Intercontinental Exchange, Inc. (ICE) Earnings Call Transcript & Summary

All right. We will go ahead and get started. Thanks, everybody, for joining us. I'm Patrick O'Shaughnessy, capital markets analyst here with Raymond James. Up next, we have Intercontinental Exchange, and CFO, Scott Hill. Scott, thank you for joining us.

Thanks for having me, Patrick.

So I think the question that a lot of us are leading off these questions-and-answer sessions today is just, hey, what are you seeing out there right now in the macro? And how resilient do you view ICE's business model to be?

Yes. So certainly there's a lot going on. You've got -- we're just chatting about it, attendance here at this conference and whether or not [ Volcker ] goes off in a few weeks. And so that's all largely coronavirus and what's going to be the impact. So that creates uncertainty and churn in the market. Who's going to be the Democratic presidential candidate? It creates churn in the market. The thing is about our business model is we've tended historically to be very countercyclical. You know the last chart we show at every one of our earnings calls is our earnings growth since we became public in 2006, every bar on the right is bigger than the bar on the left. And that's been through good and bad economic times because the reality is what we provide -- half our business largely provide is risk management services. And so in a world where oil is moving to $80 or below $50, they're commercial customers who were impacted by that and want to hedge those exposures, and we're seeing that. In our volumes right now on a kind of a year-to-date basis, our overall energy volumes were up nearly 40%. More importantly, our open interest is up nearly 20%. And that matters because what that says is we've got the commercial customers actually putting positions on, whether they're trying to lock in oil below $50 or to manage around positions they have. So our model overall has been really resilient. And again, we've talked about the emergence of our trading platform and its commercial orientation and the global nature of it. And so we've put ourselves in the middle of the oil market with Brent and then we've extended that to 600 products that are derivatives of Brent. And more recently, we've announced the intention to launch the Murban contract later this year, which will be a Middle Eastern oil benchmark. We bought Endex, and -- which is the TTF or the Dutch natural gas hub, which really put us in the center of what's now a globalizing natural gas market. Emissions markets run on our platform. And so whether it's natural gas or oil or emissions, I mean you pick the market, we provide the risk management services to our customers. And we had indicated, if you look at open interest trends, they were really up year-over-year in every single period over the last couple of years. And our indication was that that's commercial orientation. And just to give you another sense of that, if you look at the relative revenue share of ICE versus our closest competitor in the energy space, we now earn 60% of all the revenues in the energy space. It's never been higher, typically been kind of mid-50s. Open interest, which I would argue is the most important indicator of continued interest in our markets, we have 64% of the open interest in the energy market. That's typically been in the mid-50s, so it's never been higher. And we think that's the global commercial orientation of our market, and in this kind of volatile world people are living in, the real risk management for those commercial customers coming home to our platform.

How much structural growth do you think is left in that commodities trading business at this point? So if you look at trading volumes, I think your commodity futures volumes were down 2% last year, they're up 2% in 2018. Obviously, your revenues grew faster than those volumes. But do you look at this as, "Hey, this is a blip." just because of this volatility? Or do you say "No, there's still a long way to go in terms of people wanting to manage their risks."

There's a long way to go because I don't look at -- it's -- the health of our market isn't indicated in volumes. It's indicated in open interest. And if you look at open interest levels, '18 was above '17, '19 was above '18. Year-to-date, '20 is above where we were in '19, and those trends are going on because the importance of the commodities that trade on our platform only continues to grow with those commercial customers. And again, it doesn't do it through just the Brent contract, right? It does it through those 600 products that we've built over the last decade that are derivatives of Brent. It does it in the natural gas markets, where we are the exclusive provider of basis markets in the U.S., that's where you put gas into a pipe and take it out of it. And with NGX, we're the place where the physical clearing or settlement of that activity occurs. It's the Endex purchase of TTF, and what we refer to as kind of the Brent of natural gas. Why is it emerging that way? Because it's in Europe. It's in the middle, it catches the end of the Asian day and the beginning of the U.S. day. And as gas is able to start moving around the world, people want to look for what is that benchmark against which I can hedge. So I don't worry too much about volume. I recognize that it generates revenue. And right now, January was the best revenue month we've ever had as a company. And by the way, volumes in February are higher. So it's really nice when the volumes come. But in terms of the health of our market and our long-term ability to generate increasing value for our investors, I look at the open interest, and those trends have only been up for the last number of years.

Got it. So I want to take a step back here and talk about corporate strategy. And I think a big topic on your last earnings call was M&A, and obviously, there's eBay rumors that were floating out there. So maybe just take a step back and talk us through what is the strategic framework that ICE applies to its acquisition screening process? And what's the criteria that an acquisition must possess for it to be considered by ICE?

Yes. It's a good question, and thank you for asking it. So I think the first thing I would say is the way we think about M&A today is not different than it was the day before the eBay deal linked -- leaked. And so what does that mean? So Jeff said on the earnings call that we think about M&A in terms of what are the things that we're good at? And what we think we're really good at is operating marketplaces that have a really strong network effect. So think about your first question, and we talked largely about energy, but I'd broaden it and say, we run a globally relevant commodities marketplace. And if you are a commercial participant who has an oil exposure and natural gas exposure, a sugar exposure, a cotton exposure or an orange juice exposure, you're in our market. And so we've got this anchor content in the middle of a network that makes it really sticky. And so over time, our question is, do we need to acquire something that makes that network stronger? And so back in 2007, we bought the New York Board of Trade and that brought to us our first clearinghouse. Because our vision was that clearing and the risk management of clearing was really the enabler of growth in the futures market. And so we bought that component through M&A with the intent to make the network stronger, and we got additional content. So we were in energy exchange, but then we had agriculture and a small number of financial products that we're doing. So it's more content flowing through that network, which does 2 things: one, it gives you existing customers in that network more to trade; and it draws new customers into that network, which broadens the appeal of the network into which we then added interest rates a few years later. And so the M&A strategy is really focused on finding or building marketplaces with a strong network effect, and then either buying pieces that can make that content -- or improve the content in the network or building blocks that make it stronger. Another example, we're really -- we believe, putting ourselves in the middle of a mortgage market that's going to move from analog to digital. And so the way we started that out was buying a couple of pieces of infrastructure, MERS, which is a database where 75% to 80% of the U.S. mortgages in the United States reside in Simplifile, which is a set of pipes that are plumbed into counties that represent over 80% of the population in the United States. And so those are building blocks of a new network where effectively, we put ourselves into a place where if any one of you goes to close on a mortgage, ICE is now there. If you look down the sheet, you'll see your $11.95 charge from MERS. If you do it as an electronic note, you'll see an additional $4 charge. And then when your lawyer or your mortgage broker is done with that document, we have the ability to allow you to seamlessly push that document into the county versus somebody running a bunch of paper down to the courthouse and handing it off to be filed in a box in the backroom. And so that's another good example from an M&A standpoint, where we look at building blocks and we look at content. And then the last part of it overall is we do look for underperforming networks that we think we can come in or marketplaces that we think we could come in and run better. And the New York Stock Exchange is a great example of that, right? So if you think back to the deal we announced in 2012, clearly, the interest rate business was the crown jewel, right? And we had shown our interest in that in a hostile manner a couple of years before. Euronext, we didn't really feel like there was anything we brought to that network until we spun it out. But the New York Stock Exchange was a business that was losing share and had margins in the 30s. Today, we've elevated that share back to 24%, 25%, and particularly in the [ valuable ] times, closer to 25%, 26%, and we doubled margins. So that's an example of an existing network that we bought, and we thought we could run better and we have run better. So ultimately, it's content, it's building blocks or it's an undermanaged network where we can bring our abilities to bear to run it better.

Got you. And I think kind of underlying a lot of that M&A philosophy is, the company's view, if you try to operate ICE as an entrepreneurial company, and you're always trying to build and build, can the company reach a point of maturity where having an entrepreneurial mindset might become a negative rather than a positive? Like if you have an investor say, "Hey, Scott, you guys are a $50 billion market cap company, you have some very successful synergistic franchises, 60% margins, great cash flow, just don't screw it up." Like how do you take that sort of feedback and still, at the same time, try to drive the company forward and maybe make decisions that people don't necessarily understand right away?

So it's a great question. And maybe you can reach that point, we haven't. And I think if you kind of go back through history, we were a great energy franchise when we went public at the end of 2005. And during 2006, we made an offer to spend $1 billion to buy the New York Board of Trade. And one of our closest competitors said, "I can't effing believe you paid $1 billion for that." And our response was, "We can't believe you didn't." And if you think about, we effectively took all of that contract volume, dumped it into an existing exchange, built a clearinghouse in Europe based on the clearing technology that they had. There's -- I would submit to you, there's probably not been a deal we've generated a higher return on investment than that first $1 billion. But people at the time thought why are you messing with that energy franchise. And then roll forward to 2012, when we announced the New York Stock Exchange, people were like, "Oh my God, why are you buying the -- we get the interest rate, but why are you buying the New York Stock Exchange?" And a year later, our share price has doubled, right? The day that it was announced, it didn't do so well. But a year later, it had doubled. And then roll forward to 2015, man, you've got this great trading and clearing business, and you paid 16x for IDC, that's insane. Boy, 16x. I mean if I could have gotten every other data asset in the world at 16x, I'd take them all right now. But again, the thought was, look, that's a fixed income world that we think is likely moving analog to digital. IDC is the provider of fixed income prices for the world, 3 million securities, now 33 million referenced securities. We put ourselves right into the middle of the fixed income network. And now we're building the ETF Hub out of it. And so part of what we believe is, we certainly have to continue to manage and grow the existing businesses. And you've seen us do that, which is why earnings grow every single year. But we have to continue to grow. And so it's what's the next idea that ETF Hub is not going to generate growth for us this year. But in a couple of years, it will. The mortgage business right now is $140 million out of $5 billion. So it grows 20%, you're talking about 0.5 point of growth. But if the $140 million can become $300 million, it can become $500 million, now all of a sudden, 2, 3, 4 years out, those are the things that are putting up and instead of us growing 3% to 4%, we're growing 5% to 6%. And if we can grow 5% to 6% on the top line, we're going to grow 10% on the bottom line. And for that earnings chart we show every single quarter, we'll keep showing and that number that goes across the arrow will continue to be double digit.

Got it. And then maybe to build off your comments on fixed income, what are you seeing out there right now with fixed income assets that you own? There's ETF Hub, there's BondPoint and TMC now under the unified brand of ICE Bonds, there's your data business. Kind of how is that all coming together right now?

Yes. So thank you for asking it in the broad sense, because that's how we think about it. We think about ourselves as running $1 billion-plus fixed income business. And that's largely the old IDC business, or if you look at how we report today, our pricing and analytics business, not 100% fixed income, but it's largely that. And that is the prices of 3 million bond -- fixed income securities. And again, reference data on 33 million securities and liquidity indicators and indices. We have an index business that we bought from Bank of America Merrill Lynch a few years ago. And that business at the time had single-digit assets under management share, and now we're up to 20% of assets under management benchmark against our indices. So it's a very broad business sitting inside our pricing and analytics reporting. And you'll see that that's a business that's really led the growth of our overall data business for the last 3 years. And I gave guidance, it will lead us again this year at 5% to 6%. So that's a big part of it. But then in addition to that, we feel like that some of the on-the-run or near-the-run bonds are likely to start to trade more electronically. And again, it's not what we think will happen. It's what we're hearing from the people who are in those markets, right? The banks are holding a smaller balance sheet, they hold less inventory of those fixed income indices. But the interest in investing in fixed income is growing. And so in a world where it's growing, we thought, "Where is the place that we could put ourselves in the middle?" And so we did buy the bond platforms. And to a large extent, that was more the technology buy. And so we bought Click to Trade, we then built RFQ capability. But the real key for us is to get that plugged into ETF Hub and to create a liquidity pool that comes from the creation and redemption of fixed income ETFs. And so if you think about BlackRock, I think, has indicated that over the next 5 years, they think that's a market that can double in size. And so if we can establish the go-to network where the issuers and the APs all come together to do create-redeem, and we can plug our trading platforms into that, create-redeem is nothing more than buy-sell. You want to create an ETF, you got to go buy bonds. You want to redeem an ETF, which, by the way, in the last 3 weeks, we're seeing a lot more of the redeem than we are the create, that redemption is, simply, I'm going to go and sell those bonds. And so ultimately, we believe that ETF Hub is where it all comes together and starts to create a liquidity pool of trading on our platforms and others. It's a world where I don't think our ability to be successful in the space is dependent upon others in the space not being successful. I think it's going to be a growing pie, and our objective is to take a share of that growing pie.

What sort of reaction or conversations that you've been having with the asset management industry and fixed income to engage on these fixed income platforms? You've recently established your connectivity with a big order management system, Charles River and Aladdin.

And Aladdin. Yes.

So now you're at the point where you're actually actively engaging with the buy side and saying, "Hey, here's the tool set that we have."

So the importance of those OMS is that does give you direct access into the buy side. And so we clearly are engaged there, and we believe that's an opportunity to get those bond trading platforms more installed with the institutional investor. But again, I go back to the ETF Hub, and they are the key as we've been working -- we started with BlackRock, but we've been working with the entire industry all along, whether it's State Street or Vanguard or any of the other big issuers that you can think of. Because ultimately, what we want to provide is a neutral place where the entire industry can do create-redeem one way, as opposed to what exists in the world today, which is I do it one way at State Street, a different way at Vanguard and in a different way at BlackRock. And so our objective is to work with the broader industry to establish this single way to do it. And if you think that that's largely the way I started, right? I mean Jeff's looking for a place to buy and sell power and ultimately creates a single place as a neutral in-the-middle third party, where Goldman and Southern Company and all those other companies could come together and trade it in one fashion. And the sales point was, we're going to reduce your cost, we're going to widen the pool of people who can participate and we'll all do better. And our sense is that that's what ultimately the ETF Hub does. So yes, it's important to continue to expand the number of OMS, which our bond trading platforms are hooked up. But really, the ETF Hub is the anchor of the strategy.

Okay. Got it. And then switching to the mortgage space, which you touched on earlier with MERS and Simplifile acquisitions. How do you build that business from -- maybe the way I kind of think about it is, you have the infrastructure right now. How do you build that into kind of the sort of numbers that you were throwing out there? And I know that was just kind of, for an example, but how do you build it into something that you can increasingly monetize over time?

Yes. So I think that there are a couple of different ways. So again, for those of you who aren't familiar, I mentioned MERS is a database, where 75% to 80% of the U.S. mortgages reside. If you're familiar with DTCC, it's a similar thing, where that's kind of the golden record in the equity space. This is the golden record in the mortgage space. You can think about the information that exists in that database. And so in a world where we've got the database, is there an opportunity to create aggregated content or information that could be a tradable product that could inform somebody who's investing in a region? So it's looking for opportunities like that on the MERS side. And so there, that's really an untapped market generally, because you have all -- largely that's happened so far is those mortgages reside in the database. And so that's an example of an opportunity where we think there may be a data opportunity for us as we move forward. Another example I mentioned, eNotes. And so last year, we had, I think, it was 120,000 eNotes, which is simply an electronic mortgage that were filed, we charged $4. You do the math, that's $0.5 million, that's not particularly interesting. But that's like low single-digit percentage of the mortgage. And so in a world where we can grow the electronic mortgage from a low single-digit percentage to 20% or 40% or 60% or 80%, that's a big revenue opportunity. And again, that's just in the market as it exists today. In Simplifile, I talked about, that's the plumbing into the counties. And so to the extent, we can push a mortgage through it and then also a title through it. And then also think about all the -- an appraisal, think about all the different documents that you can imagine going through those pipes. That's another opportunity. We're in a world where we're still largely analog. As it moves more digital, we're right in the middle of the ability to capture that flow. And so certainly, in a world where interest rates are lower and homebuyer and builder sentiment is high, that helps that business. But we also think we've positioned ourselves in a place that even when those metrics maybe aren't as attractive, it's the electronic opportunity that really can drive value.

Got it. And then another recent deal that you've done was you acquired a company called Bridge2 Solutions. And you're combining that with your digital currency play, which is called Bakkt. When I think -- or when investors hear about trading these digital things, I think sometimes the challenge is, it's not clear exactly how you monetize the trade in those digital assets unless there's going to be the trading velocity of those digital assets to make it a meaningful number for ICE over time. So how do you guys go about sizing that sort of opportunity? And how can ICE maybe grow a business like Bridge2 Solutions faster than it would have on its own?

Yes. So let me maybe step back and describe a little bit. So what is Bridge2 Solutions? So Bridge2 Solutions today offers rewards programs or support of rewards programs for 7 of the 10 largest financial institutions. And I want to say they operate something like 4,500 rewards programs globally. And an example, I don't know if this happens on Bridge2 Solutions, but an example of something they would facilitate is, "I've got points on my American Express card." And so I went on yesterday and was buying my daughter a printer to put up in her room. And ultimately, as I got to hit buy, it said, "Hey, do you want to use Amex points?" Okay. That's effectively a digit -- my Amex points are digital currency, right, that effectively, I could have used to buy the printer at $89. I didn't bother with that. But you kind of get the point. And so ultimately, that's the way we think we can facilitate. So I brought in Starbucks coffee today, and I used dollars to buy it. And flew in on Delta and added these miles because the company is paying for it. But if it were my trip, I'd be using miles. And so all of those are forms of digital currency. And so our sense is, to the extent we can offer a more seamless way for you to show up at a Starbucks and use Delta miles to buy your coffee or you can use those Amex points more seamlessly at a vendor, that the people are going to be willing to pay for that. And by the way, if we can facilitate that at less than a 2% to 3% cost versus what you'd charge for the credit card company that as you go across air rail, that maybe there's a benefit to us providing that kind of payment opportunity. And then to your point in the background, to the extent that ultimately, we're determining, "Hey, this is a value of a Delta mile or a Starbucks point." I can tell you today what my Delta miles are worth in dollars because I can go price a ticket and I can know a dollar price, and I can know what a miles price. And so ultimately, if my neighbor is Paul Jacobson, I saw him here at the conference. And if ultimately, he was able to come in and say, "Hey know what, I've got this big liability for all these miles sitting on my balance sheet. I'd like to reduce that sum. I'll give you ninety cents on the dollar right now, I'll take those miles back." I might be interested in that. And if we can facilitate that in the background, now that's a buy-sell, right? That's a market. And that's where Bakkt started. It can buy-sell a bitcoin, yes, but it's a buy-sell of a crypto and custodian of a crypto. And so to the extent we could start to facilitate the payments using these, and then in the background, have an exchange and a clearinghouse that allows the -- because Starbucks didn't want to take Delta miles, they want dollars. And so we've got to have some place, some market in the background. And guess what? That builds liquidity in that trade. And if there's liquidity in that trade, liquidity is the greatest attractor of any additional liquidity. And so how big that can be? And then Jeff said in the original days that Bakkt was a bit of a [ moving shot ]. It's in our expense run rate, it's not that big an investment. But in a world where -- I've seen estimates that there's $1 trillion of value in cryptocurrency, if you define that term broadly, it feels to us like there's an opportunity to make a little money.

Got it. I'll see if there's any questions in the audience. They have been a quiet group today, so I'll keep going. I think we have about 5 more minutes. So switching gears to kind of recent results. I think data services seems to be playing out largely as you expected to a year ago. It's over 5% growth in 2019 on a constant currency basis.

Yes.

And the midpoint of your guide for 2020 is around 4.5% if I recall correctly. But we do see kind of growing pressures maybe on the regulatory side of things. Or whether it's the SEC's recent U.S. equity market data dissemination proposal, SEC's challenge to exchange market data and connectivity practices. To the extent that those challenges persist or even mount from here, are there -- I guess, how do you manage through that? And are there other kind of growth offsets that you would point to?

Yes. So it's a good question, and I think the biggest part of the answer is the same answer I gave you in the earlier question about the fixed income business. We said on a call, we don't expect our NYSE exchange data to contribute to both. We don't think it will detract, but we don't think it will grow. In the world we're in now, as share goes up, maybe it gives us a little bit of growth. But ultimately, we don't anticipate it will contribute. However, our pricing and analytics business, that's grown 5.5% every year on average for the last 3 years, it's going to do the same thing this year. And so that to me is the mitigant to that exchange, and again, the cash equity exchange data. You know because you followed us for a long time, the futures exchange business doesn't necessarily grow every single year. But if you look over getting M&A outside of it so that you have normalized numbers, our futures exchange data business has grown high single digits on average every year over most periods. And so while it doesn't necessarily grow every year, every year or 2, you're going to see that kind of contributor to growth. We're not getting that this year. And so that's why pricing and analytics at 5% to 6%; connectivity, 4% plus; you've got exchange data at 2%. But over time, futures exchange data will grow, pricing and analytics has a lot of growth opportunities that I've talked about. And our capacity continues to grow in connectivity, it was up 14% last year. I said we expect it to be 8% this year. And so that capacity growth, like open interest, is a really big future indicator for us as we look forward. And the good news is, it's a steady contributor. And so if I look -- we just had the best January of revenue in our company's history, right? And that's with a steady contribution from data and a fantastic contribution from volume. And guess what, February volumes are better than January. And so if January was a record thing set up well for February. And the thing that does -- because I know I've got the steady contributor from data, which is going to grow 4% to 6% for all the reasons I alluded to, we know we're going to get these strong cash flows. And so it's what allowed the Board to give us a 20% higher authorization in buyback. And in a world where we're setting records in our revenue in January and positioned well for February and the share price is going down, we've got flexibility to be opportunistic. And you saw us do it a year ago, right, where we went into the market, TheStreet didn't like what we guided coming out of our fourth quarter call. Stock got beaten down, we bought back an extra $100 million at $74. We ended the year in the 90s. And so we've got that flexibility in a world where the price is moving at odds with the fundamentals of the business, we can go in and be opportunistic in terms of reducing share count.

Great. Well, with that, I think we're out of time, but we'll wrap it up there. Thank you very much, Scott.

Thank you.