TMX Group Limited (X) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the TMX Group Limited Q2 2023 Financial Results Conference Call. [Operator Instructions] This call is being recorded on Friday, July 28, 2023. I would now like to turn the conference over to Amin Mousavian, VP Investor Relations, Treasury and Administration.

Thank you, Anas, and good morning, everyone. I hope you're all doing well and enjoying the summer. Thanks for joining us this morning to discuss the 2023 second quarter results for TMX Group. As you know, we announced our results late yesterday and copies of our press release and MD&A are available on tmx.com under Investor Relations. This morning, we have with us John McKenzie, our Chief Executive Officer; and David Arnold, our Chief Financial Officer. Following the opening remarks, we'll have a question-and-answer session. Before we begin, I would like to highlight that we successfully completed our 5:1 share split on June 13, and all common share numbers and per share amounts, including comparative figures have been adjusted to reflect the stock split. Also, I would like to remind you that certain statements made during the call may relate to future events and expectations and constitute forward-looking information within the meaning of Canadian Securities Law. Actual results may differ materially from these expectations. Information concerning factors that could cause actual results to differ from forward-looking information is contained in our press release and in periodic reports that we have filed with the regulatory authorities. And with that, I turn the call over to John.

Thank you, Amin, and good morning, everyone. To everyone listening today, we all hope your summer is off to a great start, and I appreciate you spending some time and dialing into the call today with us to discuss TMX Group's financial results for the second quarter of 2023 and the first 6 months of the year. Now before I turn to the business, I do want to take a moment and send a message of support out to all of those who have been impacted by the wildfires across Canada and actually around the world and express how grateful that we are at TMX for those on the front lines that are working to protect the lives of people in affected communities and providing that essential relief, services and support. Now my comments this morning are going to focus on TMX's first half performance and the important progress that we have made this year in advancing our key enterprise initiatives, following which David will take us through the Q2 numbers in detail. Overall, TMX continues to deliver, reaping the benefits of a diverse and balanced business model and a consistent and disciplined long-term growth strategy. We reported positive results for the first 6 months of the year, with solid year-over-year revenue growth, including record revenue for the second consecutive quarter despite sustained headwinds across key elements of the capital markets. Fueled by our purpose to make markets better and empower bold ideas, we are continuing to build TMX ever stronger, more capable, more innovative and more resilient to continue to deliver innovative solutions and a clear path for the success of our clients and stakeholders across the markets we serve around the world, long into the future. TMX reported revenue of $605.3 million, a 6% increase from the first half of last year, driven by double-digit growth in revenue from our information services businesses, or GSIA, which includes Trayport and TMX Datalinx as well as increased revenue from capital formation due to trading and clearing, excluding BOX. Actually, excluding BOX, revenue increased actually 9% in 2023. These gains were partially offset by decreased revenue from equities and fixed income trading due to lower trading volumes on Toronto Stock Exchange, TSX Venture Exchange and Alpha and lower capital raising activity. On an adjusted basis, diluted earnings per share for the first 6 months of the year was $0.75, a $0.01 increase from the same period in 2022. Total reported operating expenses increased 9% compared with the first half of last year, largely driven by inflationary pressures and FX impacts, but also by discrete investment choices we have made as an organization to accelerate our long-term growth. And David is going to dig into this deeper in his remarks to follow. Moving now to our business areas. Starting with Global Solutions, Insights and Analytics, our fastest-growth business area. GSIA represents 34% of TMX's revenue in the first half of 2023, up from 31% in the same period of last year. Revenue from GSIA was $207.3 million, a 16% increase from the first 6 months of 2022, reflecting higher revenue from Trayport, our connectivity platform and service provider for European wholesale energy markets, and TMX Datalinx, our information services division. Trayport's first half revenue grew 18% or 15% in common currency pound sterling compared with the same period in '22, driven by a 9% increase in trader subscribers, annual price adjustments and the impact of a favorable FX rate. Trayport's core Joule network connects, serves and supports a growing ecosystem of participants, execution venues and clearing houses across world power and natural gas markets. And Trayport continues to pursue innovative ways to enhance the overall client experience for energy market participants by augmenting trading tools, insights and analytical capabilities across its core Joule network. And in addition to areas of strategic focus in our business, Trayport continues to seek out expansion opportunities in new asset classes and new geographies as global energy markets continue to evolve. We continue to work on building the voluntary climate marketplace, a collaboration with IncubEx launched last year and designed to provide clients with the broadest possible view of the fragmented voluntary carbon market. TMX Datalinx revenue was $113.6 million in the first 6 months, a year-over-year increase of 14% due to higher revenue from data feeds, colocation, benchmarking indices and corporate and reference data as well as a favorable FX impact from a stronger U.S. dollar. The first half of the year was marked by important progress and notable milestones for our information services business, including strategic investments as we move to expand our capabilities, broaden our data sets and deliver leading-edge analytics and tools to our clients. The first half revenue included $3.4 million from Boston-based Wall Street Horizon, a provider of global corporate event data sets acquired late last year. And earlier in 2023, we made a strategic investment in VettaFi, a global indices and ETF service provider, which includes a commercial agreement. TMX and VettaFi teams are continuously working together towards the development and delivery of new client-centric index and benchmark products into Canada. And earlier this week, we took another step forward in our benchmark and indices strategy and product road map as we finalized an agreement with our partner CanDeal and to participate in the creation of the new Term CORRA benchmark. A CanDeal affiliate will operate the benchmark administrator and TMX Datalinx will provide licensing and distribution capabilities. Now as you can clearly see, information is key to our long-term global growth strategy. It's a vital strategic enabler as we enter into the next phase of TMX's evolution. And across the organization, we're also focused on new ways to leverage our robust proprietary data sets to solve existing and emerging client challenges. Now with that, let's turn our attention to the derivatives business. Excluding BOX, revenue from Derivatives Trading and Clearing was $82.2 million in the first half of 2023, a 9% increase from last year, driven by higher revenue from MX and CDCC due to increased volumes traded and cleared. MX total first half volume grew 13% compared to 2022, and the level of overall open interest at June 30, 2023, represented a 17% increase from the same date last year. Recent additions to MX's product suite are proving effective in creating efficient cross-market trading opportunities and continue to gain profile among global investors. Strong first half performance was driven by significant growth in activity along MX's interest rate product line with volumes up 19% in the first 6 months of 2022 and 6% growth in volumes in equity derivatives. Some of the other highlights and trends within the activity include ETF options, specifically broader index financials, REIT and crypto sectors showed continued strong interest among investors with volumes up 46% compared to the first 6 months of 2022. Investors were very active in the short-term interest rate products due to the active central bank policy environment. Volume traded in the BAX or core contract were up 33% and volumes in the CGZ, MX's 2-year Government of Canada bond future contract, increased 90% compared to the first 6 months of 2022. Now looking ahead, a key priority for MX -- the MX initiative is the transition from SEDAR to the Canadian Overnight Repo Rate Average or CORRA, with full cessation of SEDAR on track for June 2024. The 3-month CORRA Futures, or CRA, continues to gain traction, reaching an average daily volume of approximately 14,000 contracts in the first half of this year. Now turning to capital formation. Revenue was $144.6 million, a 5% increase from the first 6 months of 2022, reflecting higher issuer services revenue and partially offset by lower financing -- lower revenue from additional listing fees due to a decrease in the number of financing transactions on Toronto Stock Exchange and decrease in dollars raised on both TSX and TSX Venture Exchange. Revenue from other issuer services, which largely consists of the TSX Trust business was $60.9 million, a 50% increase compared to the first half of last year and driven by higher net interest income, slightly offset by lower transfer agent fees. Macroeconomic factors, including sustained high interest rate environment and inflationary pressures continued to weigh on capital raising activity during the first half of the year. And while the number of new listings on TSX and TSX Venture decreased year-over-year, the pipeline of go-public prospects is robust, and we are confident in a resurgence as conditions normalize. Our unique 2-tiered ecosystem remains the choice for small and medium-sized enterprises here in Canada and increasingly around the world. TMX exchanges ranked third amongst our global peers by the number of new international listings during the first 6 months of the year, and more than half of those new companies joined our markets from the U.S. Our business development effort is to continue to promote TSX and TSX Venture's value proposition among early-stage companies in targeted regions across the U.S. And consistent with our history of industry leadership and innovation, TMX continues to be focused on the future of our markets. Last year, our capital formation team undertook an important initiative called Venture Forward, designed to solve the current challenges of stakeholders across our vital venture community and strengthen our markets into the future. TSX Venture has an impressive track record of launching early-stage public companies, funding primarily growth stages and providing investors with access to unique small-cap investment opportunities, but we can always do better. And so in June this year, following an extremely productive and in-depth consultation process, TSX Venture produced a comprehensive report that outlines our commitment to doing better in support of innovation and growth and in order to clear path for new companies and investors to enter our ecosystem. The key Venture Forward commitments include: a TSX Venture Passport listing process to accelerate the listing and capital raising time line for qualified new listing applicants; a TSX Venture Sandbox, an initiative to better support the listing of unique businesses or transaction structures; and third, to evaluate the potential need for a new and highly differentiated exchange to complement TSX Venture with the goal of providing new categories of early-stage companies, alternative asset classes and investors with access to public markets. Venture Forward's commitments are in lockstep with TMX's corporate purpose across the organization as we're pursuing new ways to make markets better. In our equities trading business, earlier this year, we announced 2 new order books on TSX Alpha Exchange, Alpha-X, a visible lit order book and Alpha DRK, a dark order book. With initial features designed to improve execution quality and provide traders with innovative new functionality, the additional order books establish new platforms for continued innovation and an enhanced overall trading experience, and we are on track with this initiative to go live this fall as planned. Earlier this month, we published a consultation paper, seeking industry feedback regarding trading of digital assets, including cryptocurrency on TSX Alpha Exchange. In our view, Canada has an opportunity to be a world leader here in providing a fair and transparent structure for investors to participate in the growth of the digital asset industry. But like all we do, our priority focus is on serving the needs of our clients and stakeholders. So industry feedback will inform TMX of the next step, and we will update the market on our plans as appropriate. In closing today, I'd like to thank all of our partners across the capital markets industry, stakeholders, clients, participants, regulators for their continued partnership and support. And with that, let me turn the call over to David.

Thank you, John, and good morning, everyone. TMX results for the second quarter reflect our continued commitment to invest in long-term growth, while managing uncertainty in the macroeconomic environment. It was another excellent quarter with record revenue of $306.2 million, a 7% growth compared with Q2 of last year as reported. Our operating expenses increased 8% this quarter as we invest to position ourselves for further growth, which I will talk about in more detail shortly. We reported an increase of 6% in our diluted earnings per share this quarter. driven by $9.5 million of higher income from operations compared to Q2 of last year, partially offset by a higher income tax expense of $6.3 million due to, in part, higher earnings, coupled with an increase in the U.K. corporate income tax rate from 19% to 25%, which came into effect on April 1 of this year. Our adjusted diluted earnings per share remains unchanged at a robust $0.38. Turning now to our businesses. I will start with the segments where we experienced increased revenue this quarter. Revenue in our Global Solutions, Insights and Analytics segment grew by 18% this quarter with double-digit growth from both Trayport and TMX Datalinx. Revenue from Trayport was up 24% in Canadian dollars or 17% in pound sterling due to a favorable FX impact of $2.9 million. The 17% increase in pound sterling was primarily driven by a 10% increase in trader subscribers in addition to our annual price adjustments and a growth in total subscribers. Revenue in our TMX Datalinx business grew by 13%, driven by increases in data feeds, colocation, enterprise agreement renewals, Datalinx Express true-ups, benchmarks and indices and the impact of 2022 and early 2023 price adjustments, which we have spoken of in prior quarters. There was also an increase of $1.8 million from the inclusion of Wall Street Horizon's revenue this quarter, along with the favorable impact -- FX impact of approximately $1.5 million from a stronger U.S. dollar. The average number of professional market data subscriptions for TSX and TSX Venture products remained unchanged in the quarter compared with last year, where subscriptions for the Montreal Exchange grew by 2%. This is the second quarter in succession our TMX Datalinx business has delivered double-digit revenue growth, well in excess of our long-term objective of strong growth, which we have defined as 5-plus percent. Turning to capital formation. Revenue was up 10% this quarter, primarily from a 55% increase in TSX Trust revenue, reflecting higher net interest income driven by higher balances, higher rates and above-average corporate actions activity. This increase was partially offset by lower additional listings fees in the quarter due to decreases in both the total number of financings and total financing dollars raised as well as lower initial listings fees. The additional listing fees decrease reflected an 11% decrease in the number of additional listing transactions built at the maximum listing fee of $250,000 and a 23% decrease in the number of transactions built below the maximum fee on TSX. Derivatives Trading and Clearing revenue, excluding BOX, was up 4% in the quarter, driven by a 3% increase in revenue from the Montreal Exchange and a 6% increase in CDCC. The Montreal Exchange revenue increase reflected an 11% volume increase this quarter compared to the second quarter of last year, along with the positive impact from the pricing changes, which came into effect in January of 2023. This was somewhat offset by an unfavorable product and client mix. Turning to BOX. BOX revenues decreased 7%, reflecting a lower rate per contract, which more than offset the 23% increase in volumes on BOX in the quarter and a favorable FX impact of approximately $1.2 million on BOX revenue from a stronger U.S. dollar. Of note, BOX's market share in equity options remained flat at 6%. As a result, the entire Derivatives Trading and Clearing segment reported flat results this quarter as the increases in the Montreal Exchange and CDCC were offset by a decrease in reported BOX revenue. Revenue from our Equities and Fixed Income Trading and Clearing segment decreased 4% in the quarter compared with the second quarter of last year. This decrease was driven by a 28% decline in the overall volumes of securities traded on our equities marketplaces. Trading volumes on TSX decreased by 28%; TSX Venture Exchange by 22%; and Alpha by 40%. Despite the downturn in volumes, we saw gains in our combined market share this quarter, which was up 1% for TSX and TSX Venture Exchange listed issues. On the fixed income trading side, revenue increased versus Q2 a year ago, reflecting higher activity in swaps, partially offset by decreased activity in Government of Canada bonds. Revenue from our CDS business was up 7%, reflecting higher interest income on clearing funds, event management fees and standby liquidity fees. Turning now to expenses. As mentioned earlier, operating expenses in the second quarter increased 8% on a reported basis compared to last year. More than half of our increase in expenses is driven by inflationary pressures, coupled with higher foreign exchange rates, while the remainder is driven by targeted investments we are making in growth areas of our business in order to accelerate our long-term growth. As is evident from our disclosures, we have increased our full-time equivalent employees. These increases are in targeted areas of our business that are driving high growth, most notably, Trayport and TSX Trust in addition to our acquisition of Wall Street Horizon. With over 2/3 of our staffing increases in our revenue-generating business, the balance is across our core corporate functions to support our businesses, most notably our global technology solutions team, which accounts for the majority of the remaining 1/3. In addition to increased staffing, we have increased our discretionary investments, driven predominantly by growth investments in our Trayport, trust, markets and derivatives clearing businesses in addition to lower capitalization of our post-trade modernization project during the slowdown period as we address the industry-wide move to accelerate the move to T+1, as I noted in the first quarter. Given our investments to drive higher growth, both in 2023 and beyond and lower capitalization for the post-trade modernization project during the slowdown period, our quarterly expenses are expected to hold at the current level for the remainder of the year, consistent with what we had previously communicated. In other words, the best indication of future spend levels is our current run rate. While there may be quarterly fluctuations, I expect our first half expenses to be the best indication of our second half spend levels. Turning now to our sequential results. Revenue increased $7.1 million from the first to second quarter, primarily reflecting higher TSX Trust revenue driven by an increase in net interest income and higher additional listing fees due to an 82% increase in the number of transactions billed at the maximum fee as well as higher Trayport revenue on the back of an increase in subscribers and a number of long-term deal renewals. This was somewhat offset by lower equities and fixed income trading, driven by a 19% decline in the overall volumes of securities traded on our equities marketplaces, as well as lower Derivatives Trading and Clearing revenue, reflecting a 10% decrease in volumes for the Montreal Exchange and CDCC. Operating expenses remained unchanged from Q1 to Q2, much like we intend to do as we head into Q3 and Q4, as I mentioned earlier. Turning to our balance sheet. In the 6 months leading up to June 2023, we spent $16.8 million repurchasing 622,090 shares of our common shares under our normal course issuer bid program. Our debt to adjusted EBITDA ratio was 1.9x at the end of the second quarter, down from 2x at the end of the first quarter, and we also held over $470 million in cash and marketable securities, which was about $295 million in excess of $175 million we target to retain for regulatory and credit facility purposes. Last night, our Board approved a quarterly dividend of $0.18 per common share payable on August 25 to shareholders of record as of August 11. This is a 3% increase from our Q1 and follows on the heels of our recent increase in Q4 of 2022. And most notably, this is also our third increase in 18 months. With this increase, we will pay out 47% of our adjusted Q2 earnings per share, which is marginally above the midpoint of our target payout ratio of 40% to 50%. Our consistent growth in earnings and disciplined capital management track record underpins our confidence to continue to generate growing free cash flow and remain focused on executing our long-term global growth strategy that John referred to, to deliver increased value to our shareholders. With that, I'd like to turn the call back to Amin to initiate our Q&A period.

Thanks, David. Anas, would you please outline the process for the Q&A session?

[Operator Instructions] Your first question will come from Ben Budish with Barclays.

Maybe one for David. Just the sequential increase in the trust revenues was a bit higher than we were expecting. I was wondering if you could kind of parse that out a little bit more. I mean you mentioned a couple of different factors, more corporate actions, higher rates, higher balances. How did the 3 of those, like relative to each other, sort of impact the quarter?

Thanks, Ben. So you're right. Q2 is higher than Q1. That's actually a recurring phenomenon. So typically, Q2, we see a little bit more activity than we would see in Q1, Q3 and Q4. So if you look back historically, you will see that. In addition, then you are right, there are higher rates this quarter and also higher balances and higher corporate actions. But we really don't go into kind of parsing them all out into individual components. That's a disclosure we just have historically not done. So what I would do is look at the Q1 balance for the trust revenue. I would adjust for any rate increases between Q1 and Q2. I then also look at a historical kind of Q2 analysis to see what the norm is. And then I'd use that as a jumping off point as you go into Q3.

Got it. That's helpful. And then maybe just kind of one follow-up on the same topic. Just an update on sort of the cross-selling initiatives between the legacy trust business and AST, progress kind of moving that product upmarket. Where are you in that sort of process?

That's a great question too, Ben, and John will probably add in here as well. That's actually a big reason why we did the AST acquisition was to give us an opportunity to participate in more trust mandates, larger corporate actions. And so you're seeing the benefits of that in Q2. As you do the analysis, you'll see that there's larger corporate action activity. John, do you want to add anything?

Yes, I think that's exactly right. So thank you for the question. I mean our whole investment thesis when we did this was to be able to be able to support a larger base of clients with more diverse needs. And you see that lift in Q2 is exactly that kind of result. When you've got a larger base of clients and we can support multiple products across that, we can cross-sell, upsell, or provide additional services like trust mandates, it allows us to participate in more and much larger corporate action activities than we could have in the past. So while as to David's point, that step-up in Q2 isn't necessarily indicative of a run rate, and we want to guide you back to kind of what the Q1 plus growth looks like, it is indicative of the broader potential, given our larger service base, the services we can provide, the cross-selling opportunities and the bigger clients that we can serve. So it's exactly as you suggested, and it's working very well. You see that in the result.

Your next question comes from Nik Priebe with CIBC Capital Markets.

In the prepared remarks, I think you alluded to a partial concentration of staffing growth at Trayport. And I understand your guidance is for flat operating expenditure at the enterprise-wide level for the balance of the year. But as we look out into 2024 and 2025, can you talk a little bit about the prospect of operating leverage at Trayport specifically and the need for incremental headcount additions as the subscriber base continues to grow over the next few years?

Great question, Nik. So normal course, we're going to have positive operating leverage in the multi-basis -- multi-percentage point kind of gap. But as we obviously go to invest in growth, there are periods where, either on a quarter basis or a half year basis, we will see that actually compress a little bit. Our 2024 jumping off point will be 2023. 2023, as you can see relative to 2022, we are investing in long-term growth. I would expect it to moderate in 2024 and 2025. But that's absent any kind of opportunistic opportunity that we might actually see and take advantage of. And specifically, when you talk about Trayport, I mean, one of the things that's important in our Trayport franchise is our Joule Direct platform. Our Joule Direct platform is something that we do feel we can continue to improve and modernize. There's lots of talk about cloud architecture and more agile approach to responding to our clients' needs. So I know our Trayport team are looking very closely at that and doing early-stage investing to actually modernize that platform.

Understood. Okay. Very good. And then my second question, just maybe stepping back for a moment. With some of the investments that you've made last year and early this year, Wall Street Horizon and VettaFi as an example, do you expect to upstream any cash flow via dividends from those investments? Or are those businesses more focused on being in growth mode? I'm just trying to get a sense of what the contribution of some of those businesses might be to cash build over the next year or 2?

Yes, it's a totally fair question. So let me separate them because there are different types of investments. So Wall Street Horizon, we will, in the next quarter, essentially complete our integration of that business, and it will operate as a product line within our Datalinx franchise. So all of the growth in it, and it is a high single double-digit grower as well with the potential to be higher, will accrue into the Datalinx business and the cash flow that goes with that. And then as we execute the rest of the integration, there will be some synergy potential in that business as well. So think of that more as a traditional small tuck-in with that cash flow flowing right through the business as we continue to grow it. The difference around VettaFi being that we're in the 22% stake, the -- we're 22%, the business itself has some debt financing in it as well. It has the actual amortization of the investments that [ it has ] made and that's why you don't see a full pull-through. In the stage right now, it is -- we would deem it to continue being in that growth mode where it's reinvesting to grow faster. It is a high-growth franchise. We wanted to continue to do that. Both Jay and myself participate in the Board of VettaFi, and that's the ambition that we all collectively have for that business. So in the near term, I don't see that as being a -- as you said, a dividend producer for us. But as you know, we've got long-term ambitions to continue to build out in the index and analytics basis. And those initiatives as we build them in partnership with VettaFi will accrue to cash flow for the organization.

Your next question comes from Etienne Ricard with BMO Capital Markets.

I'd like to circle back on the ongoing transition from BAX to CORRA, the Montreal Exchange. So a few questions. I guess, first, how is the adoption of the CORRA product comparing to your initial expectations? At what point would you expect volumes to be comparable to what it used to be on the BAX once the transition is completed next year?

That's a -- it's a fantastic question. So actually, we're farther ahead than we expected to be at this point, given the actual cessation of SEDAR isn't around till middle of next year. So the fact that the average volumes in the CORRA are already 14,000 contracts a day, and I actually think in the last number of months, we've been more in the 20,000 to 30,000 range, is a really strong start. And the -- we are also just in the stage where the actual benchmarking agreements, the normalization and the presentation of the benchmark that CORRA is based on are getting institutionalized in the street. That's why we mentioned the partnership agreement that we've done with Canada, the mandate -- sorry, with CanDeal, the mandate we have collectively taken on from the Bank of Canada to produce that index to distribute it to produce the number -- to distribute the data around it. So we are still in the early stage of the development. So the fact that we've got that level of volume in the contract is actually very strong. The expectation is this really gets -- when you get closer to cessation, that you'll see these products converge. And so what we've been guiding people in terms of when you look at the volumes in both the CRA contract and the BAX contract, you really look at them in combination, and you will see that volume migrate over time. Right now, it's more BAX than CRA, and we will expect that to continue to adjust as we get closer to the transition date next year. And that's what's been driving a lot of our short-term results is that return to the trading in both the BAX and the CRA after last year, which, if you remember, was light, given the very volatile environment in central bank rates. So that's how I'd guide you on that, and we'll continue to monitor it quarter-on-quarter and keep you up to date.

And will economics be similar?

Similar in the long run. So in the initial stage, as we do our work right now, we do have -- like we have with other 2-year and the 5-year, we have market making agreements with the CRA product to help build the volume in that business. So in the initial stage, particularly this year and next year, there is a different capture rate on that product. But as we get into normalization and maturity, it should look very similar to the BAX product.

Yes. Understood. And I guess just switching gears on the Boston Options Exchange, what I find interesting is that U.S. equity option volumes still remain strong relative to pre-pandemic levels. What are your thoughts on the sustainability of volumes seen across the industry and more specifically at BOX?