NZX Limited (NZX) Earnings Call Transcript & Summary

Good morning, everybody, and welcome to the 2021 Half Year Results Call for NZX. I'm Mark Peterson, and I'm here online and locked down with Graham Law, NZX's CFO; and our moderator, Mark Velasco, who's one of our NZX team, who's also in the background. Our approach to today is that I'll lead off and take you through the high points of the results; followed by Graham, who will take you through the financials; and I'll then wrap up with a few comments relating to our strategic progress, after which we're happy to take questions. [Operator Instructions] Graham and I will then be happy to answer the question. Before we start, can you please just note the important notice at the front of the Investor Relations pack as this statement applies. So Mark, if you can just flip through to the next slide, please. Just a few opening remarks. I spoke at our full year results back in February about the extraordinary year of activity we had in 2020. Renewed capital markets stood up to the challenge of COVID and companies very much recognized the value of having access to capital. At the time, we're all wondering whether 2020 was going to be described more as a sugar rush or whether, in fact, it was more of a sustainable step change in market activity. I'm pleased to say that through the first half of 2021, the capital markets activity levels have largely been sustained. This business is alive and well, and activity levels are thriving across all areas and we remain optimistic of the future. Some measures are slightly off our activity levels from the same time last year. But remember, we are measuring against a very freakish period. Turning to Slide 4, Mark, if you wouldn't mind. This just highlights our key results at a glance. Our operating earnings for the half were $16.9 million, slightly down on the same time last year. Net profit was $7.6 million for the half, down 16%, largely due to the increased amortization from Wealth Technologies as it brings new clients on board and the lower interest income on our cash holdings and regulatory capital. Graham will unpack these further when he speaks to the numbers. We have declared a fully imputed interim dividend of $0.03 per share, with a record date being 10 September and payable on 24 September. I'm sure everybody is familiar by now with our approach to describing our results, where we break the business down into the 6 biggest drivers of our performance and our opportunities for growth. Once again, these are outlined in Slides 6 to 11, and I'll take you through these now. Now speaking to Slide 6, which talks to capital raised. Another strong performance of $7.3 billion raised over the 6 months. However, the mix is clearly different to what we experienced this time last year. 2020 was dominated by secondary equity, as we all remember, whereas 2021, we have a blend of primary issuance of debt and equity alongside a good mix of secondary issuance across all asset classes, equity, retail debt, wholesale debt and funds. 4 new equity listings utilizing the various channels to the NZX market. We had 1 IPO, 2 direct listings and 1 foreign exempt listing. And we're very happy to welcome My Food Bag, Third Age Health, NZ Automotive Investments and DGL Corporation. Over the last 12 months, the number of listed securities has grown by 15 over the period and now totals 334 as at the end of June. Green bonds continue to build in popularity with Mercury and Precinct issuing. Our issuer relationships team are now running a true origination model, which is building a healthy pipeline for the second half and further out. Many of the private companies that the team approaches are interested in taking meetings, which is really encouraging, and they want to hear about the concept of listing. Some are closer to being list-ready than others. But what it means is they hear our story directly from us, and they are going through our systems for us to stay in regular contact. Slide 7, I'll turn and talk to secondary markets and traded value. We're very pleased to report traded value at a level of $27.1 billion for the half. And you'll note on the graph that this result is very close to the levels seen through the first half of 2020, which was phenomenal. It's up 22.1% on the past 5-year rolling average, showing that this is a step change in the market activity. The number of trades for the 6 months exceeded 8 million, which was up 36.5%. And just as a comparator, we did just over 12 million trades for all of 2020. On-market liquidity for equities was again very healthy, 65.1%, which is up 4.3% year-on-year. On-market liquidity for all asset classes was 63.8%. We're now also showing on the slide a split of value traded across retail, wholesale and ETFs. And you'll note that the retail and wholesale activity are similar to the 2 comparable periods, with ETF activity continuing to grow. Assets in our depository are now at $5.4 billion, which is up 44.3%. Another point to note, our trading system upgrade went live early August, and that gets us on to the latest new trading technology and does bring with it some market-enhancing features, which will be turned on in due course, at which time the broking firms can then choose whether they want to use that new capability. The new capability includes, firstly, a self-managed prevention tool, which I'm sure will be appreciated by the market and alongside an unlet midpoint order book trading venue. Once live, we believe this will lift on-market trading levels further. We're looking forward, obviously, to welcoming BNP Paribas as a general clearing participant later in the year. Now turning to Slide 8 on Data & Insights. Another half of very good growth from our Data business. Revenue was $8.6 million, which is up 5.1%. And we've seen retail terminals drop off from the COVID peak of last year, while we continue to see greater international connection to our market with professional terminal numbers lifting 6.2%. Audit revenues also have remained strong half on half. Slide 9 on our dairy derivatives business. We had a very -- we actually had a disappointing half for our dairy business. Lots traded were down 31.9%, largely due to low volatility in the underlying physical prices. And you'll recall, we experienced that in the second half of 2020. And COVID also played a part with the inability to travel and market this market internationally. It's made it very difficult to actually get out in front of our flow providers and our customers. We remain positive towards the benefits the partnership with the SGX will bring. We have a global benchmark product, which is very rare for exchange markets, and reaching a broad international user community by the vast clearing membership SGX has should bring us strong growth. We remain on track to commence this partnership with SGX towards the end of the year. Slide 10 on Smartshares. Very good performance from Smartshares in the first half. Funds under management at the end of June totaled $5.7 billion, which is up 44.3% half-on-half. Net cash flows also grew strongly, totaling $383 million for the 6 months. We are seeing growth across superannuation, KiwiSaver and the ETF products directly. Wholesale business into ETFs continues to build, and we are pleased with the recognition shown by the government in selecting Smartshares as a KiwiSaver default provider from September. We can -- actually from December, we will take that on board. We continue to mature our operational and technology capability within this business. And marketing, operational automation and digital tools will be a key feature of our default proposition. For the first time -- I'm talking now to Slide 11, Mark, thank you, and focusing on Wealth Technologies. For the first time, our Wealth Technologies business was earnings positive, and our next objective, obviously, is to be cash flow positive here. Our growth trajectory remains very strong, with funds under administration now totaling $7.73 billion, which is up 151%. We're working on several client transitions before year-end, and we remain on target to exceed $10 billion by the end of the year. We continue to receive interest from new prospect opportunities and will manage these carefully as we are a business that wants to build a reputation for delivering on our commitments and looking after our clients. Slide 12, regulation. We remain pleased with the new model for regulation. Our intention was to create a structural separation between the regulatory and commercial functions of NZX and thereby creating clearer perceptions in the market on the boundaries, and we believe this is being achieved. And just to note on that slide, the Establishment Board has now been made permanent. Slide 13. Just -- now turning to our focus on people. In addition to the range of comments on the slide relating to our people and culture, you will have seen the announcement that we have made this morning, which speaks to some changes within my leadership team. The background to this change is that we wanted to put in place a team and structure that will deliver our ambitions over the next 3 years. I wanted to keep the client-orientated model, which has worked well, but we also wanted to bring in specialist services across the business, particularly in operations and technology. We are dedicating senior executive resource to capitalize on our significant dairy and environmental market opportunities. And within Graham's team, we have set up a specialist risk management unit. I have a very strong and capable group of executives in the team and feel confident about the future, and I'll speak later in the presentation to our strategy for the next 3 years. We are seeing significant labor market pressures. Our staff have been targeted and in some cases, they're being poached and are finding filling vacancies being very challenging. The wage inflation is very much alive. However, in saying this, we are making good progress in bolstering our capability with excellent people and technology, risk management, IT security and project delivery. Just prior to lockdown, our team moved into our new premises on Level 15 at 45 Queen Street. The new location has been designed to be used by the market. Issuers will be able to use it for smaller AGMs. The spaces in the Auckland Capital Market Center will be perfect for listing and investor events, and schools will be more than welcome onto the floor to get a greater understanding of how capital markets benefit New Zealand. As a result of this, it makes sense for the CEO to be based out of Auckland, and I'll be transitioning to Auckland before the end of the year. I'd now like to hand over to Graham to take us through the numbers in more detail. Over to you, Graham.

Thank you, Mark. Before I start, I'd like to draw everyone's attention to the important notice on Slide 10 [indiscernible]. Mark, if you could move to Slide 15. Okay. Okay. Cool. The table summarizes -- so next slide, Mark. Yes. Thank you. The table summarizes the income statement for the half year ended during 2021 and shows operating revenues have increased 10.6%. This includes new revenues arising from the development and operation of the new carbon managed auction service and it's despite securities trading and securities clearing revenues reducing from their peaks during the comparable 2020 COVID period. Operating expenses have increased 22.5%. This includes the new costs arising from the development and operation of the new carbon managed auction service as well as the increased personnel costs associated with supplementing the securities IT team and the increased information technology costs to enhance trading and clearing system capacity, improve resilience and further strengthen our cyber defenses. Overall, this has resulted in the operating earnings being 3.5% lower than the comparable 2020 period. I will break this down on the comment slides. And I also note that a detailed management commentary by business unit is provided in Appendix 1 of this presentation. The nonoperating expenses include net finance expenses being lower as a result of interest income on our operational cash balances; and risk capital being impacted by the lower interest rates; and by amortization being higher, which is as a result of Wealth Technologies' increased amortization on new client migrations. That results in the net profit after tax being down 16% on the comparable 2020 period, with the operating margin being lower at 39.9%. Slides 16 to 19 further -- provide further graphic analysis and detail on the operating revenues and expenses. Starting on Slide 16. The revenue pie chart shows that the revenue back on -- shows that the revenue coming from Smartshares and Wealth Technologies is becoming an increasing portion of NZX's total revenue. The cost pie chart shows that the gross personnel costs remain the highest portion of our costs, although information technology costs have increased significantly to now being 20% of the gross cost base, with professionals fees being the third cost category at only 8%. Moving to the waterfall on Slide 17. This highlights the more significant movements in operating earnings relative to the comparable 2020 period. First, I'd like to bring your attention to incremental revenue and costs arising from the new carbon managed auction service. For 2021, these revenue and cost numbers include both the one-off development and the commencement of ongoing auction services. Please note that in future periods, there will only be the ongoing auction services costs and revenues. Operation revenues have increased for energy development and consulting projects. For most of Data & Insight revenue categories, although royalty audit revenue is slightly lower and within Smartshares and Wealth Technology in line with the growth in funds under management or administration, for listing phase and trading and clearing phase, we have seen a reduction from the peaks during the comparable 2020 COVID period. Operating expenses have increased, with the largest increases in personnel and IT costs. Personnel costs have risen due to the new FTEs across the business units. They were acquired to supplement the security IT team resources to deliver higher levels of consulting and development revenue to expand issuer origination activities and to support growth in both Smartshares and Wealth Technology businesses, particularly with respect to corporate services and project resources they're requiring. For IT costs, these are higher than the comparable period, primarily due to the enhancements of the trading and clearing system capacity, improvements for resilience and further strengthening of our cyber defenses. Dropping into a bit more detail, the high level impacts on operating revenues are noted on Slide 18. I've already touched on the nonrecurring development revenue arising from the new carbon managed auction service for the Ministry of the Environment that was fully completed in the current period. For issuer relationships, the largest factors or annual listing phase have been positively impacted by the overall growth in market capitalization since the comparable period. Remember that it is the market capitalization at 31 May each year that drives the annual listing fee for the year following, from July to June. For primary listings, there has been a higher level of equity and retail debt listings relative to the comparable period. And for second-duration issuances, there's been a lower level of equity risk relative to comparative period. These patterns are illustrated in the bar charts on the bottom left-hand side of Slide 6. It's worth remembering that equity has a relatively higher fee than retail debt, than wholesale debt and then finally, even funds. For the secondary markets business, the securities trading and clearing revenues have decreased as total value traded and cleared reduced 2.8% to $27.1 billion from the peaks during the comparable 2020 COVID period. Dairy derivatives revenues reflects the lower number of units, which were down 31.9% due to the low volatility on GDP for the majority of the period. And we continue to have high levels of consulting and development revenue arising from a multiyear electricity market real-time pricing project and from the development of the carbon managed auction service for the Ministry of Environment. For Data & Insights, terminal revenue has benefited from higher professional terminal numbers, partially offset by lower retail terminal numbers, which are cutting off their highs from the comparable 2020 COVID period. Subscription and license revenue increases reflect growth in client data usage and license numbers, which shows our ability to capture license revenue streams post royalty audits. Indices revenues have benefited from an increase in funds using indices as benchmarks and additional index data clients. Terminal royalty audits and backdated license revenue is slightly down but remains historically high at $0.6 million, reflecting the continued high level of audits and the focus on ensuring customers are appropriately licensed and up to date. Connectivity revenue reflects increased connectivity requirements from both market participants and data vendors. The Funds Management revenue continues to grow strongly, with fund-based revenue up 35.6% with strong cash flows and market growth driving fund up to $5.69 billion at 30 June. And member-based revenue increased slightly after taking in the historical price provision in the comparable period. Wealth Technologies funds under administration-based revenues have increased 147.9% as new clients have migrated to the platform in mid to late 2020, with funds under administration now at $7.73 billion at 30 June. Regulatory revenue has now been separated out and includes an internal allocation of annual listing fees and annual participant fees. These allocations are set in advance each year based on services expected to be provided by NZ RegCo. Moving to Slide 19 for the high-level impacts on operating expenses. For personnel costs, there are a couple of factors driving the higher cost levels. Firstly, we are experiencing strong competition for talent given the current labor market constraints, particularly for IT and legal resources. And this is resulting in wage inflation, which is expected to continue in the near term. Secondly, the headcount on a period-to-period basis has increased 27.5% FTEs or approximately 11.5%. The FTE growth mainly relates to further expansion of our growth businesses and particularly Wealth Technologies, where headcount has been increasing as new clients either have been or in the process of being migrated to the platform. This is expected to continue as future new plans are won. And in corporate services, where we're having to recruit additional IT development, project, legal, HR and communications resources to support the growth across the business and the current elevated levels of project activity. There's also been FTE growth in the markets business to deliver increased levels of consulting and development revenue, including the electricity market real-time pricing project and the carbon managed auction service. It's also being to further strengthen our issuer relationship team's focus on origination, active pipeline development and conversion to new issuers. And finally, other roles in securities IT team, which are in addition to those hired at the end of the first half of 2020 to deliver technology solutions to increase trading and clearing system capacity, add the resilience and the markets developing. Capitalization of internal development resources has increased 16.8%, driven by the increased Wealth Technologies' time working on new client migrations in the current period. Additionally, there's been activity on the trading system upgrade, which have been deferred from last year due to the COVID lockdown. IT costs are higher than comparable periods, primarily due to 4 main reasons: firstly, increased cybersecurity costs. These arise from the improvements to resilience of NZX clearing and settlement systems, plus the modification of existing security services supplemented with additional cyber defense capabilities and security services; secondly, the cost associated with the development and ongoing operation of the new carbon managed auction services; thirdly, the electricity -- the energy and electricity market paying third-party specialists support to assist with the increased level of development, which, of course, generated additional revenue; and finally, Smartshares implemented the Bloomberg front and middle office operating system in the year 2020 as well as the initial investments in the digital tools, which will be a key component of the launch of the KiwiSaver default scheme. There has also been increased software licenses and data feed, data hosting costs associated with client growth in parts of the business, for example, in Wealth Technologies. Professional fees are significantly higher for the period. This results from costs associated with both the development and ongoing operation of the new carbon managed auction service such as the commencement of EEX royalty fees relating to the services they provide as part of our partnership to the carbon market and from setup costs for the dairy derivative partnership with SGX as well as our continued investment for growth in Smartshares business, including the initial setup costs of the KiwiSaver default scheme, and costs associated with exploring potential acquisition opportunities. Professional fees also include, of course, the ongoing assurance program and the royalty audit costs, which are proportionate to revenues. Moving to marketing. The span there remains low and is at similar levels during the comparable 2020 COVID period. Our issuer relationship team's marketing focus has been on additional memberships of various industry groups to identify listing opportunities, with the retail investor servicing focus being on the use of video conferencing, webinars and digital newsletters. Smartshares continued its marketing activities, which assisted in generating significant cash inflows during the year, although the appointment of Kiwi default scheme may see increased bond promotion in the future periods. Other expenses increased due to travel resuming relative to the comparable 2020 COVID period. We're also experiencing higher insurance renewal and compliance costs, which will largely be reflected in the second half of 2021. And finally, capitalized expenses relate to costs incurred in all of the expense categories, which relate to internal development activity. Moving to Slide 20, where we summarize the nonoperating income and expenses. For net finance expenses, we see the interest income on our operational cash balances and risk capital has been impacted by the lower OCR rate. The increase in amortization costs relates mainly to Wealth Technologies for future software releases and on the migration of new clients. I note that the trading system go-live was in early August, at which point amortization of the trading system will have commenced. The balance sheet, as noted on Slide 22. The 2 key points to note are: firstly, the cash balances include items that are not available for general use. In particular, the clearinghouse has $20 million of risk capital and approximately $2.6 million of quasi-regulatory working capital. And the Funds Management business has $3.9 million of working capital requirements. This has increased due to the requirements of the new agent regional phone passport. The second point to note is that funds held on behalf of third parties, assets and liabilities offset and hence, the assets are not available for general use. These relate to issuer bond deposits, participants' collateral deposits, deposited funds, including those held in the mutualized default fund. Slide 23 summarizes the capital expenditure. And as indicated in our February investor presentation, the 2021 CapEx is as we expected at a higher level. Firstly, within the core markets, the main projects in 2021 were the trading system upgrade, which had its go-live in early August; and the network transformation project, which is a multiyear project started in 2019 on a strengthened NZX's cybersecurity and is now in its final phase. Additionally, we've had the fit-out of the New Auckland office at 45 Queen Street. For the remainder of 2021, we expect a higher level of CapEx relating to the continued enhancement of NZX technology architecture as well as nzx.com capabilities and automation of the deposit system and processes. And then secondly, in the growth businesses, Wealth Technology continues to provide further functionality and create new clients. And Smartshares CapEx relates to the delivery of digital tools for improved client servicing and efficiency. This will be a focus for the remainder of the year as digital tools are important to the successful implementation of the new KiwiSaver default scheme. Slide 24 summarizes the 2021 year-to-date cash flows. Operating activities decreased. The decreased cash flows reflect the lower net profit after tax and the working capital movements. Investment activities reflect the CapEx expenditure that I've just noted in the previous slide, and finance activities mainly reflects the dividend net of participation in the dividend reinvestment plan and lease payments. Moving to Slide 26. Our fully imputed dividend is $0.03 per share, which will be paid on the 24th of December, and the dividend reinvestment plan is available for the interim dividend. And the shares will be issued at a 1% discount, which leads me to our 2021 earnings guidance. This is maintained at our full year 2021 operating earnings to be in the region of $32.0 million to $35.5 million. As always, I note that this earnings guidance is, of course, subject to the usual market caveats that are listed on this slide. At this point, I'd like to hand back to Mark to discuss NZX's strategy.

Thanks, Graham. And as mentioned, I'll just take you through how we're evolving our strategic thinking, and I'm now talking to Slides 28 through 32 of the pack. Turning to Slide 28, which speaks to NZX 2.0, as we're calling it. And we mentioned at our Investor Day back in December last year and again at our full year results briefing in February this year of our desire to build an integrated business to support the growth of New Zealand's capital markets. NZX has the ambition to build a diversified financial markets infrastructure and services business. And as previously mentioned, NZX is not alone amongst international exchanges and taking a more diversified stance to its business. LSE is obviously diversifying with information and data, NASDAQ with technology, SGX with acquiring OTC trading platforms are but a few examples. NZX is focusing on the extension into financial products and infrastructure services, and we are treating everything as core. We've got our business growing across the markets and financial services areas, and we're making very good progress at upskilling our people and technology capability. Turning to Slide 29. We're running hard to grow our issuer community, [indiscernible] and the team are going well. COVID has created a tailwind in this business -- in that business and businesses that are seeing -- see very clearly the value of having access to capital. We're also running hard to build liquidity and a greater number of investor connections into our markets and some new features coming with the upgrade of the trading system. And we know data is a critical part of the mix, and we think we have more opportunity here also. However, we think there is more value to unlock. NZX 2.0 is all about the benefits that we can accrue to both the market and investors by enabling passive capital flow to wider parts of the market. We think we can get more value from the sum of the parts. Greater scale in our funds business will enable us to provide a wider product capability and therefore, more investor choices to flow passive capital to wider parts of the market, and we continue to look for opportunities to add scale. Slide 30 focuses on our delivery. And I'd like to think that over the last 4.5 years, NZX has built a reputation amongst our investor community in delivering what we say we will. And our focus for the remainder of 2021 is laid out on this table. Slide 31 speaks to our ESG focus. And we haven't been as explicit in this area in previous updates, but we are keen to lay out our ESG areas of focus. As described on the slide, we see 2 clear areas: firstly, the activity we undertake and promote across the markets; and secondly, the focus we have internally. Like many companies, we have a way to go, but we have laid out our initiatives and plans as described. Slide 32 speaks to more of our diverse business. And as Graham has mentioned, the added benefit of delivering on NZX 2.0 is that we become a more resilient business. And as you can see, this slide shows the revenue profile of our group changing, and we are steadily becoming more diversified. Our expectation is that this continues. Thank you for the opportunity to present our update, and both Graham and I are happy to take questions. [Operator Instructions] Thank you for your time. Are there any questions?

Yes, there's a question from Grant Lowe .

Can you hear me okay? Excellent. Just a couple of questions for me just around the OpEx. In terms of -- I know you have development projects and the like. But in terms of the direction of that for 2H '21 given what you can see at the moment.

Do you want to pick that one up, Graham?

Yes, sure. So I think I'll attempt to break it down by the 5 categories. Personnel costs, I think, are -- we have pressure in the wage side of things from what we're seeing in the market, the market constraints, and that will manifest itself with higher levels of personnel costs on a like-for-like basis in the second half of the year. Information technology has taken a bit of a step-up. There are 2 or 3 components to that, as I alluded to. There's certainly one-off component with regard to the new carbon auction managed service, but there's also the step-up that we've talked about at the year-end with regard to cybersecurity licenses and extra software that we brought in there. As a result of the action plan that we have in place, there will be some other one-off IT costs that we continue to undertake with regard to, for example, penetration tests on a regular basis. So I think it is probably reflective of a new level of IT costs more so than anything else. Professional fees, we have had several new things going on. There's a lot of projects. We have the SGX partnership. We have the new carbon market and the EEX partnership that's gone through there. We are exploring other opportunities. So it will vary with what's on the go on activity levels from a project sense more so than anything else. There is an underlying base of the assurance program that we're required to undertake under contracts, which I've talked about in detail in previous years. Marketing is, we feel, at a relatively low point in our history. COVID last year and certainly, the activities that we've undertaken this year have continued online for retail, but we could see increased levels of marketing, if not in the second half of the year, maybe next year, particularly around Smartshares, where we believe there's a halo effect from the KiwiSaver default fund when -- and certainly, we can generate, we believe, extra revenues out of some targeted marketing there. And then finally, the other expenses. Where we're seeing pressure in those is particularly insurance and compliance costs. I'm sure it's the same for corporates across New Zealand. We're seeing costs being more so in those respects, and the insurance increases are quite significant. So that sort of gives you a broad-brush idea of how we see those costs.

That's great. I think that may well have answered my next question, which was just in relation to the FMA action plan and the split of one-off costs versus sort of stay-in-business type costs. It sounds like that's more weighted towards the latter.