TMX Group Limited (X) Earnings Call Transcript & Summary

Everyone, my name is Melinda Roy, and I'm part of the brokers, asset managers and exchanges team here at Deutsche Bank. Today, we are very fortunate to have John McKenzie, Interim CEO and CFO of TMX Group here to chat.

So John, I thought we could start off more high-level for those on the line who are not as familiar with TMX. Could you walk us through how the company has changed over the past 5-or-so years? And what are the firm's strategic priorities for growth over the next several years?

Yes. I'm happy to do that, Melinda. And first of all, thanks having us today, and thanks, everyone, for joining in and we're saying it's much appreciated, [ we just wanted ] to say. Yes, for the first few [ years ], we have been very transformational [ in the company. ] In fact, 2015 was really an inflection point for us where we had to relook at the [ business lines ]. As TMX [ has a great ] mix of businesses, a great asset base, but we really weren't getting all of that [ where we're ] seeing the growth. Our margins weren't [ there ]. Our peers were -- we're turning more debt than the peer group. [indiscernible] as it could be...

John, I think we lost you for a second. [Technical Difficulty]

Have you got me back?

Yes, we can hear you now. I think we lost you...

Sorry, I've gotten completely dropped.

No worries. I think we lost you when you just started. So maybe we can just start over, if that's okay.

That's fine. Do you want me to get going right now?

Please.

Okay. So I apologize for that. Again, the same challenge everyone's having with technology these days. So over the past 5 years, it was really about redoing our strategy, identifying what were those businesses that had the best growth potential for us and really focusing the efforts there as opposed to spread across a portfolio company that historically have been run more like a group of companies and not an integrated business. So the number of tactics and strategies that came out of that coming forward was, first of all, a restructuring program that we ran through 2016 and 2017, where we reduced the layers of management in the organization from 8 to 5; we integrated across our departments to get more efficiency and more interaction between our teams, and really organized more around our clients as opposed to traditional regulatory business lines; and also that helped us to dial back the project effort in the company to what was going to really move the needle. And we identified and continued to confirm this in our strategy update last year, 3 businesses which were the biggest growth businesses going forward for us, which was the Analytics space, including the Trayport business that we acquired; our Derivatives franchise, which has got good growth potential in it; and the Capital Formation space where we've got a really unique business model in the world with both a junior and a senior market, and growth prospects that allow us to grow both domestically and globally within it. So within that kind of transformation, kind of a couple of the outputs are a fewfold. One is a substantial reduction in our cost base. We actually took about 20% of the cost out between the restructuring and some divestitures we did. And we've been able to hold that cost base steady for the last few years. So we brought discipline in the organization around how we spend with that change. A restart in the organic growth in the business, so growth getting out of those growth areas. That -- between those 2 things and the leverage that creates a real step-up in our margin. So we went from being kind of a below-peer margin company to an above-peer margin company. And all the while substantially reducing our leverage in the business. But prior to 2015, because we were part of a leverage buyout in 2012, we had over 4x leverage in the company. We've got that down to 2 or less today. So all setting up for a much stronger growth profile going forward.

Okay. Great. And then maybe let's just dive a bit deeper into some of those growth drivers you see over the next few years. And maybe starting with Trayport, which is one of your fastest growing businesses, with a goal of above mid-single-digit revenue growth over the long term. So maybe can you start by explaining what the Trayport platform is exactly and which organic growth drivers do you see as most impactful over the next few years?

Yes, I'm happy to. And I mean the starting point is, so Trayport is an integral part of the European energy business today. And I'm going to use it as a starting point because it's not the limitation on where we're going to go. But think of Trayport as a platform that aggregates multiple pools of liquidity so that anyone participating in the market, so a trader that needs to be able to trade gas or power or other energy assets in Europe, can come to one screen and get access to all the brokers that trade those assets, exchanges that trade those assets. They can transact through the platform and clear either bilaterally with a participant or give it up to a clearing house for clearing. So it's an aggregation platform that brings all those marketplaces together and all those marketplace players. And it's so intrinsic in terms of the people that use it, that 80% to 85% of the trading flow on those assets goes through that platform. Now what I want [ to clear is ] it's not a trading business, it's actually a data and a subscription business. So we sell it as a subscription, very similar to how fixed income people would see Bloomberg. It's a desktop application that we provide on a SaaS model, so it's a light install. And we distributed it to over 4,000 traders, with multiple brokers and multiple exchanges all connected. And so that's the real value is that platform effect of being able to bring that whole marketplace together. And then it's the basis then of how you grow. We grow Trayport by adding more asset classes to it. And an asset class can be a [indiscernible], but it could also be a region. So we're going to do gas in Japan or we're going to do European gas, or we're going to bring gas from North America, so things like that. And there's a couple of big trends that have been helping us really fuel the growth since we've acquired this business. And one of them being a real demand and shift towards renewable power. So a lot of marketplaces in Europe are adding new renewal power into their mix that creates a new demand for a different type of trading. And also the globalization of natural gas. So natural gas used to be a very regional commodity, but with the advent and distribution of liquid natural gas and the ability to ship it around the world, you've got benchmark pricing from different parts of the world. So now U.S. pricing is getting exposed in Europe, and there's demand for that. So why don't I pause there for a second and see if you've got any add-on questions, Melinda, then we can talk a bit more about how we grow going forward.

Yes. And maybe just given the recent turbulence in the energy market, can you talk about how that has impacted the Trayport client base as well as the near-term revenue trajectory?

Yes. This is -- of all the areas, this is the -- one of those things that kind of keeps you up at night is really about how healthy are the clients. So when you see that [ permeates ] in that energy mix, are the clients going to be healthy? Are they going to renew? Or are they actively using the platform? Those are the things that we get concerned about. And so far, in 2020, that hasn't come to fruition. So even with the level of activity, the level of turbulence and the pricing around oil, the clients are actually continuing to renew with us. As I said earlier, this is a subscription business, so the relationship with clients is usually a multi-year subscription agreements. And we are continuing to renew with clients, and the plans that are actually expanding their use for [ us ] throughout this period. So [indiscernible] the health of the clients against these renewals. Where there's a bit more of a near-term challenge is when we bring in new products to market and these features to the platform. It's harder right now to get the attention of the clients because they're all trying to keep their own businesses afloat, learning to operate remotely, those types of things. We've got a couple of key products we've been working on. One is an automatic trading solution, which we acquired from a company called VisoTech. We've been integrating that into our platform and now sell it to our client base. But it's more challenging to engage the clients right now in this environment to take an additional feature or an additional product. Similar with an Analytics program we bought out. So we've built an Analytics platform on top of Trayport that allows the clients to analyze both current and historical data, check their trading strategies, those types of things. So that's got earlier stage pilot claims, but it's more challenging to roll it out in this market. So a couple of headwinds in terms of just kind of timing of bringing the initiatives to market. There's nothing that affects kind of the long-term or even midterm prospects. The other area in terms of growth for us, though, is outside of Europe, it's around North America. And just to give you some indication points, [ I think this ] region as being one, can be as big as what Europe is for Trayport. And it's largely undeveloped. It's largely white space, where you don't have a Trayport type model operating, you just have kind of direct access to brokers or to exchanges. So our initial foray was a partnership that we launched last year with Nodal Exchange. And it's actually similar to relationships we have with exchanges in Europe, where they are paying subscriber and it gives them the ability to put Trayport screens out to their traders. And so we're in the kind of the testing and development phase with them right now. And we're taking advantage a bit of the market disruption with traders being at home, working from home, so they're going to have a chance to try out the model, test it, give us feedback to see what they needed changed. And the hope is that we actually roll there in the near-term and get that piece going into the U.S. market.

That's great. And maybe we could just dive a little bit deeper into the U.S. opportunity. Is there any initial feedback that you can share with -- that you've gotten through the testing phase? And once you start to build up that U.S. trader-subscriber base, what is really the path to becoming as large as a business in the U.S. as you currently are in Europe?

Yes. I'll start with the latter piece, because it's really about building blocks and more building blocks. So the Nodal being a partner that's got an electricity, power and gas that do 50% to 60% of the OTC market in the U.S. So they're really good beachhead to build from in a trader base [ with that outcome ]. It's early to say -- it's early days to be able to give you guidance in terms of kind of what that rollout trajectory use looks like and what the pickup is going to be looking like. But once you've got that trading community carry on, you've got another beachhead now to sell into the broker community. And so we wanted to just build that network of liquidity like we've done in Europe. So we've got that exchange on, we want to start adding brokers to it. Then to get some critical mass and we can add more additional products to it as well. So it very much looks like the road map in terms of how Trayport built out in Europe in terms of region and product-by-product, and having continuously adding more traders and more brokers. And there is an element of liquidity begets liquidity here. So you've got to get through critical mass. And that's the road map. But it's kind of difficult for us at this stage to give an indication of kind of when that gets a meaningful take-up. But it is one of our highest priorities. So that's what we're going to be pushing ahead.

Okay. Great. Maybe we can pivot the rest of your GSIA business briefly. Do you still feel confident in your ability to grow this revenue base at a low single-digit rate this year given the complications from the COVID-19 pandemic? And as the economic environment does deteriorate more than expected, is there any risk of revenue base actually contracting?

Yes. This is an area where there are pluses and minuses. So on the risk from the economic environment is we end up with an extended downturn, and it leads to the industry shrinking. So the financial services industry, if brokers need to lay off and if there isn't as many users of those data products, that could be what leads to some contraction. On the flip side, there are areas where we're looking to sell, but don't have anything sell as well. So we're looking to continue to push on European trading of our Derivatives products. We're looking to expand that into Asian time zone, and that's going to create more demand for both derivative data and underlying equity data. So there's both pluses and minuses there. The other piece is that there are some products that we've got and we're building out in 2020 that are also less determinant around the economic environment. So we've got a colocation business now. It's at full capacity. So we are working on some pricing there as well as expanding the capacity of our colocation facility so that we can bring on additional clients when we know that it's got demand for extra. So [ that's actually ] all expected. We will see growth in the back of the year, even if we see some contraction on some of the traditional subscriptions, if the environment changes and the industry contracts. Now historically, any time you've been through a downturn in the past, that's usually a lagging indicator. Because it's some time before the dealer community will contract and reduce the [ seeds ] and how will that flow through. What we'd really like to do long term in this business, and we've done a very small start to it so far, is move more of these clients to enterprise agreements, where we're not actually counting feet by feet data usage and we come to the client with an enterprise agreement so they can use the data everywhere in their franchise. And then we can reassess it every couple of years and we give them the multiyear agreements. We started that process a year ago. We've got about 6 clients [ out of these ] enterprise agreements for nonprofessional subscriptions. So it's a small piece of the business, but it's a good way for us to test our way in. And we do those as multiyear, CPI built-in, maybe [ update ] later on based on the usage. And what it also does for the clients is they can use our data everywhere, they don't necessarily need to buy a competitor data to put in because they can get the whole package. So that's where we'd like to get to with the larger clients as well, but it's a longer-term path.

Okay. Great. Maybe we can pivot to the Derivatives trading clearing business. Can you maybe talk about some of the progress you've made on some of your efforts to organically increase volumes? And then maybe you could touch on why trading volumes have been so low so far this quarter?

So in terms of the things we've been doing to grow organically, it's been a combination of service offering and product. And so service offering, the expansion that we did over a year ago to add the ability to trade from Europe and add European time zone trading has been a real nice lift for us. About 6% of the flow now actually in the first quarter came from that trading in the European time zone, so up from where we were a year ago and on the path of where we'd like to see it going. And I mentioned a little earlier that we want to expand that out to the Asian time zone as well to kind of get to 23-hour trading roughly, but that's the plan for 2021. So that's how we're actually doing all the building block work this year. A little harder to do with the actual client development side because we can't have anyone travel over there right now. But we're going to keep moving that needle along so that we'll be ready to go for 2021. On the product side, there's a combination of things in terms of product we've been bringing to market, both on the fixed income products and also on the equity [ indices ] products in the near term. So on the equity side, we are working around adding new futures base on ESG indices. So indices that are tilted on [ ESG ] factors, with indices on top -- futures on top of that, that we're bringing to market midyear and later in the year. And then on the fixed income piece, we have some pivoting in terms of kind of priority for which contracts were coming out next. We've talked in the past about the 5-year future products that we relaunched has been extremely successful and has done -- a real bellwether in terms of building up liquidity again. The next piece was a launch of the 2-year as well, but we pushed that off into later this year and the focus for right now is getting out what we call CORRA future. And CORRA is a better spot benchmark overnight rate for doing short-term fixed income contracts. Right now, we've got a product which is the BAX, it's based on CDOR, which is similar to LIBOR, and people understand the issues with those overnight rates. And some of those issuers were bought more fulsome when we saw some of the disruption in the market. In March, it brought some of the issues to light and it, again, reprioritize this need to move on to the CORRA future. So that's the priority. We're kind of getting that out to market very soon, and with the 2-year product to follow later in the year. Now with respect to volumes, what we saw coming into this year was really a strong uptick in volumes and derivatives in January and February. Even before the COVID disruption took form, we were looking at very strong volume growth. And then 30-plus percent growth in terms of what we saw in March. So far in this quarter, I think you're seeing a couple of factors. One is a lot of that activity in March was people getting the balance sheet trued up. So some of it was some onetime activity in nature that didn't necessarily translate into April because they got a lot of their activity done. Some of the volatility then came out of the fixed income curve, specifically when rates were dropped to the level they were. And there wasn't a lot of look longer out in the curve. And so over time, you expect that volatility to come back into the curve that'll create different trading at different levels. But in the immediate term, in the April period coming off of March, there was a bit of a pullback from that market. Where we kind of take indications of strength going forward is lesser in the trading that goes day-to-day and what does that open interest look like. So people continuing to make markets, open interest in contracts. And if you look into that data in April, it's actually just as strong as it was in March and stronger than it was a year ago. So that's a good indicator going forward to where volumes could be.

Okay. That makes total sense. Maybe we can pivot to the Capital Formation segment now. So we saw relatively low levels of listing revenue in 2019 from a muted IPO and secondary financing environment, which had, of course, continued and even worsened in 2020 with market volatility and economic uncertainty. So can you talk about the various headwinds in 2019? And then when do you think the financing environment can begin to normalize?

I'd be happy if it were to normalize after this call. But we'll have to get [indiscernible]. So there's 2 [ trading ] pieces. The finance market in, as you said, '19 has been challenging for a couple of reasons. One, a lot of volatility was harder for deals of price. The same cheap debt and cheap private equity that, again, is fueled by cheap debt. And we saw that trend kind of starting at the end of '18 when the volatility made it hard to price deals, and really continuing through '19. But that was -- and that was really more about secondary financing activity. Through that time frame, we actually continued to see a really strong pipeline on new issues. And that's probably a different experience than a lot of other exchanges had and likely because we have the 2-tier model where we can attract junior companies very early in their life stage versus just seniors. We're getting a lot of new issue activity, IPO activity from small companies. So we had a great year last year in IPOs, and a lot of them coming from innovation companies, even if the secondary financing market wasn't as strong as it was the year before. Now when we came into 2020, we're actually on track in kind of January and February to see growth in that market again, where we're seeing deals being done and some big deals, too. We've got big deals like Green for Life going public into February and a lot of -- a lot more follow-on financing than we had seen in the previous period. That all went sideways in March with the absolute disruption in the marketplaces. But actually, to be candid with you, I expected a bigger pullback in financing activity than what actually occurred. We actually saw companies that were coming to market and getting deals done even though the market was so frothy. And that was a real testament to both the companies themselves willing to test the market and get a transaction done and the investors willing to support good companies. So kind of the expectation going forward, and if we use history as a bit of a guide post, any time we've had a major turndown in the marketplace or a disruption that's led to a pullback in financing, that has generally always been followed by some of the strongest periods afterwards as companies come back to market to shore up their balance sheets. And then especially in this environment today, I think a lot of these companies that really sustained themselves by adding additional debt when they were already highly levered. It's going to drive even more so the need for equity financing in the future. Now we can't predict the timing. But certainly, if you looked in the past to kind of the 2008 financial crisis, the year that followed immediately afterwards was one of the strongest years on record falling by weak period. So we do anticipate that financing will come back to market, but it's hard to predict exactly when. And the challenge this time around is you really do have companies that are much higher leveraged -- levered than they were last time. And it's not just the financials, it's across the spectrum of companies. So you could have companies throughout the spectrum coming back to refinance.

Okay. Yes, great. Maybe we can move on to some financial questions now. So expenses. So how should we think about a core level of expense growth on an annual basis? And then how much flexibility do you have in your expense base to protect margins and a lower volume backdrop?

Yes. I mean, that's a great question. So I mean our approach to expenses and expense management, as we talked about our transformation right at the beginning, has really been about putting expense discipline through the company. So that even where we're investing in growth areas in terms of organic growth, we're always looking for what's not working that we can deprioritize to fund things that are going to have higher value. Most of our expenses are fixed [ on ] base, and we manage them as a pool and we challenge our teams to identify how they're going to fund from a target basis. So -- and even funding an inflation in it. So we do actually try to keep expense growth even below inflation by trying to fund some of our own inflation through our own opportunities to identify savings. The other place that we look at is, within our expense base, although it's primarily fixed, there is a component that's discretionary. That's the spend that we do on development, on client development or travel, those types of things, that we're able to pivot to the highest growth opportunities. So we manage those more in an agile model, where we look at our portfolio of investment programs and we reprioritize on a quarterly basis to see what's working, where do we want to overinvest and where we want to pull back in. And that's allowed us to be a bit more nimble. So for example, when Trayport has higher growth ideas, we're able to up-spend in Trayport and we can tighten up in other areas. In terms of kind of the flip side, and you see it a bit in our result this year, is there are places with more of that discretionary spend, where we've got some ability to pull back or deprioritize if we're in a different -- or a tougher environment. Now some of that happened naturally over the last couple of months. It's very hard to spend on travel and business development. So we're going to see some of those savings on a natural basis. In fact, I think you would have seen our expenses would have been even lower in the first quarter, they were buoyed actually by strong performance on our incentive plans because our performance in the quarter was so strong and because our share price was so strong, and that feeds part of our long-term incentives. That's actually what created some of the expense in the quarter that was [ an anomaly ] year-over-year. Otherwise, I think you would have seen some savings year-over-year as a result of that. So we do have some flex to contract. We did that last year when we saw the challenges early in '19 around Capital Formation, the capital raising business. We were able to pull -- pare back about 3% overall in the year by just getting a little tighter in what we were doing and a little tighter on priorities. So -- but we always have that kind of flex, but it's not a business that's got a lot of variable costs that you're going to push up and down.

Right. And maybe I could just ask one on the back of that about margins. So you've been quite successful in improving the firm's margins over the past year. Is there a certain level of operating margin expansion that you're targeting over the next few years? And how important is it to you to close the margin gap versus some of your closest U.S.-based peers?

I think compared to the average, we've probably already done it. But it's really more of an output measure first, Melinda, as opposed to something that we're specifically targeting. And what we target is long-term revenue growth in that mid-single-digit range and maintaining a tight expense base to get the operating leverage out to drive double-digit operating earnings growth. So that's really where the margin expansion comes from us, is that, that approach of driving revenue and maintaining our organic expenses tight. And the output of that should be continued margin appreciation.

Okay. Got it. That makes sense. And then maybe one on capital allocation priorities, especially in this new market environment. So what types of businesses are you looking to acquire if the opportunity were to present itself? And could you be more opportunistic with M&A in the near term as valuations have come down recently?

I think that you're very precise in the comment there, it makes a ton of sense for [ it ]. Given the strength of our business and the strength of our balance sheet and valuation correction in the marketplace, I think there's a lot of opportunity for us. The areas that we focus on are ones that help drive the growth areas of the strategy that we've talked about. So things that will help us grow Trayport and information analytics faster. Things that will help us expand derivatives faster. Things that will help us expand capital formation, not just from the ability to bring in more issuers but also to provide more services to those issuers. Those are kind of the areas that we focus on, on M&A opportunities. So things that accelerate our business plan as opposed to things that would just be portfolio-type investments. So Trayport acquired VisoTech, that was a small piece that we could integrate and expand. We would look to do more of those. We're continuing to look at other opportunities, both in small size but also larger size as well that could be more bigger accelerators of that business. Similarly, on our Capital Formation side, you know that we've got the TSX Trust business that we acquired a number of years ago. It provides services to listed issuers, also got some ability to do it to private companies as well. It's actually recently stepped up to about 27% share of the marketplace, and when we acquired it, it was about 13%. And the rationale there is trust and transfer services are services that every issuer needs. So we are looking at that space as well. What are those other services that we can provide on a scale basis that are needed by multiple issuers that we could then provide from a central marketplace. So those are the types of things that we're looking at. Size-wise, they could be small tuck-ins that we're going to integrate and push through our platform, but they can also be larger, and we've got the balance sheet capacity to do it.

Yes, absolutely. That's definitely helpful. I just wanted to remind everyone on the webcast, we have few minutes left, so please submit any questions if you have any. And John, in the meantime, I have just one more question while we're waiting for the Q&A to queue up. But I wanted to talk a little bit about the competitive landscape in the Canadian cash equities market. And can you maybe give us some color about how that compares to the U.S. equity markets? And then if you have any comments or views on Cboe's recent acquisition of MATCHNow from Virtu?

Yes, I'm happy to. So a very different marketplace in Canada and the U.S. in terms of -- it starts [ from size ]. It's just -- obviously, it's a smaller size than the U.S. market, but still distributed to about a number of players. So even though the cash equity market is probably 1/10 of the size of the U.S. base and the size of the market themselves, we still have 13 players that are competing for market share in it, similar to the way you have in the U.S. The difference being that as the main marketplace between TSX, TSX Venture and our Alpha market, we have about 2/3 of all the trading in our names that flow through our system. So much larger position from an incumbency standpoint. And the rest of the market is spread across the others with some of the bigger ones being Nasdaq Canada, which was an acquisition of Chi-X, and some other domestic local players that -- one is backed by Royal Bank, one that plays in more smaller cap, names that we wouldn't even list. So it's an area that we really focus on providing great client service, make sure that we're priced competitively. But there's no reason for our market share to really move all that much around. The other dynamic in the Canadian market is how much gets done in dark pools or ATSs that way. So I think in the U.S., it's probably more like 30-plus percent of the market that trades dark. In Canada, it's closer to 10%. And so that the acquisition that Cboe made of MATCHNow, MATCHNow was a dark pool ATS in Canada, had about -- when they started that process, about 70% of the dark trading, so about 7% of the total marketplace. It's actually since declined to our benefit because we've been expanding our own dark offerings that we provide as an exchange, so we've actually expanded from being about 15% in dark market to closer to 30%, and they've gone from about 70% to 50%. And as an asset, it's an asset that we also got the chance to look at as well, but didn't see where there's value for us to be paying a premium for essentially a few points of market share. I didn't add anything incremental value to our client base. If it was something that we could do at a low-cost basis, we would do it, because it would be a nice tuck-in, but it's no value in terms of us providing that kind of premium spend. Cboe is a great player. You guys know them really well. My hope is that with Cboe's kind of global client base, they've talked about kind of why they had an interest in this and it's about providing more services to their global client base. I'm hoping that with their entry into the Canadian market, it helps with what we've been trying to do as well, which is bring more global capital into the Canadian market to interact and actually grow the pie. We're going to make sure that we're competing quite effectively with them. So really what they choose to do with it beyond that, it's hard to say. Nasdaq Canada has been in the market for a while. There was speculation that they would move into the listing business, the capital formation business, that they would move in reserves business, and they haven't gone into either one. And my gut on that is that the cost and the effort to do it aren't worth the payoff for the size of the marketplace. Now we're really strong in incumbency and listings. In terms of both our brand, we only trade the things that we list. A company can only be on the index if they're listed on a marketplace. So there's really strong competitive advantages there. And then similarly on our Derivatives platform, we own the clearinghouse as well. It's a vertical like a U.S. futures market. So anyone who wants to start derivatives have to figure out how they're going to clear it as well. So again, really strong competitive advantages. So I don't know at this point what else Cboe will do with the platform, but I do hope they bring new clients to the market as a result of their acquisition.

Great. That was wonderful color. And we just ran out of time. So thank you so much, John, for joining us today.

My pleasure. And I hope everyone is doing well and staying safe. And I apologize for the technical glitch at the beginning there.

Okay. No worry. Thank you, everyone.

Thanks. Bye-bye.