MarketAxess Holdings Inc. (NASDAQ:MKTX) Q1 2023 Earnings Call Transcript

MarketAxess Holdings Inc. (NASDAQ:MKTX) Q1 2023 Earnings Call Transcript April 26, 2023

MarketAxess Holdings Inc. beats earnings expectations. Reported EPS is $1.96, expectations were $1.9.

Operator: Ladies and gentlemen, thanks for standing by. Welcome to the MarketAxess First Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. And as a reminder, this conference call is being recorded on April 26, 2023. I would now like to turn the call over to Mr. Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Steve Davidson: Thank you, Bo. Good morning, and welcome to the MarketAxess first quarter 2023 earnings conference call. For the call, Chris Concannon, Chief Executive Officer, will provide you with an update on key business trends; Chris Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter; and then Rick McVey, Founder and Executive Chairman, will provide an update on the market environment and the long-term opportunity ahead for the company. Before I turn the call over to Chris Concannon, let me remind you that today’s call may include forward-looking statements. These statements represent the company’s belief regarding future events that, by their nature, are uncertain. The company’s actual results and financial condition may differ materially from what is indicated in those forward-looking statements.

For a discussion of some of the risks and factors that could affect the company’s future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31, 2022. I would also direct you read the forward-looking statement disclaimer in our quarterly earnings release, which was issued earlier this morning and is now available on our website. Now let me turn the call over to Chris Concannon.

Chris Concannon: Good morning. I’m very pleased to share with you our strong first quarter results on my first earnings call as CEO of MarketAxess. We continue to execute our growth strategy during the quarter and delivered record revenues which increased 9% or 11% on a constant currency basis. Earnings per share grew 15%, reflecting the continued improvement in our underlying revenue and earnings growth trends, as shown on Slide 3. These strong results were broad-based across products, protocols and geographies, reflecting the powerful diversification of our model driven by the investments we have made over the past several years. Specifically, we delivered record levels of average daily trading volumes across nearly all products.

The fourth consecutive quarter of strong estimated market share gains, record levels of commission revenue across U.S. high yield, emerging markets and eurobonds, record levels of revenue and trading volume contribution from our international businesses and record levels of volume from newer client segments, new initiatives and record levels of automation. In summary, we had a very strong quarter with records across key products and protocols. The impact of the rapid rate rise in 2022 has now filtered into the broader market, resulting in the banking sector market dislocation in March. While we have seen a retracement in industry volumes over the last several weeks, we believe this is a temporary pause as the markets digest the events of March and their impact on the trajectory of rate hikes for the Federal Reserve.

Lastly, I could not be more pleased to have Nancy Altobello as our new Lead Independent Director of the Board, which was announced earlier this week. Nancy brings a wealth of audit, talent management, diversity and corporate culture experience to the role, and I’m looking forward to our continued collaboration and partnership. Slide 4 highlights the strength of our unique all-to-all solution, Open Trading. We were very pleased with the performance of Open Trading in March. As liquidity became more challenging in March, we saw daily highs of Open Trading share grow to 57% in high grade and 61% in high yield. For the quarter, we registered record Open Trading average daily volume of $4.5 billion, up 21%, with record U.S. high-grade share of 34%.

We are executing approximately 13,000 trades per day in Open Trading and approximately 32,000 trades per day across total credit. Open Trading also delivered total price improvement of $252 million, well in excess of our quarterly revenue. Slide 5 highlights our multi-dimensional growth across new products, new initiatives, new client segments and geographies. First in new products, we grew estimated municipal market share to a record 6.4% in the quarter with 376 active client firms trading. We have also recently integrated the muni broker system with the MarketAxess pool of liquidity to provide clients with more trading options. In U.S. treasuries, we continue to see client growth in our treasury offering with 250 active participants on the platform up from 145 in the prior year.

We have established a very strong pipeline of future growth cylinders with record volume across dealer RFQ, portfolio trading, our diversity dealer initiative and Axess IQ, our front end for private banks in Europe. We are also seeing strong contributions to our growth from newer client segments, including hedge funds, systematic funds, dealer initiated flow, and private banks. We generated a record 216 billion in trading volume from these important client segments, which now represent 25% of our total credit trading volume. Our estimated share of U.S. high grade can fluctuate given various market factors including the banking crisis, block trading activity, new issuance, and growth in client segments outside of our focus on institutional client flow.

For example, we estimate that the dealer-to-dealer retail segments of TRACE grew 31% year-over-year and now represent a combined 28% of high grade TRACE up from 25% in the prior year. Lastly, in emerging markets, we had record ADV, this quarter with local market volume growing 10% year-over-year to a record $71 billion in the quarter. Slide 6 shows the continued strong adoption of automation tools by our clients, powered by CP+. Automated trading increased to a record $69 billion in volume and a record 398,000 trades. Importantly, our automation tools have continued to grow through periods of significant market dislocation, which is a testament to the quality and accuracy of our CP+ data. Today, Auto-X represents 20% of total credit trade count and 8% of our total credit trading volume.

At the core of our automation tools and workflow is CP+, our world-class algorithmic pricing engine, which was a key driver of our record data revenue in the quarter. With the recent launch of Adaptive Auto-X, which is currently in pilot, we are delivering an algo trading solution that automates trading across protocol and liquidity pool while seeking to greatly improve their execution quality. Before I turn the call over to Chris Gerosa, I wanted to provide an update on market trends with three important trading days remaining in the month. Market volumes are weaker in April, but U.S. high grade estimated market share is improved from March and is running above first quarter levels. Now let me turn the call over to Chris for a review of our strong financial results.

Chris Gerosa: Thank you, Chris. On Slide 8, we provide a summary of our quarterly financials. For the quarter, we delivered record revenue of $203 million, up 9% driven by strong market share gains across most products. On a constant currency basis, revenues would’ve increased approximately 11%. Record information services revenue is up 12% or 18%, excluding the impact of foreign exchange. The benefit of the contract signed in the fourth quarter and increased adoption of CP+, Axess All Prints and TraX data was a positive driver of a strong year-over-year performance. First quarter post-trade revenue included the negative impact of approximately $700,000 on the strengthening U.S. dollar compared to the prior year quarter. Excluding the impact of foreign exchange, the year-over-year growth rate would’ve been approximately 8%.

The lower contribution from RFQ hub was driven by a tax adjustment related to the 2022 financials. The effective tax rate was 25% below the prior year period. On Slide 9, we provide more detail on our commission revenue and our fees per million. Total commission revenue increased 10%. Our growth in total credit commission revenue was driven by record increases in estimated market share and healthy increases in our trading volume, but was partially offset by lower average fee capture across U.S. high grade. The reduction in high grade fee capture from prior year was driven principally by the lower duration of U.S. high grade bonds traded over our platform compared to the prior year. While U.S. high grade fee capture declined year-over-year, duration has remained relatively stable over the last several months as reflected in the corporate bond duration index.

On Slide 10, we provide a summary of our operating expenses. First quarter expenses increased 10% driven principally by investments to enhance the trading system and our data product offering. Excluding the impact of foreign exchange, expenses would’ve increased 12%. Employee compensation and benefits increased $5 million on a 12% increase in headcount, mainly in technology and customer facing roles to support revenue growth initiatives. Tech and communications expenses increased $3 million due to higher subscription and data hosting expenses. Clearing costs were flat, despite higher Open Trading volumes due to renegotiated clearing fees related to U.S. treasuries and the favorable impact of foreign exchange. Our marketing and G&A expenses increased principally due to increases in advertising.

G&A costs, higher office related expenses that have been reduced in a prior year due to the pandemic. On Slide 11, we provide an update on our balance sheet, cash flow, and capital management. Our balance sheet continues to be solid with cash and investments totaling $440 million, and we had no outstanding debt at quarter end. We are prudently investing our cash to take advantage of a favorable interest rate environment to continue to deliver strong net interest income in the coming quarters. We are a strong cash flow generator as our trailing 12-month free cash flow came in at $271 million. During the past 12 months, we paid out $107 million in quarterly dividends to our shareholders. And our Board of Directors declared a regular quarterly cash dividend of $0.72 based on the financial performance of the company.

Now let me turn the call over the Rick to provide an update on market conditions and a long-term growth opportunity ahead of us.

Rick McVey: Thank you, Chris. Slide 13 provides an update on market conditions and U.S. credit. As we have noted over the last several quarters, last year’s rapid rate increases dramatically impacted investment grade index returns, and the higher rate environment is now beginning to flow through to the investment portfolios of banks. The distress trading conditions in some parts of the bank and finance sector in March led to a short-term increase in TRACE volumes with transactions and distressed bank names moving back to the phone, due to the extreme volatility. We believe that the recent softness in corporate bond volumes reported to TRACE is likely to be temporary due to the uncertainty in the banking sector and the upcoming May Fed meeting.

The overriding theme in my view is the highest yield environment we have seen in over 13 years and the opportunity for global investors to reallocate assets back into fixed income. That trend was apparent in the record, high grade TRACE volumes in Q1 reflecting higher trading velocity. Market volumes in credit normally fall in April from March due to the holiday calendars. So part of what we are seeing currently is seasonal. Investment grade TRACE ticket count in Q1 grew 59% and average trade sizes declined 25% as fixed income becomes an investible asset class again, and investors reenter the market. Both retail and institutional investors are seeing a higher ticket count leading to an essential need to embrace trading automation for efficiency.

Lastly, all these positive market drivers are manifesting themselves in increased velocity of trading. Turnover was an annualized 74% in the first quarter in U.S. high grade up from 64% in the first quarter of 2022. Yields are at their highest level since 2009, and at that time, high grade annual trading turnover was around 80%. Trading velocity is benefiting from higher yields, greater market participation and the technology benefits of improved trading efficiency. Slide 14 illustrates the total revenue opportunity we have before us, which has expanded significantly in the last few years as we have invested to expand our product offering. The product set that we had in 2018 gave us access to a total addressable market of approximately $4 billion in revenue.

Since 2018, we have diversified our products and protocols and expanded geographically. For example, we acquired unique capabilities in the U.S. treasury market. We complemented our organic growth and municipal bonds with mini brokers. We have expanded into ETF share trading with our investment in RFQ hub, and we accelerate our growth in post-trade data with the acquisition of regulatory reporting hub. We have also increased our investment in data products, including our comprehensive real time data product CP-plus, and our entry into the index space with both high grade and high yield indices. The investments that we have made over the last several years have expanded our total addressable market by $3 billion to a current estimate of $7 billion.

We are in early stages of executing in many of these areas, and we feel more confident than ever in the long runway of growth opportunities still in front of us. In summary, on Slide 15, we continue to execute well across against our growth strategy. We delivered the fourth consecutive quarter of accelerating revenue growth driven by a combination of strong market share gains and improved market volumes. Our global footprint continues to broaden and deepen as we diversify our product offering. We have a strong pipeline of new products and new trading protocols and increase client diversification driven by growth with hedge funds, private banks, and dealer initiated order flow. Now, we would be happy to open the line for your questions.

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Q&A Session

Operator: Thank you, Mr. McVey. We’ll take our first question this morning from Rich Repetto of Piper Sandler.

RichRepetto: Yes. Good morning, Chris and Rick and Chris. First congrats Chris for taking over the helm. I guess the first question is, you come from a long background of automation or other experience in other asset classes and you talked about a lot of metrics here that smaller trade sizes, increased velocity, that point to this electronification. So I guess, one question is this Adaptive Auto-X, what kind of impact do you think is that a key to further along the automation trend or what other – what tools do you see besides Auto-X that are going to really spur that conversion?

Chris Concannon: Well, first thanks for the question and thanks for the congrats. Rich, you’ve probably – you’ve covered me for a long enough number of years that you probably already know my answer to the question. I’m quite bullish about electronification of the bond market. I’ll start by mentioning we did have record volume and record revenue in our automation suite. But the first key ingredient to automation is data. Data is a key ingredient. If you have good data, you’re going to have good automation. Second, if automation replicates what manual traders do identically or a similar replication, then you’ll have constant growth in automation, meaning people will adopt it to gain efficiencies. The key ingredient to what I’d call accelerated growth of automation is if it achieves better results than the human execution and does it efficiently.

And that’s really what we’re targeting Adaptive Auto-X to do, which is achieve better results by automating the execution, solution across protocols, across liquidity pools and giving it unique data. Our automation, it’s important to point out our automation suite, which Adaptive Auto-X is just in pilot now and just launched just a couple weeks ago. But our overall automation suite grew 40% year-over-year which is quite healthy growth to hit those records. And more recently we saw in – we launched Auto-X in municipal, and we saw that grow quickly to 23% of total exempt trades, which is pretty impressive growth. So my point is, Rich, that automation when it’s starts to be adopted, it can have pretty healthy growth rates, even in the more challenging market that we saw in the first quarter.

The automation tools held up throughout the difficulties of March. With all that said and all that growth and all those records when you really add up our total automation footprint in the U.S. corporate bond market, it’s just under 2% of the market. So we have a really long way to go when it comes to automation. To put that in comparison, the FX market has seen algos – client algos now achieve over 20% of the market. So while we’ve still seen record volume and record growth in our automation suite. We’re at the early stages of automating the full bond market.

RichRepetto: Got it. Got it. And Chris, I think you guys addressed some of this, but we are seeing volumes now lighten up from mid-March and you talked about seasonality of April and sort of reallocation I think is still going on. But can you just make investors a little bit, has the outlook for 2023, I thought super strong. Is that still a case or is this just a momentary pause or has anything changed the outlook for volumes – credit volumes for the year I would say?

Chris Concannon: So great question. I mean, we couldn’t be any more bullish about the bond market, despite the – what I’ll call momentary or temporary disruption in the market. Rich, bonds are cool again. We’re seeing a higher interest from our clients as well as their clients in terms of allocation of investment dollars towards fixed income market. It’s certainly a market that is providing better yield and better principal protection than the stock market. I would say we are in a risk off environment coming off the heels of a – the market disruption in the banking sector. But we also are seeing a unique April month of holidays. I will tell you my friends in the equities, the FX, the derivatives, and even the crypto market, they’re all complaining about volumes.

So it’s not unique to the fixed income market. It’s really market wide that we’re seeing this risk off environment. We do have the Fed next week, so I do think a lot of investors are sitting on the fine line waiting to see some of the Fed moves, and we are going through earning season as well. This week we are seeing higher levels of activity. So it’s encouraging now that all the vacation and spring breaks are over, we’re seeing higher levels of activity. More importantly, we do see and expect higher new issue market in May. So we’re hearing more positive things around the new issue market in May.

RichRepetto: Got it. Got it. Lastly, most of the top level managers and fixed income trading platforms are skilled golfers. So I guess my question, Chris, what have you done to improve your golf skills?

Chris Concannon: So that’s a very appropriate question Rich. I would say my golf score is correlated to our revenue and market share. As it – as our revenue and market share goes up, my golf score, my handicap will continue to rise.

RichRepetto: Got it. Thank you.

Operator: Thank you. We’ll go next now to Chris Allen of Citi.

Chris Allen: Yes. Good morning, guys. I won’t comment on your golf game. I know, how challenge it is. Just on the CP-plus uptake showing up in the market data. Is that just a longer-term ongoing trend or is that maybe an anticipation of Adaptive Auto-X launch? And then maybe you could just give us some color just on what the feedback has been on the pilot phase there and kind of expectations around when that’ll be formally launched to the broader marketplace?

Chris Concannon: Sure. And your first question on market data or just CP-plus generally.

Chris Allen: Just how that’s kind of flowing through into market data, like what’s driving that?

Chris Concannon: Yes. So obviously the growth in market data, and as we mentioned, we saw record revenues in our market data in Q1, largely driven by the growth of CP-plus across U.S. high grade, high yield EM and Eurobonds. It’s certainly becoming the benchmark of real-time pricing in the U.S. corporate bond market and where – that’s where we’re seeing the demand for CP-plus. So we’re excited about that. That CP-plus is a key driver of our automation success. Again, record revenue and record volumes in our automation suite driven by the superiority of CP-plus. It’s a key ingredient as well to our Adaptive Auto-X, which allows clients to take advantage of across all of our different protocols and also take advantage of providing liquidity based on CP-plus pricing.

So it’s certainly a sign that our largest institutional clients are comfortable with the price point of CP-plus and what it produces in terms of price of U.S. bonds. Adaptive Auto-X’s early days, I will tell you the excitement as we went out to talk to our largest clients across the U.S. and Europe, they’re all extremely excited about access to Adaptive Auto-X. We had to actually reduced the pilot because of overwhelming demand to get into the pilot, but it’s early days and something that we’re super excited about.

Chris Allen: Thanks, guys. I’ll get back in the queue.

Operator: Thank you. We will go next now to Kyle Voigt of KBW.