TMX Group Limited (X) Earnings Call Transcript & Summary

So hello, everybody. This is Graham Ryding here, the analyst at TD covering diversified financial stocks. I'm joined with John McKenzie, the CEO of TMX. John, thanks for joining us today.

Well, thank you very much for having us, and really appreciate the continued investor interest in the name with all the froth in the marketplace right now.

Yes, that's an understatement. I thought your stock would be a topical name and your company would be a topical discussion, given the volatility and everything that's going on with COVID-19 and the capital markets. So again, appreciate you giving us your time, and I've got a bunch of questions here if you're ready to just jump right in.

Please go ahead.

So operationally, maybe we could start there. Just how is your, I guess, your business continuity planning? How has that gone so far in terms of setting up to ensure that markets are working and functioning and importantly, how your staff is operating in a safe manner?

Yes, that's a great question. And thank you for starting with that because the safety of our staff and our clients has been the #1 concern through this. And it really has been an evolving piece of work for us that we started a number of weeks ago, but very much benefiting from investments we've been making over the last number of years. So what I can tell you at this point is we're actually at the point where about 95% of our staff are working remotely in terms of keeping the markets all functional. That's TSX Venture, the MX as well as the clearing houses. And about 5% of our staff are on-site in terms of performing critical functions. And all of our critical functions that we do on-site are separated into multi-site offering. So we're not relying on any one particular building or office or facility to keep things going. Everything is either in duplicate or, in some cases, triplicate in terms of triple redundancy. So we've done all that without actually getting to the point of actually invoking our formal BCP plan, which would be where we would actually suspend some nonessential activities, we've been able to do everything through remote work structure and keep everything operational.

Great. And the -- you put out something a couple of days ago. I think -- well, first of all, I guess, TMX would be, I assume, considered essential service, but that's fair.

Yes, that's fair. But it's -- we never assume anything. So you can imagine, we've been in constant contact with our regulatory partners, with governments, ministries of finance, to ensure that people knew the criticality of the markets being open and how -- why that is so important and ensure that we've got -- we get that consideration as an essential service. Now the clearinghouses we operate, CDCC and CDS, are actually already designated systemically important systems by the Bank of Canada, and the exchanges, all being regulated operations, are all critically important as well, but we wanted to make sure that we got that essential designation, which we were successful with in terms of the province of Ontario, province of Québec. And so we're comfortable that we can keep things operational. And the notice that you saw that we put out last week was really in response to some of the market noise, which I think was more political or retail in nature than in terms of our clients on questions of whether or not the market should stay open. And we wanted to really reinforce how important it is for markets to be available in terms of the critical functions that they perform. The access to liquidity for investors, access to those investments, price discovery that you wouldn't have if markets weren't available and even more importantly access for capital for companies in a time when they can really need it. And one of the most important capital raises we saw last year and we're continuing to see capital raising by a company, IVM (sic) [ IMV ], a biopharmaceutical company, raised $30 million at the market, which they're going to be using for R&D efforts in things like COVID-19 vaccine research. So this is what the markets are for. It's a critical function, and we're glad that all the regulatory and government partners supported for that.

Yes, when did that issue -- that raise happen?

That was a week ago today.

Well, that's amazing. And you put out something on issuer relief news press release that -- it looks like you're relaxing some of the admin requirements. But is it more than that?

It's primarily around the admin side. So it's giving them relief in terms of when they need to hold their AGMs, relief around timing of things like shareholder plan management, things like that. So they've got time to do it without the administrative burden. We also, though, in addition to those pieces, put some relief in around the size of a normal course issuer bid that a company can do. So in terms of making sure they've got lots of tools and flexibility for maintaining their treasury functions. And the other area on TSX is that we put some relief in place for kind of minimal listing threshold as well. So to ensure when you got a market disruption when there's a lot of sell off that we don't have valuations that that trip companies into kind of delisting risk and that we're working with those companies through them to have a continuity of listing for the benefit of the company, the employees and the shareholders.

Right. Understood. So maybe I could shift to just market structure and the impact of market volatility on that. You did have some issues at the end of February. It looked like you have sort of a bandwidth issue that caused you to shut down your trading venue. Could you just describe for us what happened? And I guess, what the fix was and your confidence that it's been resolved?

Yes. Starting with what happened. And it's, first of all, we're cognizant of the impact that it had on the marketplace. And certainly, we didn't want to put our clients in that position. But what happened was when the market really became highly volatile and we saw an unprecedented level of transaction volumes coming in, in addition to the actual transactions themselves, we saw a substantial increase in messaging. And messaging, when we talk about that, that's buy orders, sell orders, cancels, things like that. And when markets become more volatile, you can tend to have an even higher degree of messaging than you would have normally. And we had tripped through, I think, 180 million messages by mid-day. But the piece that really strained our capabilities was the rate at which messages were coming in. And so this kind of like burst in terms of messages per second. And what we saw on that particular day was messaging coming in more than multiple times our previous peak and multiple times of what we'd even tested for in the past. So we scale our systems to multiples of previous averages and previous peaks, and we scale the messaging rates as well. And this blew through that very quickly and caused a backlog of messages that forced the system to shut down. So the team was actually able to really triage that very quickly, identify where the problem was in our system, add more capacity overnight, test it and get it up and running for the next day. So the actual following day, the Friday, we saw even more messaging and more transaction activity than we did on that Thursday, and we're able to handle it without any issues. And that's a fix that's held us all through this last month that we've been able to monitor it and see that we have enough capacity to continue to operate without tripping that. Now long term, we'll continue to do other work in terms of whether or not there are design changes we need or engineering changes we need. But we believe we've got this covered, and we can manage anything the market can throw at us right now.

The market is throwing a lot at you right now. There were several days of trading just the last couple of weeks when the circuit breaker has actually kicked in. Did everything play out as design in terms of how those breakers are supposed to work and then also when markets reopening?

Yes. You know those breakers are designed to work on a North American basis. So one of the things we've learned a long time ago is that given the interrelationship between the Canada and the U.S. markets, these have to be coordinated. So the circuit breaker is based on movement of the S&P 500. Exactly as designed, the regulators halted all markets when it tripped through that level and then everything did restart on an orderly basis after the 15-minute cool-off period. Personally, I think this is something that the industry will need to look at in the future as to whether or not the circuit breakers had the designed effect anymore. They were really designed historically around the ability for the market to disseminate news and to stop rampant selling. So given the level of computer trading and algorithmic trading and high-frequency trading, I think what we saw in the marketplace is when the markets restarted 15 minutes later, it didn't change necessarily any of the behavior. So that will be something to look at as an industry later on once we're through this.

Yes, that's interesting. And how about, I guess, just overall functioning of how you're trading and clearing and whatnot? Like we're seeing some pressure in the wholesale funding markets of your lens, has everything been functioning properly in terms of cash and derivative trading and counterparty risk? And has there been any pressure on the clearing platforms?

No specific pressure on the clearing platforms, certainly pressure on the participants that are operating. And then when you have this level of volatility, there is requirement for more margin to be provided. There's requirement for more liquidity. We actually just -- we're just moving to what's called cover one liquidity, and the clearing assets over -- just over a week ago which means enough liquid resources for the largest participant, should they fail. So there's a lot of capital in the system, and we have seen no issues at this point of participants being able to meet those margin and liquidity requirements certainly because everyone right now has got operational challenges. It -- sometimes, it's taken a little bit longer to get cash in as appropriate. But it's nothing that would raise a concern about the ability of the market to function. And I will add on top about that, that capacity within the clearinghouses is something we also monitor and measure as well. I think you know that we've been working for a while on the modernization of those platforms. They are legacy platforms that run on mainframe. So making sure we've got enough capacity to process everything there has also been top of mind. The types of clearing volumes that we've seen, we're getting to the high end of what we've tested to. So we are doing some reengineering in those systems as well right now to create more capacity, even though it's a legacy system that needs to be replaced.

Got it.

And then just to finish off on that, we haven't seen any participants that have any failure risk. There was one participant in the U.S. market, a participant of CME, that did fail. They were properly margined. It was cleared out properly, but no impact for Canada.

Okay. And then just thinking about the volatility in your different business lines, maybe we could jump to that theme. First of all, broadly speaking, on a net basis, am I right to think that you could be one of the firms in this market that actually benefits from this stock volatility?

Yes. And it's something that I don't want to tout too much because I know that a lot of our clients are challenged right now. But you've actually got -- you've got the lens right. When you think about the transactional components of our business, we are seeing records in most of those businesses. So volumes on the MX side are at record levels for our derivatives business, March year-to-date, up 35%. And actually -- and MX was strong right from the get-go starting in January. We were up 14% in January, but that's been growing month by month. And even March just versus the kind of the Jan-Feb average was up another 19%, 20%. So that's been really positive from a volatility standpoint. Same thing on the equity trading. While January and February were kind of in line with the year ago, equity trading was seen up almost 70% in March in terms of the 3 weeks so far in March or 87% if you compare it to the January-February average. So those areas have been really high. On the cleared volumes, we've been seeing cleared volumes in terms of total transactions a day at kind of 4 million to 5 million a day, where our previous run rate averages would have been about 2 million. So all those pieces are at the high end. And what we can't give guidance or what we really don't know is kind of how long that trend will continue in terms of marketplace volatility levels and at what point we would start to see it level out. But nothing in the indication that we're seeing it level out yet.

Right. Okay. And that was one of my questions, if -- is this kind of volatility good for cash market volumes and derivatives? But is there a potential risk here that you have some market participants pull back and future volumes would sort of decline as a result of the extreme volatility?

It's certainly possible. And we're already seen -- in the last couple of days, we've seen still really strong volumes on the MX side for the fixed income futures but not as heavy as it was before. And that could be that some of the banks or institutions that's taken care of what you were trying to take care of in terms of hedge activity or things like that. So we could see this start to level out. But it is hard to say when. And then the other piece of your question is what does that volatility do around financing activity, and companies coming to the market to raise capital. And interesting enough that even through this period, we've actually continued to see companies come and raise money on the marketplace. So I'm pleased to see that they've been able to continue to use the market that way. We haven't seen large-sized transactions, but we've seen quite a few small transactions.

So from what you've seen, I guess, through March is, is it fair to say the messages, the volumes on the transactional side of your business has been very strong and more than offsetting any lower activity on the capital position side?

Yes. I think that's a fair takeaway.

Okay. And what about on the -- just lastly on the interest rate derivatives side. When rates are at this low and the yield curve drops so materially like this, does that have an impact on your interest rate futures products and volumes?

It can, but it's also tied up into what our expectations. So if there's expectations that there still are potential changes, then you can still actually have volatility around that. And while you are seeing, as you said, you're seeing a very flat curve on government debt right now, we're not seeing that necessarily on the corporate debt. The corporate spreads are actually quite a bit wider and whether or not that impacts the volatility for the underlying government debt is kind of a wait to be seen. So there's still a lot of factors that have the potential to create volatility even in a low-rate environment.

Okay. And then on the market data side of your business, I think it's a fairly recurring revenue stream. So am I right to think near term, this business should continue to be steady? Let's talk about North America, I guess, for now. But I guess longer term, the potential concern would be that if this translates into some employment pressure in the financial markets, that's where you could potentially be impacted?

That's exactly the concern. And we're looking at this -- we're looking at this downturn and trying to understand what kind of market impact is going to have because the difference in this market sell-off versus what we would have had in 2008 is -- remember, 2008 was a crisis in the financial institutions themselves and impacted the capitalization, the liquidity in those institutions. They had a direct impact on financial sector employment. This is different because of what's driving it. And it's hard to predict right now what it's going to do for employment activity in the financial sector in the medium or the long term because it really -- we haven't seen anything like it yet. So I think your premise is right. But I don't have a good predictive model in terms of how this will shake out in it, and it could be that some institutions come out very well.

Right. And how about Trayport? It's an important part of the market data side of your business, but also part of your growth story. Any reason to think the volatility here would be an overhang on that growth engine? And I don't know, is business development perhaps slow down over the near term?

Yes, I think it's fair to anticipate, and we haven't done any prediction around this yet, but we will, that there could be some delay in some of our growth strategies. And it really is, as you indicated, around the business development side. So we've got a couple of big programs we've been pushing for Trayport in terms of bringing out an analytics product this year, selling the trading product from VisoTech that we now have integrated across the Trayport platform, selling that to more clients, and also even just working with clients in terms of renegotiating some contracts, renewals, bringing on new seats, things like that. All that business development activity is impacted by the fact that people aren't in the office, and we're working in a remote basis. The other piece I think about Trayport in the short term, not the long term, is very much like the data business is if the volatile market or a long-term disruption caused and a contraction in some of our energy customers, could that impact what our renewals are like in the future, and that would be a potential. Now none of this changes what our guidance is around the business. We still see this as a business that we can grow kind of high-singles, low-double digits, but whether or not there's a couple of quarters in terms of delay, in terms of things that we're developing will be the challenge. Now the interesting piece of anecdotal feedback that I got was we talked in the past about our partnership with Nodal in terms of bringing Trayport to the North American market. That is something that we're still working on, on getting executed and launched in the beginning of this year. And now that you've got a lot of traders that are actually at home because they're not making markets around oil and things like that and they don't have as much to do, they've got time to work on testing out and installing the Trayport screen. So we are going to try to take advantage of some of the downtime some of the firms have as an opportunity to get Trayport on their screen where they might not have had it before.

And it's sort of a -- it's a cloud-based software that can essentially just be uploaded, if people are interested?

It's a SaaS model. So yes, it's -- you're not doing a heavy install in anybody's site.

Yes. You're not going to people's houses with that hazmat suit and installing in their hard drive?

No. No, we're doing it remotely, like everyone's learning how to do everything right now remotely.

And maybe just that last sort of piece, the capital formation. There's a few different pieces in that revenue line. I sort of think that it's roughly 50% is recurring in terms of some of TSX Trust, and then you've got annual sustaining fees through these issues. And then 50% roughly seems sensitive to financing activity in terms of IPO and additional fees. Is that a fair assessment of that business, not revenue?

Yes, completely fair assessment.

And then coming out of this downturn, on the one hand, you may find some companies could be hesitant to raise equity with depressed valuations and perhaps interest rates are low, but fixed credit might be more appealing. But on the other hand, some companies are really going to need to raise capital potentially, and the credit markets may not be as hospitable, like how you're sort of viewing the potential puts and takes on that side?

And that's actually when -- the piece that's been interesting through the last few weeks is the fact that our capital formation team that works with issuers on finance and activity has been fairly busy in terms of bringing new issues to market. Now not as much in the IPO market. It's hard to do a large IPO in this marketplace. So I will give Green For Life tremendous credit for the IPO that they did a few weeks ago when the market was really volatile, and they were able to get a good transaction done. So I'm hoping that's a harbinger for other folks to follow, but recognize that IPOs are tougher. But we are still seeing a lot of capital-raising deals get done. And as you said, the debt market isn't necessarily going to be available to all these companies in the same way because we've been coming off of kind of an extended period, kind of 18 months where financing activity has been down. And so some of the companies are already debt-heavy on their balance sheets. Sorry about that.

No problem.

Enjoying the home office there?

Yes. You might hear my kids in the background at some point.

No problem. So there -- it's going to be interesting to see. There could be a piece here where we do see a lot of companies come back to the equity market because they're already too highly levered. They need to clean up their balance sheet, delever them, and the equity market is going to be the right place to do that.

Okay. And then just lastly on the expense side. Your expenses seemed fairly fixed in nature relative to the movements you could see on the revenue side, but I assume you've got some ability to determine your discretionary spending, looking a little bit further out, if need be. Is that right?

I'm going to let you in on a secret here. Our travel spend is going to be down this quarter. So you're largely right. Our expenses are largely fixed. We do have a piece that is discretionary in terms of what we deploy for a lot of the project investment. We're trying to keep the project spend going. So the things that we're doing around our post-trade modernization, the work that we're doing on the Trayport products that we talked to or on the issuer side, our issuer services automation program, we're trying to keep all that going. But certainly, there are some pieces on the expense side where we're going to see some savings just because the G&A, the travel, the entertainment, the conferences just aren't happening to the same degree. I'd love to see us catch up later in the year in terms of the opportunity to get back in, in terms of client development, but we'll see how that goes. The other thing I'll guide you to on the expense side is there is that piece in our expense base that our long-term incentive plan that's tied to share price. Obviously, share prices have come down. We're hopeful that they continue to climb back up as they have been the last couple of days. But that's something that from a mark-to-market standpoint, there'll be some saving around the first quarter.

Okay. So maybe we could move to sort of your balance sheet and your liquidity. That's something everybody is quite sensitive to right now. First of all, just leverage. You previously said your comfort zone is between 2 to 3x debt to EBITDA. I think you're at 2.2x as of Q4 '19. I presume that hasn't changed, that hasn't changed much your appetite or your leverage given the market activity?

No. Yes, so we're actually was about 2.1x we were at the end of the year. We continue to be in a strong position there. And within that mix of where our leverage, our debt comes from, I think we've got about $250 million, $260 million of the time that was in commercial paper. We've actually been active in the commercial paper market for those -- the paper that was coming due in March to all be re-upped and termed into April. The market has been more challenging that way in terms of kind of short-term market and availability, but we've been able to get all that done. We have -- overall, we've got the ability to draw about $500 million. That's the size of our credit facility. So we're only drawn less than half of it today. It's fully backstopped into 2021. So we've got the ability to backstop if the commercial paper market wasn't there for us. So balance sheet continues to be in really good shape for us. And I don't think we're going to need to do anything there to shore it up, given that we're still strong free cash flow business.

And what is the size of like the amount of commercial paper you're using now? And will that persist or will you pay that down this year?

Yes. So right now, we're around the $250 million range. And as we generate excess free cash flow, if we're not deploying that in terms of investment or M&A, we'll be able to reduce that this year for sure.

Okay. And then what's the size of your credit facility? And what do you have in unrestricted cash?

So overall, the credit facility size is $500 million. So we've drawn less than half of it and all backstopped.

Got it. And what about your free cash flow outlook? Have you talked about or do you have an expectation for 2020, roughly, of what you think the business can generate?

Well, Graham, we would never give an outlook on free cash flow. But the guidance that we've given around kind of our growth plans and our ability to generate profitability, that's not changed. I think you've rightly identified that we're going to have some puts and calls there in terms of businesses that are going to outperform and some that might be a little delayed on the growth. But we don't expect that to materially impact our outlook and how that would translate into cash flow. No material change in terms of what we would expect to spend or deploy the cash for. So the outlook we've given around kind of CapEx utilization, both for kind of run rate business CapEx and what we're doing around post trade, they remain the same. And we're going to continue to execute against our plan. So I wouldn't say that the market environment is changing anything in terms of how we're executing there.

Okay. And then your current dividend is about $150 million a year, I believe, at the current rate. After CapEx and whatnot, do you plan to sort of build cash? Would you buy back shares? What's your appetite for potential like acquisitions or investments given the change in the market?

Yes, it's a great question. And we actually do have a small buyback in place now that we launched that NCIB about a month ago, which, I guess, great timing, I guess, because the shares got quite a bit cheaper to buy back. So we've been active in the market with that NCIB. Like any Board, when we meet next in May, we'll re-look to say, is there -- do we need to look at how we execute against that in terms of abundance of caution, risk management, are we compelled to continue to deploy cash that way, and we'll relook at every quarter, for sure. But right now, I don't see anything in our outlook that would suggest that we would need to put a change in there. We do plan to continue to grow dividend with the earnings of the firm, so staying within our target payout range and paying at the top end of the range that we are now, we'd like to -- we want to continue to do that. So I don't see any change in that. On the bigger spend side, on the acquisition side, we are going to be still actively looking in the marketplace. There's -- the 2 pieces that we think about both were we're still in an interim leadership environment that we're working our way through, and now you've got this market environment as well. Neither one of those things changes the fact that we're trying to execute on a strategy where if we can identify an acquisition that will accelerate, we're going to want to be able to take a run at it. And I'm hopeful that with this kind of repricing in the market, we actually might see some better value for assets that valuations haven't made sense on in the past. And given that we are an organization with really strong cash flow and a strong balance sheet, we're going to be in a good position to execute on things if we can find the right assets at the right price. So we won't put anything on hold. We will keep pushing it ahead.

And Trayport is obviously an important part of your business. So is it fair that something that could complement or plug into that part of your business would be of interest? And what about TSX Trust, we thought another area that you would be screening for opportunities?

Yes, I want -- we're going to screen on, and we continue to screen on both of those areas. So things that we can plug into Trayport, integrate and deploy across that platform or even things that would be as big as Trayport, if we could do a Trayport 2.0, we would absolutely pursue that. And then that was great guidance that I got from the Board was don't miss a beat on strategy. If there's an opportunity to pursue something like that, we want to make sure that we aggressively go after it. And then in the other lens, you're exactly right. So things like TSX Trust, services and businesses where we can provide a technology-based solution to a broad set of our issuer clients, because we have one of the largest issuer client bases in the world, we are continuing to look at those types of business opportunities, either to expand or accelerate trust or to provide services that would be complementary to trust and other capital formation services that we have. So you're right on the lens that those are the 2 areas that we're the most focused on.

Okay. Then just from a -- there's a CEO succession plan going on at the Board level, coupled with -- we've got a very uncertain sort of economic outlook here and capital markets are volatile. How do you sort of put those 2 pieces together with the potential sort of screening for acquisitions? Do things get potentially delayed or pushed out on that front because of those 2 factors?

In terms of screening for acquisitions or anything that's an investment and on the strategy that we're on, we don't think that we hold back on. Our Board's focus has been on execute the strategy even in an interim period. And that's the marching orders and the mandate I took away. Now certainly, I didn't realize at the time that the interim leadership period would be -- have as many challenges in it that were solved when we first came in with January, and it has been unprecedented from an environment standpoint. But I don't expect that we're going to slow down on strategy at all. My understanding from the Board and it's their process is they are continuing to move ahead with the leadership process in terms of screening external candidates and the internal candidates. Unfortunately, there's not a time frame I can give you on that, but it is moving ahead.

Okay, great. Those are sort of the main things I wanted to throw and update from. How about yourself? Do you have any closing thoughts or anything you'd like to sort of leave us with before we end this call today?

The biggest thing I'd like to leave you with, and one of the things that we don't talk about enough in investor meetings, but I really want to shout out to the staff within TMX and all of our different critically important businesses right now. This is a really passionate group of people that care very deeply about what we do and keep things running. And we've got not only folks that are coming into the office that are core critical recovery staff that are making sure things keep operating, but folks that are working in a new way from home to ensure that we don't miss a beat in terms of market operations. And I hope that the clients and the stakeholders, the regulators and our shareholders see that we're doing just that, that we're not missing a step in terms of keeping the markets operating the way they should be so that they're available for folks to get liquidity, so they're available for companies to raise money, and that's been our pledge. So you saw it right on our website, that's our pledge to the market to keep things open. We couldn't do it without the phenomenal staff and effort that they're putting into it. And I just want to make sure I use this opportunity to thank everyone for doing that.

Great. Makes a lot of sense. Thanks a lot, John, for giving us some time today. All the best to your colleagues and yourself and your family as we go through this uncertain time.

And the same to you, Graham. Thank you very much for spending the time today. I really appreciate you to give us a chance to reach out to people this way. All the best.

Great. Talk soon. Thanks.