TMX Group Limited (X) Earnings Call Transcript & Summary

I mean, in some cases, it made the platform more important, because the volatile markets -- some of the big benchmark contracts that trade on Trayport actually saw volume spikes of 20%, 30%, 40% so in terms of client engagement in it. The area where we've been the most nervous in terms of what keeps you up at night has been with the distressed energy prices particularly around oil, what does that do to the health of some of our clients. So even though, like you said, it's a subscription model, what happens if your clients are under financial stress themselves? Or are they cutting seats? And what does that do for our own client base? And fortunately, we haven't seen that come to fruition in any material way yet. We've actually seen continued client renewals, continued actual uptick in terms of usage of Trayport. And I think through July, we had 7 new clients come on. So it performs a really important function in stressed markets as well as normal markets. And I often get asked out, and particularly around oil because that's the piece that's been under the most stress, and also as TSX and TSX Venture being big listing venues for energy companies. We see that in multiple ways. Energy has been pressure pointed from a number of reasons because you also had supply challenges and price challenges and basically ESG challenges around it as well. But we're actually not in oil in Trayport in any material way to date. This is actually having us a chance to relook and say that maybe oil is something that we should be bringing on the platform because we can help to aggregate these markets that are actually in stress right now. So it's an area we're continuing to talk to the brokers to see if there's a value proposition for us to put oil on screen and help them in that market as well.

And I think maybe you're kind of alluding to this a little bit, but if you have any information around customer engagement and renewal rates on the Trayport platform, I think that would be helpful to those tuned in as well.

Yes. So even through the worst part of the pandemic, in terms of people working remote at home, we were seeing customer activity levels of about 95% all through there. So we -- as a SaaS platform, we can actually see how active customers are in the platform, and there's really been no downtick in the usage.

And then a little over a year ago, you announced Trayport's acquisition of VisoTech, which expanded their capabilities to include algorithmic trading. Maybe could you explain a little bit how the deal augmented Trayport's current capabilities and how perhaps you might look to leverage VisoTech's strength to improve the broader organization of TMX.

Sure. And probably an important piece there is why did we even need that. Because at the end of the day, as the mix has changed in terms of what energy has done and what people care about, the renewable energy became a bigger piece of the mix. And that's a continuing trend that's going to keep growing. But what does it mean for in terms of changes in terms of how people trade is renewable energy trades more in the spot market, because the wind blows when it blows and the sun shines when it shines. So it's not like a hydro power that's more consistent and you can trade forward. You've got to be able to do spot trading to change whatever loads you're taking on. And that's why the algorithmic trading capability became so important. So we knew VisoTech already. Some of our clients were using it and had asked us to integrate to it. So we knew that it was a good fit for Trayport. We acquired the platform. And last year, we finished integrating it in. So that actually now is -- it's a premium product that we can deploy across the Trayport network. And that's key because when we think about other things that we can integrate in, we look at that lens, what can we integrate in the platform and then deploy as a premium service across to the client base? So 2020 has been now a year of selling that into new clients as a premium service. And in terms of how it impacts the clients and gives them new capabilities so that they can trade those power contracts more effectively, for us, it looks like a premium subscription that adds to our revenue per user as an organization. And in addition to that, it gives us a team that's got analytical capabilities that we can then look to see, is there other ways we can use those in the firm? We've done some R&D type work in different parts of the organization in terms of what those next analytical tools might be. Nothing that we've gotten to in terms of a marketable product yet, but that's the kind of capabilities we acquired in there.

Got you. And I guess just maybe one last one here on Trayport. Last fall, you guys announced the partnership with the Nodal Exchange here in the U.S., giving you a little bit of a toehold here, to allow Nodal traders to use the Trayport Joule screen. Maybe can you explain the different ways you think the partnership helps grow Trayport's footprint and offerings outside the core European market?

Yes. And think of the partnership also similar to other exchange relationships that we have. So Nodal is an exchange client of Trayport, very much like its parent EEX is in Europe, where they contract with us to provide the ability to put Trayport out as the front end screen to hundreds of their traders. And that's the commercial relationship that kind of underpins the partnership. We're in the process of still rolling that out with them. So it's a committed partnership between us. The challenge this year has been more about how you roll things out when it's hard to get attention from -- in the resources that you need. And where it's been challenging is that -- it's getting the independent service vendors engaged in the integration work that they need to do for Trayport so that those traders can use -- and these would be firms that provide the connectivity from the trader to the exchange. So that's what we're doing in terms of that rollout. We've actually got some folks that are live on it now, and we're going to continue to push that ahead. And what it does for us is with Nodal, you've got about 50% of the U.S. market for that OTC gas and power. So they're really good, strong position. And that gives enough liquidity there once we get those traders trading it through Trayport that we can now talk to the broker community in the U.S. to sell them onto the platform as well if they want to be able to interact with liquidity from those traders in the exchange. And that starts to build the network effect that we have in Europe. So the challenge of building a new market, it's player by player to start to build the liquidity up. I think you know this already. In the European market, we've got 80% to 85% of the trade in any of our products goes through a Trayport screen. We're starting from net 0 in the U.S. and building it from scratch. But it is white space. There isn't an incumbent we're looking to push out. It's actually building new capability for the industry.

Got it. And then, I guess, within that vein, it's going to be hard to tell what next year looks like even especially with some of the delays that -- we're getting everything implemented right now. But for us and for kind of investors that are tuned in here on the call, is there a high -- at least a high level way to think about what tapping this U.S. market could mean in terms of growing the user base at Trayport?

The way I always think about it is, what's the addressable market? And that's not to say that it's not a challenge to get there, and there isn't a lot of work to do it. But we have, call it, 4,500-plus traders in Europe that trade through Trayport. The U.S. market from our analysis is also a market with thousands of traders that are trading these products. It's a different construct. In Europe, you've got multiple countries with different levels of regulation or deregulation in it. United States is very similar in terms of kind of state-by-state approach to what's deregulated and what isn't. And the more deregulated and fragmented region is, the more valuable Trayport services are like it is in regional gas and power in the Northeast or California or Texas or markets like that. So we certainly look at it as a market potential of what does the trading community look like. How many thousands of traders out there? It looks similar to the European opportunity if we can build the presence.

Got it. And then maybe just moving on to cap formation here. I know TMX is a little bit unique, and you guys have this junior, senior, 2-tier type of exchange construct here. Can you just maybe discuss that and why -- how that came to be and why you feel like it's a unique value proposition for TMX?

Yes. And I think we're really unique there, not just a little unique. There's a lot of markets around the world that have tried to replicate it but without the same success. I mean, it really grew out of the junior mining and junior resources community. So for years, in terms of some of the small exchanges in Canada before we consolidated, that strengthened doing these junior properties that were getting financed in some cases at the development stage. So you had an industry in a community which included both the exchanges, the lawyers, the investment analysts, the investment bankers who knew how to use a public model to fund a mining property when it was still exploration. And how do you do things that are pre-revenue and pre-earnings and really almost in a penny stock world? And over time, we built that out into a formal, matured exchange model focused on junior companies. In the last 5 years, our focus has been more about how do you bring other types of companies into that platform that also can raise public money that way that have similar characteristics. So the focus actually from kind of 2016, as we've been focusing on this, has been more about bringing more innovation companies in the sector. Because if you think about technology companies while they're working in a digital world, their financing story doesn't look different than a mining company in terms of where you're trying to fund the next generation of research and development. You might have to do multiple rounds before you actually get to something that's a profitable product and takes off. And so that model works really well, that a company can raise early public money. It can get liquidity through that vehicle and then actually come back to market multiple times. I'm having a work-from-home problem here. And that's actually where the value comes from. So the last, actually, 4 years, we've seen the mix of companies on the venture exchange. Kind of about 5% of the companies were innovation companies in 2016. It's 12% today. And again, these are small-cap companies that can do early seed financing and then grow with the organization. The uniqueness then of the 2-tier model is that we're with them for their life cycle. So they can do multiple rounds with the venture exchange, get to a size where they're graduating to the TSX and eventually becoming an index-sized company. And so we've had almost 700 companies over that time period graduate up from venture to the senior market. I believe about 20% of our senior index is companies that actually started as venture companies on the venture exchange. So that's the uniqueness of the model.

And then I guess in that regard, you guys are exploring more international listings on U.S. tech companies, listing at the junior exchange. What are the puts and takes here to a U.S. entrepreneur looking either to raise seed capital in the more traditional VC, PE type of way here in the U.S. or list in the U.S.? And how does like the venture exchange kind of nestle between the 2 of those?

Yes. It's usually actually -- I mean, the #1 piece of our sales effort in the U.S. is ensuring that they're even thinking about the venture exchange as an option. So like you said, if a digital entrepreneur in Silicon Valley is thinking about their Series A to Series B and working within a fairly close community -- and right now, our focus on our sales effort is to ensure that they actually learn about what venture has to offer as part of that mix of what they could be doing for capital. And that's why we've got people on the ground that are working in that community to build that awareness. The puts and takes, it's going to be a question for the company itself. And it's not public or private. It's not going to be the same answer for everyone. But some of the things are around access to capital, access to a broader investor base than potentially a narrow investor base in terms of a private equity. There is a methodology that private equity is sometimes less intrusive than the public listing. I think a lot of people are finding out that, that's not always the case, that a public market actually can be more forgiving in terms of multiple rounds, wherein the private market, you've got to beat the valuation you had last time in terms of next round you do, and those can be quite intrusive. So those are some of the different pieces in the model. There isn't the ability to do it in a public market in the U.S. And even if you can get big enough to maybe get to the bottom of Nasdaq, the ability to get much analysts or investor coverage is actually harder than if you're in the Canadian market where you're a bigger piece of a smaller marketplace, and you can get more attention. And that's part of the sales pitch as well. One of the challenges that we have, and it's one of the pieces that we continue to work on, is not all retail platforms in the U.S. from retail investors look to the Canadian market. And so that's part of our long-term sales effort. It's getting more of those platforms to provide access to these companies through U.S. retail so that they actually can be traded in the U.S. market. But that's one of the bigger challenges.

Got it. And then just maybe just capping off here in Cap Formation. I know 2019 and early parts of 2020 have been kind of challenging for that business. I think you even alluded to earlier, though, that maybe we're starting to see some green shoots in that area. So I guess, any kind of high-level color on the market dynamics and what the outlook for that growth algorithm in this segment looks like?

Yes. And first of all, I would say that I think -- I mean, we thought the market held up stronger through March, April, May than I initially thought it would. With the amount of volatility that was there, you can see how it would be very hard to price deals. But some great deals were getting done, and not to the same levels that we had in previous years. But now we're seeing through July and August, I can tell you anecdotally that July and August were 2 of the busiest summer months that we've seen in a decade particularly around Venture financing. The 2 sectors that have been absolutely driving things have been technology companies. I don't think that's a surprise. We're seeing the same thing in the U.S. in terms of tech names that are getting financed and have some really strong fundamentals to work from because they're becoming more important in this economy. But we're also seeing a resurgence in resource companies as well as commodity prices start moving in a way they haven't moved in years. So those 2 sectors have been extremely strong. We're starting to see great tech IPOs, both junior and senior market. We had Dye & Durham about a month ago go public. We've got [ Nuvia ] coming shortly, which will be a large IPO. And we've got some interesting things coming down the pipeline. So when you kind of look forward, there's 2 ways to think about pipeline. One is the long-term lens that we've talked about right back to our Investor Day of kind of the 1,500 companies that we work with over time that could eventually publicly finance, but we always have to look at the short term in terms of our team and what do they have in their caseload and their file loads that they're working on. And our team that manages both the additional financings and the initial financings are currently working all out. So they're in a backlog position where they're working hard to keep up with the demand. And that's a problem that we haven't had in years. So it's a good problem for the market, and it's a good opportunity for new issues to come to market and for investors to participate in.

And then let's pivot over to the trading business on the derivatives side. You guys operate the Montreal Exchange, which is the largest derivatives exchange in Canada. And I think when we started analyzing the stock a few years ago here, we're obviously familiar with CME and all the futures market here in the U.S. And one thing that kind of stood out to me was kind of the, I guess the lack of futures adoption in Canada, especially in the rate complex versus the U.S. market. I mean can you discuss what's happening here and why this adoption might be a little bit slower than we've seen in your -- south of your border?

The -- it's more -- it's less about the adoption and more about the adoption of a trading on exchange. And that's actually what we've been finding, has been trying to pinpoint where the right places to build out, that there are points on the curve that are traded and quite liquid, but they're in the OTC market. And so the expansion we've been doing, when we look at other marketplaces, exactly you said, and you can see what does that rate complex look like. This is -- it's not rocket science in terms of what the whole product road map should be. We're looking to see how do we replicate and build that full rate curve out for the Canadian market as well so that people can trade all points on it, they can trade strategies across and things like that. That's why we ran a relaunch of the 5-year product about 1.5 years ago. So we already -- we are very strong in the short end of the curve in the 30-day. We were strong in the 10. We had nothing in the 5 year, but it was a liquid OTC. So then it's really -- the challenge then is how you move that liquidity on exchange in terms of capitalizing that so that it can interact with the other products. And our strategy to do that was to work with a couple of market makers that were deeply involved in the OTC market, allow them to share in the upside of the revenue of building it and commit $1 million-plus in terms of capital to those contracts to ensure their liquidity. And the results of it were extremely strong, and we've seen growth of kind of the 30,000 to 40,000 contracts a day, and that for what was essentially nothing before. And there's still room to go before it's at the level of what our 10-year does, so there's a lot of growth room. But for a model, it proved out that this was the right model to bring liquidity on exchange. And so now we're looking to do that again when we look to bring the 2-year back. So we've got a gap between 30-day and 5-year. We're going to bring a 2-year product out. And we're again going to market for folks to make markets in that. And now that we've kind of proven out the potential of the 5, rather than being a challenge to get 2 people to do it, we've got more interest than we're going to need in terms of it being more competitive in terms of market makers coming in. So I think that's a real positive development in terms of how we're going to build that product suite out. We've also launched the new rate product at the short end of the curve called the CORRA Future, which has got a different overnight rate. That's again in response to what the clients were looking for, for a better benchmark rate. We're going to look into a 30-year product to get the long end of the curve out there, again, based on client demand. So all of this is driven on what the clients want to be able to trade, but built with liquidity from the get go. One of the big learnings from history is that if you simply put a product on the market without seed liquidity, it will sit there. It's like opening a store in the mall, but the mall is not open. And so it's really important to build liquidity, and that's what we're going to do in the next product launches we do.

And then as you just think about the macro backdrop here, obviously, the rates -- global rates market has been challenged right now, right? We're sitting pretty close to 0. Visibility like this for probably a while. I think -- how should we think about you're building out those rates complex? Can you deepen your wallet share and your engagement on not only getting the 5-year up to kind of where the 10-year volume penetration is, but you mentioned the new short-term CORRA Futures. You mentioned the 2-year and potentially a 30-year. Are you able to lay the groundwork in this really kind of weak micro backdrop to really take advantage of it if and when it does start coming back in more full strength?

Yes, we are. The new short-term is a good example of that because we launched that in partnership and in consultation with the industry in the middle of COVID. And the short end of the curve is the weakest part right now. So in terms of what has been -- had the most impact in terms of pullback, because like you said, that near 0 rate view, it's been in the 30-day. I think we were down 40-ish percent in the summer on that product. And so the -- as long as you're working in consultation with the clients, we can absolutely do that and get those product pieces in place for when market volatility returns. And I think we know from history, market volatility can return even if rates stay low. It's about whether or not there's expected changes and how flat the curve is in the out period. So we can have limited volatility at the short end, but we could have volatility in the 5- and 10-year period, depending on what actually comes into the marketplace. So that's -- we really want to make sure we've got the full product suite there so that the clients can trade whatever it is they're going to need to in the future. And it goes back to the earlier point when we talked about global growth is if I want to appeal to traders in other time zones and other regions, they may be interested in different parts of those curves as well in terms of whatever hedging exposure they want to do. So it is important to have that full product suite even if we're in a low rate environment right now.

And then maybe, John, before kind of final closing thoughts here as we're kind of getting close on time, I want to tap into your legacy CFO brain here for a minute and talk about margins. TMX has done a really great job of kind of expanding margins. I think you ended 2Q at like 60% versus 52% in 2016. And I know you guys don't give any sort of OpEx guidance, but maybe can you give us a sense of how to think about operating expenses growth going forward and/or margin expansion from this point forward?

Yes. You should expect that our focus on operating leverage and profitable growth continues. And so the guidance that we give around -- sorry, the direction that we give around mid-single top line and really managing the cost base so we can get the leverage out for double-digit on the bottom line, that gives you the natural ability to expand margin, and that's the continued focus going forward. So we've actually learned quite a bit this year around our cost structure as well and where we can actually pull levers that we haven't been pulling on. So we are spending less this year in terms of things that we've saved related to our work-from-home strategy and our COVID strategy. We're saving more than we're spending to enable it. And I do believe that going forward, Jeremy, that we'll be able to turn some of that into permanent savings because, as you said, it's going to be a hybrid model in terms of how we go-to-market in the future. The more we invest in the digital capabilities, that will change the way we do business development. Maybe we're not sending 12 people to a conference around the world for each conference. Those types of things. So we're going to be spending money in different places and create more opportunities to shift spend into things under growth areas. So I think you can expect us to continue to have that strong expense discipline and focus on spending where we're going to get the best growth opportunities.

Great. Well, John, we are set on time here, but thanks so much for being here. We had a great conversation, covered a lot of topics. And for investors looking to learn more about Trayport, like I mentioned earlier, on September 29, we will be hosting the TMX team for a Trayport demo and kind of showcasing some of the use cases. So John, thanks so much for being here.

Thank you. It's great seeing you. Take care, Jeremy.

You, too.