ICE - Cboe Global Markets: Quality Exchange Operator With Robust Fundamentals

Summary

• CBOE is a leading exchange operator, essentially a software business with a highly reliable set of revenue streams.
• It has also been profitable and increasingly cash-flow generative for some time.
• Additionally, the stock maintained value in the face of an overall market contraction and should continue to do so, all the while paying a dividend.
• This company presents a unique investment case. It has the capacity to reliably preserve value while also continuing to grow, making it a buy in my view.

Overview

Cboe Global Markets (CBOE) is a trading exchange operator and owner of the Chicago Board Options Exchange. The company owns 7 equities exchanges, 4 equity options exchanges, one futures exchange and one foreign currency exchange. This makes it a market leader in the United States, there being 13 total equities exchanges here. CBOE is a direct competitor to Intercontinental Exchange Inc. (NYSE: ICE ), NASDAQ (NASDAQ: NDAQ ) as well as NYSE (owned by ICE). Each of these, CBOE included, also has operations internationally.

As an exchange operator, CBOE generates revenues for providing access to institutional investment entities. This primarily takes the form of charging for access, market data, and clearing fees, as seen below.

Since modern markets are electronic, CBOE is in essence a technology company and indeed subject to the economics of software. The exchange business is of course a very particular niche, but the reader must note that CBOE is not in of itself a liquidity provider. This means that it does not make markets (quote buy/sell orders) and that its business is restricted to providing - and charging for - the infrastructure for securities to trade on. This makes cost of capital much less of a concern and reaffirms its nature as a software business.

First beginning to trade publicly in Q2 2010, CBOE has captured 93.7% of the returns of the NASDAQ Composite (inclusive of dividends) since then:

Notably, CBOE has significantly outperformed the NASDAQ this year as of this article:

This recent performance makes the stock an interesting proposition - it is a technology business that has not been subject to the significant sell-off in technology securities during 2022.

CBOE successfully retained its value during 2022 - something that has certainly not been true for the technology sector overall. This is evidenced by the fact that CBOE significantly outperformed both the iShares Expanded Tech-Software Sector ETF (IGV) as well as the Vanguard Information Technology ETF (VGT) this past year:

As such, CBOE is a business that has the economics of a mature technology entity but is clearly insulated from larger market forces affecting the technology sector, presenting what is a relatively unique investment. This article will look through CBOE's financial picture to see if its fundamentals are in line with its price performance.

Financials

CBOE has displayed consistent and healthy growth in revenues over the past decade, apart from fiscal year 2019. As with many entities involved in the capital markets space, CBOE had an exceptional year in fiscal year 2020 due to significant market volatility. Of note, it didn't experience a decline in revenues afterwards, although growth has indeed slowed significantly.

These revenues should also be considered in light of the nature of CBOE's business. In a way, it has a captive audience for its services; there is no other provider that can provide the market data and auxiliary information for the exchanges that it operates. The exchange operator itself, in this case CBOE, is the only one that can do so. For the exchanges that it owns, it's the only game in town. As such I am inclined to believe in the long-term sustainability of its revenue base.

Being a mature entity, CBOE is a profitable one and has seen its net income correlate closely with its revenue performance:

While this net income picture is somewhat variable, without every dollar of revenue filtering into profits, the trendline is clear. Additionally this company has been profitable for every year of the last 10 - a sign of sustainability indeed.

As to cash flow, CBOE has continued posting robust results with an ongoing upwards trajectory. The trailing twelve month figure also appears to be on the upswing, indicating continued strength post-pandemic as to the firm's capacity to generate free cash flow.

Nonetheless it also appears that CBOE is facing an increasing cost of capital in its business, with cash interest paid increasing significantly in recent times. It has increased its total debt significantly since fiscal year 2017, since then operating with a positive net debt. This means that it does in fact have more liabilities than assets on hand.

Investigating this further, we do see that the company has had a downward trajectory as to its balance sheet. The quick ratio (assets/liabilities) as well as the current ratio (12 month forward assets/liabilities) are both trending at historic lows.

This level of leverage is not overly concerning in my opinion, with CBOE having a 2x basic leverage ratio going forward and a 0.83 current leverage ratio. With the levels of profitability and cash flow that the company is generating, I think this should be entirely manageable and that solvency is not an open question for this company.

The coda to this is the fact that CBOE has consistently increased its retained earnings, although experiencing a small dip in this metric at the start of 2022. On a pure value level, this entity is that much more valuable than it used to be. Looking over at its valuation, we also see that it is trading at a relatively high historical P/E (TTM basis), but not at an absolute peak level. I wouldn't call the stock cheap, but I wouldn't call it particularly expensive either. The market pricing is fairly accurate. However, note that the fundamentals are quite sound and that this value should be retained going forward. The prior year acts as hard proof of this security's capacity to weather overall market conditions.

Additionally, we have the company's dividend to consider. While not a particularly high yield, especially for the new rate context in which investors find themselves in, I consider it secure on the basis of the fundamentals and acts as a reliable return floor for this security.

Conclusion

CBOE is a good value stock that also has room for growth. As mentioned, I believe that its revenue base is highly secure and should continue to increase going forward. The company is quite profitable as well as cash-flow-generative. This security has also demonstrated persistence in its valuation even as the technology sector declined materially. Additionally, the nature of its business provides a reliable margin of safety as well as exposure to the heart of the (world-leading) American capital markets.

Appreciation here should come slow and steady, continuing to display low correlation with technology indices and the market overall. Taking these factors together and considering the ~ 1.75% dividend yield make this stock a quality, reliable, buy in my perspective.

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