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

All right, everybody. Welcome back to the 2024 Piper Sandler Global Exchange and Trading Conference. My name is Patrick Moley. I'm a senior research analyst covering the exchanges, trading companies and online brokers. Happy to be joined by our last fireside of the morning, CFO, Warren Gardiner of Intercontinental Exchange, ICE. ICE is a global exchange and clearinghouse operator. They IPO-ed in 2003. They've been the driving force behind electronification of the energy futures market. And more recently, they've made a push into fixed income in the mortgage industry. So Warren, thanks so much for sitting now with us.

Yes. Thanks, Patrick. Thanks for having me. Thanks, everybody, for joining.

Yes. So starting off, maybe talk about the environment, interest rates uncertainties persisted, geopolitical tensions are high with presidential election coming up. How are you thinking about this setup heading into the back half of the year and what it could mean for ICE's business?

Yes, it's a good place to start. I mean, it sounds like there's a lot of demand for risk management tools, frankly, which is what we do. And so I think as I think about the next couple of quarters and really into the next couple of years here, I think the setup is nice. I mean, look, we've got a business that's very much diverse across different asset classes, from energy to ags to financial products, as Patrick mentioned, fixed income and mortgages. So we've got a good group of asset classes that we're in that have both cyclical and secular trends that we're well positioned to take advantage of as a company. And so we're excited about those as we move into the next couple of years here. And so I think about that, coupled with a revenue base that is largely recurring in nature, over 50% recurring in nature. Operating margins in the mid-50s -- high 50% range and a free cash flow stream that, obviously, gives us a lot of opportunity to continue to invest in that business and grow well into the future. It really is a unique competitive advantage in that sense. And so we're excited about as we look forward here. I think if you kind of zero into some of the key areas of our business, I think about energy, our energy business, our energy futures business, open interest is up 25% year-over-year. Open interest in our oil contracts up about 20% and more so in gas and global natural gas. Think about our interest rate business, we're up over 30% in terms of our open interest. Fixed income, that's an asset class that obviously went through a challenging couple of years with the move higher in interest rates, but I think having -- I won't say settled, but certainly at a 4.3% tenure -- 4.5% tenure, it becomes a pretty attractive asset class for people, and we're seeing customers really reengage with that business and invest in that asset class, which has been good for that business the last couple of quarters as well. And then mortgage, it certainly is a challenging backdrop for the -- on the origination side. But you are seeing supply of new homes on the market increase. We are having purchase volume, which for mortgage is above 6% now, I think almost -- it's well into the double-digit percentage in terms of number of loans outstanding that have a 6% or so plus mortgage, that was maybe a few years ago around 1% or 2%. So the backlog of future refinancings is obviously growing too as well as we kind of move further and further away from that 3% mortgage. So I think if you look across the business in all the different areas that we're in and the setup to use your words, I think, is pretty good, not only again for the next couple of quarters, but I think the next couple of years here.

Sure. Maybe we'll start off with the mortgage business, still a difficult environment like you said, but I think a lot of people are excited to see what you can do with the business. Myself included in a better environment with Black Knight acquisition closely last year you're now #1 in both originations and servicing market share. Can you talk about what the overall acquisition of BKI has meant for ICE? And then just talk broadly about the overall vision for the mortgage business.

Sure. So it's a lot like the other asset classes that we've been in, obviously, for a longer period of time. I think one of the better examples, honestly, is just the energy business and how we built that platform out. And it started with a handful of contracts within energy that still exists today. And through a series of acquisitions and organic growth and new product development, we have a platform today that is thousands of products and well over $1 billion in revenue. So -- and we did that, and that's sort of the blueprint we apply, where we create this foundational network, which, in that case, would have been a handful of those energy contracts, Brent crude oil, for instance, and then go build around it. And so that's what we're doing in mortgage and really through the use of data and technology and bringing additional transparency to that asset class, additional efficiency to that asset class, which again, in the mortgage market is right for opportunity. And then so if anyone that's gone through that process knows that it can take months to get a loan -- get a mortgage loan. It take months to get a refinance -- to refinance the mortgage on an existing loan that you've been in multiple years. And so bringing data technology to that with the existing network that we have and bolting on or creating product organically, it's going to be the same blueprint that we've applied to these other asset classes over time. And I think it is that market share, that foundational network that begins with Black Knight and Ellie Mae and having that full workflow that really positions us to do that, I think, in a very unique way.

Getting a little more specific on the opportunities that you spoke about. Can you kind of walk us through how you think about the potential for a product road map in mortgage and the opportunities to sort of offer mortgage-based products in the other businesses like fixed income and the exchange business? How do you think about that kind of product set?

Yes. That's one of the unique opportunities that we have to. And so I think when you think about, for instance, on the data side, Black Knight, Ellie Mae before we acquired it. Those are unique data sets. Raw data -- a lot of raw data comes off those platforms. And Black Knight has over 50% of the loans in the United States serviced on that platform. Ellie Mae, a nice mortgage technology, legacy ICE mortgage technology originated around half of the loans in the United States each year. And so it's a lot of real-time information around the mortgage market that we uniquely have on that platform. What those platforms didn't have before was the ability to create sort of a product, a data product out of that and then sell it into other areas of the capital markets like we do. And so that's one of, I think, the key synergies that we're looking forward to is bringing together the capabilities we have within our fixed income and data services segment, where we have close to 1,000 customers that today consume end-of-day pricing for mortgage-backed securities that I think will have interest in additional data and transparency that we can provide from some of the mortgage products that we have. That exhaust, if you will, that comes off of those platforms. And so again, that's unique data with the unique skill set that we have that we can bring together to create something that just doesn't really exists like it does in the world today. So those are areas that we're very much excited about. We've either got -- we've also launched over a number of quarters ago at this point, but a Rate Lock futures index and a Rate Lock futures product. And that, again, those -- that data coming off of the mortgage platform. We've leveraged an index business that we have in our fixed income segment to create this index. And then, of course, we have the futures platform to trade that off of. And so those are -- that's in the early days, of course, today. But again, a unique product that we're bringing to the market that I think can bring just additional efficiency and transparency to people's workflows.

So since you closed the acquisition 6 months ago, you've had a chance to kind of look under the hood and you talked about the data exhaust coming off. Are there any areas that where you've seen demand for possible productization of that data that you maybe weren't initially thinking was an opportunity that was there, but just kind of presented itself as you had time to kind of integrate it?

Well, I don't know if there's anything that's necessarily that we've figured out that didn't kind of have a sense of or a blueprint for before. But those are the areas, like I said, on data that we really do see the opportunity. And again, because of the network we have on both sides of the aisle, if you will, in that sense, to really -- to not only create the product but distribute the product. And so I think those are certainly the areas that we're going to focus on to start. We're also very much focused on modernizing the technology stack underpinning some of the Black Knight products as well. And that's something that we've gotten off to a very quick start on. Again, I think we'll not only over time, improve just the user experience, but also improve the opportunity to extract different types of data and again, just make it a more efficient transparent workflow for people over time, too. So I'm certain that over a longer period of time to comment to your question, that those will -- those opportunities will arise. That -- that's really the core of what we do and how we grow these businesses. And again, I come back to the energy business, where 20 years ago, we didn't have a road map for all of the thousands of contracts that we have today, but over time, with communication with the customer and understanding their pain points, you're able to develop these products, I think, in a unique way. And so that's really what we'll be focused on as we kind of move -- progress here. And again, that network that we have, both on the servicing side and the origination side and connecting those over time is really provides us with, again, a very unique opportunity to have that communication and that dialogue and to really understand the workflow and the pain points across that workflow to develop those products.

So when you set out on the mortgage journey, you had the intention of reducing the amount of time it takes to close the loan, the costs -- so I mean at the risk of simplifying this too much, how far away do you think we are from the average American going to take out a mortgage, maybe done so in the last 5, 10 years, saying themselves while that was a lot less costly and was a lot faster than I've experienced in the past, thank god for all the great work ICE has done.

Yes. Well, look, I think we're still -- they may never know ICE in that process but they certainly like their originator and their broker, if you will, more. But I think we're still in the early innings of that, but if one were to utilize a lot of the products that exist today, I think you can -- you're starting to really get there. I mean I've experienced this using an Encompass originator and I've have used a non-Encompass and maybe an internal technology originator, if you will, in the past. And there's been a dramatic difference in the time and the ease it is to kind of create those products. And there's actually been some surveys done on the cost and the efficiency of an Encompass user versus a non-Encompass user in terms of the time and cost it is to originate a loan. And so we're delivering those efficiencies today, but I do think that there is a tremendous opportunity to make those even better over time. And that's the goal. And I think importantly for us, while we do have a fairly strong network or market share across these flagship products in Encompass on the origination side and servicing with MSP. There is a tremendous opportunity to cross-sell a lot of different data and analytics products that those customers aren't consuming. And importantly, their customers, again, that are on our platform. So it's a captive customer base that we can really go and sell into. And I think that's a big opportunity that we see not only with the existing product set, but also others as we kind of progress through this journey.

All right. Moving on to energy mortgage businesses based headwinds that hasn't been the case with energy coming off your fourth consecutive record quarter with -- for energy revenues, volumes in the second quarter, tracking up 30% year-over-year. Open interest is up 20% year-over-year. You've taken share in crude oil and nat gas. Can you talk to the strength that you're seeing. How sustainable do you think this is? And what are you kind of doing to continue to drive demand for some of the existing products and, I guess, new products as well?

Yes. I think -- well, look, I think there are a couple of different trends that are -- that have existed and continue to exist. I think will continue to exist well into the future here, too, to be clear. And so -- and we're very well positioned for them with the platform that we have. And we've got a platform across a lot of different, if not all sources of energy, and we have it across the world. And so we're really well positioned to go and chase growth or capture growth wherever it's happening in that particular asset class and ecosystem. And that's really how we've always approached that platform. I kind of come back to the earlier question where we really listened to the customer base and developed our product suite around where they felt their pain points were going to be or where they thought they were going to be focused in the future. And so as I think about the trends that are out there, I mean, you have an energy transition occurring and evolution probably better said in energy that it's going to be very long-tailed in nature and going to occur across oil and gas and in some -- in our environmental products, importantly as well, where we're a leader with and have been for well over a decade at this point. And so I think as we think about those trends, they'll continue well into the future. And so as long as we're kind of paying attention to that customer base where those pain points are. Those opportunities to create new products and drive growth across the platform are going to continue there. And I think we've got a lot of products not only that are maybe more mature that have a lot of runway, but newer ones as well. I mean when you think about JKM, which is a Japan Korea Marker, that is going to increasingly be an important one for LNG moving around the world. TTF is another one where, again, very much tied to the growth of LNG and the readjustment we've seen in supply chains post Russia-Ukraine -- post, but certainly since Russia and Ukraine has been important part of that growth there and getting gas to Europe from other areas around the world. And so I think, look, as long as you believe that the consumption of energy is going to continue to grow the number of sources of energy will continue to grow, delivery points and emerging economies will continue to grow and develop, then I think we're -- around the world, we're very well positioned to kind of continue to sustain that growth that you've seen us deliver over the last number of years.

And I know this question gets asked quite often, but you raised pricing in the energy complex this year. Can you talk about those increases and your kind of thoughts on your ability to take price going forward in energy?

Yes. Look, we've always taken the philosophy across the platform, not just to energy that where we deliver value or create value for a customer, we will capture and share in that value. And that exists within mortgages and exists within our approach in fixed income and then, of course, over in energies and energy futures and futures overall. And so one thing more specific to the energy future and what we did there, is, it was a number of years ago, we -- last year, I guess it was, these are contracts, big oil benchmarks that we really hadn't touched headline price on for a number of years, but of course, delivered a lot of value to our customer base and felt like that was an opportunity to go capture some of that value. And so we did that, and we didn't -- more recently in this year, we did not touch those contracts, but we did touch a couple of other energy contracts, and we touched some of our data products, and some other fees around the clearinghouse as well. And so the point is we've got a number of different levers, I think, across the platform where we think we've created value that will go capture that value. And I think you'll see us continue to take that approach. I don't think it will need the same contracts, the same rate every year by any means, but we will pick our spots that way, and that's what you've seen us done pretty consistently historically.

All right. Moving on to fixed income and data services. I'll start off with a high-level question. As rates have risen, demand for fixed income has obviously increased, and a lot of folks are expecting that to continue. Can you talk to how ICE's positioned to benefit from that trend? And maybe speak to the longer-term vision of this business.

Sure. So what we've got there is the core of that, the foundational network, if you will, back to sort of what we're talking about with energy or mortgages is the pricing and reference data business. And we provide end-of-day fixed income prices to 3 million-plus securities around the world and at the same time each day so that maybe not some of you that aren't probably fixed income managers, but fixed income managers can price their NAVs to calculate performance, charge their fees, things of that nature. And so it's a very mission-critical offering there that we serve to thousands of customers across that asset class. And what we've done like with other areas of -- or other asset classes that we're in, is to take that network and go build around it with new products and new services and try to build out our presence across the workflow. And so I think as fixed income becomes a more efficient and automated asset class, which it too seems to be more in the earlier to mid-innings, if you will, like mortgage maybe being more in the earlier innings, we'll have the opportunity to develop those products across the workflow and sell the current product set within the current customer base as well within the workflow. So more recently, what we have seen to your point is certainly the last couple of years, the sharp move in interest rates definitely had an impact on the customer base. I think we saw some continued strong trends in retention, things of that nature, where we did see some weakness was in our -- with our top line sales. As interest rates have started to say, stabilize, I don't know if they're going to necessarily go up or down from here or to what magnitude, you've seen reinvestment in that asset class and reengagement in that asset class from a lot of those customers. And so that's a lot of why you've seen the ASV in our fixed income data and analytics business pick up from the low single digits into the mid-single digits, more recently. And so it's really going to spend that reengagement with an asset class that these interest rates becomes pretty attractive relative to where it was maybe only a few years ago. So that's been a positive as we obviously look into the balance of this year and the next year for us.

And you mentioned the -- on the transaction side, that softness, largely retail driven. I think you've talked about building out institutional connectivity. Can you talk about the things you're doing there? And how important do you think institutional connectivity is to broadening out the product set and kind of getting to where you want to be longer term?

Yes. It's an important part of it. And you're right, that retail is still a large part of that platform. And I think a good component of that liquidity pool that we certainly want to maintain and grow. So I don't want to make it seem as though that we're putting that to the side by any means, but certainly something that we can help leverage as we build out that institutional connectivity. And that was a lot of the premise for the acquisitions that we did a number of years ago was to do that. And we made some good progress there. We've grown market share within the institutional business for a couple of reasons. I mean we've done a lot of the blocking, tackling on getting new accounts connected to the platform, connected to those liquidity pools. We've also launched new protocols like our RMA protocol that's brought in more institutional liquidity. And then we also leveraged the presence we have, of course, in the data set to kind of bring more people into those liquidity pools as well. So again, kind of leveraging the full network and the customer base that we -- the existing customer base that we had on the institutional side to help those liquidity pools grow from that perspective. And so all of those have kind of combined to be -- help us make progress on that front, and I think will continue to. And in addition to that, we've -- we're also well positioned within the municipal bond space, which from an electronification standpoint is making progress, but it's still behind where corporates would be or some other asset classes would be. So that, too, is another opportunity beyond just institutional to kind of see more electronification with areas such as that.

Sure. And maybe just bringing it all together, this all-weather diversified business consistently have grown EPS over the years. How do you kind of think about the longer term just growth algorithm or earnings algorithm in sort of a more normalized environment?

So I think history is probably a pretty good guide ultimately for -- and so again, we talked a little bit earlier about some of the current positioning that we have in terms of -- from our energy business with double-digit growth in open interest. We've got a fixed income business that seems to be inflecting from some of the macro pressures that we were under the past couple of years and getting better, and then I think it's -- you can argue on mortgage where we are in that cycle, I suppose, but it does feel like we are bottoming and getting some stability when that starts to really pick up from a macro perspective, I think, is difficult to know with certainty, but certainly, I think we're getting to a point where customers are starting to really reengage and think about the next number of years here. And how they want to be positioned from a technology standpoint to catch that ultimate -- that uptick of volume. So I feel very good about that kind of heading into the next number of years in terms of how the revenue profile can look and we'll continue to make the investments that we've communicated and continue to kind of invest in our longer-term growth potential.

Okay. I think we got time for one more on M&A. It's been a difficult environment for M&A, particularly large-scale M&A and getting it through you guys probably know as well as anyone. It's been -- M&A has been an important part of your growth story over the years. So as we look to the upcoming presidential election, it seems like the -- there's a potential we get an administration change. Do you think that would impact your appetite for M&A in any way? And then maybe just broadly how you're thinking about M&A from here regardless of who wins the presidency.

No. Look, I don't think that really changes our approach. We're -- we've been able -- we've operated in all different types of environment, whether it's M&A or just running the business. I mean that's part of the all-weather nature to a degree is we've been able to operate and grow through many different environments. And so I don't think that really necessarily impacts how we're thinking about things. We're really looking when we do M&A, looking for the best opportunities that are going to deliver the returns that we've communicated to our shareholders and executing on that. And so -- and that can range from a lot of different asset classes that we're in today. It's not just going to mortgage, if there's opportunities across fixed income and exchange segments as well, particularly areas like environmental for instance. So we're certainly looking at those and we're always looking at those. That's part of the strategy to grow through bolt-on acquisitions and to develop products organically as well. But I think, look, at the current moment, we're still coming off of a fairly large transaction, we're 3.9x gross debt to EBITDA. So we are focused very much on paying down that debt and getting to those leverage targets. Not to say that we haven't been able to do bolt-on acquisitions in the past, but certainly, I think the focus at the moment is really to get back to those targets and go from there. So.

All right. I think we're out of time, but thanks so much, Warren, for joining us.

All right. Great. Thank you. Thanks for having me.