Colorado-based investment firm Upslope Capital Management is bullish on Cboe Global Markets Inc (NASDAQ: CBOE), one of the world’s largest exchange holding companies. In its Q2 investor letters (you can download a copy here), Upslope Capital discussed its investment thesis on CBOE, calling it “the definition of a high-quality business”. Let’s take a look at the firm’s comments:
CBOE owns and operates leading exchanges/trading venues for options, futures, equities, and FX around the world. Notably, its venues are #1 in market share in the U.S. for options, #2 in the U.S. for equities, and #1 in pan-European equities.
As regular readers may know, the “exchange model” is one I am quite fond of. Established players benefit from a strong network effect (liquidity begets liquidity and is very hard to break), high margins and generally attractive long-term growth prospects. Secular growth is generally supported by longterm increases in the following: (A) electronification (phone- to web-based) of trading, (B) sophistication of investors and other market participants, and (C) overall complexity of global markets.
Ideally, we can also find positive cyclical growth. While I have followed CBOE for quite a few years, it came into focus recently after the February VIX ETP product implosion (wonky background here and more detail below), which led to CBOE falling ~25% in a short period. The simple run-on sentence version of the thesis: “sentiment is bad and price is reasonable for a great business that I’d be happy to own for the long-term.” The longer version:
– CBOE is the definition of a high-quality business: steady historical growth plus very high margins and returns on capital, supported by deep competitive advantages (network effects) and led by a talented management team. I anticipate sustained top-line growth over the longterm, as well as cost savings from BATS acquisition and positive operating leverage.
– Strong management team led by CEO Ed Tilly (in-role since 2013) and President/COO, Chris Concannon (joined via BATS acquisition). CBOE (and legacy BATS) has a history of strong product innovation. Concannon in particular is a noted market structure expert, having previously served as COO of Virtu Financial and as a staff attorney at the SEC. Notably, he acquired almost $1mm of CBOE shares in the open market on May 31.
– Positive cyclical exposure: one of my assumptions for the current market environment is that volatility will stay elevated vs. recent years (hardly a bold assumption). On balance, this should be good for CBOE.
– Misguided worries about VIX products: CBOE shares sold off hard in February following the implosion of several VIX (volatility index) ETPs (exchange-traded products, similar to ETFs). While CBOE has no role in managing VIX ETPs, CBOE had been a beneficiary of their success, as well as of the broader “short VIX trade.” By some estimates, the ETPs in question contributed only ~2% of total CBOE revenues. Looking ahead, I see three scenarios: (A) traders return en masse to the “short VIX trade” and there is minimal adverse impact to CBOE, (B) the “short VIX trade” fades away, but is eventually replaced with other VIX-/hedging-related trades, as volatility shifts higher, or (C) traders exit the “short VIX trade” and do not replace prior activity in a material way. In my view, scenario ‘B’ is the most likely and an eventual positive for CBOE. ‘A’ seems somewhat likely; ‘C’ seems highly unlikely. This is not scientific.
– Historical M&A premium should return: CBOE has historically traded at a premium valuation, in part due to speculation of an eventual sale to a larger exchange (e.g. CME). In my view, a sale to CME (or others) has strategic merit and a premium should return.
– Key risks: VIX issues are complex and hard to predict, potential technology glitch could lead to losses, potential to lose share in competitive markets, regulatory risk, exposure to European equity markets (pricing based on notional value of securities traded).
Cboe Global Markets Inc (NASDAQ: CBOE) owns the Chicago Board Options Exchange and the stock exchange operator BATS Global Markets. Shares of the company have dropped 2.95% over the last three months. However, the stock has jumped 11.52% over the past 12 months.
CBOE isn’t a very popular stock among hedge funds tracked by Insider Monkey. At the end of the fourth quarter of 2017, there were 19 funds in our database holding shares of the company. Meanwhile, during the second quarter of 2018, Clinton Group opened a new position, joining Incline Global Management and Horizon Asset Management which maintain bullish positions in CBOE.
