspective. Am I reading that right? So I think about EBITDA margins in the business right now kind of running in a 63-ish percent range. The peak was in the high 60s, maybe even hit like a 71% any given quarter. But is the current range is likely where we're going to live or there's still an opportunity to get into that high 60s range.

I think, as you alluded to, we did see an acceleration in expense growth over the past several years, completed 9 acquisitions over the course of 3 years. I think in 2022, our expenses ramped up 22%. Last year, it was another 15%. However, this year, in our most recently issued guidance, we've messaged a range of 6% to 8%, which is obviously nearly half of what they increased a year ago. So with that uptick in expenses, you did see compression or actually degrading of the actual margin. I think what we've messaged, one of the key themes that came out of the strategic review that you hit on earlier was stabilization of the margins. Stabilization of the margins is definitely top of mind for us as is disciplined expense management. So -- to the extent that we do have incremental expenses, what we're doing is ensuring that they're definitely attached to revenue-generating opportunities. So just to point to a few of the examples that Dave already listed today the Robinhood launch of index options. There's an opportunity there for us. We're investing from a marketing perspective, from an educational perspective. The securities financing transactions initiative that he mentioned -- that investment has been ongoing for about 18 months to build that. However, that starts producing revenue already in 2025. In APAC, the opportunity for increased Data and Access sales. So opportunities there to hire local sales resources on the ground in the local language. Is that a just very subtle uptick in expenses? It is. But on the flip side, there's net revenue attached with it. So again, it's a balancing act of really trying to rein in that expense growth, but still investing organically in the business to continue to grow that net revenue longer term. Getting back to your original question as to the margins, 70%. I think, again, this margin stabilization, the mid-60s, again, it's just that discipline. It's the balance of continuing to invest in the business to grow that long-term net revenue while really watching the margins, watching the expenses, ensuring that net revenue is there for years to come.

All right. Makes sense. Let's talk about one of the other kind of strategic factors you guys discussed in the past, which is acquisitions. It felt like the firm has done a lot over the last 5 years. So there is a clear need for a bit of a pause, go back, reexamine it feels now that you went through that process. There's been maybe a little bit of a shift in posture or at least maybe that's how I interpret it. Maybe that's how investor have interpreted that like, look, if there's something interesting, we could consider it so you're kind of like back in the M&A market, maybe to some extent. So maybe help us unpack that. Am I reading that correctly? And we're all getting a little too far ahead of ourselves. What are kind of your acquisition priorities? Or are there -- are acquisitions a priority, I guess, over the next 12 to 18 months?

Yes, we've never said no M&A. I think it probably depends on the context of the question and how they're listening here interprets the response. So for us, you're right, we did 9 acquisitions in 3 years, and we've been chewing and digesting them since. And when we acquire, we integrate fully. We bring the asset up to Cboe standards from compliance, technology and so on. So that after we finish, we can actually benefit from that scaled infrastructure. So those expense increases over the years are all about really priming ourselves to be able to lever out of that with growth. When it comes to how we think about M&A and opportunities, they will be aligned with our strategic initiatives that we've talked about, derivatives and data and so on that we've talked about as our strategic priorities, anything to put those strategic initiatives would make sense for us to look at, and everybody walks around with their eyes fully wide open. But anything will look to have to deliver long-term value for us as we go through and be really deliberate and intentional as we go through.

Are these more capability deals? So in other words, things that you already have, just adding on top of that? Or you would consider also doing something larger, more like a larger consolidation deal. There are not many of those. But just kind of thinking about the scope of a transaction, if you were to do something.

It really depends on the case by case and what's out there, what we look at and what we think at the time.

Okay. All right. Fair enough. A couple of minutes left here. So let's hit on capital returns. That's also been a nice pivot. The pace of share repurchase has improved. The balance sheet is in a great place. What are your sort of capital return priorities, but also give us a bit of a framework that's kind of in the -- let's just pretend there's no deals, right? In absence of any meaningful transaction, what should the payout look like over the next 12 to 18 months?

I think from that perspective, it's a combination and the balance of a number of different levers from a capital allocation perspective. So share repurchases, as you mentioned, we messaged in our most recent earnings call that we've already repurchased upwards of $200 million in shares for 2024. Other levers that we look to from the capital allocation perspective, our quarterly dividend. So we do have a history of paying the quarterly dividends. And then we have increased it consistently in the third quarter, which we did again here in 2024. The return through those 2 aspects will be balanced against, I think, the organic investment in the business. Again, just continuing to invest where it makes sense to drive that long-term net revenue growth as well as just some potential dry powder. It's nice. We appreciate the balance sheet flexibility that we have. So again, from a capital return perspective, it will be a combination, continue to be opportunistic from a share repurchase perspective and continuing on the track of the dividend as well.

Great. Okay. We'll look at that. We're out of time. Thank you, both. Dave, Jill, thank you for being here. I appreciate you.

Thank you, Alex. Appreciate it.

Thank you.