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

Well, good morning, and good afternoon, everybody. I'm Rob Phillips with Nasdaq, and I'm pleased to be joined here with Tony DeLise. He's Chief Financial Officer of MarketAxess. If you have any questions, you can submit them through the section on the left panel of the screen. They'll be directly emailed to me, and then we'll have some time at the end of the presentation for the Q&A. And without further ado, here's Tony to talk about MarketAxess. Thanks, Tony.

Thanks, Rob, and thanks for hosting us and arranging the meetings. It's a little bit of a presentation format. So I'm going to share my screen and run through a couple of slides and then leave some time for Q&A here. So let me just get the presentation up. And hopefully, everybody can see the presentation. So I'll take you through a few slides here. MarketAxess, we're an electronic trading venue for fixed income products. And it's really a market in our core business, which is credited, it's a market that's been characterized by dependence on dealers for providing liquidity. And it's really liquidity on demand. It's not -- in our market, it's really not continuous live 2-sided markets like you see in equities or even on around treasuries. And the majority -- and this will be, in some cases, the vast majority of trading in credit products that we offer is not done electronically, but that said, coming out of the credit crisis, there's been regulatory and market trends that are driving structural changes in our markets. And you saw that immediately coming out of the credit prices with the new postcrisis capital requirements and that resulted in a reduction in dealer capital committed to making markets, liquidity dispersed, execution risk [indiscernible] buy side. On the MiFID II side, that's been supportive of moving flow to e-trading venues, the new best execution requirements and reporting requirements have been favorable. And then the trend more recently, and I'll touch a little bit on this later on, is around automation. So both algos responding and automated execution, those are themes playing out right now that are driving changes in our markets, and we're capitalizing on those trends by expanding the available liquidity pool, delivering cost savings to clients. And you could see on the right side of this slide, we've delivered healthy revenue and earnings growth over the past 5 years. And we -- when we tack on 2020, the revenue and earnings growth will look even better. We offer trading in really the less liquid sectors of credit. So our core 4 products are U.S. high-grade and U.S. high-yield bonds, emerging market corporate and sovereign bonds and Eurobonds. We also offer trading in U.S. municipal bonds. And then more recently, through our acquisition of LiquidityEdge in late 2019, we now offer trading in U.S. treasuries. We've got a broad network of participants on the platform, over 1,700 active clients and front-to-back trading capabilities. So we have price discovery tools like market data, we have unique content, such as our Axess All real-time trade tape in Europe and our Composite+ pricing services that help clients with decision-making. We've got a variety of protocols. So not only disclosed and anonymous request for quote, we also have live market execution, which looks more like order book style trading. We have mid-market execution, which we recently launched. We also have straight-through processing capabilities and audit trails and transaction cost analysis to support best execution requirements. So everything you'd expect from a fully robust front-to-back solution. And then in Europe, we also provide post-trade transaction reporting and trade matching services. And these -- the trading efficiencies we're delivering, the unique content, the liquidity and the variety of protocols, that's driving more clients onto the platform and driving more order flow onto the platform. Our -- I'm going to skip a couple of slides here and talk to you about what we're focused on in terms of our growth strategy. It's pretty consistent. If you've heard this story before, it hasn't varied all that much. It's continuing to drive market share forward in our core products and some newer areas like U.S. treasuries. It's promoting our Open Trading or all-to-all trading protocols, and then it's expanding our geographic reach. And just on that first item, which is priority #1, to increase market share in our core products, what you see on this page, the left side shows our best estimate of average daily market volume across those -- across our credit products, and it comes out to about $70 billion a day. Around $60 billion of that would be in our core 4 products. So across U.S. high-grade, U.S. high yield, emerging markets and Eurobonds. Overall electronic penetration in our market share does vary by product, and our best estimate -- if you look at our market share, our best estimate for our core 4 products, it ranges from low double digits in Eurobonds, the mid-teens in high yield and emerging markets and over 20% in U.S. high-grade. When you combine those 4 products together and look at it on a composite basis, we've traded about $10.5 billion a day in those 4 products in 2020. So our composite market share would look something like the mid-teens. Treasuries is a newer area for us. It's -- right now, we're primarily active in the dealer-to-dealer space, and our market share there is somewhere in the 7% to 8% range, but the big investment and the big push for us is to leverage our client network and to build out client-to-dealer trading capabilities in treasuries. Our model is pretty straightforward as we grow trading volume, it generates revenue growth. We've got more clients trading. We've got more clients trading multiple products. We're expanding geographically. So a bigger portion of our volume comes from outside of the U.S. And just one little tidbit to leave you with on this slide and this is how you have to think about our ability to grow the top line, we've got a simple revenue model. It's the size of market, it's market share and it's pricing. So take the size of market x market share x pricing, and that gives you our revenue. And if you size it up, if you look at what a 1 percentage point change in market share means across our products, both on the credit side and now in the treasury market, it equates to something like $40 million to $45 million in revenue. So that's really the one big takeaway on this slide. The second leg of our growth strategy is promoting Open Trading. And if you've listened to any of our earnings calls or had a chance to talk in any sessions, you'd see that Open Trading features in all of those discussions. And in Open Trading, what we're doing, we're connecting all market participants in one pool. So any participant can initiate an order and act as a liquidity taker. So that could be a long-only money manager, insurance company, pension fund, ETF market maker, it could even be a dealer seeking liquidity. And then any participant can view and act on that order by providing liquidity. So again, it could be a long-only money manager, insurance company, pension fund, ETF market maker, a dealer to be a liquidity provider as well. When you look at what we've delivered over recent years and more specifically in the third quarter, our Open Trading volume was about $3 billion a day. And what that means is about 1/3 of our volume and 1/3 of our transaction revenues derived from Open Trading. And 7 years ago that Open Trading percentage and revenue contribution was close to 0. Now one in every 3 trades takes place between 2 counterparties that don't have a relationship. And the big differentiator and the value that we're delivering is price improvement for both the liquidity taker and the liquidity provider. And just to put this in perspective, estimated cost savings for liquidity takers and liquidity providers, it's been -- in 2020, have been greater than our company-wide revenue. So we've delivered close to $900 million in price improvement for our clients, September year-to-date. One of the pieces of the story in Open Trading that we're really excited about right now is the growth in dealer-initiated orders, which was up close to 40% in the third quarter, and also the overall growth in client participation. We've got close to 1,600 firms that completed a trade in the third quarter through Open Trading, and we see more uptake each quarter as liquidity expands and as clients embrace our Open Trading protocols. The third piece to the growth story is more focused on growing out our international business. And Europe has been a big investment area for us over the past several years. We've also expanded our geographic reach with dedicated offices and resources in Asia and in Latin America. But for our European clients, we not only have more clients trading on the platform in Europe, but also trading a broader set of products, and we've seen healthy growth in emerging markets and in Eurobonds and in U.S. credit from European clients. And undoubtedly, as under the MiFID II requirements around best execution and reporting, that did provide a favorable backdrop beginning several years ago, but what's really driving the adoption, this is more -- again, more specifically, in this case, maybe in Eurobonds, which really driving the adoption is Open Trading penetration. And today, about 1/4 of our Eurobond business is conducted anonymously through Open Trading. And what's fueling that is unique content. We have our Axess All real-time trade tape running in Europe, we have our Composite+ pricing services that helps clients with pre-trade price discovery and with decision-making and with auto execution. Emerging markets is also driving growth outside of the U.S. This is a great story with more than 50% of our emerging market business now comes from non-U.S. clients. And just 4 years ago, that was below 30%. So we now have over 1,000 clients trading emerging markets on our platform, and we believe we're well-positioned to capture a larger piece of the global credit market. The -- one of the items that I did want to touch on was around automation, and we believe this is one of the themes supporting growth in trading on our platform is automation as both the sell side and the buy side address cost pressures and automated trading volumes rose to over $30 billion in the third quarter, and we had close to 90 firms, including large asset managers that were using our Auto-Execution functionality. And with Auto-Execution clients set parameters when they launch an inquiry, price responses come back if the responses meet those parameters, trades execute. And what's really neat about it from our standpoint is that it's using our Composite+ and liquidity scores to help with that decision-making process. The other piece of automation is more on the dealer side. And dealers are using algos and something we would never have talked about. If you turn the clock back several years ago, we would have never talked about algos running in our world. And now dealer algos continue to grow on our platform, we had approximately 3.7 million algo price responses in the third quarter, resulted in almost 300,000 trades, and we continue to see strong growth in our automated trading capabilities. And one of the important pieces here is we've seen a sharp rise in the average number of responses per inquiry. And you think about what makes us unique. It's competition for orders, more price responses back. There's a better chance of getting trades executed. The more competition there is for an order, the better the price that we're delivering and the more likelihood that clients will come back and launch more inquiries. So we've seen a big increase, almost a doubling of price responses back since 2017, which -- a lot of that is driven by what we're seeing in the algo world. The last slide that I'll touch on is around our balance sheet and free cash flow. We've got a pretty simple balance sheet when you look at it. We're not using our balance sheet to make markets or to take positions. We don't have any debt outstanding as of September 30. We've got a simple capital structure with one class of common equity, and we've funded our operations and funded our growth initiatives through free cash flow generation, the trailing 12-months free cash flow through September 30 was a little over $300 million, which was roughly double where it was in 2017. Yes. I would point out one thing, at least on the balance sheet today, it does look a little different as we went live for self-clearing of U.S. bonds just this past August. And as a result, we funded certain clearing house and settlement agent deposit requirements, customer reserve requirements and settlement position activity. So the balance sheet looks a little bit different today, but when we look at where our capital priorities are and where we're deploying capital, it is to support our regulatory obligations and self-clearing requirements, but we've been funding our organic initiatives through free cash flow generation so the investments that we've been making in Open Trading and new protocols and international expansion have all been funded from our free cash flow generation. M&A, I can't say that it's been a big piece of the playbook or featured highly in our growth to this point, although we've announced or closed 3 small transactions in the past 12 months. I mentioned the LiquidityEdge acquisition, which moves us into the rate space, specifically into U.S. treasuries. Just yesterday, we announced that we closed on the Deutsche Börse Regulatory Reporting Hub business, which adds scale to our existing post-trade business in Europe and strengthens our data business. And then we announced, have not yet closed -- we announced, but have not yet closed on the MuniBrokers acquisition, which enhances our municipal offering and our municipal bond networks. The last piece on the capital priority side would be around capital returns to shareholders. And it's been a focus of ours for a number of years, it's been a pretty consistent policy and thought process around dividends and share repurchases. On the dividend, we've been targeting around a 1/3 payout of free cash flow and earnings. We've been growing the dividend as free cash flow and our earnings have been growing. On the repurchase side, we've had a standing repurchase plan in place for a number of years, really designed to offset dilution from equity grants. But last -- so the last 5 years-or-so, the -- we've been through the dividend and share repurchases, we've been paying out about 50% of free cash flow, but the takeaway on this slide is we've got lots of leverage in the model. We've got strong free cash flow. We've got the capacity to both invest organically to do these add-on acquisitions and yet still return capital to shareholders. So with that, I'm going to pause and take my screen off of sharing. And Rob, I guess, open it up to questions if there's any in the queue there.

All right. None so far, but folks, we are standing by if there's any questions that do come in because actually -- it's okay, Tony, I had a couple, I thought I could throw at you.

Go ahead.

I'll start there. And you've covered one already, by the way, congratulations on the closing the Deutsche Börse acquisition. There -- I'm sure you get questions about this. You said not central, but you've got the 3 that you've done. You had mentioned also MiFID II? By the way, is that going -- is MiFID II going to create some opportunities? I suppose the same question, too, for any kind of regulatory growth or changes?

Yes. Rob, it's probably more on the MiFID II side, it was probably more questions around that several years ago when some of the requirements went live. And certainly, with -- at the time and immediately afterwards, we do think it was supportive of e-trading and the best execution requirements and the reporting requirements did drive more flow onto e-trading venues. I can't say -- in discussions today -- that it features highly in discussions today, but it was supportive at that time. And Rob, these acquisitions, which I didn't spend a lot of time discussing, we've largely done this organically. It's not been a roll-up play, and you can see we've been thoughtful around when and where we deploy our resources on the acquisition side. And all of them have -- there's a little bit of a story there with -- on the LiquidityEdge piece, it does move us into the rates market. It's a competitive space, but there were things that LiquidityEdge was doing around customizable liquidity that felt more consistent with our view around how we deliver liquidity to clients and was more consistent with our view around Open Trading and all-to-all trading, and we've got a big investment -- we're in the midst of in building out our client-to-dealer network and treasury. So that's moved it into the rate space. And the Deutsche Börse one, it adds scale to our business. It brings along several hundred clients. They're predominantly in Germany, France and the Nordics, where we do not have a big footprint. So it is not a lot of overlap there at all. And what we're -- on the post-trade side, one of the big benefits for us is it comes with unique transaction data and content that we're using to build out our pricing tools and our Composite+ pricing service and liquidity scores and our Axess All trade tape. So it's important beyond the revenue contribution on the post-trade side. And the third deal that we announced, the one that hasn't closed around municipal bond space. I mean, that one is -- we're still early days in our muni market initiative, and we hit 2% market share in the municipal bond space in October. So it was a high watermark, but we know that the market is just right for electronification. And MuniBrokers, they provide an -- it's a venue to -- for the inter-dealer brokers in the municipal bond space, and we have a view that over time, we can take advantage going bidirectionally to take advantage of the liquidity in our Open Trading pool and also take advantage that resides on MuniBrokers. So 3 relatively small deals, but all key to our growth plans.

Just -- my next question actually was about growth. So Open Trading, if I understood right. It's -- from 0, it's grown to 1/3 of your transaction. So when you see the growth opportunities and to invest along with, have there been any holdouts who've come aboard and [indiscernible] like clients who are new to the...

Rob, it was -- yes. When we first launched Open Trading, this is going back a number of years. There was sort of general resistance of putting orders up and competition. And -- but that's behind us. Virtually every client -- and the numbers at this point probably don't -- are meaningless because virtually every client participates in Open Trading. And I'm saying every client participates in Open Trading as a liquidity taker. So if you can get a better price from a party that you have no relationship with, you'll take that better price. So every party is acting as a liquidity taker. If there's -- and holdouts might not be the right way of thinking about it, but if there's still room to grow on the Open Trading side, it's still early days on liquidity providing, and we're providing tools to clients to help them act as price makers in Open Trading, but it's still early days. And when you look at our top 50 institutional investor clients, rough numbers, probably 1/3 of them are very active as price makers. And they've built out their trading desks and their workflow where they can respond with prices to orders of interest in the platform. So maybe about 1/3 of our top 50 are sporadically active and 1/3 of them really aren't active. And so there's -- and there's various resistance points and reasons why they may not be active. And it could be workflow, it could be comfort around providing in response, it could be because of the time frame within which you have to respond, there's lots of reasons why clients haven't moved, but that would be earlier days. And it's not that it's a disappointment. It's just going to take time. And I think the other piece of Open Trading, and this is -- much of what we do today is really on the back of a traditional request for quote, but when you look at the newer initiatives that we have, under the Open Trading umbrella. So we launched live markets, which is an order book style trading for the most actively traded bonds and the most liquid bonds. And typically, those are around new issues, brand-new protocol, new protocol in the market, early days, but that's now available to our Open Trading network. And the one even more recently was around, which we call Mid-X. It's a mid-market auction protocol, where we set the mid-market price using our Composite+ pricing service, and then we open up an order book and match climate orders. That's we're about 5 weeks into that initiative. And so those all fall into the Open Trading umbrella. I think at the end of the day, it's not all bonds trade the same way. And that's why it's important to continue to invest and launch new protocols and address pockets that have some unusual characteristics in live markets and Mid-X fit those requirements.

Thank you, Tony. Actually, we did get a question to come in. It's probably a great way to wrap up this session with a few minutes we have. So it's how are the volumes trending recently? And are your share gains from the COVID environment sustainable?

So market trends recently, share gains from COVID? So let me just give you a little bit of sort of some interesting facts around this. And I think certainly, during the peak of COVID, it sort of -- not say the peak of, sort of volatility in the marketplace. We've always benefited when the market is more volatile. So when you look back at the end of February into March, first part of April, market was more volatile, we typically benefit in that case where dealers may back away from market making. We have liquidity on the platform. Clients are more active. And what happened during that particular time, market volumes rose dramatically as well. I think the piece that is most encouraging is what's happened in the last 6 months. If you look at the environment in the last 6 months, and if you had told me that we'd have massive new issuance, that spreads would be grinding lower, that volatility would come down, new issue -- again, the new issue was massive. I think if I had said that, that probably wouldn't have been a good recipe for us and yet what's happened in the last 6 months, this is why I do think the gains, the market share gains are sticky. It's -- you look at the last 6 months, and even with that environment, we've shown significant market share gains across all products. The Open Trading penetration has been sticky. I think there were some questions back in February and March on whether that Open Trading penetration expansion that we saw was going to stick. It has stuck the last 6 months. So we feel good about it, but I think it also tells you that it may not have been COVID or the pandemic that -- that may have been part of what triggered it, but I think it has more to do with the groundwork that we laid in. And what we were doing around Open Trading and the price improvement and cost savings we were delivering, what was happening around automation. These aren't new for us. It's just -- they've accelerated during this time period. I think -- that's a trigger point than what's COVID, but the important thing is that it's been sticky and continues to advance even when the market conditions, I wouldn't say are perfect for us.

Well, a great way to end it. Tony, I just learned a lot. Thank you very much for your time. Congratulations on all MarketAxess achievements. And I would like to thank everybody for joining us.

And thank you, Rob, and thank Nasdaq for doing this.

Appreciate having you.

Take care.

Will talk soon. You too. Thanks everyone.