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

Thanks, everyone, for joining our virtual fire side chat this afternoon. I'm Brian Bedell, the broker asset manager, exchange analyst here at Deutsche Bank. And so we are very excited to have both Chris Concannon and Tony DeLise from MarketAxess with us again this year. I think most people on mind know Chris and Tony, but I'll just give a quick intro. So Chris is the President and Chief Operating Officer of MarketAxess and joined last year after a very long history in electronic market trading structure, spanning about 25 years on the equity side, culminating at Cboe Global Markets with previous leadership roles at Bats and Virtu and Nasdaq and way back when actually Island ECN and even the SEC. And Tony is a 14-year veteran of MarketAxess joining in 2006 as Head of Finance and Accounting and becoming CFO in 2010. And Tony has a ton of CFO and account experience previously going back over 30 years to PubliCard and Arthur Andersen, but all that sounds like a purely financial background. Tony is much more than a CFO, having been involved with the firm's strategy for most of its time as a public company. So he can answer those questions as well. Anyway, thanks to both of you for being with us today.

So I'll start out with some questions of my own and leave some time for questions for the participants. And just some quick instructions on that. You can ask a question via the web portal. Or you can e-mail me at [email protected], whichever is easier for you. So I'd like to focus a good portion of our time today really getting into the drivers of the pace of electronification of corporate bond trading. This is really the heart of the debate around the magnitude of earnings growth. We can potentially foresee for MarketAxess over at least the intermediate term. But maybe just to start with you, Chris, and Tony would also be great to get your perspective here as well. But can you give us a brief overview of how your team is navigating in the new work-from-home environment? And what they're doing differently for clients, given sales and service meetings are not happening in-person? And then maybe a sense of what client inquiries have been like pre-crisis in January versus the more volatile period in February and April and now more recently in May?

Sure. I'll take that. It's Chris. First, Brian, thanks for having us. We're pretty excited to be here today. I think this is a great virtual session, which we're doing a lot of virtual these days. On our response to the current crisis, both commercially and really just physically, I have to say it was very successful. We had a very successful and safe conversion to work from home in early March. Obviously, we were preparing for this for some time because of our offices both in Hong Kong and Singapore, and we were experiencing these issues back in January, early February. So certainly had some advanced preparation that we were working on. But I have to say, it's been truly successful and a unique experience for all of us. Our employees are working longer hours. We were converting into a work-from-home mode like everyone else during what was a market crisis. And so not only was it challenging just to go through the conversion, but obviously, a challenging market to work in. We were also helping our clients convert. Many of our clients were going from their trading desk into their homes and needed to reaccess the platform. So we had thousands of log-ons that we needed to revalidate for our clients to bring up our platform in their home office. So it was quite an exceptional time. One interesting thing is our sales team. You would think the sales in most companies in this environment is the most challenging part of the business because you don't have sales meetings and dinners. But our sales team was super-creative. They started producing more analytics than normal for our clients just to deal with some of the market abnormalities that were going on, where they could find liquidity, what bonds were looking more liquid than others. And then they were even created on the sales side with virtual happy hours and virtual sales meetings, and we even had clients organize a few peloton races with their -- a few salespeople organized a few peloton races with their clients. So super-creative. Employees were more productive than ever. It was truly amazing and continue to be.

So you don't need to go to spring break in Florida to generate higher cross-sells in your business?

No. I mean you definitely need a sales team, you need that constant touch. I think our sales team proved that they could generate more analytical sales through -- than just in-person sales. So it was -- and we were even onboarding new clients throughout the crisis. So it was an impressive time.

Yes. No, I hear you on the longer hours, and I think vacations have also taken a back track to working in the current situation. Maybe in talking about the -- how the work-from-home environment, I think you've said this before, Chris, but how you think it might drive an inflection in the pace of electronification of corporate trading to permanently higher levels? And maybe can you tell us what you think from a behavioral perspective is driving that?

Well, the interesting thing about inflection points, you only know you were in them years later. So we can't really be certain that this is an inflection point, but we definitely -- it feels -- it has the attributes of an inflection point where we saw obviously, the metrics alone suggest that there was higher adoption. But practically speaking, if you're in a work-from-home environment, trying to source liquidity and you don't have your traditional phone turret in front of you and your hot keys to speed-dial people, it becomes much more challenging. And the electronic solutions are pretty efficient. You can certainly achieve higher liquidity levels by a click of a mouse versus multiple IMs and phone calls. And so there's definitely benefits that we are seeing just from user behavior on the platform. I do think traditionally, where there's higher levels of volatility, you see temporary increases in electronic market share. Those temporary increases tend to level out. They don't go back to the original market share. So you do have these spikes of behavior in volatile markets. And in other asset classes, you see the electronic adoption increase during volatility. And then just -- if you think about the environment that we're in, it's filled with liquidity challenges. While things have improved, it does require traders to source alternative avenues for liquidity. And as you can see in our open trading numbers, certainly in the first quarter and continuing that trend, that is a growing source of liquidity for many of our investors trading on the platform. So again, in challenging times, when you do look for alternative sources, they found one in open trading, and they continue to use it. And more importantly, given the wider spread environment that we continue to be in, the savings from that alternative source of liquidity is substantial. In the first quarter, it was $200 million for just people seeking liquidity. And obviously, if you're providing liquidity, it's a sizable savings as well.

Yes. That's -- it's clearly very interesting. Maybe just -- maybe, Tony, if we can zero in on some of the market share numbers through April this year. Just looking at TRACE data, of course, there's an increase for MarketAxess of around 100 basis points or so in high-grade to, I think, a little over 20.5%, about 150 basis points in high yield to a little over 12.5%. But just in thinking about the go-forward rate, isn't that understating the share gain if we consider how much industry volume is connected with a huge increase in debt issuance in March and April? And of course, this increases the stock of corporate debt outstanding, which is definitely favorable for trading. But how would you gauge how much your share of trading maybe would have increased in April, if we normalize for that issuance-driven volume?

Yes. It's a good question, Brian. And we -- if you look at new issue volume in the past 3 months, even including the month of May here, it's more than $250 billion in March and then more than $250 billion in April and already in May, it's north of $200 billion in investment-grade new issuance. So you know the dynamics for us typically when the new issue calendar is hot, that does provide some headwinds for us in terms of market share gains. And I think it's also, even from your question and from talking in the past, you know that our market share in newly issued bonds is typically lower than seasoned bonds. And just to put that in perspective, when you look at newly issued bonds, let's say, trading in the first several weeks after a bond breaks, our market share is low single digits. So it's much different than our market share in seasoned bonds. And I was just looking at something earlier today on the new issue impact on market volumes. And if you look at the period -- and just bear with me for a second, but if you look at the period from January of 2019 through February of 2020, so 13 months or so, newly issued bonds represented something like 13% of overall TRACE volumes. So for investment-grade TRACE, about 13% was newly issued bonds. Any given month, it ranges up or down, but at that 13%. Last 3 months, it's been between 25% to 30% of market volumes [indiscernible]. So just massive increase in trading velocity around new issues. We still have the same headwinds. So I don't have the exact figures in front of me. But the underlying trends in the -- if you were to break out, say, non-new issuance, the underlying trends are more favorable than what you see in the headline number. We'll do a little more work around that -- in all likelihood on the July call, we'll provide a little more color. But you could see that new issuance not only for investment grade, even on the high-yield side, over the last 2 months, has been very healthy new issuance. And our high-yield market share has been running at all-time highs in the last several months.

Yes. I know that. And I'm sure we'll start to see that in the May and June data start to come through. Maybe if we can get a little bit deeper into the weeds of the drivers of automation, Chris. Maybe you can talk about more specifically about the evolution of the changes in client workflow that you've been seeing. And maybe just starting with how liquidity has improved on the platform on the dealer side and how that has morphed into higher response rates. I think you called this out on your -- on the 1Q call. The response rates to the RFQs. Maybe -- might be -- so we'll just spend a minute just describing the nature of the RFQ and the response and fixed income trading, how that works.

Sure. Well, obviously, the market is a request for "market" where clients will request from a variety of dealers to get quotes in a given bond and on our platform, that's done all electronically. So it's a fairly seamless process. For the client, we're integrated to the large OMS platform. So clients can populate the platform with orders, click a button to request quotes from numerous dealers, as many dealers as they would like. And they can request to receive prices back from our open trading solution, our all-to-all anonymous solution as well. So fairly seamless and efficient process to find liquidity globally. They can reach out to -- they can be anywhere on the planet, even in their home office and request prices from dealers all around the globe, depending on the bond that they want. Dealers are responding electronically. That's really good for us, as we grow the electronic part of the market. We are continuing to see those responses be automated as we refer to them as algos, dealer algos that are automatically responding to any request that comes in. And we saw, obviously, in the first quarter, 3 million algo responses from dealers, and that's up 37% over last year. So encouraging signs from the dealer liquidity perspective. And we do think it helps the further adoption of electronic trading. The other unique benefit to liquidity, as we discussed earlier, is the Open Trading benefit, that alternative liquidity coming into clients as a response is improving overall liquidity as well. So you have the increase in responses from dealers using electronic algos to price bonds. And then you have the alternative liquidity coming in through the anonymous all-to-all. So both of those aspects are improving electronic liquidity on our platform.

And then when you say anonymous all-to-all, is that mostly coming from the institutional client side?

It's really a mix. It's a healthy mix of both just dealers, traditional bank dealers responding anonymously or -- and many times, they'll want to -- they might have a position that they want to respond to a client in or it can be alternative market makers. Some of the largest ETF market makers will be on the platform responding through our all-to-all market. And then it can be clients as well. So clients can, in fact, respond to another client's request for price. And we saw that increase actually during the heart of the market crisis in March, where we did see clients seeing levels of price bonds hitting prices that they, in fact, wanted to be a liquidity provider in that bond. So we did see behavioral changes happen in March. And that's an important part where we see clients using our all-to-all to be a provider of liquidity in a challenged market.

Okay. Yes. And maybe just along those lines, also on the institutional client side, if you could describe how comfortable they are with increasingly automating the trades. And maybe what are some of the major resistance points? What are situations where they do not feel comfortable? And how do you convince them to get more comfortable with that?

Yes, it's a great question because it's obviously an area where we're seeing volumes grow, where our clients are taking certain parts of their daily trading activity and moving it into an automated solution. We have really 2 automated solutions and more enhancements to come. Our Auto-X solution just allows you to auto RFQ. So you can load a list in the morning and hit -- put in dial up certain parameters on the auto execution. And you can actually send out RFQs for your entire list without individually doing each RFQ. You can also then set parameters on if you receive the right responses, if prices are within a parameter that you preset, you can auto execute. So it's really no-touch trading and a very sophisticated low-touch solution for our clients. On the other side is the auto responder solution, which was rolled out earlier this year, and we continue to add enhancements. We just added a critical enhancement to that this month. So we're pretty excited about that. That is just you can basically monitor the market for the bonds that you need. And as other clients request for prices, launch their own RFQs, you can respond to those with your own price and be a liquidity provider by an automated means. So it's a pretty intriguing way for investors to save money by being a liquidity provider and not crossing spread. And if you look at the spreads that we're experiencing today, being -- avoiding crossing spread can save a lot of money. And that's something we want our clients to do. So auto responder and our Auto-X trading solutions. Typically, clients, we see the adoption at smaller trade sizes, so under $1 million in notional size is a typical starting place. But what we've seen for those clients that did early adopt auto-execution solutions, they tend to increase that size over time. So as their list of bonds get bigger, their workflow gets more challenging, they tend to increase the list of the sizes that are going through our automated trading solution. So we're seeing trade sizes of $4 million, $5 million even going through and working pretty seamlessly. It's based on client comfort of what the execution quality looks like. And when you compare our solution against TRACE, it's very positive. So we continue to see client adoption of just our automated solutions. Again, that's still a small portion of the overall electronic pool that we operate, but a very critical growing piece of that is that automated trading solution.

So it's blocking and tackling and getting the people to get more comfortable with it showing them what they're saving, reinforcing that and having them trade higher in size, automated and it keeps on. Is there a certain point where you think some of the size of the trades -- won't be done at an automated level? Is there a kind of feel linked to that?

No. I do think -- again, it's client-specific. It also is bond-specific. So you're in an investment-grade product with higher liquidity levels, you're more comfortable increasing sizes to $5 million and even above that. When you really look at auto-execution solutions, they’re replicating what a trader is doing on the platform, and it's very dependent on our unique data feeds. So our CP plus data feed is what powers those automated solutions. That's the guardrail that allows you to auto execute. And so as we develop better data products, we develop better automated trading solutions. And we do see clients as they adopt and become more dependent on our data feeds, like CP Plus, they are more likely to adopt our automated trading solutions because they're relying on that critical data that we produce.

Okay. Yes, that makes sense. Maybe shifting to competition. Tony, maybe if you can talk a little bit about competition. You've been the dominant player for so long in electronic corporate bond trading, but with this area representing the best runway for growth. And to what extent are you increasingly seeing competitors? Of course, Tradeweb has been making over the last couple of years bigger efforts at getting into that market. Or even you have some newer entrants like Intercontinental Exchange through some acquisitions and organic efforts. I guess to what extent do you see competition maybe greater fragmenting that market more over the long term?

It's funny, Brian, when I was listening to the intro, I have been here for 14 years. When we talked about competition over the years, there have been -- from day 1, when Rick started the company, there were dozens of companies competing in this space. And over my tenure, the past 14 years, there's been 20 or 30 different start-ups, new entrants that have come and gone. The consistency and the competition really is around Bloomberg and Tradeweb. We have been competing with them almost from day 1. And there is some consistency there. Fragmentation, I think it's more concentrated today. When we go down the -- this is -- we're talking about credit here. When we look at the competitive landscape, it really is Bloomberg and Tradeweb and Trumid. And those are the 3 names that you would really hear in our space. It might be different by geography in terms of stacking or ranking in terms of the competition. But nobody has seeded this market to us. And while -- when you look at institutional client trading in the U.S., we're -- and you look at some survey where 80% or 85% of what trades electronically in the institutional space. There's competition out there. Tradeweb is a wildly successful company and has lots of positive initiatives. And -- but they've been in our space for the past 20 years. They've had a variety of initiatives in the credit space. And are they more aggressive today? I think in the past several years, they do talk more about all-to-all trading. They've had some success in portfolio trading, clearly on the dealer-to-dealer side with what they're doing with dealer sweeps. They've had some success there. You mentioned ICE also. I can't say in the institutional space that, that's who we're really bumping up against, they are relevant in the retail space. But in the institutional client space, ICE is not -- today, they're -- it's not somebody we're bumping up against. I'm sure that they have views or a vision about moving into the institutional space. But today, that's really not where the competition lies.

Not right now. Yes.

And again, I say geographically, it does make a difference as well. Because if you move outside of the U.S. and you move into Europe or into Asia, Bloomberg is the bigger competition. They're much more relevant in Europe, in particular. They've got a big beachhead with private client banks. We're doing much, much better in Europe and have picked up demonstrable market share over the past several years. Open Trading has a lot to do with that. In the content and data to help clients with price discovery and making trading decisions has a lot to do with that. But we're playing catch-up against Bloomberg. We feel a lot better today about our competitive advantages and have our sights set on them. When you look outside of the U.S., we have our sight set on Bloomberg.

Yes. No, that makes sense. A lot of industries like this, where there's pretty strong growth, people are always worried about -- or investors in this space are worried about price competition, as they've seen this across many industries, especially in equities, as Chris knows as well. But it might not benefit anyone to compete on price, of course, but do you think this is inevitable as the electronic pie grows? Or doesn't really make much of a difference to compete on price. And so we won't see a whole lot of degradation going forward?

Well, I'll jump in since I was part of the problem in equities creating price competition. It's very different as I see it. When you think about the competition in markets in equities, fairly unique. Because equity exchanges were born and they service the broker dealer. They don't go direct to the end client. And that's an important critical part of the differences. So the brokers bring all orders to the exchanges. And so there's an element of inflated competition for the wholesale market inside the equity exchange. And that's why there's such price competition. If you look at the MarketAxess business, it is one-part market, but it's mostly network building. When you think about the network that this company has built over 20 years, it's hard to replicate. And it's a substantial investment to go around the planet and get on the trading desk of every major institutional investor in bonds. And that network continues to grow, and that's an area where we continue to invest. That's very different and creates a very different marketplace when you look at the competition in cash equities, where they were battling for broker flow. Here, we have clients trading on the platform, asking dealers for price, and we're continuing to expand that network. And there's a great network effect playing out in products like emerging markets where our clients are trading with dealers that they would otherwise not interact with over Open Trading. So the network effect is proving to be fairly resistant to price issues right now. And if you think about the equity trading, the way it played out, it did -- it had to get up to like 80% market share of electronic before you started to see that substantial pricing pressure, and we're far from those numbers. The one competition that Tony didn't mention, which is, I think, our largest competitor is the phone company. We continue to battle the phone company everywhere we go. And -- so the opportunity for growth is enormous. Price competition plays out many, many years from now.

So you want to provide... go ahead. Yes.

And Brian, just to add on that one, I'd tell you that we really don't compete on price. Like, if you talking about the competition, and forget about the phone company for a second, but if you're talking about the competition, we really don't compete on price, like on our list price. We've competed effectively against Bloomberg in the U.S., outside the U.S., and they don't charge for execution. And even when you stack up the non-Bloomberg competition, we understand that some of the competitors may promote that they have lower pricing, but it's the all-in cost of execution to our clients that matters. And we've got deeper liquidity. We've got the benefit of our Open Trading network, which is delivering significant cost savings and price improvement for clients. And as long as we're delivering value that way, and our value proposition is clear, the list price on what we're charging for commissions it matters, but it doesn't matter. What matters is that the liquidity is the all-in cost of execution that matters for our clients.

Right. It's a really small portion of the overall decision process, the pricing is. And I just got an inbound question, which steps have a little bit -- what I was going to ask about. And that is your acquisition of LiquidityEdge. Maybe if you can talk about your sort of a game plan with LiquidityEdge, how much of that you think you can leverage into volumes beyond the interdealer market?

Sure. I'll take it. Yes, obviously, we're pretty excited about LiquidityEdge, now MarketAxess rates. Obviously, a great first quarter, with record volumes in the first quarter, truly challenged market. The treasury market was challenged in March from a liquidity standpoint. And we think we fared quite well in terms of market share relative to the other dealer-to-dealer markets. We're pretty excited about the plans for LiquidityEdge. I'm happy to announce that just this week -- last week, we launched Phase 1 of our integration, which is allowing institutional clients to access the LiquidityEdge market. And as you may recall, LiquidityEdge has very customized liquidity solutions on the platform. So you can certainly marry the right liquidity provider with the liquidity needs of a client. We were able to integrate the LiquidityEdge platform to our MarketAxess broker-dealer and its huge client network, and we now have the front end for LiquidityEdge being available for clients to trade from the MarketAxess relationship into LiquidityEdge. So that's the first step. The second step, Phase 2, is a more integrated solution that we are building, where a client can, off of their own MarketAxess terminal launch rates, see a streaming, click to trade solution as well as an RFQ solution. So a bigger build-out, but we're glad that Phase 1 has already been kicked off, and we're excited about Phase 2.

Okay. Yes, that's certainly exciting. Maybe just -- we're almost out of time, but there's a question about expenses. And maybe I can fit that with the question I had as well, which is just thinking about investing in the business, obviously, both you and Tradeweb have been revenue growth stories, but there is substantial investment required to grow that revenue. So maybe if you can talk, Tony, about pretax margins sort of over maybe the intermediate to long term? They've risen only gradually over the last few years. But at what point, would you expect some of these investments to really scale more dramatically and we could see some more significant rise in the pretax margins?

Yes. Brian, first thing I'd tell you is I'm not shy about being happy about 50% operating margins. We've been in investment mode for a number of years here. And you're right that it is around growing top line revenue. But to do that, we have to continue to invest. And I would tell you this, we're not managing to a margin outcome. We're not -- we don't build our plans based on an operating margin percentage that we're targeting. We are looking at this for the long term, and there are investments required. Yes, I would tell you this, and I'm just -- I'm looking in front of me, I see first quarter revenue was up 36%, expenses were up 27%. I could tell you if we could deliver that every quarter, every year, I think us and our investors would be happy with that kind of revenue growth and expense growth that leads to 45% operating income growth. So I'm not suggesting that our expenses longer term are going to grow at the same pace that you saw in the first quarter. But there is an investment required. I think more narrowly, and anticipating the question on expenses, where do you think expenses go longer term? And I'd tell you that if you give me a scenario where we're not adding new product surface, for example, and it's somewhat status quo on the product offering, I still think you're looking at it a double-digit expense increase on a longer-term basis. This is still early days in electronic adoption. Even when we look at U.S. investment grade, U.S. high yield, the vast majority of what trades does not trade electronically. There are resistance points. It's going to take investment, investment in new protocols, in new client segments. So looking out longer term, I still think we're looking at low double-digit growth in expenses. There is margin expansion on the horizon. If you can tell me -- Brian, tell me right now what your forecast is for market volumes? And if you tell me it's going to be up 40% a year, I can tell you, that margins are going to expand -- that's the way we've seen the last couple of months here. I think it's -- I'm not sure that we should plan on that type of market volume growth. But the takeaway is we're going to continue to invest. We're going to continue to invest in people. We're going to continue to invest in launching new protocols and helping our clients make trading decisions, as Chris had described.

Yes. And the incremental margins are still much higher than your current margin. So obviously, if we didn't that kind of growth, you would...

Yes, exactly.

Yes. Yes. Okay. We -- I think we're out at a time. And just any closing remarks, guys?

No. Just thanks for having us, and it's been great, and the conference looks great. And hopefully, we're not in virtual conference mode for a long time, and we'll do this in person.

Right. Yes. Now looking forward to that again. Thank you both for joining, really -- we really appreciate it.

Thanks, Brian.

Okay. Thanks for that. We will talk to you soon.

All right. Take care. Bye.