CME Group Inc. (CME) Earnings Call Transcript & Summary

All right. We will go ahead and get started. Thanks, everybody, for joining this afternoon. You guys have all probably heard me say it several times, but in case you haven't, I'm Patrick O'Shaughnessy. I cover capital markets here for Raymond James. Up next, we have CME Group. And on their behalf, we have Chief Financial Officer, John Pietrowicz. To my left here is John Peschier from Investor Relations. The first, JP, is going to go through some slides, and then we'll move into Q&A. With that, John?

Great. Well, thank you. Thank you, and good afternoon, everyone. I'll walk through a few slides kind of set up how we've been doing, and then we'll go into Q&A. So first off, CME Group has a tremendous business model. We're vertically integrated with our clearing house, which provides risk management expertise and provides our customers substantial capital efficiencies. We've got Globex, which is our trading platform, it is used in 150 countries and provides access to our markets, which operate nearly 24 hours a day. And then we've got our deep liquidity pools of globally relevant benchmark products, which allows customers to move large positions in and out of the market without moving the market. You can see from the pie chart on the right, we get about half of our revenue from financial products, about 1/3 of our revenue from commodity products and the balance is primarily driven by market data and other products and services that we provide our customers. So this is a highly defensible business model and a great platform for growth. The key financial driver for CME Group is transaction volumes. We charge a fee for transactions that are cleared or traded across our platform. With our diverse product set and continuous innovation, we've been able to grow, on average, 13% per year over the last nearly 50 years through a myriad of financial and economic conditions. And you can see that on the far left-hand side, we are doing extremely well so far this year with about 23.4 million contracts traded a day. Let's take a look at some of our more recent volume activity. As you can see, this is actually a little dated. If you look at the volumes to date, we're up about 32% with all our product lines up and 5 out of our 6 product lines up double digits. That's just -- that's including the last couple of days. So we're generating about 23 million contracts a day. We're seeing particular strength in our commodity products, which you can see circled, which tend to be our higher priced products. And also, we're seeing excellent growth in our equity products up about 65%. So off to a strong start in 2020. One of the key growth drivers for CME Group is the -- expanding our global customer base. We've invested in customer-facing employees around the world and developing liquidity 24 hours a day. And we've been extremely successful, and it's really paid off. You see we're generating about 4.5 million contracts a day out of Europe and about 1.3 million contracts a day out of Asia. You can see that so far this year, we're up about 35% in Europe and up about 45% in Asia. So off to a strong start. All told, we generate about 25% of our volume and about 1/3 of our transaction -- electronic transaction fee revenue from customers outside the U.S. CME has a tremendous leverage in our business model. As you see from the chart on the left, this is our financial results for the last 10 years. This includes NEX, which we closed out in the fourth quarter of 2018. In 2019, we generated about $4.9 billion in revenue. We had 62% operating margins. We've exceeded our first year synergy targets related to the NEX transaction, and we guided to flat expenses in 2020. So with this kind of financial characteristics, we generated a tremendous amount of cash. We get that cash back to our shareholders through our innovative capital return policy. In addition to our regular dividend, which we increased to $0.85 from $0.75 the year before, a 13% increase, we have the annual variable dividend. The annual variable dividend is something we implemented in 2012. And we take a look at the cash that we have on our balance sheet at the end of the year, we target about $700 million in cash and rental holds. We look at our cash needs for the following year, and we dividend the rest back to our shareholders through the annual variable dividend. In 2019, our annual variable dividend was $2.50, that was up from $1.25 the year before. We've been focused on paying down our debt related to the NEX transaction, and we're targeting a debt-to-EBITDA of 1x by the end of this year. So we have a tremendous amount of leverage. And since -- leverage in our balance -- leverage in our business model, not on our balance sheet. And then if you take a look at our dividends through 2012, when we initiated the annual variable dividend policy, we dividended more than $13 billion back to shareholders. So to summarize, CME has a tremendous business model and a great platform for growth. We've got a -- we're very much a network business so that we're very focused on bringing in new customers, innovating new products, giving our customers maximum capital efficiencies that we can and providing access to our markets, which operate nearly 24 hours a day. And then we look to reward shareholders through growth in our innovative capital return policy. So with that, we'll turn it over to some Q&A.

Great, certainly. Thank you, John. So there's probably few, if any, companies in the U.S. that are built to thrive on market volatility as much as CME Group. I think you kind of touched on that a little bit with some of your first quarter-to-date volume data that you were showing. You guys are kind of where people go to manage risk and there sure is a lot of risk out there right now. Are there any kind of underlying trends that you would point out that you've seen in the year-to-date on the recent trading that you think are particularly notable?

Okay. Great. First off, volatility definitely helps in terms of volume, but we're definitely focused on growing our business regardless of the volatility environment. We're very much a network business. That means that every customer I can bring on to the platform improves the overall benefit for everybody on the platform because it tightens the bid-ask spread. And the bid-ask spread is the most expensive part of the trade. So we're very focused on bringing on new customers, innovating new products and providing those customers capital efficiencies. And then our products are available 24 hours a day. So we've done a really good job in terms of bringing on those customers. And then when you have volatility like you've seen recently, you get that acceleration in terms of the amount of trading. So for example, we had 5 out of our top 6 trading days in our history last week. We generated about 30 million contracts a day in the month of February. So we've seen just a tremendous amount of activity. We've been able to handle that volume without any issues and that's really due to the dedication of all of our employees in CME Group to make sure that we're handling that kind of volume, especially when the world needs to manage the risk, and they come to our platform. So in terms of interesting trends, what I thought was interesting is all of our product lines are up. So risk is not just one dimensional. Risk is multidimensional, and we've got all of the products people want in order to manage risk, whether it's risk in the global food supply, whether it's risk in the global energy market. We've got all the most important financial products that the world needs on our platform. So what I thought was kind of interesting is that it was across the board in terms of the volume and also the global nature of the business, which I showed you some numbers up there with EMEA up about 35%, APAC's up about 45%. So risk is global, and our product set really is a global product set. So when the world needs to manage risk, whether you're in London, Singapore, Chicago or New York, we're available to help manage that risk.

So one of the big themes for CME Group in 2019, and it sounds like it's carrying over so far into 2020, has been the growth of your non-U.S. trading. I think your non-U.S. trading volume was up around 10% in 2019, and you kind of gave the numbers for EMEA and APAC so far this year. Can you talk a little bit more about what is really driving that growth outside the U.S.? And then maybe contrast that to what you're seeing in the U.S.?

Sure. John, do you want to...

So I think if you look at last year, we had some pretty tough comps for the year before, which was extremely active. And as John mentioned, what we're seeing so far this quarter, the numbers are kind of changing by the day, but you're seeing Asia growing the fastest, more than 50%. Europe is growing about 40%. And when we look at the U.S., it's actually up about 30% year-to-date. So I think when you look at it, the U.S. is more mature, certainly, and I think one of the things that we've done is really invest in the sales force. So when we first merged these 3 great exchanges together in '07 and '08, we were very siloed in terms of how we would sell the product. So the guy that runs interest rates would bump into the guy who ran energy at the same hedge fund they're going to see that day. And neither of them would know that they were going to see that customer. Now it's totally coordinated. We have one head of sales, we've broken the sales force down by customer type, and we're very focused on driving more activity, and getting more clients on to CME. Once somebody starts to trade with CME, they're not going to trade anywhere else. So the main thing we're focused on is getting the new clients connected to us. The next acquisition we've focused now on is very much on cross-selling. So we monitor everything that we do very closely. We've had approximately 500 meetings, joint meetings with the NEX folks and the CME folks looking to cross-sell and try to drive the additional customers. So I think that's how things have changed there. Like I said, in the U.S., it's a bit more mature, but we're seeing growth really from every part of the world right now.

Got it. And then I think some of your growth also comes from your new product innovation, I think relative to some of the other exchanges out there. It seems like you are coming out with more products, and you're talking about more products. What is it about CME Group that is kind of -- that creates this new product engine?

Great question. I'll let John answer part of it, too. I think what's really interesting is that our relationship with our clients is stronger than ever. Really, since the financial crisis, people have really turned to CME Group for that efficient trade. So when I mean efficient trade, that means a tight bid-ask spread, that means a high level of capital efficiencies. And when you are offering that kind of value, the customer really -- becomes a really great input into what kind of products help them to manage their risk in the most efficient way possible. So I think that's part of it. I don't know, John?

Well, I think if you just look at the laundry list of new products that have been successful, we've had the Ultra 10-year treasury, which didn't exist 4, 5 years ago. Last week, during 1 day, that contract traded more than 1.5 million contracts, which is a pretty exceptional number. The other new product that's had a lot of a claim is the Micro E-mini. It's 1/10 the size of our popular equity E-mini contract, and that's been really interesting for retail customers to use for a lower cost alternative with leverage. So that's certainly something that's out there. We've created things like weekly treasury options. And then Monday, Wednesday, Friday, FX options. So once we find an idea that works in a product area, we work quickly to replicate that across the other areas. But as John mentioned, a lot of clients now are bringing ideas to us to get products off the ground. We often have webinars with 2 or 3 different product ideas and where the customers basically settle on a solution. So again, like we were talking about with the sales effort from a new product development, it's been significant. And just one number to throw out there. If you look at our business and our financial products, since 2010, new product, new innovation that didn't exist in 2010 represents about 2 million contracts per day, which would be the fourth biggest exchange in the world as a stand-alone business. So we're definitely not resting on our laurels. We're looking at how we can extend this even further.

So you guys took a modest pricing increase in February, and I think you're kind of on an every other year type of a schedule. I think when someone could look at your business model and the barriers to entry in your competitive strength, you probably get the question, why don't you take more pricing? Why don't you take it more frequently? What are the pros and cons that you see to take in pricing?

A great, great question. I think when you look at the price increases that we take, and you're right, we announced that we had a -- between 1.5% and 2% price increase, which goes -- the majority of which goes into effect February 1. We're very careful in how we approach pricing. When you have as high incremental margins as CME does in the roughly 90% range, you want as much velocity going across the platform as you can, 24 hours a day. So when we do -- when we take pricing action, we take a look at it on a product-by-product basis. We look at it bottoms up. So we look at a number of factors, including the health of the market or the health of the clients. We look at how you can get that exposure via some other marketplace. So we're very careful in terms of how we take pricing action, and we always do it with the view that we don't want to impact volume. The more velocity, I can go -- can get going across the platform is not only good for CME Group, it's also good for the customer because it tightens that bid-ask spread, which I said, was the very expensive part of the overall cost of trade. So that's part of it. For example, last year, we didn't take any significant pricing action in 2019. 2018, we did, we took some pricing action. So we're very careful in pulling that lever. Really, what we want to do is we want to be the most compelling place for our customers to express a point of view on the marketplace. And I think we've been very successful in making sure that we don't impact volume as we do take some pricing action.

So the other side of the coin is, we've seen you take these relatively modest pricing actions, but then when we look at your rate per contract, it has had modest declines in the last few years in most of your key asset classes, so in rates and equities and energy. What are the dynamics at play there that are leading to that rate per contract decline? And I think when I talk to investors, they say, "Hey, I think volume is going to continue to grow, but I'm worried about RPC coming down?"

No. I think when you look at our rate per contract, there are multiple shifts -- mix shifts that can occur. So for example, when I showed you the charts, we're seeing particularly strength so far this year in our commodity products, which are higher priced than our financial products. So when you have a higher proportion of your activity coming from commodities versus financials compared to a previous year or previous measurement period, you're going to have a higher RPC. You could have mix shifts within a product line. So for example, in our financial products, interest rates, in particular, the long end of the curve, our treasury products have a higher rate per contract than our Eurodollars, which is on the short end of the curve. So even within a given product, you can have mix shifts that occurs. So that's one factor that impacts the rate per contract. Another factor that impacts the rate per contract is a member, nonmember mix. So if you're a member of the exchange, you tend to pay the lower fees than the nonmember who pays a higher fee. So if you have a mix shift within the member and nonmember types of customers, you'll have an impact to the rate per contract. We also offer tiered discounts. So the volume -- so there's -- at a point in time, depending on -- and it's in most of our product lines, the next trade will be cheaper than the previous trade once you cross that tier. So it's revenue accretive. It's just RPC because it lowered the RPC. What's important is that we generally do not reduce prices. Generally, we are -- we either keep our prices the same or slightly increase, like we discussed just a few moments ago. So when you see an RPC shift, it's really -- it tends to be a mix shift, a product mix shift, a membership mix shift, on occasion, it could be a venue mix shift, if you're doing something that's, we call, off-exchange or ex-pit that could also have an impact or there's a discount tiering. So I think when you take a look, you'll have multiple mix shifts for this quarter. We've got higher activity in our commodity products, we're having tremendous amount of volume as well. So you'll have a couple of mix shifts that will happen.

Just one thing to add to that. We're very transparent. So the volume comes out by the day, basically, by the minute, if you're really interested in it. But then we also put out the rate per contract with a 1-month lag. So yesterday, we put out the rate per contract through January. So by the time CME gets to earnings day, there tends not to be any major surprises because we give out some of that information as the quarter plays out.

So switching gears now to M&A and corporate strategy. One of the interesting things to me as an analyst in looking at the different exchanges is the wide variety of capital allocation strategies across the different companies. CME's approach over the last several years has been to be very selective regarding acquisitions. And then on the capital return front with strong preference is to payout the extra cash and dividends and not do share repurchases. You can trans that to somebody like ICE that is maybe more open-minded about the different type of deals that could contemplate, and they are very aggressive with the share repurchase plan. So why has your capital allocation strategy evolved as it has?

It is really interesting when you think about exchanges, back when you first started covering us, our peers are not really our peers like they used to be. A lot of our peers back in 2005, '06 and '07 have really taken different directions. And I think a lot of it has to do with the success that we had in our acquisitions early in our -- or early in my career, and early on as we were a public company. We were the first company to go public, and we were able to make several moves, which really defined us even to this very day in a very positive way. We did the border trade in NYMEX and followed that quickly with the Dow Jones Indices business acquisition. And it gave us these great six asset classes that are very global in nature. We talked a little bit about it. You saw some of the charts, and it really set us up in a real position of strength globally. And our peers might not have that same benefit that we have in terms of the diversity of the product set, the global nature of the product set. And I think we made some really good moves in terms of building out a sales function and I think we've done really well with the S&P Dow Jones Indices business, which locked in the S&P contract to CME Group exclusivity for as long as we have an ownership of that business. So I think that really set us apart, and we are now able to be very selective in terms of how we execute on M&A. We think the NEX business is going to be viewed very positively as we migrate that onto Globex and integrate that business. So I think we are just -- we're in a different position than some of our peers. In terms of our capital return policy, I'm very pleased with the way that has played out. It was very innovative. We did it during 2012. We've dividended back out about $13 billion or more than $13 billion since we implemented that policy. And I think it's very important to be consistent in your capital allocation process and I think we've been -- we've done that. Also it's very transparent. John talked about how transparent we are. We give out our volume every minute of every day. We give out our rate per contracts at the end of -- on a trailing basis every month, a 3-month rolling rate per contract. This is also very transparent, I walked you through kind of the calculation. So I think that transparency is very positive. I think as an aside, it's very easy just internally for somebody to come and say, "John, I'd like you to invest in this project or that project." And it's very easy to say, "Well, how are you going to do better than our shareholders, again, if I gave this back through a dividend?" And so it gives you that kind of an ability to pressure test projects internally as well. So I think it's been very, very successful. I like the transparency of it. I think our Board is very pleased with the -- with our capital return policy as well.

So it's been about 2 years since you announced the NEX acquisition. It sounds like you're well on your way to meet your expected cost synergies. You touched on it a little bit in your presentation, but can you give an update on some of the revenue synergies? And it might be too early to quantify any of them, but are there any tangible things that you'd point to where you say, "Hey, this is how these 2 entities are really combining and creating something more powerful?"

Yes. It's -- we're very pleased with the way our integration has been going. We exceeded our first year synergy target. Really, it started in middle of last year, when we kind of reorganized the business. NEX was very siloed in how it ran its business. So each business had its own organizational structure, if you will. And CME is a very flat organization, and it's more functionally oriented. So the first thing we did in September was to move the organization into our CME's structure and that was very successful, allowed us to achieve the synergies that we needed to achieve, especially on the administrative side of the business through midyear. We also aligned our sales organization. John touched on it in some of the remarks he made. And that's been very powerful. So the entire sales force of CME and NEX are under one organization. So that means that we can train the sales force across all of our products. It means that we can use the same tools, metrics and tracking across the entire sales organization globally. And NEX has a more global sales force than CME even does. So we're able to leverage those sales relationships across all of CME group. So John mentioned, we had about 500-or-so cross referrals, cross introductions since we kind of kicked this off. So we're able to run global campaigns. One of the campaigns was the cross-sells and cross introductions. We're able to track it and we're able to see the fruits of some of those meetings. So I think that's been very powerful. Most of those were in Europe, and most of those were in FX. So we're very, very pleased with the way that's performed. A lot of the synergies that you're talking about, I think, will really come to fruition once we get those businesses on to the Globex platform. It allows us to innovate products, innovate functionality across the cash and the futures as we migrate BrokerTec onto Globex in the fourth quarter of this year and then EBS, which is the FX platform next year. So I'm very, very pleased the way things are going. We've got -- one other point is that we do have the systems up for testing. So we do have some of the testing going on right now for BrokerTec. That will ramp up as we get closer to the cutover. But so far, some -- I think some really good early signs in terms of generating benefits of having it all together.

I'll pause now to see if there's any questions in the audience? All right. Then I'll keep going for 1 or 2 more here. So BrokerTec, which you just mentioned, it's arguably the crown jewel of the NEX Group acquisition. But yet, it competes in a very competitive space, then you have up-and-comers like LiquidityEdge and FENICS and Tradeweb that have all demonstrated share gains in that -- the dealer-dealer rate space, treasuries. How confident are you in the competitive position of BrokerTec? And how might the move to your platform -- and you just touched on a little bit, but maybe to expand a little bit more how the move to your platform should -- or could potentially impact the competitive position?

Yes. Certainly, we face competition across our entire platform. But certainly, the NEX businesses have significant competition related to each one of those platforms. And I think when you look at BrokerTec, for example, there is some streaming capabilities that some of the competitors have launched. We have launched a streaming solution as well on the BrokerTec side. So we've invested in providing that functionality. But I think what's really going to differentiate us is when we put Globex -- when you put BrokerTec on Globex, nobody out there is going to be able to offer customers cash and futures on the same technology stack, which I think will be very powerful. So for example, if you are trading futures and you're trading cash on BrokerTec, and you're trading FX on EBS, right now, you're dealing with 3 different types of technology, whether it's Globex at CME Group, whether it's the NASDAQ platform for BrokerTec or it's EBS for FX. So you have 3 different kind of companies that were managing that, 3 different types of technology. And now it's all going to be one company managing it, CME Group, and one technology stack, which is Globex. So I think that should be helpful in terms of customers having to deal with multi-platforms going down to one. And then also, the power of having the futures and the cash on one platform, offering innovative solutions between cash and futures and offering our customers' operational efficiencies. We're currently working with the FICC, which clears cash treasuries to provide capital efficiencies more than we currently are able to offer with the BrokerTec and CME's futures. So all of that, I think, will definitely create a powerful offering, an offering that nobody else will be able to match. And we think that will be very beneficial for our clients.

All right. Very good. I think we're out of time. So we'll wrap it up there, but thank you very much, John and John. And we'll have a breakout session downstairs.

Thank you, guys. Thanks for your interest in CME Group. So thank you.