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Morningstar | Intercontinental Exchange Rides Market Volatility to Growth; Threats Linger on the Horizon

Wide-moat Intercontinental Exchange finished 2018 in line with our expectations. For the quarter, the company generated revenue net of transaction-based expenses of $1.3 billion, a more than 14% increase from the previous year. Most of this improvement was driven by higher revenue from transaction and clearing that included the contribution of new acquisitions BondPoint, TMC Bonds, and MERS. I t earned $0.94 per share i n the fourth quarter, a 25% increase from the previous year. Much of this year’s growth is attributable to increasing volatility in markets. In addition, the company provided initial 2019 guidance suggesting data revenue will grow by 4%-6% with GAAP operating expenses increasing only modestly. Should volatility hold and the company see continued strength in transaction and clearing revenues, the firm’s guidance appears to suggest some significant operating leverage in 2019. For now, we’ll be maintaining our fair value estimate of $73 per share, as we think uncertainty around data pricing and potential competition from new exchanges is a valid threat.

CEO Jeffrey Sprecher appears to be dismissing the threat of its customers uniting to create a member-operated stock exchange. When asked about it, Sprecher was somewhat dismissive saying, “And lastly, on the members exchange, I guess, I'm not aware that there's management or anybody working on anything, but that's really not their obligation to discuss it with us.” That is our impression. In order for MEMX to succeed, the company will have to build its technology platform, get approved by regulators, and do all its hiring. Thus far, we have seen limited evidence this is actually happening. Based on LinkedIn searches we can find only one person named Jim Doe employed by MEMX. We suspect that’s likely a fake profile. However, we think investors and management are wrong to entirely dismiss this threat. Customers are angry and highly motivated to circumvent the data fees they pay to the firm's NYSE.

Though it’s still early days, Intercontinental Exchange’s acquisitions of TMC and BondPoint so far appear to be winners. During the earnings call, President Ben Jackson said, “volume on BondPoint and TMC was up over 9% over the prior quarter and 20% over the prior year. And in notional terms, what was traded, we were up 12% over the prior quarter and 50% over the prior year. And note that I was highlighting there that notional is greater than volume, which means the average trade size is also increasing on the platform.” It will be interesting to see if and how the firm marries its valuable intellectual property within fixed income to widen its moat. While it’s possible Intercontinental Exchange’s presence within equity data services and trading could weaken, it may be offset by its strength within fixed income.