Cboe Global Markets

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 5/5

Cboe Global Markets, Inc. is a leading provider of market infrastructure, tradable products, and data and analytics solutions, operating exchanges and clearing facilities.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Cboe’s core business revolves around facilitating trading, providing a platform for buyers and sellers to connect and execute transactions. Its revenues are derived from transaction fees, access fees, data and information solutions, and regulatory services.

Business Overview:

  • Revenues Distribution: Cboe’s revenue streams are diverse:
    • Transaction Fees: The fees charged for executing trades on Cboe’s various exchanges. The value is directly correlated to trading volumes, which are subject to market fluctuations.
    • Access and Capacity Fees: Fees charged to market participants for their access to Cboe’s technology platforms, trading systems, and for capacity for managing data, which tends to be stable and growing with the market.
    • Market Data and Access Solutions: Revenue from the sale of market data and analytics services, which are derived from high value data solutions that the company creates and sells to market participants.
    • Other Revenue: A combination of other revenue sources such as regulatory services, which remain fairly stable in comparison to other components.
  • Industry Trends:
    • Increased trading volumes, which have resulted from the continued volatility of both the stock and options market. This is a major driver for revenue growth for Cboe.
    • Increased focus on risk management and hedging strategies, which increased the interest in derivatives such as options. The recent increased volatility of the stock market, driven by many external factors, such as macroeconomics, and also geopolitical factors, has fueled more interest into these types of products, thus resulting in even more revenues for Cboe.
    • Technological advancements and regulatory requirements, which are changing the ways in which markets operate and the type of products the company has to offer. It’s an ongoing investment challenge for Cboe to stay in compliance with regulation, and also keep up to date with the latest technology requirements.
    • Growing interest in alternative asset classes and digital assets and the growing use of algorithmic trading strategies, that further increase trading volumes on the market.
  • Competitive Landscape: Cboe operates in a highly competitive industry, characterized by a small number of exchanges that compete on pricing and product offerings. A few significant competitors include Nasdaq, CME Group, and ICE. This sector of the economy presents itself with high barriers to entry that include high technological costs, high regulatory hurdles and the difficulty to create and secure a network with a vast number of market participants, thus resulting in oligopolistic market.

Cboe distinguishes itself through continuous innovation, particularly in the options and derivatives segment. It’s an innovator and creates proprietary products and services in order to have an advantage over their competitors. It also expands its reach through acquisition of other marketplaces, thus increasing overall revenues.

  • Business Differentiation:

Cboe’s competitive advantage lies in its focus on the development and provision of novel and sophisticated products and its position as the largest options exchange in the United States and Europe. This combination of product innovation with a leading position in the exchange marketplace provides the company with an economic moat. The company also leverages its technology capabilities and experience in order to further expand into adjacent products and markets, such as data & analytics offerings, and digital asset transactions. Cboe also has a significant international presence that they continue to capitalize on.

  • Management and Recent Concerns:

  • Recent concerns include regulatory changes impacting transaction fees. The SEC’s ongoing proposal related to best execution may potentially hinder price execution across different exchanges and also reduce Cboe’s transaction fees. However, managements see a path through this proposed ruling, and they don’t believe the overall impact will be substantial.
  • Competition: Despite the large amount of competition, management is confident that Cboe will keep attracting new customers. * Cboe’s recent earnings calls show the management team is focused on growing revenues, reducing their operating costs, maintaining capital discipline, and also reinvesting earnings in order to create sustainable long-term value. * They are also investing in new technologies such as trading platform updates and expansion, as well as data and analytics businesses, which may present some short term increase in expenses, but will pay dividends in the long run. * Management is confident in the execution of these long-term initiatives and on their ability to continue to create value for the shareholders.

Moat Assessment: 3 / 5

Cboe has a narrow moat characterized by: * Network Effects: Cboe’s core business revolves around exchange, which benefits from network effects, as more participants improve liquidity and trading efficiency. These network effects make it difficult for new competitors to create new marketplaces. * Intangible Assets: Cboe has several brands and intellectual property related to financial indexes which provide further protection in some areas of their business, but not in all. * Switching Costs: While not substantial, the complex integrations that are created between the customers and Cboe, especially for high frequency traders, create switching costs making it somewhat difficult for competitors to break into those clients.

Risks to Moat and Business Resilience

  • Regulatory Risks: Changes in regulations, especially those related to market structure, transaction fees, and trading practices, could greatly impact Cboe’s operations and profitability. New regulations may hinder its competitive advantage.
  • Technological Disruption: Rapid technological innovation may render current platforms and services obsolete. Cboe’s ability to adapt quickly and to incorporate technological advancements into its platform will play a major role in the success of the business.
  • Competition: Intense competition from other exchanges and electronic trading platforms can put pressure on Cboe’s pricing and market share, which can make for lower margins.
  • Market Volatility: Though Cboe can benefit from increases in trading activity that are driven by market volatility, that volatility is not always consistent and can disappear quickly during certain periods of economic stability.

Financial Analysis:

  • Profitability: Cboe has high and consistently growing operating and profit margins over the years, making the company a very successful business that generates value for its stakeholders.
  • Revenue Growth: Recent revenues have grown significantly from both the trading volumes as well as the data/analytic businesses. Recent acquisitions, such as Bats and MATCHNow, have played an important role in the revenue growth for the company.
  • Earnings: The growth in earnings has been very consistent with revenue growth, as the company’s management team is very effective in managing costs and expenses.
  • Free Cash Flow Generation: The company generates a large amount of free cash flow from their businesses, which is used for acquisitions, R&D spending, debt pay-down, and return to investors through dividends and share buybacks.
    • As of this latest 10Q, it seems that operating cash flow is $679 million and free cash flow is $637 million. This cash is used to pay down debt, and return some cash to shareholders through share repurchases.
  • Debt Levels: Cboe is not a highly leveraged company, and has a significant cash position, thus giving it the necessary flexibility.
    • As of this latest 10Q, the long term debt is at 4.05 billion dollars, with a total cash balance of $1.25 billion.
  • Capital Structure: Cboe targets a market-based leverage that’s around a 3x debt-to-EBITDA ratio which management believes provides a balance between financial flexibility and efficient capital allocation. They maintain a target debt to EBITDA, and reduce debt levels to this target after a major acquisition is made.

Understandability: 3 / 5

  • Cboe’s core business of facilitating trading in multiple types of products is relatively easy to understand, but the specific business and different revenue streams are a bit complicated for a novice investor to comprehend.
  • The financial statements of the company require some time to understand, especially when they are impacted by acquisitions and other financial transactions.
  • The technology infrastructure required to operate an exchange is quite complex, which requires further understanding of certain concepts to fully grasp the intricacies of the business.

Balance Sheet Health: 5 / 5

  • Cboe has a very robust balance sheet with a large cash balance and an adequate amount of debt.
  • The long term debt is manageable and can be reduced quickly by paying it back with its significant cash flows.
  • The company has a history of very predictable and stable cash flows which allows it to invest in the business for the future and also pay shareholders a consistent dividend.
  • Cboe generates large amounts of free cash flow, giving a huge safety net in case of any economic downturns.
  • The company has no exposure to goodwill impairments that could hurt its equity value.