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Morningstar | CME Group Benefits Greatly From Volatile Markets as NEX Group Comes Into the Fold

Wide-moat CME Group had an exceptional 2018 that surpassed even our optimistic expectations. For the year, excluding $134 million in revenue from the newly acquired NEX Group, CME generated top-line growth of 14.6% for the year, surpassing our expectation for 12% to 13% growth. Altogether, CME Group had a fantastic quarter fueled by increasing volatility resulting in higher trading volumes. Specifically, interest rates and equity index trading volumes grew a whopping 37% and 71% from last year’s fourth quarter. Overall, trading across CME’s entire product line jumped 31% year over year. Though we don’t anticipate every quarter will be this good, we don’t expect to see the same placid volatility of the past few years. So far in January, trading volume is down by 6% from 2017 levels. We will be updating our model to reflect full-year results and the inclusion of NEX Group, which should add about $800 million in revenue. Investors should expect a mild increase to our fair value estimate of $140 per share resulting from better-than-expected near-term results.

We do think NEX Group will result in some nice synergies on both revenue and costs, as CME Group can cross-sell existing interest-rate products and penetrate NEX’s customer base. Specifically, we are paying attention to CME FX Link, a product enabling customers to trade the spread between spot foreign exchange and foreign exchange futures. During the call, management said that FX Link is "really doing nearly 10,000 contracts a day, and we only launched it in May.” That said, it is still in early stages. The biggest beneficiary to this merger should be CME Group’s existing currency, FX, business. However, in the first three months since the merger, FX trading is down 10.7% compared with a year ago. In addition, CME Group has begun publishing trading volumes on NEX’s BrokerTec. Here, CME’s acquisition is faring better, as total volume is up 4.5% year over year since the deal was closed.

Finally, the company provided some preliminary 2019 guidance. For the year, the company expects expense excluding licensing fees to be around $1.65 billion-$1.66 billion, with capital expenditures of about $190 million. This capital expenditures guidance is more than double what CME Group had been spending before the acquisition. The company attributed this to NEX’s different business model and ongoing investment in optimization. We’ll point out that it appears CME Group and NEX had different accounting treatment for capitalizing some wage expenses in intangible assets. Going forward, CME Group will not be capitalizing some wages and be reflecting them immediately. We don’t think this is a big deal, but it did give us something to monitor.