State Street Corporation (STT) Earnings Call Transcript & Summary

Hi. My name is Keith Horowitz. I am the bank analyst at Citigroup, and I'm really pleased today to have one of our banks presenting at our fintech conference. It's State Street, and it's going to give them an opportunity to really kind of dig in more so than in other conferences on how they're really using technology to kind of differentiate they're offering and how it's driving growth. And what we're going to do is, first, we're going to start off with Lou Maiuri, who's Chief Operating Officer; and Eric Aboaf, Chief Financial Officer, who's going to go through some slides, and then we're going to go through some Q&A. So with that, I'm going to hand it off to Eric.

Or Lou.

Or Lou.

Great. Thanks. Good afternoon, everyone, and thank you, Keith, for hosting this conference. I'm glad to be here today to talk to you about State Street. And as the Chief Operating Officer, I'm responsible for our IT operations, Charles River Development, or as we call it, CRD; our product management; global market; and our Alpha platform organization. And so for today's presentation, I'm going to do a couple of things. I'm going to spend some time reviewing our Charles River Development business. And second, I'll cover our progress in creating Alpha, which is the industry's first front-to-back asset servicing platform from a single provider. Before I do that, I have to have some forward-looking statements here. So I have to mention that I'm sure today's discussions will contain some forward-looking statements. Actual results may differ materially from those statements due to any number of important factors, including the risk factors in our Form 10-K and other SEC filings. Our forward-looking statements speak only as of today and we may not update them even if our views change. Okay. That's out of the way. So for those of you that may not be familiar with our journey, over the past 2 years, in 2018, we purchased a company called Charles River Development, or CRD as we call it. It's a cloud-deployed software technology, and it forms the foundation of State Street Alpha, which I will explain further as I get into the presentation. And beginning on Slide 3, I'd like to review our key achievements since we acquired CRD, and then lay out our plan for the next 2 years as we evolve our business model to drive growth. And starting with what we've achieved since the acquisition. You can see on the left-hand side of the slide, we have successfully integrated our core State Street back and middle office services, as well as a number of our global markets products and services within CRD, providing a true end-to-end platform for our clients. And the key principle of the platform strategy is maintaining interoperability and creating a curated set of trusted partners to complement our capabilities and giving our clients flexibility to integrate other providers and influence industry innovation. And as a matter of fact, since the acquisition, we've increased the number of partnerships that leverage the CRD platform by nearly 25% or approximately 150 additional partnerships, and I'll cover that in more detail later. The success of the integration and partnerships have led to Alpha deals, which most recently drove approximately 1/3 of State Street's asset servicing businesses in the third -- business wins in the third quarter. And additionally, we successfully integrated with Microsoft Azure, a significant milestone that will enable us to expand our capabilities and provide cloud-native solutions to our clients. And then looking ahead into 2021 and '22, we expect that CRD and Alpha will continue to provide revenue growth opportunities for State Street. And CRD is expected to grow in the low double digits on average over the next 2 years. And SaaS client conversions are expected to continue and increase the predictable revenue stream within CRD. Now we will operate with fintech agility as we progress our innovation strategy, launching new cloud-based capabilities within our Alpha platform. We are also well positioned to strengthen our presence in the wealth management segment and expect to create multiple fintech revenue streams through Alpha sales and client onboarding. And the road map illustrates the ongoing technology journey that we've been on as we continue to innovate and evolve our business model going forward. So turning to slide 4. You'll see that CRD's performance has trended very nicely since the acquisition. And although there is some episodic revenue recognition, which is expected as a result of how revenue is recognized for on-prem installations. From a quarterly performance standpoint, CRD stand-alone and quarterly revenue grew 16% compared to the third quarter of 2019, and that's better than the rest of State Street. And on a full year basis, CRD stand-alone revenue growth is increasing nicely with 2019 growing at 8%, and 2020 expected to grow between 11% and 12%. And of that 11% to 12%, we also expect software-enabled and professional services revenue to contribute a larger portion of the total revenue. This is important because software-enabled revenues are primarily SaaS-based and are relatively stable and predictable, compared to that on-prem episodic revenue I just spoke about. And we also expect professional services to grow as we have more SaaS conversion projects to work on. And you'll also notice that our new bookings continue to ramp up. And with year-to-date now at $25 million and we still have a quarter to go, they're trending very nicely. So turning to Slide 5. I want to share with you how we are measuring CRD's success. We've established and closely tracked a rigorous set of key performance indicators to help us measure and assess the performance of CRD from 2 angles: growth and durability. On the top half of the slide, you can see 2 key growth metrics, annual recurring revenue and uninstalled revenue backlog. Now the annual recurring revenue or ARR represents the annualized amount of most of our software-enabled revenue that is expected to be recognized ratably. And as you can see on the top half left-hand quadrant, it's grown nicely with a 14% CAGR ever since our first quarter reporting on CRD's revenue, thanks in part to our ongoing efforts to shift clients to our SaaS model. And the uninstalled revenue backlog represents revenue to be recognized from signed client contracts that are scheduled to be installed over a rolling 24-month period. And from this chart, the upper right hand quadrant, you can see the current view over the next 12 to 24 months. And as of the end of the third quarter of 2020, CRD had $92 million of uninstalled revenue backlog, which grew 11% compared to the fourth quarter of 2018, and this demonstrates a sizable amount of future committed additional revenue that is on the horizon. Now looking at the bottom half of the page from the durability perspective, we continuously monitor the average deal size and average initial client term. Both metrics have improved significantly compared to the pre-acquisition period, with deal sizes doubling to over $2 million. And as of the end of the third quarter of 2020, initial client terms rising 40% to 5.8 years. Now moving to Slide 6. CRD is a key component of our Alpha strategy. And as we work relentlessly to become our clients' strategic enterprise partner, evolving the State Street business model to a platform-enabled tech bank is critical to executing on our vision. Our clients are increasingly looking for solutions that help them efficiently integrate and harmonize data, reduce friction, connect fragmented systems, obtain efficient liquidity services and interact with third parties. The Alpha platform that we have built will help change the way our clients operate while simplifying how State Street works and making us more efficient and productive at the same time. So let me talk about the client benefits, and I'll go into our benefits. From a client benefit standpoint, Alpha is a leading enterprise outsourcing solution, which includes analytics, decision-making, liquidity, investment management software as well as services from the front-to-back office. And it's all underpinned by our innovative data platform that seamlessly integrates with clients' proprietary technology, operations and third-party services, and it also offers a clear cost and scale curve opportunity. From State Street's standpoint, when we sell Alpha, we're selling all the State Street products by engaging clients as one State street. And the platform positions us at the center of our clients' transformation as their enterprise outsourcing partner, which increases the stickiness in our relationship with clients and enables us to influence industry innovation. It can also generate overall revenue growth and margin improvement by creating new revenue streams, specifically with high-margin fintech revenue. Now I'd like to demonstrate what Alpha means to our clients on Slide 7. Our focus has always been to effectively serve and drive productivity and quality for our clients, and we've developed and continuously enriched the Alpha platform with that purpose in mind. Now the financial industry is being challenged by fee compression, with many of our clients looking for ways to improve their operating margins. And as you can see on the right-hand chart, this is an illustrative example of possible cost savings from a mix of both actual and prospective clients that have provided us with a detailed cost data to perform the exercise. But based on this analysis we've done, these current or potential clients can expect to realize is operational efficiencies in a targeted annual savings, conservatively, of 10% to 15% from their tech and ops cost base. The Alpha platform provides built in flexibility and scalability to help our clients manage different asset classes across geographies, launch new products, reduce manual intervention in their processes and operations and streamline their operating model. Now this creates efficiencies and opportunities to lower expenses in areas such as resiliency, business continuity and operational risk exposure. But our clients can also benefit from a suite of operational solutions delivered by Alpha, including robust data and analytics, higher trade matching and settlement and fully automated real-time cash management. And these solutions can help them make informed investment decisions, manage risk and invest in innovation for future growth. Now turning to Slide 8. When we first started on our Alpha journey, we believed we would be in a unique position to help our clients solve their largest problems and make their investment management processes more effective. Through differentiating offerings via the Alpha platform, we expect to shift more share of wallet to our back and middle office services offerings and drive growth and core global trading businesses, and as such, achieve incremental revenues from new products and incremental sales of existing products. So while it's still early days in our evolution, I'm happy to say that we are making progress in executing. This slide provides examples of client case studies. These are 4 institutional services clients we have engaged in our Alpha solutions. Three of the clients were existing clients, State Street clients, that are now also Alpha clients, and one is a brand-new client, which we did nothing with. And they also represent clients from different sizes. So the AUM, in this sample set, ranges from $10 billion up to about $500 billion, demonstrating the ability of Alpha to help clients of any size. Now by adopting additional Alpha capabilities in the front, middle and back office, the existing clients were able to transform their operating model either through front-to-back consolidation or through consolidation of State Street as their sole provider, whereas the new client is leveraging our Alpha platform to do full streamlined outsourced solutioning with us. And for the existing clients, these expanded relationships are expected to help drive revenue growth for State Street between 5% and 15% per client, depending on the scope and the mix that they have with us. And overall, one State Street value proposition via the Alpha platform is expected to drive revenue growth for our core product lines. So Slide 9, in summary, CRD's continual growth as a fintech has helped capitalize on revenue opportunities for our SaaS businesses and other emerging segments, such as wealth management services and platform-specific offerings. And through our Alpha platform, we are uniquely positioned across the front, middle and back office services to enable a level of simplification of service delivery that will truly be leading industry -- leading the industry and industry changing. Now we expect CRD and Alpha will allow us to gain market share, drive revenue growth, generate productivity savings for State Street more effectively than our competitors and strengthen our market leadership as we advance our technology-driven strategy. So with that, I'm happy to join Keith and Eric for Q&A.

Thanks, Lou. So I guess, let's start with Alpha first. You mentioned that it's the industry's first front-to-back offering. Sitting in my seat when we listen to conference calls from some of your competitors, we also hear that they have their own version of front to back. So how would you compare the Alpha offering versus other peers that are also marketing their own version of a front-to-back offering?

When we first acquired CRD, Keith, we -- you probably didn't hear the term front-to-back that often and start to emerge after the announcement. So it's a fairly new strategy. And I'll unpack exactly what that means for a second. We quickly saw our peers, as you said, launch their own front-to-back strategies of solutions. And I actually believe -- we believe this, that we actually have a very unique advantage here, a very unique set of capabilities, which I'll explain here. Other than our strong pipeline and I think competitors trying to replicate the strategy, I see that as a tremendous vote of confidence that we have the right idea and the right match for the need in the industry. So we're happy about that. The way I would unpack this is that some of our competitors are partnering with third-party providers to try to replicate the front-to-back strategy. And I would submit to you, Keith, that looks a little bit of like the way things were, right? Very fragmented, pieces and parts, different tech stacks, different data stacks, all trying to work together. So that's a little bit of more of what we've been doing. And I think what's key about this is that you have to possess enough of the core capabilities to ultimately provide clients the benefit that they're looking for and the efficiency and simplification that we need. And that's a core statement, because I don't believe that any of them are in the position where they have software assets, the service assets and the data assets from investment management of the front office, middle office and back office, payments and clearing and everything in between, to achieve that. So that's sort of the way I think of it. There's a lot of partnerships out there, and partnerships are fine. We believe in the partnership model. But you have to have enough proprietary core capabilities to really provide the value to clients, and I'll get into what that is here in a second, and the value to ourselves from a productivity and simplification standpoint. So when I unpack this for our clients. So we definitely want to bring -- minimize the third-party platforms that they're using, the amount of disparity that they're using. So you're talking about the software providers, data providers, analytic providers, broker-dealers, all of that sort of fragmentation. What we're doing is bringing that together. Again, we have the most amount of the core than anyone else have to sort of bring that as one State Street, one system. As I said earlier, talking about lots of infrastructure here, trading, compliance, record keeping, payment clearing, admin. There's a lot of stuff in between -- an investment professional making a decision and putting that into portfolios and clearing in the marketplace. So again, if all you're doing is piecing parts, lots of vendors, best of breed, you're not going to achieve, ultimately, the benefits. And some of the benefits start with data, standardization of data, harmonization of data, providing clients with more real-time access to information, which is incredibly important. And then under the current partnership model, I think people are spending a lot of time reconciling and homogenizing data, so that -- we're not doing a lot of that. But we are using partners. And I think what you'll see is we're using partners where it makes sense to provide capabilities and innovation. But they're working to our standards, if you will, technology standards and data standards that we're promoting in the industry. The other thing that's happening here is that, again, how can we provide that 10% to 15% value to customers? We're just not changing the price. We need to engineer productivity for ourselves. So if you can imagine if it's our technology and it's our data that's going through the platform, less reconciliation work, less manual work, we can achieve some scale here and share some of those economic benefits with our clients. So that's sort of the way I think of it. The other thing I'd say before I close on this question is that CRD has -- Charles River has 50 of the largest 100 investment managers in the world. So we've already got half of that client base that we really get to talk to in helping them change their business model, and we've been engaging in those conversations in an active way. So hopefully, a little texture around what's the difference between some of the conversations that are out there and what we're doing.

That's great. Yes, that chart was great. I think that's first time you showed that chart on the 10% to 15% cost savings. And I think conceptually, people understand that there's a lot of room to simplify these processes. But is there any way that you can make it a little bit more real for us, give us some tangible examples without using any kind of names, like exactly what is going on when you're able to cut out 10% to 15% of an asset manager's cost save?

So let me take one of the examples. I think I gave you 4 institutional clients. One of them was roughly a $500 billion asset manager. So let me unpack when I say front, middle, back office, what it means, and I'm just going to zoom in on the front and middle. So let's just take this particular client who came to us and said, I've got lots of infrastructure, help me optimize my front and middle. We're talking about 20 to 25 systems, technology systems. And people around those systems and fragmentation and reconciliation, compliance, collateral management, risk system. Just imagine all of that infrastructure there. So what we're able to do, as you can imagine, each one of them is a software stack. There's maintenance cost, there's people costs and reconciliation cost, just to keep it alive, let alone run it every single day. So that we're taking out 20, 25 platforms in an integrated platform that work together to give them some benefit. So we're getting rid of that laborious type of work. We're focusing in on powering up their platform with data, robust analytics, more real time information. We have higher trade matching, again, because we're using more of our capabilities, more of the data standards. So we're not sitting here reconciling between our own infrastructure and providing more automated real-time cash. So they're all different with respect to -- if you're a fixed income manager, some of your infrastructure is a little different than a large-cap equity. But these were more difficult configurations that we're dealing with here to sort of help these clients achieve that benefit. So hopefully, that gives you some sense of how we're doing that. And then I don't want to miss this part. We're also spending time engine engineering productivity for ourselves. We just don't want to put new tech in and do what we do the same way. That's not going to achieve the goal. We really have to find ways to work more efficiently and effectively and take out the friction now that we have all those capabilities in front of us. So...

And Keith, it's Eric. I'd just add that this is becoming increasingly a CEO, COO, CFO level sell. Historically, the back office custody purchase was the head of ops than an asset manager. Now we've added, with the Charles River offering and this front-to-back offering, it's the CIO and an asset manager or the head of trading and suddenly interested with the head of ops, right, because that starts to collect up. And now it's gone up to the COO or even kind of my peers at the asset managers who are sending and saying, wow, "If my ops and tech costs are 20% of my expense base, it's actually the most controlled group part of my expense base, because it's not really value-added and State Street can come in and help me take a chunk out of that." It's making a difference and it's elevating the conversation. It's those same -- speaking to the peer CFOs that I have that I speak to who are saying, "My goodness, I got to go spend another $10 million, $20 million, $30 million, $40 million, $50 million of cash on IT internally, or can I start to lift this out?" And that's what's kind of -- that's how the kind of the interaction is changing at the client, and as Lou described it, because the functionality suddenly is at a kind of tipping point where it's suddenly that much more exciting and beneficial for the -- all the users, including the front office who will really carry a lot of weight.

The only thing I'd add, too, to that before -- I'm sure you want to go another question here, is I think Keith, that there's been a lot of consolidation going on in the industry. So when that happens, there's just more of those platforms showing up, and we can help rationalize that. The other side that I don't want to miss, though, is we're also seeing a lot of our asset managers that they focus more on generating manufacturing product, distribution, managing risk. They want to get into other asset classes, other geographies. And if you can imagine every time one does that, they needed more infrastructure, right? You get into a different asset class, a different fund structure, there's more stuff you need to operate that. And the platform gives them, sort of, I don't want to coin the phrase, it's been used by others, but this operational Alpha element that we can just put it on, you can scale into that environment, you can use that asset class and worry more about just driving and having great investment results while we operate it for you. So those are the other 2 factors that are going on here that help provide people with some scale and efficiency. And those ranges we gave you are on the conservative side. We just -- we took actual examples, but they can be more for a certain type of configuration, so...

Okay. One of the key trends obviously in tech is cloud. And you emphasized in your remarks about having -- the importance of having cloud-native solutions for your clients. When we think about cloud a lot of times, we think about these cost savings. But why, in your view, is it so important? Why do you emphasize having cloud-native type of solutions for your clients?

Yes. I mean, there's the classic it makes software management easier, upgrades easier. You can roll out capabilities faster because you're not dealing -- it's really hard. And by the way, we still care about our on-prem clients, and we still have a portion of them. And there -- a lot of them are moving to the cloud. But it's a lot harder when that software is sitting in someone else's infrastructure. To upgrade those things are hard. They take a long time. They usually -- people wait till the last minute because it's just a lot of work. And then if there are issues, technology issues, it's harder to diagnose those. When you're in this cloud environment, a lot of those problems go away. You can upgrade clients faster, they can get the benefits of the engineering and innovation that we're putting in place. The client experience is better because if there's a -- if there's an issue or a functional issue, our engineers can get right in there and resolve it for them and improve the experience. The other thing that I love about this is we talk a lot about data, which is really, really important. And people used to have data warehouses. We all heard about these technologies and sort of ecosystems that were built. But the cloud now provides a space where you can meet your clients in a public environment, it's their cloud and they can build applications. We don't have to move the data. We can just sort of curate it, manage it for them. And when you really look at where the world is going with regulatory requirements, data at rest, data resiliency, data residency issues, it does provide us some scale. So if I have a client in the Middle East that wants our platform, I can now use a public provider, keep their data at rest and not get worried about where the data is actually residing in U.S. jurisdictions or other places like that. So it actually gives us a little bit more agility on that side. So -- and I got to tell you, like, the other thing that we're doing is we've got 2 clients up and running right now. 40 clients are basically getting converted. And most every new client that we bring on to Alpha goes to the cloud. I mean, the on-prem model is just messy and costly for everyone. And we do incur costs when we do this because, of course, we have more infrastructure, but we incur revenue to obviously cover that. So it's better for our clients. It's a revenue stream for us, but it's just a better overall experience for everybody.

And that's a good transition to data, maybe it gets a little bit into the CRD. But like in general, when we think about data issues for the asset managers. There's 4 different books of record. It's really sloppy. There's manual reconciliations. Clearly, there's cost savings aspect that you can bring in terms of cleaning up the data. But in terms of data analytics, in terms of -- from a revenue perspective, from an asset manager, are you seeing any opportunities to kind of bring them better data analytics through a cleaner data set?

Yes. So we've announced a whole bunch of partnerships. So the one that comes to mind is MSCI is a great example. So we've partnered with them. And the whole idea here is that we're working off the same tech stack. We're working off the same data taxonomy. So the clients -- if we're enriching their -- and curating their core data, then we can now use the analytic engine that can augment it with risk analytics, insights, ESG, indicators, all in one experience. And we have a couple of views. We want to remove reconciliations. So there's no reconciliation. It's just there, and we want to remove what we call the swivel. What I mean by the swivel is we don't want our customers to log into CRD or Alpha and then have to log in MSCI. That experience is done right through the digital experience that we have. So it's seamless. But we're able to bring world-class capabilities to the platform, spur innovation, continue to have innovation and then augment that data. And the last thing is, as I said earlier, with our -- we call it Alpha data platform on the cloud. It allows our clients, some have, I'll call it, secret sauce, right? They have quantitative groups that want to do their own thing or they want to do their own client reporting. And this really allows them to just use the data. They don't have to move it. It's their cloud instance. And if, god forbid, they didn't use us someday, we'd still persist and be their cloud instance, and they would have their data. So it really does change the game. Because as you've heard me say this 1,000 times, Keith, data moves around too much in our industry. It physically moves, storing forward from one platform to the other, and that has to change because it just creates a lot of the latency and friction that we have. I mean, this will result in better cash management, better analytics, better risk management. So we think this is ultimately the big outcome that's -- every time I talk to clients, it's about, I want my information, I want it better, faster, cleaner, cheaper. But you got to do everything I set upfront to get here, right? You got to sort of make sure it's faster and cheaper coming in and managing it. You just can't have thousands of people wrecking every trade, reconciling every trade, because that's where the cost is. We've got to squeeze it out of the system.

And then back on the partnership model, when you kind of think about some of your peers, are they able to also kind of tie in with their technology? Are you seeing them also kind of leverage these partnership models? Longer term, maybe do you see some of your partners like MSCI actually teaming up with another one of your competitors?

I have -- there's some of those that are out there. What I don't know is this, is that I -- we have platform economics in play here, and I would say that it's both direct and indirect. So when I say direct, meaning with a lot of these partnerships, it's either rev share or it's some mechanism where we're providing distribution and for that distribution and we're being paid for it. There's sort of this indirect also. So by having -- in any platform, having producers and consumers together and you bring them together, so think about our wealth platform. We're bringing manufacturers of product and sponsors of product together. And so you create this platform environment where people are exchanging, if you will, whether it's capabilities or monies that it sort of builds on itself and brings more value. So I haven't seen a lot of that. Like I can't tell in some of the things I've read that you've read whether there's actual economic exchange happening. But there is here because we're -- we were the first ones out of the gate and so we're open. We want to work with folks. We have a lot of partners now. We just don't work with anyone. We're not sort of like the Amazon, if you will, to use that analogy. We definitely are choosy, we curate our partners, we make sure that it's a fit. It's complementary to what we're doing. It's the types of firms that our customers want to do business with. So...