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

Equity index revenues account for 20% of CME's total revenues, and they faced difficult comparisons versus the first quarter of 2022. Can you provide us with an overview of the equity index complex and how the financial industry utilizes these products? And how much of the change in activity is due to lower volatility?

Yes. Thank you. Great question. I would say we've got the best equity futures franchise in the world. We've got all exclusive rights to all the major currency payer -- not currency payers, all the major indexes. Sorry, thinking about FX there for a second. So you think about the S&P, the Dow, the Russell, the NASDAQ, so we've got exclusive rights to those contracts for futures. And then we also own 27% of the S&P Dow Jones Indices business, which is a premier indexing company. And that 27% gives us the exclusive rights, as long as we own a percentage of that business, to the S&P and Dow Indices products. We also earn about $0.25 billion in earnings derived from our 27% ownership of that index business in 2022. So we definitely have built what we think is a tremendous platform for people to hedge their equity risks. It was also our fastest-growing segment last year, up about 36% from the previous year -- I'm sorry, up about 39%, actually, of '22 versus '21. And I think one of the things that really is great about our -- the complex that we've built is the capital efficiencies we're able to provide our clients when you're trading in and amongst all those indices. So we're able to offer our clients very tight bid-ask spreads, and we're highly capital efficient. We also do a number of things to really grow that complex. As you guys know, we are very much a network-based business. So we're very focused on bringing new customers in and providing new products for those customers to trade because as we bring in those products and customers, we create a tighter bid-ask spread, which is best for everybody on the platform. So we have been working on bringing in new customers. So we've launched things like micros, which has been extremely popular, and that's brought in new clients. We've been helping our clients move from over-the-counter to exchange-traded products. We've launched things like total return futures, dividend futures and BTIC, which is called Basis Trade at Index Close, which really is helping our clients move from the less efficient over-the-counter markets to our exchange-traded products. And also, we've been partnering with S&P Global and our S&P Dow Jones indexing company to create ESG products. So we've got the S&P ESG Index, which really is setting us up for the long term. So when you think about volatility and what it means to the equity markets, I think when you have such disparate information about whether or not the economy is going to be -- continue to boom, whether or not we're going into a recession, when you have that unknown, certainly, we are the place to hedge your equity risk. And as you know, as the risk-free rate increases, you certainly have a revaluation of the equity values, which obviously is a risk, and we are able to help our clients manage that risk. Finally, I would point out that when you think about volatility and you think about our equity complex, we are doing a lot, as I mentioned previously, to grow the business regardless of the volatility environment. So things like bringing on the Active Trader segment, which really our micros really addressed the need, also helps in terms of continuing the growth in our equity business.

Just staying on the topic of equity index products, which have structural growth drivers. Can you speak to retail exploration of complex derivatives, CME's ability to launch shorter-dated products and demand for exposure to the NASDAQ and S&P indices?

Sure. Our Active Trader segment has really been extremely resilient. Certainly, our -- what you call retail is significantly different than other retail clients on other platforms. Ours have been extremely resilient. We continue to grow the number of customers, and our products really are very efficient and are something that I think are -- as we look at the Active Trader segment, really is something that is very attractive to that segment. And also, I would say, we have created a really good ecosystem around the Active Trader segment. So working with and partnering with our intermediaries, we've been able to provide the right kind of mix of products that those customers want. So think about if you're an active trader, you can come on to our platform, trade the micro products, so the micro S&P, the micro NASDAQ. We also have a micro crypto. We've got micro FX. We've got the micro WTI. So pretty much every asset class that you want to trade, you could trade that on CME. So it has been something that has been hugely successful. We generated -- we put up about 3.3 million contracts a day in 2022 in our micro products. So they've been extremely popular. In terms of future products in short-dated products, we've launched what are called event futures, which are same-day kind of products. They've been performing extremely well, up around, I want to say, 12,000 contracts a day most recently for those contracts. And then also, we've launched what our Tuesday -- what our -- we call Tuesday and Thursday options, and those are generating about 250,000 contracts a day. So we continue to work with our clients on what they want to trade. And as I said, we've got the exclusive rights to these instruments, and we provide the safety, soundness of the CME Group along with the products that they really need.

And can you talk about client feedback for daily option expiries? Do you first see demand resembling the pace of activity at CBOT's index options complex?

We certainly work with our clients on their needs. Now obviously, CBOT is regulated by the SEC. We're regulated by CFT. So there's differences there. But to the extent that people want shorter-dated options or shorter-dated projects, we -- like I've said, we've launched the Tuesday and Thursday, which have been successful, recently launched the event contracts, which are ramping up in terms of activity. We'll continue to work with our clients and our intermediaries on other products to address their needs.

So markets are currently in a commodity super cycle, and the commodities complex accounts for around 25% of total revenues at CME. Can you start with how CME's agriculture metals and energy franchises are positioned to benefit from current macroeconomic conditions?

Sure. Why don't we start with energy? So we talked about how in 2022, we saw the market dislocation as a result of the war and the increase in prices there. So we did see a volume drop off last year in energy. So in the short term, that was a negative for our business. But if we look at kind of the broader backdrop and kind of what this -- the impact of this war could mean for the future, we're seeing more and more with the U.S. as a swing producer both in crude oil and natural gas, increasing amounts of export going to both Europe and Asia. So if we think about our West Texas intermediate crude oil or our Henry Hub Natural Gas products, we're seeing more of that product get into the hands of global participants who will then need to hedge that exposure on a go-forward basis. So given the shift in supply, we're seeing those benchmarks become more and more important on a global scale and on a global basis. If we look at base metals, we're also seeing some positive signs there. There was obviously a pretty big dislocation in the nickel market earlier in 2022. And we've been hearing increasing inquiries from customers looking for alternatives in some of those markets. We've had success growing our copper business over the last several years. And we are starting to build out a nice aluminum business. You may have seen we recently announced a partnership with Marex, who's one of the largest base metals brokers, and they are including our aluminum products now on their Neon platform, which is a nice growth driver for us. So we're seeing about 16% increase in metals trading so far this year. So we are definitely seeing some positive signs for the longer term on the commodity side of the business.

And as we think about future growth opportunities across the CME complex, can you remind us of international expansion, options adoption and new product launches in ESG and maybe other metals?

Yes. So I touched a little bit on metal. So maybe to start with international. This has been a focus area for us for the last several years. We typically see outsized growth coming from non-U.S. locations. We did see a little bit of a downtick this past year due to the impact of the war in Europe. Obviously, the impact is there on the economy. But we continue to see outsized growth in Asia, in Latin America, and we expect to continue to see outsized growth internationally for the long term. So what we've done is we've looked to launch regionally relevant products, recently launched €STR in our interest rate complex. We've got some local agricultural products, if that's Canadian wheat or South American soybean products. So getting regionally relevant products is one angle. We also look to increase our distribution and our partnership with local intermediaries in region to help expand our reach into clients. That could mean joint marketing events. That could mean just partnering to do education events, to provide content for those intermediaries. And the last piece is we've really shifted our footprint. So if we think about our head count, back in 2010, we had about 60 client-facing employees outside of the United States. Today, that's at more than 280. So we've really looked not at just increasing our headcount. It's really a reallocation of the client-facing staff that we had to put them more into those higher-growth regions to make sure we're capitalizing on that opportunity. So if we look at 2022, we saw 6.3 million contracts a day coming from outside the United States. That's an all-time record level despite what we saw in Europe and the dislocations there. So it's a nice growth avenue for us. Another focus is on options products. So we've continued to invest in our options technology and analytics platforms, and we're really seeing a lot of results come through there. In 2022, we had 4.1 million options contracts traded per day, and we've actually seen another uptick here in 2023. We're up at 5.2 million contracts per day traded so far this year. So if we look at either our international complex or our options complex, these suites of products alone would be pretty sizable exchanges on their own basis. So having these just be 2 legs of our growth tool is something that we're really pleased with and a bigger focus area for us going forward.

And given the breadth of the CME platform, can you speak to customer demand for CME data and analytics? How should investors think about growth near term and in the future with the Google partnership -- with further Google partnership progress?

Yes. Our data business, I'm really pleased with it. It has grown about 6% in 2022, and it was up 8% for the fourth quarter. So it's generating about $610 million in revenue in 2022 for CME Group. So really, we've been very focused on really looking at how people consume the information and what kind of information they need. And what's unique about CME Group is this data is proprietary to CME Group. So -- and it really -- it spans all of the asset classes that people care about. So we've done a lot to drive revenue in our data business. So think about things like derived data, think about historical data. So if you're a -- if you were somebody that is interested in the markets, and you wanted to see about how -- what trading patterns were like, you can buy our historical data to run scenarios and test strategies. So we've done a number of things until now. So for example, we've put a lot of data into the cloud. We have a thing called Datamine, which makes it easy for customers to consume that information. What we're excited about with Google, and let's talk a little bit about kind of where we're at with Google so far this year, we started really -- 2022 was really a foundational year. This is to put together the platform to make it easy for us to roll applications into the cloud. So 2022 was to get that foundation right, get the processes right for us to start to migrate our applications to the cloud. 2023, we're looking to accelerate that migration to the cloud. So we've got various teams working alongside Google to move to the cloud. The key first areas for us is going to be our market data business and clearing and move those processes onto the Google platform. Over time, we're looking to leverage all of Google's capabilities. Their engineering is tremendous. Their data and analytical capabilities is really second to none. And we, as a firm, don't need to invest in things like artificial intelligence, machine learning and BigQuery. We can leverage the investments that Google has made because we have this partnership and leverage those investments onto our own platform and data and trading systems. So we're looking at different ways for us to create those analytics to help our clients manage their risk or make -- or create trading opportunities for our clients. Now this may manifest itself in market data revenue. It might increase our transaction activity on the exchange. We're looking at different ways to monetize the really -- the deep and important data that we have at CME.

At this point, we can pause and take investor questions. [Operator Instructions] And while they're getting that situated, how do you think about the potential to increase pricing in 2023 compared to historical growth of 1% to 2%? And how does that compare to your outlook for expenses this year?

Yes. We just announced the impacts of the pricing actions we took in November. So in November, we took some pricing actions and worked with our clients and informed them of what the pricing changes were. And on the last earnings call last week, we announced that based on trading activity for 2022, we would expect the impacts of the pricing actions that we took to be in the range of 4% to 5%. That's 4% to 5%, both on financial products, and 4% to 5% on commodity products. So that is significantly higher than what we've done historically. Historically, we've done about 1.5% to 2%. We have taken pauses in the past because we take a very surgical approach when we adjust prices. We look at it on a product-by-product basis. We look at it on a market-by-market basis. We don't do like across-the-board price changes. All with the objective to not impact volumes. We've got extremely high incremental margins. So we want to make sure that we don't miss any trade. So with that, we did the analysis. We informed our clients in November. And those pricing actions take effect February 1. So you'll see 2 months of impact in the first quarter and a full quarter impact in the second quarter. We've also made pricing adjustments and market data. We have a pricing adjustment, which begins January 1, and that's, again, 4%. And we also in 2022 made adjustments to our pricing on our SOFR options. So we incented our clients to move from our LIBOR-based benchmarks to our SOFR options product, and we waived fees, and that was an impact of about $11 million in 2022. That was completed at the end of Q3. It was very successful. We had a significant shift in options, trading activity from euro dollars to SOFR, which is the new risk-free rate that we've been working with our clients and the government for quite a while on. And also, we had about $8 million expenses as we migrated those option contracts, which ran through our license fee line, which again was completed in the third quarter. So a number of pricing actions we've taken. All of them have been communicated to our clients. And as I said, so far this quarter, our volumes are on par with what we saw for full year '22. When you look at our expenses, we've done a tremendous job over the years managing our expenses. We came in, as I said, at the start, about $25 million below our full year guidance that we made at the start of the year. And this is something that has -- we've been very focused on over time. And if you look at 2018 and compare that, assuming we hit our guidance for 2023, which we've got a long history of hitting our guidance, it would be a sub-3% growth rate when you factor in the creation of OSTTRA, which is a joint venture we launched in September of last year. And the synergy captures, if you assume that all that synergy capture was at the very start of the acquisition we had of NEX. So very low expense growth over the last several years. So very pleased with the entire organization and how they've managed expenses. And we also -- that's excluding Google. So we do have costs that we're going to incur to migrate to the cloud. We said on a cash basis, it'd be on average $30 million per year over the next 4 years before turning cash flow-positive. So last year was $30 million. This year, it's approximately $60 million in cash expenses. But again, as you guys know, when you migrate to the cloud, you don't have the capital cost you used to have. So that's about a $20 million in capital that we don't have to spend. So that gives you a net $40 million. So it's $30 million last year, $40 million this year. Over the next 2 years, we expect to, on average, for the 4 years, be about $120 million. That will vary depending on the speed with which we migrate our applications to the cloud, and then we'll turn cash positive. So really excited about the Google partnership, as I indicated at my previous remarks. It's going to provide a lot of benefits for us in terms of investment. It's also going to provide a lot of benefits for us in terms of being more flexible to launch new products, and we're able to leverage Google's expertise.

And can you spend a moment on CME's capital return policy? And would the firm consider M&A to create new growth avenues?

So start on our capital return policy. We have a bit of a unique capital return. So we have our 4 regular quarterly dividends, and then we have an annual variable dividend structure where we return any excess cash generated to our shareholders. So this structure has been in place since 2012. And since that time, we've returned over $20 billion in dividends to our shareholders. We think the transparency of the structure and the consistency that we've used it has been well received. We also have a strong yield up over 4.3% in 2022. In terms of M&A, our capital structure is also very conservative. So we're under 1x debt-to-EBITDA at this point, and we're very cash generative. So we think the combination of these factors are unique dividend structure. And this cash generation puts us in a strong position that if something were to come up, we have a lot of flexibility. We have done a number of different transaction structures over the years from large-scale M&A like the acquisition of Board of Trade or NYMEX to the creation of the S&P Dow Jones joint venture, the OSTTRA joint venture, the Google partnership. So we're comfortable with the whole range of different M&A and strategic growth transactions. I would say that we are constantly looking for ways to create value for our customers and shareholders. And if something were to come up, we have the flexibility to act. Last thing I would note is we do continue to think that large-scale cross-border M&A is challenged in this environment, particularly given just the current political and regulatory environment, but we'll continue to look for new opportunities and new ways to grow.

With that, I think this is a good place to pause. John and Lynne, thanks again for joining us.

Thank you. Thanks.