Intercontinental Exchange (ICE) is an operator of financial exchanges and provides ancillary data products. They own the New York Stock Exchange, which I think is an okay asset by itself. The real gems are its futures and derivatives exchanges and the data provided by the exchanges. Their largest commodity futures product is the ICE Brent crude futures contract.
The company is a financial infrastructure and data roll-up that is constantly diversifying its product offering through acquisitions, ex: acquiring Interactive Data in 2015, to offer more fixed-income data offerings, TMC Bonds, Bondpoint, etc.
Segments:
Trading and Clearing (49% of revenues): ICE operates multiple trading venues, including 12 regulated exchanges and 6 clearing houses, which provide clearing execution and risk management services across several asset classes. There is seasonality in this segment.
Data and Listings segment (51% of revenues): data and listing services for financial and commodity markets, including pricing and reference data, exchange data, analytics, feeds, index services as well as corporate and ETF listing services. These are subscription-based and recurring in nature, which are not impacted by the same seasonality as the Trading and Clearing segment.
I think the NYSE is an okay asset by itself because pricing in equity trading has declined since many exchanges can provide the service. ICE has mitigated this pricing decline by selling the data derived from its massive order flow and other proprietary data sets (i.e. the famous data repository model). That’s why I think ICE shouldn’t be viewed as an exchanges operator, but increasingly as a provider of proprietary data and of software.
Its commodities and interest rate futures businesses are quite interesting as there are network effects associated with complex financial products. Once an exchange achieves liquidity in a product, it becomes the cheapest venue to transact that product, and the exchange has a cost advantage. On the investors’ side, as more buyers and sellers trade a proprietary product, it becomes increasingly liquid and cheaper for investors to transact on a single exchange. That creates a barrier to entry since a new exchange will not be able to take trading volume away by introducing a competing financial product.
We must consider the complexity of financial products like futures or derivatives compared to equities, namely counterparty risk (imagine having Lehman as a counterparty in ’08). An exchange’s clearinghouse must execute a transaction and ‘clear’ it between a buyer and a seller to limit the risk of a counterparty failing to fulfill what the contract says it must do. So with complex financial products, after achieving liquidity, one exchange becomes the main place to trade a specific product (in contrary to equity exchanges). Like in other industries, once network effects are achieved, exchanges can eventually increase prices, which shareholders love.
Now I want to go further into the value-add provided by ICE’s data business, which has a regulatory moat, which I learnt myself while spending time within my fund’s complex financial products modelling team. There is a pricing and analytics segment within the data business, which offers prices for fixed-income and equities that exchange customers must provide to clients and regulators. And regulation has increased a lot since the GFC, which means compliance departments need this pricing data (see Basel I, II and III requirements). Risk teams also need this data to calculate capital positions, which must be supplied to international regulators. Since so many firms (ex: funds) depend on this data, and for many products, ICE is the only vendor, there are large switching costs for clients. And the upside of financial products’ demand being seasonal is that the data varies a lot over time, which means newly created data sets with their limited history can’t keep up with the historical data that ICE provides. Plus, as ICE develops and acquires new data sets and offerings, it increases the depth of their offerings. And if a customer becomes reliant on multiple ICE-provided data sets, it makes the company a one stop-shop for companies.
Another great element to the data business is the potential of operating leverage. The cost of building a proprietary set of data is mostly fixed, but as the data business grows, additional revenue will not require additional investment and so, will flow to the bottom line. I think we could see considerable margin expansion for the data business.
That being said, I know you’re all rejoicing because ICE seems to have pricing power in its data businesses, but I think there was a regulatory threat, which is now reduced. The regulators want investors to have access that is affordable and if ICE raises prices too much, it would attract the attention of regulators in a negative way. Thankfully, on June 5, a court decision said the SEC could not challenge or dispute the fees exchanges charge for trading data. I think the exchanges will still be careful with price increases.
Let’s go deeper into the Interactive Data acquisition from 2015 and its implications. It doubled ICE’s data revenue, and aside from Bloomberg, no other data vendor has as comprehensive a database as ICE. It’s difficult to obtain price information on low liquidity bonds, which often must be calculated manually. But as fixed-income ETFs are becoming popular, there is a need for accurate pricing data, so databases on fixed-income prices are becoming increasingly more valuable. And as mentioned previously, there are regulatory requirements, which means banks must report pricing and liquidity data to regulators. ICE has also bought BAML’s fixed-income indices, which gives the company an even wider licensing fixed-income business. I think the licensing business for fixed-income indices is in early innings of the ETF revolution, not dissimilar to what S&P Global’s Indices segment was 10 years ago for equities. There is tremendous potential for growth for this licensing segment.
Valuation
The company thinks it will grow revenues 6-7% a year. I think it will see operating leverage as well, bringing net margins from 37% to 45% within 5 years. That gives earnings of 3.3B$ in 2025. Paying about 15x 2025 P/E is reasonable in this market where other great businesses are often trading at much richer multiples.
In sum, Intercontinental Exchange benefits from the networks effects tied to its trading and clearing segment. These network effects attract the bulk of all volume traded for several products, which ICE leverages to obtain proprietary data sets from the products traded on these exchanges. These data sets are extremely valuable, and are needed by clients, for regulatory purposes. The data segment will also benefit from licensing being in the early stages of the fixed-income ETF revolution.
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