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

Great. Well, good afternoon, everyone. Next up, I would like to welcome Rick McVey, Chairman and CEO of MarketAxess. MarketAxess is a leading electronic trading platform in fixed income with an expanding array of products across U.S., European and emerging market bonds, munis and U.S. treasuries. Over the years, MarketAxess has been a big driver and an enabler of electrification of fixed income markets, resulting in solid market share gains and very impressive, over 30%, revenue growth so far in 2020. And with many new initiatives in place, we look forward to getting an update from Rick on the evolution of fixed income markets. And of course, how MarketAxess is positioned to continue their growth in the future. Rick, thanks for being here.

My pleasure, Alex, good to see you.

Great. So look, why don't we jump right in? My first question was really around the current environment automation. And we've seen essentially a step function higher we respect the MarketAxess market share this year, its current conditions, obviously, with many people working from home, plus the rise in volatility, have really accelerated a lot of the automation that we've been talking about over the years. I guess, can you walk us through the areas where you've seen the most drastic shift in customer behavior this year that contributed to sort of this acceleration? And as you think about next year, is the return to normal, in any sense, going to subside that growth or put any pressure on that growth? Or do you think this has been more of a permanent mind shift change?

Yes. I'd say that the client behavioral shift this year has been more significant than most years we've seen in the past. And it's very broad-based. You see investors embracing automated tools of execution and increasing their percentage of electronic trading and global credit. And in fact, throughout fixed income, dealers are also continuing to invest very heavily in automated market making having good success with algos, getting more prices out to more clients. Profitability has obviously been very high this year for dealer market making. They're also using open trading increasingly for their own liquidity. So we've seen a significant increase in dealer-initiated order flow in the MarketAxess, which is one of the new behavioral pieces that we've observed over the last 18 months or so. And then I would say, too, that the Alt-A marketplace that we have created continues to attract new market participants. So you see electronic market making businesses that have been active in other asset classes, investing in credit, getting larger most quarters. So that community of new participants continues to grow and is becoming a larger part each year of what we're doing through open trading on the platform.

Yes. So it definitely sounds pretty broad-based. I was going to zone in a little bit more in the high-yield markets with you. And the reason why I ask is because in the last even few months, I mean, we've seen significant acceleration in high-yield market share for you guys, to some extent, Tradeweb as well. So maybe it's a little bit of an industry dynamic as well. But obviously, you're a much larger player in the space. So help us understand maybe some of the more meaningful changes behind this momentum in high-yield, and how you guys are trying to capitalize on that trend?

Yes, no -- and thanks for bringing it up. It's the biggest year-over-year share gain we've ever seen in our core products. So it's notable what's happening in high-yield for the year overall, but especially over the last 3 months or so. And we're in this virtuous cycle where asset managers continue to get more comfortable with electronic trading for high yield. So there's more order flow coming into the system, which attracts dealer interest and alternative market maker interest, which makes the pricing even better for asset managers. And as a result, they continue to get more comfortable with increasing volume through the platform. The other piece we've seen this year is that if you look a year ago, most of our high-yield market share was in $1 million and under trade sizes. Order flow into the system now is very healthy in the $1 million to $5 million size bucket and the average trade size for high-yield is going up. So you've got a combination of more order flow, higher tickets, more participation. And I also think and your colleagues are very familiar with this, having played a leadership role in, what I would call, the new market making model that the ETF growth has something to do with our success in high-yield as well. As the ETF assets continue to grow, the arbitrage opportunities, especially when volatility is high, can be very attractive. You see more participants seamlessly interacting between the underlying bonds and the ETF fixed income shares. That's all in the mix, too, in what we're seeing with very high growth in the high-yield market.

How much of that benefit has been partially driven, I guess, by the systematic community, right? The electronic market makers, where they know how to do this in the equities world and they do this with equity ETFs, and now trying to kind of replicate the same dynamic with high yield? Has that been a big part of the story for?

It's been an important part. I wouldn't say it's an outsized portion of our growth. Traditional dealers are still responsible for well over half of our high-yield volume as market makers. The ETF community is probably closer to 30% of the activity. But it's really -- the product continues to get stronger for institutional investors, which is driving the order flow higher into the system.

Got it. Great. Well, let's talk about some of the more specific attributes of MarketAxess, and I really wanted to start with open trading. It's been such a critical driver of growth for the firm, as you mentioned. I think now accounting for 34% or so of total credit volumes and driving over 50% of credit volume growth over the last trailing 12 months were obviously quite significant. Can you walk us through, I guess, the effort to expand open trading further? How large as a percentage of overall credit trading do you think this could become? And are there any sort of trading patterns that you could point to, once market participants start kind of transacting in the open trading environment, whether it's increased turnover or anything else?

Yes. Well, so obviously, one of the key themes is we've really opened up the market for global credit trading to all participants. So you get a lot of good things with that. Orders can interact with even more dealers around the world. We're attracting new market makers. And of course, asset managers can connect directly when we identify matching opportunities in the system through open trading. So there's a lot on offer there in open trading, and we got started on it very early, 7 or 8 years ago and have been investing very heavily in it. And I just think now we, again, have a network effect going where the order flow is quite substantial. The trading opportunities are better than any other marketplace in the world. And we're attracting new liquidity into credit. As far as expanding it, it's more of the same. The investment includes not only enhancing the current protocols and the data that we're driving into open trading to make it easier for people to set pricing very quickly on the platform when opportunities emerge, we're also investing in new trading protocols, and as you know, and have written about, we've launched Live Markets. We think the liquid end of credit can trade in an open order book style, newly issued bonds, very liquid benchmark issues. We've also had early success with matching sessions in Europe that we call Mid-X. So you see this year that we're investing in alternative protocols because we think the broadest menu of trading protocols on the largest credit trading network is ultimately the winning formula. And we will continue to incent new market makers with volume programs that will attract their interest to continue to grow their activity on the platform. All of that is in the mix with respect to the way that we're building out the open trading network.

Great. That's very helpful. Maybe as a quick follow-up to that. When you kind of double-click into various asset classes within open trading, the majority of the growth here has been coming from investment-grade and high yields or kind of your core traditional asset classes. Can you talk a little bit about why the eurobond and emerging market penetration has been a little bit slower? Are there any structural impediments to that or just differences in competitive environment? And what are you doing specifically with respect to those 2 to drive further adoption of open trading and sort of those asset classes?

Yes. The growth rate is compelling across each of those 4 products and even some of our new products. We're just at different stages of the evolution. EM hard currency open trading has been active because those bonds typically will settle through DTC or Euroclear and there are easy settlement solutions to be able to promote open trading and hard currency EM. It's more difficult in many of the local markets because they have their own settlement structure within those currencies, and we have to tie into each of them uniquely in order to be able to offer open trading in more of the EM local markets. So there is an obstacle there that we're knocking out one market at a time, but it does require real work. In euros, I would say that historically, investors have been more relationship oriented. So it's taken a little longer for open trading to really take hold, but you now start to see that growing pretty quickly in eurobonds, too, just from a smaller base and a little later start. But it consistently delivers better transaction cost back to investors. And in totality, each of the last 3 quarters, Alex, we have delivered higher estimated transaction cost savings back to our clients through open trading than we have generated in company revenues. That's a really good position for us to be in, in terms of the value proposition of open trading around the world.

Great. Well, look, as a byproduct of open trading, let's talk about some of the newer protocols that you guys have launched, Live Markets obviously being one of them, and again, essentially, your version of a central limit order book protocol for liquid markets. Goldman is obviously one of the largest supporters of this initiative for you guys right now. Can you talk us through sort of early client reactions, early adoption processes, what are you guys doing to get other market makers and dealers onto the platform to really expand it?

Yes. So the -- I think that there's broad-based acceptance that a central limit order book has a real shot of succeeding now with all the advancements in open trading and the tools that we now have around real-time data and the liquidity of some of the bonds that I mentioned earlier. Very pleased that your colleagues took the leap of faith to be out in front, promoting market making in our Live Markets platform. That has made a difference already in the content that we have, the eyeballs that we're attracting, the trades that we see going through the system. And there are lots of interesting additional market maker conversations going on the back of that with other leading market makers in credit. So I think you'll see more news to follow that will increase that base of API-driven market makers and make the liquidity pool even more attractive. But I think what's really on offer here is higher trading velocity for the credit markets, which would be a great thing for all participants, dealers and investors is that if we can really continue to grow the marketplace and have both live trading and RFQ and mid-accessions all working in one place. I think the end outcome here, we're already seeing signs of that with the TRACE data this year is higher market turnover and higher velocity. And that would be welcome news for dealers that are trying to identify more trading opportunities, while keeping their balance sheets light at the same time for asset managers, they're always looking for ways to extend their portfolios and still be confident about market liquidity. And of course, for us, because this has always been part of the electronic trading growth story is that with greater electronic trading, you frequently get higher market velocity. And we think we're on the path toward greater turnover right now and Live Markets will be a piece of that.

Yes. Maybe just sticking with this discussion for one second. Currently, I believe you guys have some incentives in place when it comes to Live Markets. And look, at the end of the day, it's still fairly small and probably will be relatively small percentage of volume over the very near term, right? So it's not like it's going to cannibalize in your revenues from the rest of the organization. But probably think through the longer-term implications for capture rates, as you think about a portion of your activity migrating maybe into central limited order book format? Do the fee rates or the capture rate essentially become similar or lower capture rate, but you kind of make it up with volumes because turnover increases?

Yes. Well, so first of all, worth noting that we've had a great year for fee capture. One of the success stories for MarketAxess in 2020 is the increase that we've seen throughout the year in fee capture. And it's coming from a couple of key areas. One is the huge increase in high-yield market share this year to levels that have been over 17% of the market last couple of months, up from 9.5% or 10% a year ago. So just think about that, Alex. It took us 19 years to get the first 9.5% and 1 year to get the next 8%. So that's just been a phenomenal story. And as you know, high-yield fee capture is one of the highest fee capture products we have. The other part is in high grade, where the average maturity of bonds traded on the system has expanded. So for 2 reasons: one, investors are showing more comfort trading longer maturity bonds electronically; and two, the new issue activity has been focused on longer maturity issuance. And so that's driving duration and maturity higher, which, of course, increases our fee capture in high grade. So we've had a really consistent range of fee capture, but this year will be one of the best in terms of increasing our fee capture during a very high-volume year. With Live Markets, we really view it right now is increase in market opportunity that we don't really have much of today. We don't typically do all that well in newly issued bonds. We don't even have the same share in highly liquid corporate bonds that we have in less liquid corporate bonds. So yes, it will come with a lower fee capture because bid offer in those bonds is significantly lower than it is in seasoned bonds, but it is additive volume for us, and we think will be additive revenue. And right now, it's such an early concept that it's hard to really predict 3 or 4 years from now where we'll be on protocols between Mid-X, Live Markets, RFQ. But where this is targeted is really where we are underrepresented today in highly liquid and new issue bonds. So we view it as additive. And in the end, if it's highly successful, and the blend is a little bit lower in terms of overall fee capture, but our market share and market volumes are growing even faster, that would be a great outcome for our shareholders.

Right. Yes. So at the end of the day, it sounds it's ultimately just more incremental in terms of the corner of the market where you trade mix up.

That's what we see it.

Yes. So a lot of those lines, let's talk about another kind of area of the market that historically has been hard to penetrate, which is larger size trades or the block trades. And I think on the last call, you mentioned -- or maybe -- I mean, Tony mentioned that MarketAxess block share volumes remains relatively unchanged versus last year, kind of maybe in the 10% to 11% range, give or take. Now how do you guys think about penetrating that corner of the market? Is there anything you're doing proactively to address it? And what do you ultimately think the opportunity there -- the addressable opportunity there is for MarketAxess?

Yes. So a couple of things on that. Live Markets is clearly a piece of it because a good percentage of blocks are done in newly issued and liquid benchmark deals. So success in live markets, I think, probably comes with a higher share in block trading. The other piece that we are hearing more regularly now from asset management clients is they are really thinking seriously about the opportunity to break more blocks into smaller trade sizes because we've got such a diverse liquidity pool that's active in $10 million and under trade sizes. And they've been running quite a bit of analysis on their ability to potentially reduce transaction costs by breaking down those blocks and executing them in discrete increments through the system. So that's one to watch. We've seen recently that the block percentage of the market come down a little bit, not substantially, but I do think that, that may be one of the other pieces that as we've increase automated trading tools for asset managers, it becomes even easier for them to transact in smaller sizes. And the pricing advantages may be relevant to them in terms of breaking some of those blocks up. So that's another piece that I think is worth watching.

Got it. That's interesting. Let's shift gears a little bit. I was hoping to touch on some of the new initiatives or some of the other new initiatives rather because you guys, obviously, you have a handful of the model. One of them being LiquidityEdge, an acquisition you made maybe 1 year, 1.5 years ago or so. I guess if we look at the market share, they're slow kind of hovering around 2%, give or take. So by no means, it's a big portion of revenues for you guys. But it does sound like it could be an interesting growth opportunity, one being through kind of expanding these kind of trading capabilities to your credit network, but also then introducing other protocols like net spotting and things like that. So help us kind of understand where in the integration and the evolution process is LiquidityEdge for you guys and how meaningful growth driver you see it over the next few years?

Yes. So our rates business and the acquisition of LiquidityEdge was really about bringing in a great liquidity pool in U.S. treasuries and expanding it broadly across our network. And of course, that comes with real work because that was a pure D2D business when we acquired it a year ago. But right now, as we speak, we're seeing the first rollout to investor clients for treasury liquidity. And so we've created single sign-on with click to trade into the LiquidityEdge liquidity pool that we acquired. And that's really where our focus has always been, Alex, is on the institutional investor business. It makes up about 95% of our order flow and volume and revenue. And this is really the first time that we'll have a real treasury liquidity pool available to asset managers. And in a different form than what they're using today because it is another live order book. So we think there's room for another competitor. We think the protocol that we offer is unique. We've got a couple of thousand end investor firms on the platform, and we're just getting started now with that expansion into the client space and gives us another option for growth in the years ahead that we're excited about. It also closes a gap for us, as you point out, on treasury net hedging. We've been doing single security hedging through the rates platform that we now own over the last 3 or 4 months. We now offer net hedging that's just getting underway. That's more of an efficiency tool than it is anything. It's super relevant to corporate bond market share, but to be able to link those bonds to -- those trades together and have one treasury net hedge will be yet another added efficiency for our clients, and it's another byproduct of the acquisition that we made.

Great. Let's shift gears a little bit away from trading. I want to talk about your data offering. Because look, everybody needs more data. We've obviously seen -- this is a very valuable tool for folks. Now CP+ is probably one of the only sources of real-time market data that is based on actual trades. So clearly, there's a huge utility for something like that. Can you talk us a little bit about how your current customers are consuming this? How are you thinking about perhaps monetizing that outside of MarketAxess ecosystem, if at all? And just a little bit bigger picture, again, with so much demand for data, how are you thinking about the sort of 10-ish percent revenue growth a year that you've seen in infra services for some time over the next couple of years?

Yes. The biggest value that we get out of our investment in great data products right now is the expansion of our electronic trading market share. So our data is deeply embedded in our trading system. It gives both dealers and investors a great starting point of where to think about where the mid-market is in hundreds of thousands of unique credit securities around the world. It is a critical piece of our auto execution and an auto responder technology tools that we're delivering to our clients, so that they can use that data to automate their trade process even further and extract efficiencies from the trading system. And I have no doubt that data is an important piece of why you're seeing our market share grow more quickly now than it has in the previous years. Longer term, there's rich opportunity for us to use that data as a separate revenue cylinder. It's a growing part of what we do, but a relatively small part today, but we think a lot about our ability to feed that into NAV solutions around the world for global credit. We think about indices, which we could use our data either as a partner to other index providers or for some of the indices that we are developing on our own. So there's quite a bit of rich opportunity, we think, over time in how we think about growing that data business. But right now, the best return on equity for our shareholders is using that data to build market share in electronic trading.

Great. Makes sense. Shifting gears a little bit. I wanted to talk about some of the inorganic initiatives. And over the last 2 years, you've made -- you've become a little bit more acquisitive. Again, fairly small, more kind of add-on businesses, but look, the balance sheet still remains in very good shape and with lots of capacity. So curious how you're thinking about inorganic opportunities for MarketAxess for the next couple of years?

Yes. I think very much more of the same. This was a key reason. As you know, Alex, what was so attractive to bring Chris Concannon onto the MarketAxess business and really be able to expand our strategy and our business agenda. And we're doing that organically through initiatives like municipal bonds and the build-out of EM local markets in Asia, but we're also doing it increasingly inorganically. And quite honestly, what we really love is finding these small companies that have unique capabilities that could be much larger when they're connected to our global network. And so we're not betting the ranch. Our hallmark has always been organic growth. We think it will be for a long time. But the ability for us to bring a great rates liquidity pool into MarketAxess and expose it to 2,000 end investors to take muni brokers and connect it to our muni bond business, connect 2 different client communities, expand order flow there, leverage the investment that we made in technology for Reg Reporting in Europe by buying the Reg Reporting business from Deutsche Börse. So those trades make a ton of sense to us. It's really just leveraging the investment we've made, leveraging the network that we have, and we think we can make these much bigger parts of our revenue growth in the years ahead. So I think you'll see more of the same when we can bolt-on new product capabilities or client segments, we will continue to look for those opportunities.

Got it. All makes sense. All right. Maybe working kind of our way down the P&L. Let's talk about operating leverage and expenses. And look, obviously, in the year like we have this year, the operating leverage power in the model really comes through. What I was hoping to spend a couple of more minutes on though is kind of how to think about the base of investment from here. You guys have been investing in the business heavily. And that is why you are where you are with the market share gains that you're putting up. Overall expenses, I feel like have been going up 10-plus percent range for the last couple of years. And generally, investors think that's probably decent baseline to think about. Is that still the case? And as we look out into next year, albeit, market share gains, hopefully continue, just the macro backdrop could be more challenging from a comps perspective. So to what extent you guys would be able to pull back on some of the expense growth into 2021, if revenue growth, let's say, slows down a bit?

Well, I don't think pulling back is the right answer at all. We're seeing more demand for electronic trading and global fixed income than we've seen in the last 21 years right now. So this would be, in my mind, a mistake to pull back on investment. We're going to keep the investment level very high. And our organic growth has created fantastic returns for our shareholders. And when we meet with them, they want us to be investing to capture as much of this growing opportunity as we possibly can. And it's accelerating around the world. So now is the time for us to really expand our leadership position, and the way that we'll do that is through investment. And you saw this year, you'll see it again next year. And the margins are going to move up or down within a range because of the level of revenue growth. And there are so many different factors that are going to swing that revenue growth number around. And we don't look at it on a quarterly basis or even an annual basis. But if you look at -- if you include 2020, MarketAxess has both 5-year and 10-year compound revenue growth at about 17.5%. That's a really attractive business, and there will be years where it's 12%, there'll be years where it's 30%, but if it's growing, we're gaining market share every year, and the markets look like they're embracing what we do, we're certainly going to keep up the investment spend so that we can occupy just as much of the space around the world as we possibly can.

Great. Well, perfect. That makes sense. I'm going to switch gears a little bit and take a look at some of the questions that we got online. We have a handful of them. The first one that I think is interesting to address is around the muni markets. And the core of the question essentially is that you guys have made investments, you made acquisitions in the muni space recently. Why do you think the muni market is right for disruption and then move more towards electronic venues since historically has been fairly analog? And any other major sort of hurdles you think will prevent the muni markets looking like, let's say, high-yield markets look like today?

Yes. And we certainly are investing with the intent that munis can be the next high yield. We've had a really good year of proof of concept. Volumes are up about 100% from where they were last year. And it's already starting to be relevant revenue-wise because the fee capture in munis is very high due to wide bid offer and the market fragmentation. And if you look at electronic trading developments in munis over the years, it's been mostly in the retail space. Those venues are D2D between the online brokers, the RIAs, financial advisers and the retail market making guys. That space is not really growing. What we're after is the institutional space. And I would say that if you look at it today, it's kind of organized messaging in hopes of finding the other side of a muni trade and we think what we do in a very organized way with our open trading network is a far superior solution to what's taking place today. And with asset managers and dealers, both extracting more value than ever from MarketAxess, we're seeing a growing base of support where investors are saying one of their pain points is the muni business. And they like what we're doing, want to see us continue to invest. There are using the system more than they have in the past. And there is a broad base of dealer market makers that are available and ready to go to work on open trading orders. So there's a market in the world that needs all-to-all trading. I think it's the U.S. municipal bond market. We think we've got a great shot to make that happen. We're really encouraged with the trends that we see this year. And the institutional market, the true electronic market share is so low today that we think that there's a very large opportunity over the next 3 to 5 years.

Great. Well, on that note, I think we're almost out of time. So Rick, thank you very much for joining us again this year. On behalf of myself, my team, Goldman Sachs, we all really appreciate you supporting the conference, and hope you have a great holiday season.

Thank you, Alex. It's a pleasure to be with you, and thank you to for hosting today and all your colleagues for always hosting a great conference. We enjoy being here.

Perfect. See you soon.