MarketAxess Holdings Inc. (MKTX) Earnings Call Transcript & Summary

So with that, I'll kick it off.

So maybe just a quick current events question. Obviously, other stuff in the news that the coronavirus fears has impacted the markets. What are you guys seeing right now in terms of your volumes and then the characteristics of your volumes?

Sure. Happy to comment to the extent that we can. Maybe monthly volume report, we would expect to be out, as it normally is after the close tomorrow, FINRA TRACE numbers will be finalized today. But suffice to say there's a lot of volatility across markets last week and that included credit. Everyone is familiar with the headlines on 10-year U.S. treasury yields, which dropped about 60 basis points through the week. But for our world, even more important than that was a fairly significant widening of credit spreads during the week. And especially in high yield, where various components within the energy sector and the transportation sector were impacted more than others. And as you know, Patrick, for following us as long as you have, credit spread volatility is really the key one for secondary activity in our markets. So safe to say that overall market levels, especially in high yield, were elevated last week. And in my opinion, this is really where the benefits of Open Trading or all-to-all trading liquidity really come through for our clients. One of the things that we said on the earnings call in late January is that we had a good growth year in '19, with 17% top line revenue growth, but it was against the backdrop where the market environment or market conditions was really not all that favorable for our business model, because if you look at the year, credit spreads were tightening all year long. Credit spread volatility was not that high. And we still had a very good growth here. So periods of sustained credit spread volatility, especially when credit spreads are widening, tend to be the best market environment for us.

Got it. And then maybe kind of shifting gears a little bit. Let's talk about the competitive landscape. In corporate bond trading, to what extent do you think competitors are gaining market share with your core client base, which is institutions and doing larger institutional trades? But maybe to put it another way, are you seeing out there, anything out there that might reduce your ability, the MarketAxess ability, to grow? Or maybe would introduce pricing pressure at some point?

Yes. No, thank you for that. And obviously, we're -- we've had a lot of competition in our space from the start, and we expect to have it going forward as well. So no surprise, especially the success that we've had in the current market cap that there will be ongoing competition interested in the credit space. I think it's really important to remember a couple of things is that fixed income is not one big market where everybody plays in the same pool. It's actually 3 markets. And whether you look at the rate space for government bond trading or you look at the credit space, where we operate, there tends to be an institutional customer space, an interdealer space and then a retail space, which in fixed income is also D2D. And you really have to unpack the story in those 3 segments to understand what's really going on with the competition. And the reason it's important is that, in the corporate bond space, we can get pretty good estimates based on the TRACE data of the size of the opportunity in each of those segments. And based on the TRACE data, we believe that 80% of the market opportunity in electronic credit trading sits within the institutional customer space. That's where you see the trade sizes and the trade flags and TRACE that are marked as customer trades. So 80% of the long-term growth opportunity is in the institutional customer space. That is where we have always focused. From our -- starting the company 20 years ago, our focus has always been on building the institutional client network, building the best liquidity pool in the world for credit trading and occupying that space. A lot of the action that is going on competitively is in the other 2 segments. So the interdealer space has really historically been primarily a voice brokerage business with firms like BGC and TP ICAP very much in the mix, some hybrid examples there of electronic trading coming through. But it is an area that's starting to move more electronic. And I think revenue-wise, it's where Tradeweb has had the most success is in the interdealer space with dealer sweeps. We've also had some success, and we're very transparent about it in our earnings call that now 90 -- 94% of our volume, 96% of our revenue comes from the institutional client segment. The balance of around 5% is in that wholesale D2D space because dealers are now using our all-to-all venue or Open Trading for their own liquidity. So there's some movement in that space. And then the final segment is the retail space where tens of thousands of financial advisers and retail reps around the country trade with probably about 60 or 70 retail market-making desks through the retail venues. One, of course, is Tradeweb Retail. The other 2 were purchased by ICE last year, so TMC and BondPoint are now part of ICE. And an important segment, or we think in terms of the market opportunity, it only represents 4% or 5% of the long-term growth opportunity. And most of that D2D retail business is already electronic. So the current growth rates in that segment are pretty slow. So you've got institutional client electronic trading at 80% of the market opportunity, wholesale D2D at about 16%, retail at 4% or 5%. And when you really look at the competitor that people are thinking the most about and try to unpack their story, we did about $460 million in credit trading revenue last year. They did about $160 million. Within their K, they disclosed that $80 million of their revenue came from their retail business. The vast majority of it, I would guess well over 90%, is credit. So 50% of that competitor's credit revenue is in the retail space. And I think 25% is in the interdealer, 25% in the institutional customer. Long way of saying, when you get back to the biggest space in credit, we feel better than ever about our competitive position. And no, to your question, do we think there's anything valuable coming away from MarketAxess in that institutional customer space? Absolutely not. And not only is that our view, we talk to all of the major corporate bond trading desk in the Street regularly and that's their view as well. But we now have the only viable, robust all-to-all electronic trading platform with continuous order flow from institutional clients all day long. So we're approaching 30,000 institutional customer orders per day, 19,000 trades per day, there's nothing that compares with that and that leadership position in institutional client credit trading, in my opinion, is growing and where the business is coming from in the D2D space is really from firms like BGC and TP ICAP as it comes away from the voice broker business and into some of the electronic solutions.

And I think supporting your view that competition is not impairing MarketAxess' growth is that your revenue grew 17% in 2019, which was your fastest annual growth rate since 2016. I think, not only is it due to things that you're executing on, but there's also, I think, the perception that, hey, maybe we're finally at that tipping point for the industry where it's ready to go electronic, where the buy side is using this auto execution tools, where the sell-side is using algorithms. Do you think we're really at that inflection point where things will kind of build from here? Or do you think there was just a bump in 2019 and maybe things kind of cooled back down 2020? Where do you think we are in that progression?

Yes. No, I think it's a really interesting point, and we've talked extensively about this in our earnings call, too, that the demand for trading technology in the credit space has never been running as high as it is right now in our 20 years of existence. So there's huge pressures on getting trading costs down, both buy side and sell-side. There's also an incredible draw to all-to-all trading for new sources of liquidity and lower transaction costs. So there's a combination of everybody wanting more efficiency and more technology for Auto-Execution, soon to be Auto-Responder, dealers moving to algos is creating that efficiency piece and then that, combined with lots of liquidity and better pricing in the all-to-all Open Trading module, is driving us, I think, to higher and higher levels of electronic trading. I think where it will be most obvious is in periods of sustained volatility. If you think back, Patrick, the last time we had that was fourth quarter of '18, it was a big lift for us in terms of market share that quarter. So when you get the combination of the trends that are going on toward demand for technology solutions and e-trading plus the right market environment, I think that's where you will see that level of growth coming through. And I'd also say there's one other trend that I think is super interesting, and I believe it's just at the beginning. If you think about really what's going on in global fixed income trading and the model changing in credit, in particular, this has been a 7- or 8-year process of adoption to the bank regulatory changes that went through in about 2012, where the capital requirements went through the roof for the banks holding inventory, so the investors have had to get used to a new style of sourcing liquidity and banks have had to get into a new way of moving risk on and off their balance sheet much more quickly. So what's so exciting about what's going on now is that we have this robust all-to-all liquidity pool that's clearly a significant market structure change and adding a lot of new liquidity to the market. The dealers are staying in front of more client orders than ever before, even in smaller ticket sizes through their algos, which are new in the last 3 years. There's been a total convergence of the ETF fixed income share trading business with the corporate bond trading business, which is bringing lots of new players in capital into our space. And part of our growth story last year was the fact that credit turnover is starting to show an increase again. There was a steep decline in credit turnover and fixed income turnover in general, post the regulatory reform, and now I think there are all these new solutions and new ways for dealers and investors to move risk that's starting to pick turnover up again. And the corporate bond is literally twice the size today as it was 10 years ago. So watch that theme too, because I think it's equally important to this inflection point that velocity of trading could be on the verge of growing substantially over the coming years.

So you guys started out as a request-for-quote platform. You've spoken about your all-to-all Open Trading platform. Now you have Live Markets, so streaming bids and asks for recently-issued bonds and other bonds that are in the news. How do you see market structure evolving in terms of -- there's probably not going to be a one-size-fits-all solution for certain types of trades or certain sized trades, this can be the right solution. So where do you see that going?

I agree with that. And we felt about 6 months ago that based on the automation that we saw with our dealer clients and investors starting to really embrace data-driven auto-execution that the time was right to move ahead with the Live Market environment for segments of the corporate bond market. But when we think about Live Markets and where it probably works, it's mostly around newly issued bonds that are 4 or 5x more active and liquid in the first 3 weeks of trading than they are after that. So lots of two-way activity as bonds are finally finding their final home following a new issue. And then the very large benchmark deals from frequent issuers, including financials that trade actively through the day. So we are onboarding clients, and more importantly, we're working on APIs with a number of market makers to get continuous liquidity into our Live Markets page, but it will be an area where we think we can significantly improve our share outcome for newly issued bonds, block trades and highly liquid benchmark deals. And that's an area of the market where I would say, Patrick, I completely agree that for those kind of trades, the two-way liquidity was sufficient that the market didn't necessarily need RFQ. The rest of the corporate bond market, RFQ has been the preferred protocol. So this is an example of us moving into various protocols to suit the liquidity needs of our clients, depending on how different segments of the market operate. And I would say you see testing of new protocols around the market, dealer sweep is the inventory matching just dealer-to-dealer, that's an exclusive platform that's had some success. You see sessions-based trading, and we'll continue to leverage the massive client network that we've built over the last 20 years by continually investing in new protocols to complement what we've always done in RFQ.

You touched on block trading a little bit, and I think Live Markets is a solution for some of that. But how do you crack the code for blocks for nonrecent issues? Because certainly, I think that's been kind of the sticking point for a lot of your clients, and it's still 40%, 45% of the market. So how do you actually penetrate that portion of the market with a lot more success?

Yes...

You know, I'm going to jump in whether my mic is working or not.

Go ahead.

No. On the block side, we have done a lot even with the protocols that we have. If you look at our market share in block trading, today, it stands around 10%. Block trading in the U.S., high-grade market is trade size over $5 million. We're about 10% market share. You look back 5 years ago, market share is about 5%. So we've doubled market share. That's largely been with our Request-For-Quote protocol, what we're doing there, we can prove to clients even in larger trade sizes, particularly for short-dated paper, you put up the order in competition, you get a number of price responses back, better chance of getting your trade executed. We've done much better at that promotion. And the friction in blocks is not with short-dated paper. And if we created a graph for you, we would show you that in paper, 2 years and in, that our market share is more than 20% in block trade. So it's not short-dated paper. Where you do see friction is in longer-dated paper, larger trade sizes. What Rick described with Live Markets, that's a big piece of the solution, we believe, to addressing block trading. And in those actively traded bonds, new issues that come to market tend to trade in larger trade sizes. So we do think part of that solution is around Live Markets. But we also feel that as a liquidity pool, particularly in smaller trade sizes becomes deeper and deeper. And you'll see -- we put some statistics up over the last earnings call about the improvement in the number of price responses back. That's because we have dealers and alternative market makers running algos, automatically pricing or automated pricing. As that liquidity pool becomes deeper and deeper and as we help clients break up those large orders into smaller trade sizes with confidence, that's the other part of the solution. So it's really directing or addressing the block trading from 2 sides with the Live Markets protocol and then deeper liquidity and helping clients with new tools to break up those orders into smaller trade sizes.

What's the importance of having the capability to offer rates trading side by side with credit trading because that was certainly a strategic priority for you guys when you went out and you acquired LiquidityEdge?

Yes. So I think there are 3 strategic and long-term benefits that we see from the LiquidityEdge acquisition that we completed in Q4. The first is they are the fastest-growing dealer-to-dealer government bond trading platform. And it's -- there's been an interesting change in that space because the CME bought NEX, which owned the biggest D2D government bond trading platform in BrokerTec, and you can see that there's some deterioration of their share since that acquisition, and it's being picked up by a number of companies, including LiquidityEdge. So we think there's an opportunity to compete in the core space that they have been in D2D government bond trading and continue the attractive growth rates that they've had. Secondly, we -- it does bring us the benefit of closing the gap on treasury hedging for corporate bond trades. And most of that was just a treasury trade going on away from us with corporate bond processing, but it will close that gap because we are already linking corporate bond trades into our new government bond pool on a single security basis. And we think by around midyear, we'll be able to match treasury net hedging for groups of corporate bond trades that can be -- where the duration can be hedged with one government bond trade and save transaction costs for the dealer or the client from crossing bid offer, 8x, 9x, 10x and net that out for one trade. So that's Phase 2. And Phase 3 is, we think there's a brand-new opportunity to compete in the client-to-dealer government bond space because of the ownership change that's taking place with Tradeweb this year, where it's highly likely that on the back of the LSE-Refinitiv deal, the LSE will also become the controlling shareholder in controlling voting rights of Tradeweb. And that is, in our opinion, a fundamental change in the space because most of you will know that, historically, Tradeweb has been 50% owned by Thomson Reuters Financial and 50% owned by 10 or 11 large banks. So the lockups end next month, we expect that the banks will liquidate their remaining position. What we're hearing from the Street is the LSE-Refinitiv deal is likely to close in the third quarter. We think that levels the playing field. We're fast at work designing what we think will be a new and very interesting client front end for government bond trading and the third leg of this acquisition story will be using that liquidity pool to also compete in the C2D space.

I think another interesting trend going on right now is portfolio trading and fixed income. And I think there's a few use cases, ETFs, just trying to do efficient basket trading and others. But I think that there's also some questions around how electronic really is portfolio trading, how electronic can it become? Some question about could it cannibalize trades that are done individually, and how you're going to basket them, potentially at lower price. How do you see portfolio trading evolving? And how can you monetize it?

Sure. No, important new question as well and portfolio trading, I would add to the list of new tools for transferring risk, but it's situational. And really what we pick up from our clients and the dealers that are active, and it's really the top 6 or 7 dealers that are most active, is that it tends to be when a client is transferring risk in their portfolio where they're getting out of one sector and into another, where they've got tax losses, they want to harvest, but they want to replace that risk with new bonds into their portfolio where they're doing a curve trade, so they're offsetting buys themselves in the portfolio and by sharing that portfolio risk with one or more dealers. From time to time, they feel like they can get a better price on the package than they might have been able to do so by going out on MarketAxess with a bidder offer list. But in the grand scheme of things, portfolio trading has grown actively in the last 2 years, but it's still a very small part of the secondary market. FINRA was on a panel -- at the FIMSAC meeting that I attended a couple of weeks ago, FINRA, of course, runs the TRACE tape and they said that while it's growing, it still represents less than 2% of the secondary share in high grade and high yield. And a number of trades, because we can see them on the TRACE tape when a group of bonds hits the tape at exactly the same time stamp, it's growing, but the number of portfolio trades today is probably around 8 to 10 trades. The other defining feature of these is, oftentimes, they're bilateral. So it's one client sharing risk with one dealer. That doesn't, to me, fit the true definition of what we normally think about with fully wide open electronic trading. That gets into the category, which is mostly about processing benefits. The individual prices are not negotiated individually. It's off a benchmark. Mid-market index, sometimes ours, sometimes IDC, sometimes Bloomberg. The bonds and the baskets are often negotiated off system, but there are STP benefits that come to the client. And I think what you're seeing in some of the volume releases is that some of that portfolio processing on a few bilateral trades a day is showing up in the electronic numbers showing a lot of volume growth, not what most people would think of is comparable to fully electronic trading, and it wouldn't appear that there's a lot of revenue attached to it either because you're seeing volume reports going up exponentially and revenues going up a little bit. So we're going to probably draw the line based on whether it's a competitive multi-dealer portfolio trade that feels more like we're delivering value and sourcing liquidity versus a single dealer trade. We, just in February, started to do more both high grade and high-yield portfolio trades on the system, a very small part of what we're doing. It's an interesting place to watch. I think the best execution requirements for asset managers will continue to favor negotiating the best price on each line item in most cases, but there will be the situational needs that lend themselves to basketing a group of bonds together in a portfolio and sharing that risk with one or a few dealers.

All right. So as promised, I will turn it over to the audience and see if there's any questions? All right. I'll keep going then.

You're doing a good job, Patrick.

Thank you.

That's what that means.

So Tony, we'll test your microphone again here.

Testing. Testing.

So MarketAxess' margins are certainly below 50%. Operating margin, down a little bit from peak. You guys have a lot of initiatives, require some investment spending. Are you guys kind of thinking of 2020 as kind of being peak investment? And then kind of the scale of the business starts to demonstrate itself a little bit more going forward?

I don't know if 2020 is the peak of the investment. I could tell you that to this stage, we probably haven't had more initiatives going on at one time than we have right now. But I'd also tell you that on the margin side, I believe, Rick believes there is scalability and margin expansion on the horizon. But we also believe that it's -- now is the time to invest. It's never been more important to invest to increase the addressable market, expand geographically, get into new client segments, launch new products. And we're doing all of that right now, still with the 50% operating margins. We've got -- the thing about the initiatives that we've talked about here is we've got Live Markets going on. We have automation. We continue to build out our automation capabilities. We've got clients in dealer treasury trading. We've got municipal bonds. We have private client bank initiative. We have a clearing initiative. All of this is going on at the same time. I do think we could have the margins today. If that was the mission, was just to show margin expansion, we could have those margins today at 55% or 60%. It would feel very good short term. It wouldn't feel so good long term. I think we're doing all the right things to invest for the future. And those initiatives that we're talking about, that will drive revenue growth going forward. And you will see margin expansion on the heels of that. I don't know -- again, I don't know if 2020 is the peak, probably not. I think there's still a big and -- a big agenda we're trying to execute on. And I don't think that agenda is going to get any smaller. I do think it is the -- it definitely is the right time to invest.

But here's a way to follow-on that and put the opportunity in context, right? Because we feel the demand from dealers and investors all over the world every week that we're operating now for more electronic trading solutions in all fixed income markets. The FT had an article about a week ago citing the global fixed income revenue for the top 12 banks in the world at $60 billion. I totaled up what I can find in the electronic trading revenue for global fixed income, and it's just over $2 billion. I have to believe that electronic trading over the 10 years ahead of us is going to occupy a much bigger slice of that pie than it does today. That's what we're after. This is a massive global fixed income market with loads of opportunities in every region and every product, and especially in credit, at very early stages. So this is the time that our Board is unanimous in their support for the broader investment agenda. We want to occupy as much of the space and leverage the network and the technology that we've invested in for the last 20 years as we possibly can. And so right now, we're responding to demand and we're getting into more marketplaces where we know we can compete. And I think when, 5 and 10 years from now, this is going to be a much bigger space than it is today.

All right. I think that is a good note on which to end this. So thank you guys very, very much.

Thank you, Patrick.

That was very helpful. And we'll have a breakout session downstairs.

Thank you.