Virtu Financial, Inc. (VIRT) Earnings Call Transcript & Summary

Welcome back to Piper Sandler's Global Exchange and Fintech Conference. We're very pleased to have Virtu Financial's CEO, Doug Cifu. He's done a number of acquisitions. He bought Knight, he bought ITG. They are one of the leading wholesale market makers, and experienced -- definitely a beneficiary of the retail frenzy we've seen throughout last year and this year, even continuing, at least in our view, continuing on here more recently.

So I guess we'll start in -- I assume, Doug, did you tune in and see Chairman -- Chair Gensler's talk and any comments or feedback or color you'd like to provide?

I did. I did, indeed. And thanks very much, Rich, for having me. I appreciate it, as always. I think this is like our 10th year of doing this or so. And it's kind of interesting because like history, as it often does, repeats itself, right? And so we go through these cycles. And I'm not at all trying to minimize, and I will address the comments. But we went through this period in 2013, '14, '15, a little bit 2016, where everyone -- well, I guess, you probably didn't have your hair on fire, Rich, but a lot of people had their hair on fire saying HFT, Flash Boys, this book came out and there's all these ills in the marketplace. And front-running and people used all these exaggerations about the marketplace. And this is going to change, and that's going to change. And Schneiderman got big fines out of Barclays, and then he went off to prison. I really miss that guy. And ultimately, at the end of the day, the SEC looked at this, there was a tick pilot, there was this, there was that, and really not that much changed. Really not that much changed, because people recognize that there was a lot of value being added by the "HFTs", particularly those of us that were market making firms, right? And we kind of moved along our way. And the prior administration, Chairman...

Clayton.

Clayton. Jesus, I'm blank, and Jay is a friend of mine. And [ Brett Reeves ], how quickly you forget? And Brett Redfearn, right? They obviously were more, I said, attuned, I guess, to the equities market, really understood it, really understood how the ecosystem had developed. And that's really important because philosophically, you think about it in this country, right, Gensler talks a lot about Canada, Europe and Australia, whether institutional investors like it or not, we've made a policy decision 30-odd years ago that we were going to do this separate ecosystem for the retail investors. And give the retail brokers a lot of credit, the Schwabs, the Fidelities, the E*TRADEs, now even the Robin Hoods, the other 195 brokers out there, they really have extracted a lot of value for their clients, right, in the form of price improvement. Really have extracted a huge amount of clients. And they can create execution, better, frankly, than any of the institutional investors watching this could get. I've had a number of clients on the institutional side, say, dang in my PA or whatever it was when I was in between jobs, I traded on TD Ameritrade or E*TRADE, and you're right, you can create execution. You can send 1,000 shares and you get better than the NBBO. So at the end of the day, I'm not trying to minimize anything that the Chairman said. He's incredibly intelligent. He is very diligent. He's a very thoughtful man. I worked with him when he was at the CFTC. He did some really good things around swaps and sets. And obviously, was involved in Dodd-Frank. This is a very complicated ecosystem. It's an ecosystem that has developed over time. It's an ecosystem that's provided an enormous amount of value. There are things that need to be changed. The Rule 605 disclosures, honestly, are incredibly antiquated. We are releasing a report today, a white paper today, that I will talk about tomorrow at the SEC hearing, that really calculates what we call real price improvement. All of the urban legends around odd lots, around posted odd lots and odd lot orders, we debunk all of it. I mean, candidly, it's all nonsense, stored up by the critics that either are, what I'll call, like the Lincoln Project guys in markets that just want to get paid for like talking about stuff they really don't understand, or they're trying to sell something to the buy side. But at the end of the day, if you have -- if you really look at the data, which we're providing, this is all proprietary Virtu data, looking at every trade that we did in 2020 for retail clients and aggregating all of the price improvement including, which we'll talk about, I hope, size improvement, which means if the inside is 200 shares we get a share -- we get an order for 500 shares, guess what institutional clients, retail clients get filled at the 200 share price, right? Rather than some VWAP price. So think about how outstanding yet that is. And that liquidity doesn't exist on an exchange. Rich, 40% of the retail orders that come to Virtu. This is just Virtu. I don't know what Citadel does. I'm guessing they do something similar. 40% of the retailers that come to Virtu, either marketable orders or nonmarketable limit orders, are available on a national securities exchange or an ATS. Nonmarketable limited orders by rule, by rule, so a resting limit order that we get from a retail client is reflected on the national securities exchange. So those that say, "Oh, retail doesn't help in price formation." Well, it certainly does when someone's got a limit order, okay? So that's the first thing that's complete horse hockey, if that's a word. Andrew said I can't curse. The second thing is with regard to marketable orders, 30% of those, we don't internalize. We still have to price improve from them. So what do we do? We go to national securities exchanges, ATSs, and we try to get midpoint liquidity because that saves us money. So for all of you guys out there that want to trade retail, go post at IEX midpoint, right, in size and 8,000 names in the way that we do as a wholesaler, and guess what, we'll remove from you all day, because we're spending hundreds of millions of dollars every year, sourcing that liquidity. And when we come up empty, Rich, we still have to price improve it. The brokers don't care that we didn't internalize it, right, so that cost us hundreds of millions of dollars. So if you think about that ecosystem, how crazy is that, right? That we're sitting there in the middle doing all this and managing this risk at the same time, that is not going to happen on a national securities exchange. The notion that, magically, like fairy dust gets thrown into the marketplace, you de-segment, and all of a sudden, Virtu and Citadel, we just put all of our natural interest that we want to buy and sell on a national securities exchange. We don't get our faces ripped off and the spreads don't widen. I mean, I don't know what trading universe that would happen in, but none that I'm aware of. So the critics that say, oh, if you put it all on an exchange, spreads would narrow. Honestly, I don't even -- it's embarrassing that people make that argument. They have no data whatsoever. It's the same thing is saying, Rich, that you'd have a full head of hair, and I'm 6'5, 210, right? There's no truth, in fact.

So one thing I wanted to clarify...

I went off on a tangent, but I wanted to go off on a couple of tangents here.

Well, I think there's one point that I think investors should understand and it may take a little explaining, but when you say if there's a bid at $10 for 100 shares, and then a sell comes in, say, for 500 shares, you price improve off the $10 for that full 500?

Correct. Correct. So even if like the next level down had 200 and 200, right? And so the VWAP for that would be whatever, and an institutional client like if we had a parent order, and we said, hey, listen, we beat VWAP over the day by like 0.5 basis point, whatever it was, they'd be thrilled. Well, imagine if you're an institutional client and you send us an order for 10,000 shares of Virtu, for example, right? I imagine the top book of Virtu, I've never looked, frankly, because we don't trade it, is 10,000 shares. It's probably like 1,000 shares at most, I don't know, something like that. Those actual 9,000 shares, you'd be happy if it traded through, I don't know, $0.10, $0.15, I have no idea because I don't look how Virtu trades. We're giving top of book pricing effectively on that entire order, right? We call that size improvement. So when you look at this study that we put out that I'm going to talk about tomorrow at the SEC, you'll see that the aggregate amount of that size improvement, just using a simple VWAP formula, as we would with our institutional clients, literally is a couple of billion dollars a year. So in aggregate, when you take away for odd lots, it's de minimis. When you add for size improvement, we're providing about $3 billion of price -- of real price improvement. The 605 reports are c***, real price improvement is $3 billion. My friends at Citadel, who have a larger market share than Virtu, my guess is their real price improvement number, if they chose to put it out, I have no clue, but it's going to be order of magnitude, 20%, 30% larger than ours. So they're doing probably about $4 billion. Susquehanna is probably doing a couple of billion -- Susquehanna and everybody else is probably doing a couple of billion. So there's $10 billion of 605 style price improvement, plus-size improvement, it's all happening in this marketplace. So you're going to tell me that a right thinking SEC is going to look at all of that, after discussing it with some of the largest financial institutions in the world that are retail brokers and say, no, that doesn't make sense. Let's all give it to the New York Stock Exchange, like it's -- let's party like it's 1985 again. Let's make spreads a quarter and let's bring back the specialist system, and let's go back to commission style trading. Not going to happen. It just won't happen.

Yes. I think we all will look forward to reading your white paper tomorrow.

Not that I have an opinion on it, Rich, at all. I'm very shy.

Yes, it wasn't -- let's just say, I think we'll all look forward to reading.

That's great. I have written testimony you'll see, and then there's this white paper attached to it that goes through it. It's very factual. We've prepared it, because we know FINRA and the SEC are going to ask us for the backup data. It's all there. It's all there.

Got it. Let's move forward. If there's something else that comes to mind that you want to make a point back on that. I'm happy to return.

Yes. No problem.

But let's talk about the organic growth opportunities for Virtu. So you've integrated ITG. You got a number of -- whether it's -- whether it's auctions, market-making ETFs, et cetera, you even mentioned crypto opportunities, capital markets desk. We are a little bit beyond the quarterly release and conference calls. Anything -- what's your priorities in regards to that growth opportunities?

Yes. Yes. I mean, we -- Joe Molluso, our President, put out today -- well, I guess the company did, but Joe really prepared it, did a great job, which kind of lays out. We filed an 8-K today for everybody, everyone's benefit, so that we could talk to investors more fulsomely. And really, what he did was try to take a -- what has -- if you look over the last 5 years, right, what's the kind of normalized, for lack of a better word, EPS that the firm has had, right? I mean one of the challenges we've had, and this is feedback we got from investors, we always try to listen to you was, it's hard -- there's been a lot of changes at Virtu, right? 2015, you go public, then you buy Knight and you buy ITG and your synergies and expenses going up in capital and you're doing this and you're paying back debt. So try to normalize all that and say, okay, this is what EPS looks like on a normalized basis, okay? This is what the growth opportunity should provide, and I'll talk about those, Rich. And then we've said very publicly, very, very publicly, that we're committed to these stock buybacks, right? And so those are obviously going to reduce our share count over time. So in the supplemental investor deck we put out today, we tried very hard to kind of lay that. And the middle layer of it, obviously, is to say -- is to try to separate the wheat from the chaff and say, okay, we are growing organically. And to try to size that opportunity over a period of years, right? These businesses don't get built. We didn't start Virtu and magically, we weren't making a couple of million dollars a day as a noncustomer market making firm. But in terms of options, I have said publicly, it's already an 8-figure per year business, and it's growing like a weed. I loved it. We're doing it the Virtu way. The block ETF business, right, has been -- was very successful in 2020. And in the first quarter of 2021, that success continued. We had over $950,000 per day of organic growth in the first quarter -- organic growth initiatives in the first quarter of 2021. So that's 1a. 1b would be the block ETFs. And then 1c is taking what we obtained from Knight Capital and expanding it outside of U.S. equity. So those 3 main drivers are kind of what has provided the growth, which is in the investor materials. Again, $900,000, I think it was $961,000 a day, something like that. It's all publicly-available information. In addition to that, Rich, we have -- and we've talked about it publicly, we are a -- this is not a statement on whether Bitcoin is good, bad or ugly. That's sort of not my judge to make. I don't really care, frankly. Because to me, if it's a store of value and people want to store it as an ETF, as a future or a spot, if you will, that's nirvana for Virtu because we're a market maker in all 3, and we're going to do that. So we're doing that up in Canada. And to the extent the SEC sees fit to approve crypto ETFs in the United States, I think that's a huge opportunity for us, right? Fixed income, credit. We're a block ETF market maker. It occurred to us, right, because we were losing edge that, hey, maybe we could be a market maker in the underlying. And we are doing that. So we are now a market maker in credit for the first time. Joe Molluso tells me it's $942,000 a day. See? He wants to make sure I don't have a Reg FD issue. I overstated it by $19,000 a day. That's what CEOs do. I apologize. And then the last thing is on the execution services side, the new business we started, which is Virtu Capital Markets, which is a really, really nice capital-light agency style business doing these at-the-money offerings, right? So those -- I guess it's like 6 kind of things that we're doing right now, they're all kind of going at their own path, Rich. And as I somewhat colorfully said on the last earnings call, in response to one of your colleagues asking me 2 very pointed and very repetitive questions about April, I said, listen, I'm running this company. My mandate is, I don't want to sound like some pie in the sky kind of CEO because I'm not, but I run this company for April 2023, '24, '25, whatever my long-term view is. And I have a 3-, 5-year plan here with regard to this company. We're going to grow it organically. The way we've talked about it. We're going to continue to be excellent around managing our expenses, and we're going to get better at that, right? And we're going to take every penny that is not nailed down, and we're going to buy stock back with it. Right? So the bar for doing something inorganic has to be better than Joe calling up our 10b-18 broker and buying stock back, right? That's kind of painless and kind of accretive. So if you add A plus B plus C, right, that's the growth story of this firm. And I've been long -- for a long time, and I will continue to be very long Virtu for a long time. Because I believe in what we do, I believe where we're positioned, I believe in our efficiency. I believe -- the Chairman, today, talked about like concentration and competition, and Virtu is in there doing that, right? And we're competing with Citadel every day, and there's other great competitors in there. But the only reason we can do it is because we're scaled and because we're efficient. So that's the long-term vision, Rich, for Virtu. Again, all investors are terrific. We spend a lot of time with them. Short term, there's going to be blips like this focus on PFOF. There's going to be quarters where we're going to make X, and then there's going to be another quarter where we're going to make a lot less than X, and then it's going to go up and down. And so that frustrates people, I get that. But I want you all to kind of hear what the long-term vision of this company is going to be. And I'll talk to any investor. But obviously, my view is I'm working long-term to create that shareholder value. And I think we're doing it.

Got it. Got it. Buyback is a significant part of that.

Yes. Absolutely.

Vision here now.

100%.

So can you talk about some of the restrictions so people can sort of gauge like there is restrictions on the amount you can buy. And I think people took a look at last quarter and -- the fantastic quarter for Virtu. And -- but could you walk through, I guess, the timing, which is...

Yes. I mean, Joe would be better at this than I am. I mean, obviously, I know there are securities trading windows, right? We're subject to -- one of the things that Gensler talked about already was like executives trading stock. Well, the company is no different, right? There are trading windows where after we file a 10-Q or a 10-K, all material nonpublic information is out there, right? And so we bought back $170 million through the end of the first quarter. I thought that was a lot, right? We're trying to be responsible, one to our legal obligations; and two, we have to be realistic, right? The float in the stock is not insane, right? So we don't want to -- so we give instructions to our 10b5 -- 10b-18, excuse me, agent, and we elect -- and we create a 10b5-1 plan, Rich, for the in-between periods, right, where we have to kind of guess as to -- we have to make that election and then we -- I used to be a securities lawyer, so I guess I arguably should know this stuff. We have to make that election and then kind of guess as to what the volume is, but we don't want to become 52% of the market. I don't think that, that's in our best interest, right, because we want to kind of manage this process and VWAP it intelligently. But again, we're telling you is like right now, we're in a dark period, right, because we're in between quarters, right? So we're going to be buying back less because we gave instructions to our -- once the information is out there, we can be opportunistic like any investor would be. So we're managing that. Joe is -- there's nobody better than Joe Molluso with doing that. He spent a long time as an investment banker at JPMorgan. I trust his judgment. And so if anyone has any questions or complaints, please call Joe. But more importantly, what we're telling you and what our Board has supported is that's the long-term plan for this company. So okay, maybe we didn't buy back enough to make you happy in the first quarter. We're still in the market buying it back today, and we're going to be doing it a year from now, whether it's X, Y or Z, right, we're going to be buying it back in every dollar that we don't need to otherwise invest in something and pay back debt, which is pretty de minimis, we're going to be using towards our buyback plan.

With the increased trading activity in general...

Is that Joe calling? Is that Joe?

He's calling to correct you.

Yes, I screwed up. Yes. What did I screw up now? Okay.

The -- with the increased trading activity, has there been any material changes in trading capital, I guess, is the question?

No. I mean the good news is, put that in quotes, right, is we're not Robin Hood in the sense that like we're a market maker. So we control -- absent other than our institutional business, we control our margin, right? So whether we're end-of-day long 10 million or 100 million of GameStop, which we would never do, just for the record, is entirely within our control, right? And so we can manage our margin. We always have, and you know that because you've been to Virtu. On the institutional side, right, where clients are sending us orders, and you got to take them, right? So we're like Robin Hood, there we both self-clear, but we also have engaged the services and more importantly, the capital and the balance sheet of 3 very large partners: 2 here in the United States and one in Canada, whose names you would recognize, right, that cleared for us. So frankly, the margin and the capital is on the move. If Robin Hood had a -- if JPMorgan was clearing Robin Hood in January and February, JPMorgan might not have been happy, right, but they have enough -- they would have been able to post the $2 billion or whatever it was. I mean, that was -- the issue was Robin Hood was self-clearing and its capital and its broker-dealer was smaller than the margin call and then they stipend you like a penalty charge on top of that. I know more about margin and capital and how the DTC works. I'm going to guess than any other CEO, other than Bodson, who runs the DTC. Because I started this firm, it was our own money, when Vinnie and I started the firm. And so I learned the margin rules and how the DTC works quite well.

So that's a good question. So they now are contemplating [ tiers 2 plus one ].

Yes.

Would that have any -- hopefully, would have a beneficial return.

Yes, that's a good thing from our perspective, right? We don't have a stock lending business, right? So we try to manage our book. And if that business breaks even borrowing and lending, we're very happy. So reducing the time that we have to finance our positions is a good thing. I'm going to guess Joe could probably figure out how much that was. But it's significant, right? And it's good for the entire industry. So we have -- we're very involved with the DTC. We have a representative on the Board. And so we are -- Bodson runs a world-class organization. Those guys really know what the hell they're doing. And they have a plan to go to T1. We're 100% supportive of it.

Got it. Got it. So you are planning for the long run with these organic growth in your 3, sort of, priorities: grow organically, manage expenses, buy back shares.

Right.

So I guess the question is, in the long run, how did -- is there a way -- will growing these organic initiatives, whether it be options or you have to -- like looking at the volatility of the earnings stream, is that something that can -- you think can be reduced? Or do you think that's just sort of as you look at it at a long-term basis?

Yes. I think you got to look at it on a long-term basis. I mean everything that I articulated is a transaction business, right, where in all of the aforementioned, we're collecting bid-offer spread except for -- in the Virtu Capital Markets business, right? And part of the problem, put it in quotes, is that because a lot of our P&L and our trading profits come from these transaction businesses, they're going to -- there's going to be a certain element of them that is going to go up and down with market volumes and market volatility. That is endemic to running a trading firm. And those growth initiatives, in some way, actually, Rich, are going to exacerbate that, right? Because if you're an options market maker when there's more volatility, I imagine you make more money, and that is the case. An ETF block market makers make more money when there's more of a disconnect. So you know what? The label is true. We are a market making firm. We trade a lot and so guilty as charged, your honor. Again, I think that's a great place to be. I think we're going to be the most efficient party. I think what we're trying to do though is explain to people that it's not just -- we're trying to separate the alpha from the beta, right? It's not just the market that's moving up and down and somehow Virtu is just kind of like this steady state thing. That's a very difficult thing to do. And I understand that. I think long-term investors get that, and we have a number of people that have been long-term investors and kind of have hung in there with Virtu through the cycles. And it's part of educating people. And that's why we tried to put out that clarity today, Rich, that we did. Look, if I could wave a magic wand, would I want to be my friend, Rick McVey at MarketAxess that trades at 52x EPS or whatever he trades because he runs an amazing business. He's a great guy. He and Chris do a great job. And I guess the market looks at that and says, okay, well, they're -- one, it's electronification. And two, they're taking a brokerage commission effectively. So somehow -- I mean it's a little volume dependent also, right? But I guess the bid offer widens. So therefore, our business, our dollars aren't as valuable as their dollars. I don't get it, but the market is what it is.

The market sometimes is hard to decipher, Doug, I can tell you that.

Yes. Yes. But look, I think the variability and upside is a great thing, right? If we had another quarter, like the first quarter 2020, Joe will correct me, but I believe we paid down close to $300 million of debt, right, in one quarter, right, because we had this bounty. And if that happened again, we'd just buy $300 million of stock back. Right? I mean, depending upon the price, obviously, it's 10 million shares. Hopefully, it's 5 million shares because the price goes up, but like, that's material. We have 192 million shares outstanding today, something in that zip code, right? So like if you think about what the trajectory of this firm is going to be like, we're going to have those quarters, right, where it's going to do this. And we're going to take that. We're just going to reduce our share count, right? And so like if that's not the most accretive thing one can do. I just got a text from Joe, let's see if I got 192 right. He said $300 million. I got it right. So there you go. Like to me, that's kind of a no-brainer to do that.

Yes. I think the -- well, hopefully, the market will reward you once they see a buyback, debt -- paying down debt certainly is in that process, but maybe reducing the...

Yes. Look, I mean, I'm long Virtu. I get paid in a lot of stock. And just for the record, I get paid gross stock. So I pay the taxes on it. So every year, I'm buying Virtu because I'm paying taxes. If you look at like the little comp thing for Doug Cifu when you look at my share count, it goes up every year. I don't have the company sell any stock on my behalf. So in 2000, I don't want to -- you can probably figure it out, I don't even -- I'm embarrassed to tell you, I don't remember because my wife pays the taxes. But I probably -- it was like $4 million, $5 million of Virtu stock easily because of all the shares I get issued to me, there's no withholding for me. So I'm buying stock every day that I'm CEO, and I will continue to do that.

Doug, my friend, we are out -- my time.

Wow, that was quick.

Yes, it was. Time flies here. I do, and I suggest to investors as well to read the -- read your white paper tomorrow. And thank you for laying out long-term vision.

Absolutely.

We think it's a company that I think people need to understand and look at it that way.

All right. I really appreciate it. And promise me next year, we're going to do this in person man. I'm tired of this pandemic stuff.

You're telling me.

Let's go.

I think the nuances that you lay out in these papers, it's unfortunate you need to, but...

It's all about education, Rich, all about education and transparency. We went through this in '13, '14 and '15. We came out the other side a much stronger, better understood firm. The exact same thing is going to happen here. I'm 100% confident of that.

We're going to wrap there. I'm going to say, thank you, Doug.

Thank you, guys.

For our audience, next up at 4:30, like in 2 minutes, we're going to do an equity market structure panel. And we hope everybody will tune into the last, and we focused on equities here to round up the day. Thanks, Doug. We'll be in touch. Talk soon.