Nasdaq, Inc. (NDAQ) Earnings Call Transcript & Summary

Okay. Well, we're going to get started with our next session. Thanks for joining us, everybody. Good morning, and good afternoon. I'm Alex Blostein, Capital Markets Analyst at Goldman Sachs. It is my pleasure to welcome Sarah Youngwood, CFO of Nasdaq. Sarah joined Nasdaq about 9 months ago from UBS, where she was also CFO and held other senior roles at both UBS and JPMorgan prior to that. Sarah arrived at an exciting time for Nasdaq as the firm is in the middle of integrating its recently completed acquisition of Adenza, which has really solidified Nasdaq's position in the Financial Technology space while also building on a strong footprint in other fast-growth areas like Anti-Financial Crime software as well as Market Technology infrastructure. So thank you so much for being here.

Thanks.

It's slightly different audience than what we're used in financial services world. So a figure we could get started with maybe a little bit of an introduction and level setting who Nasdaq is in the context of a being technology firm. So most investors in the room are probably familiar with Nasdaq's brand, primarily as an exchange. So at a high level, we can maybe get started with you telling us a little bit about why Nasdaq makes an interesting investment as potentially a technology company.

No, that sounds great. And yes, indeed, many of you probably know us as an exchange. And 50 years ago, that made absolute sense. We were just an exchange, in fact, a series of exchange. If you fast forward to today, we leveraged the technology that we built as an exchange, which is the technology that enables you to exchange more than $200 billion messages per day to actually do much more than that. So we're very good at moving data. And what we're doing is we are leveraging those skills to put data in workflows, and we've become a platform company that provides all sorts of critical services and we've become the trusted fabric of the financial system. So we're doing much more for the financial system than just being an exchange. And so first adjacency, if you want to think about it that way, if you are an exchange, you can do surveillance of trades. That's part of the core job of an exchange. So we've had that business. We're #1 in that business for a long time. If you can do surveillance of trades, you can probably do surveillance of transactions. That's what brings us to financial crime management, which is a very big space of growth for us and a tremendous business that we acquired. And if you are an exchange, of course, you participate in the capital market transactions. That's the IPO. But once you're an IPO-ed company, whether you're at Nasdaq or not, you need some additional services to be a great public company, whether it's IR services, board services, ESG services, we can provide all of that. And then -- and their -- that managers can benefit from a lot of the data that we have whether they are long-only or whether they are hedge funds to make better decisions. So that basically broadens up to be a fintech company leverages data into workflows and innovative technology deployed that way. And so what does that do as an investment thesis, it has enabled us to have more growth, more resilient growth, more diversified growth. And that puts us today at over $4 billion in revenue and $1.6 billion in free cash flow. If you look at that scale. And if you think about what you are used to, which is the rule of 40, we are actually the rule of 60. So that's the revenue growth plus the EBITDA margin for us it's a rule of 60. And when you combine rule of 60 in S&P 500 with the scale that I just mentioned, and there are only 15 companies that are at that level. So we're pretty proud to be part of it.

Great. Well, let's zone in a little bit more on this. I was hoping we could start with the market opportunity you see for the firm and really looking it through the lens of customers and thinking about what are the typical companies? What are the typical kind of customers that Nasdaq services today? What are the challenges you sort of helping them tackle. And ultimately, what does that mean in terms of market opportunity, both with the SAM and the TAM as you think about the business?

Yes. So we have a very large TAM of $79 billion. And we did an Investor Day if you want to look at all of the components, I'm not going to go through all of that. But if you want to look at that $79 billion, what we've done since 2017 is we've been very intentional about deploying technology, deploying AI, deploying the cloud. So cloud 10 years ago, AI 7 years ago and acquisitions along the way. And the goal was, as I said, to become the trusted fabric of the financial system. And it's one thing to have a SAM or a TAM, it's another thing to actually have the right to win within that SAM and that TAM. So our SAM, which is really the vended portion of that $79 billion, it's $31 billion. Our Solutions business that corresponds to that is $3.3 billion as of last year. So we are just above 10% penetrated in our SAM. And with the acquisition that we have done of Adenza just last year as well as Verafin that we had done about 3 years ago, we believe that we're extremely well positioned to net capture that for SAM within that large TAM.

Yes. So when we think about the growth prospects of the business, there are three kind of components that really always stood out to us. The first one being the Index business. And it's a business that Nasdaq has had for quite a bit of time. So maybe we can start there. It's been a phenomenal grower. So talk a little bit about the opportunities you see for the Index franchise at Nasdaq, and we can then hit on some of the others.

Yes. So if you think about some of the macro trends that we're all seeing, you've got the trend of passive. So passive is becoming a bigger piece of the opportunity set, and we have the fastest-growing Index franchise at about $600 billion, just a bit below that of AUM. That was basically a $100 billion business in 2017. So it has gone tremendously. And why did it? First of all, because the Nasdaq brand, it's one of the top 100 brands in terms of its value. So in the world very rare to find a B2B brand that actually has that much authority. So you've got that Nasdaq brand, which creates a moat. And that moat stands for innovation. So you've got Nasdaq 100, that's the one that you all know. What I think is exciting about it is that we've got plenty of expansion opportunities in that, both globally and taking that retail franchise into more institutional, particularly the insurance business as we develop the whole ecosystem around it. But we also are doing a lot of new products, and we have about 30% of the franchise at this point that is actually not NDX related. So very important that we're able to do many other thematics, quantitative indexes. So it's really a full-blown platform that stands not just for technology, although technology is very important, not just here, in general in life. But really stands for innovation and innovation across a lot of thematics.

I got you. Makes sense. Makes sense. Let's talk a little bit about the Anti-Financial Crime business. And Verafin has been a big success for the firm. And just for background, Nasdaq acquired Verafin back in 2021, I think we're about $3 billion. It's been a solid grower north of 20% type of growth in that business. Can you talk a little bit about the drivers and the opportunity there you see ahead of Nasdaq.

Yes. So again, I'll start with the macro trends. You've got the $3.1 trillion issue of illicit funds flowing through the system. So $3.1 trillion of illicit funds flow through the system that's just last year. In addition, you have almost $0.5 trillion of fraud and the losses that result from that. That's again, last year's numbers. So you've got a very large issue. We calculate the TAM for this at $13 billion. The SAM at $6 billion. So you've got a very large opportunity set and a real problem to solve. What's also interesting about this problem to solve is that it's a problem that loves data. We have lots of data and ability to move that data. And governments are -- for example, in the U.S., PATRIOT Act provides for the ability to share data to go after criminals. So this is an area where sharing competitive data done right, and we have all of the right licenses to do it in the correct way. It is actually absolutely appropriate because nobody wants the $3.5 trillion of issues that are benefiting criminals against people or institutions. So that's the problem set. The company that we acquired Verafin was set up 15 years ago in Canada, in Newfoundland to be specific. And the beauty of being positioned there is that you recognized 15 years ago that you needed to be in the cloud. And that you really needed to serve people way beyond where you were. So their first domestic market, in fact, was not Canada but the U.S., and they serve from Newfoundland, the U.S. market and grew that to 2,500 community banks. So we've got consortium data in the cloud, and they also had this brilliant idea 15 years ago that you needed to do algorithmic AI, to actually analyze that data and to effectively find the bad actors and separate them from the good actors and provide that information to the banks. So again, very well positioned because they were using data in a structured way, all of the things which enable us today to do gen AI already in production with clients on that topic, and we can reduce the time that it takes to review SAR, which is a suspicious activity report from 1 to 0.1. So it's a 90% reduction versus not having our product. So it's a fabulously effective use of data and workflow. We have 2,500 banks, as I mentioned. We have also $8 trillion of assets that are covered by those 2,500 banks. So you have a lot more validity when you have the data of others and not just your own data. And then that positions us now to add Tier 1s. We already have 4 Tier 1s. The last one, which we just added last quarter was actually in the -- actually, it was this quarter, but we talked about it at last earnings call, it was an international Tier 1, which is an interesting step because our expansion is both going up market to the large banks, which adds to the data set as well as to the opportunity set because they represent a very large part of the SAM, and we've gotten to where we have gotten in terms of profitability without them so far. And then we have the international, which is interesting because it's much more concentrated than the U.S. market where it took a while to gather the 2,500 banks that it takes to get to $8 trillion assets.

Yes. So maybe double click into that. I think one of the more significant relationship you announced, I think it was around the Investor Day with Citi, which is, of course, a very, very large bank. So maybe talk a little bit about sort of proof of concept that you're getting through that relationship, how important do you think that is going to be for you sort of lending other Tier 1 banks. And Citi has a huge international footprint also, so therefore, kind of helping you guys expand outside the U.S.

Yes. So we're super excited about our bread and butter business, which is small- and medium-sized bank. And I'll start by saying that because we've got 2,500, there are 10,000, so plenty of growth to come in that first area of growth. But the relevance of a Citi is both to that small -- the first piece. If I'm a small regional bank, it never occurred to me that I should build a gen AI platform. Because I know that I'm not going to be able to deploy that type of technology that I don't have the right technology that I don't have the right environment, and I naturally want to use a financial crime management provider like Nasdaq. If I'm Citi, I'm asking myself the question. And as they did that, they answer very clearly. Nasdaq has a lot more to add to us and what we can do on our own. Therefore, they're using us because we are able to see even better than them their own data because of our ability to structure data, of course, we can look at data that is in any core banking system. We can look at 70 core banking system. That's the beauty of training yourself on every regional bank. We have seen every flavor of data. So we are able to see in their data. We do it in a very respectful way, and as a former bank CFO, I can tell you that there is nothing more important to Citi and every bank, large or small, than they trust aspect. Nasdaq is trusted by large banks to access and interact with their infrastructure. And so if I'm Citi, I'm already not scaled because it's Nasdaq-vetted. I see the value. And then I see the value of the consortium data. And then the last part is, if I'm a small bank, now I benefit from the fact that when you're adding a Citi or another one that looks like Citi, you're adding $1 trillion, $2 trillion at a time. So the data set gets better in an exponential way when we add those Tier 1s, which makes the value proposition better for the bread and butter and also adds the revenues.

Yes. Great. Makes sense. All right. Let's touch on the third kind of pillar of some of the growth areas, which is within Financial Technology, which is, of course, Adenza. It was a sizable acquisition that Nasdaq did a couple of quarters ago for $10.5 billion purchase price. You guys are in the middle of integrating this today. So just to kind of level set everybody in the room, maybe spend a minute on sort of rationale for why this deal made sense for Nasdaq to do, expected benefits of Adenza in the context of Nasdaq and maybe a bit of a mark-to-market and where you are in the journey of kind of capturing some of the benefits that you were hoping to achieve through this deal.

Yes. So many people don't know the word Adenza but many people know AxiomSL as being the regulatory capital software, so 97% of the G-SIBs uses it, everybody uses AxiomSL to do CCAR, to do regulatory reporting. We deal with 55 -- 110 regulators in 55 countries. So we are, I would say, the only comprehensive platform that enabled you to do that. So that's one of the trend, which, again, we always go back to macro trends. If you're evaluating how to have like a higher growth business, I think it's very important to tie yourself to areas of growth. And here, you've got sustainable regulation that are a need. The financial institutions are very interested in outsourcing that to the extent that the institution can do a lot for them. And can do it with regulators approving of the work. So we provide that. So that's AxiomSL, a very, very strong platform. The second piece is Calypso, and that's about the trade. So this is pre-trade, trade, post-trade and some of the treasury management services. Also very interesting because this is for some of the smaller banks, but also for some of the capital market actors having the ability to have effectively trade in a box. So you have a lot of system providers who help you do core banking infrastructure. We are focused on the trade part of that, but we do it really well. And we are the most integrated platform that does it pre, post and trade. And so why did we do that? What's very important is go back to 2017, we said we want to be the trusted fabric of the financial system. And for that, I think it's clear that you need to have financial institutions see you as a trusted vendor, as it was a partner, not a point solution vendor. Before that, we serve them in surveillance, we serve them in Verafin, which is financial crime management. We serve their capital markets in -- for an IPO, but we are point solutions. So we've got all of those people in large banks, but they don't talk to each other. At some point, we become so contiguous, we do exchange technology, we do risk management technology. We do regulatory technology in many places. At some point, the C-suite is involved because we are one of the large trusted partner of banks. That was the thesis. That was what we believe is the unlock to become actually able to leverage this very large SAM and TAM. So that's really the reason why we did that transaction to become this trusted fabric of the financial system, which was that -- a series of steps that we had taken since 2017, both organically and inorganically to get there. And so from there, we couldn't be more pleased with the execution, our culture has really been an excellent feat. And so we have very strong engagement. We also have a very strong execution to artifacts there on leverage. We are ahead of the targets that we gave you. At some point, we had talked about being at 4.0, 9 months ahead or 6 to 9 months ahead or 9 to 12 months ahead the date. And in fact, 12 months ahead, which was last quarter, we were already at 3.9. So deleveraging a very important priority for us. The second one would be synergies. We get usually $80 million net synergies. Those $80 million, we had said 70% of the actions would be in 2025 by -- 2024 by year-end. Well, by the second quarter, we had announced that we had done, that 70%. So again, ahead of expectation. And then we announced cross-sell revenues of $100 million plus. And there, we already have several campaigns that are in place. We have 11 cross-sells that have happened as well as about 10% of our pipeline that's already in fintech cross-sells, so those are all for fintech, which is one of our divisions. So we're seeing a lot of momentum, and we are seeing from our clients that they were interested in us doing more for them, which was really the thesis.

Got it. Got it. That makes sense. Just maybe double-clicking on Axiom for a sec. You said 97% of G-SIBs already use it, right? So at a high level, you could say, well, you sound pretty penetrated that much. So outside of the big banks, can you talk a little bit about what's the next leg of growth is for Axiom, in particular, when it comes to regulatory software? And to what extent the regulatory or the scrutiny of regular regime really matters, right? Because obviously, we have an election coming up, depending on the outcome of the election, the regulatory landscape of banks could go one way or another. How much does that matter?

Yes. So first of all, it seems like there was a lot of talk about regulation actually happening right now because it seems like there were very few issues, which are actually a meeting of the mind between the two sides. But that one is probably one of them, where there will be regulations either way. And it's really all about calibration. AxiomSL does not benefit from the calibration being more punitive or less punitive to clients. What's important is that there will be regulation. If there will be regulation, there will be a need to report. And that needs to report, which is what we cater to can be calibrated to a very low capital requirement or a very high capital requirement, a very low regular -- liquidity requirement or a very high one for us, actually, we're advocates for our clients and we certainly are not looking for them to not be at a level playing field. But we want to make it easier for them to deliver across regulatory environment. And that's exactly what we have been doing. I just want to point -- I'll answer on the nonbanks. But before I go there, when we are penetrated with a bank, that means we do one thing with them. But the revenue growth formula for AxiomSL and Calypso actually and for many of our products is really about upsell, but we land small and we expand. And so for AxiomSL and Calypso combined, 50% of our revenue growth is about upsell, and then the other 50% is CPI as well as a new logos. So we are not at all afraid about growth opportunities with those we have already landed because we are in the business of more products, more regions, and that's really the business model. But to answer your question, we also have expansion opportunities in, for example, the broker community, which now is going to have more intense regulatory reporting. And if it's more frequent, then you can't really do it in Excel, you go to your provider, Axiom does that. And there are many other applications where we can be helpful. And those are some of the campaigns that we're doing.

Got it. All right. I got one more and then more thematic set of things, but let's talk about AI for a second. Obviously, a super important topic for both investors and companies. So maybe spend a couple of minutes on how Nasdaq is incorporating this technology from both an expense and efficiency perspective and as a revenue opportunity perspective as well?

Yes. So I think that all companies, and hopefully, all the ones that come here and all of the ones who are not technology companies should be doing AI on the business. So everybody has the right to code faster deliver more legal efficiencies, being financial efficiencies and everybody doing that. I think the difference with us is that, as I mentioned, 10 years ago, we decided that cloud was important. And 7 years ago, we decided that AI was important with some pockets starting at even 15 years ago. If we did do that puts us in a position where our data is structured so that we can actually really apply those large language models and all of those gen AI capabilities to data sets rather than spending massive amounts of expenses in creating that environment. That's a very big differentiator, which enables us to put gen AI in the products. And I mentioned one of the example that's already likely in production. So we -- there are plenty of things which are in hackathon or in test or in beta. And then at some point, you get to, no, I've got hundreds of clients who already have it. And so in that category of having hundreds of clients who already have it, we've got the gen AI financial fund management workflow. So that has been very, very positive to be able to do that. And then we have applications that are a little bit everywhere. We are able to create data assets, for example, in our Capital Access Platforms regarding ESG. And so that's an application. We also have a broad summarization that's in beta where you can take all of your, for example, audit committee documents and summarize it to 1 or 2 pager. And as part of our Nasdaq Boardvantage platform. And we've got lots of different applications to do it in all of the parts of our products, but we believe that it's going to become necessary both defensively and offensively to have gen AI embedded in the products. And that at the end of the day, the difference is going to be about do you have the data that is able to be orchestrated so that you can actually deliver it efficiently to your clients for the benefit of shareholders.

Yes. I got you. All right. Let's shift gears a little bit. I once -- I was hoping to hit on a couple of financial metrics as well on KPI. So as you were talking to investors and as you're measuring yourself internally, what are the kind of most important KPIs that you would like investors to track when it comes to Nasdaq's performance?

So the first one I would give you is, we are very focused on adding shareholder value. And -- so I'll walk back from there. How do you get to that? We are very focused on revenue growth and expense leverage on that revenue growth. And if I think about that I started with, which is that rule of 60, what I like is that we address the three pieces, which add value to shareholders: Revenue growth, EBITDA or operating margin and the reason why it's or operating margin is because it's cash flow conversion. We are very focused on cash flow conversation too. So I would say those are the three. Revenue growth, the best measure of revenue growth is going to be the ARR. So in SaaS business, as all of you know in this room, but not everybody knows in every room. And really, the focus on ARR, we think, is very important, but we also give you medium-term outlook in terms of revenue, so that you are able to see how it translates into our profitability. And then for our Solutions business, we've got 8% to 11% medium-term outlook. And we target to have a spread of 300 basis points to that, which is really on the 500 to 800 basis points of expense growth. So if you have good revenue growth leverage in terms of the expense growing less than the revenue, and that creates the operating leverage. And then we do that with free cash flow conversion, which we target to be above 100%.

I got you. Helpful. So -- and again, importantly now, that Solutions revenue, the 8% to 11% growth is obviously, the vast majority, the revenues, right? And at the end of the day, that's still the...

Close to 80% of the revenue. And what's actually really cool and being new, I did all sorts of analysis, first of all, as I was evaluating Nasdaq. But then as I came to Nasdaq, what's fascinating about Nasdaq is how resilient that growth has been. So we have some businesses that have some beta factors, but they fetch each other, like, for example, the Index business and Market Services are pretty much negatively correlated to each other. And so what we looked at is that over the last 2017 to 2023, the 6 years, which is since our pivot, we actually had consistent organic growth that was always between solid and excellent as opposed to it's a weighted average over a long period because you had some good years and some bad years. It's always a consistent growth with a lot of recurring revenue that 80% and even the 20% really is not deterring from that.

Yes. So when you think about the 8% to 11% growth in Solutions, and I appreciate that it will be hard to kind of summarize that in a couple of minutes that we have left here. But as you think about the growth algorithm to kind of help you kind of get to that 8% to 11%. Can you help maybe frame what's coming from new customers, what's coming from cross-sell and what's coming from pricing, understanding that different businesses are probably going to have a slightly different way of getting to that growth. But as a whole, how would you frame that?

Yes. So if you look at all of the charts, and we provide some pretty good data on our revenue growth formula. So you can look at it in Investor Day, you can look at it every quarter. What you will see is that the biggest bar in our chart is existing clients. So we generate more than the majority of our growth from existing clients. And that's because we have, across our businesses, a very strong set of products, and therefore, we have repeat clients who start with something and then add to it. And we also have a lot of very modular businesses where we learn and then you can expand and expand and expand, which we think is a very easy way to let the clients drive the decision, which we're all about the clients. And so we do -- for example, Adenza, we say it very specifically, it's half, which is the upsell and then the other half being the CPI as well as the new logos. For Verafin, for example, you've got a mid-20s medium-term outlook and you have 111% to 112%, like that type of domain for the net retention. So again, that gives you, in that case, a bit more from the new clients than in the Adenza businesses. But you always have a good balance between the two with us skewed towards our existing clients.

Yes. Great. Let's hit on capital allocation for a second as well. You mentioned the deleveraging plans, which you guys have been executing against very nicely, and that's progressing. But also Nasdaq has been obviously quite acquisitive in the past. And that's one of the more sort of common questions that I get is like, well, should we still expect Nasdaq to get back and do larger deals once they hit their leverage target. How do you think about the capital allocation framework for the firm from here?

Yes. So we have a capital framework that is very set to, first of all, organic growth, that's like the number one. Second, we do pay a dividend, and we call it a progressive dividend. We gave a 35% to 38% payout ratio range, and we're within that range already, even though that was planned for a few years from now. We also want to at least offset employee dilution with our share repurchase. So we want to have -- the good news about having that 100% free cash flow conversion is we have a lot of free cash flow. And that free cash flow enables us to do all of the above. Right now, our focus is on deleveraging. And we are definitely making very good strides. And you see that in -- us achieving all of our targets early in that regard, and we really can see a benefit, whether it's from an EPS accretion dilution, from a free cash flow acquisition or from a multiple expansion of being paid for our growth, I think, to be paid for that type of growth you can't sit at the higher levels of leverage. So we have a target to be below 3x. And then after that, it's really about what is best in terms of adding value to shareholders. So the great news is that with the acquisitions we have done and the organic investments we have done, we're in a place where we believe that we have an organic path to deliver on our medium-term outlook. And that formula is a fantastic value-add to shareholder. And so likely, it is hard to find something which adds strategically, which adds financially and which adds from a shareholder value better than that organic path even if we are situated below the 3x leverage. If there was such thing that was even better than that, obviously, we are in business of adding value to shareholders, and we would consider it. But it needs to meet being better than the alternative, which is the choice we have.

Great. We have about a minute left. So if there's a quick question from the room, we can probably take one now. Okay. Otherwise, we can leave it there. Sarah, thank you so much. Thanks for being here.

Good. Thank you very much. Appreciate it.