TW - Tradeweb Markets: Reiterate Buy Rating As Growth Momentum Should Continue

2023-11-02 11:17:27 ET

Summary

• I reiterate a buy due to expected growth momentum and positive regulatory and market structure developments.
• TW experienced sequential and annual revenue growth, with strong performance expected to continue through October and into the fourth quarter.
• The expansion of the fixed income electronification ecosystem and the renewal of the data licensing agreement with Refinitiv are positive factors for TW's future.

Investment action

I recommended a buy rating for Tradeweb Markets Inc. ( TW ) when I wrote about it the last time, as I expected TW to continue reaping the benefits of this high rate environment and gain share in the credit market as the secular trend of electronification drives large trading volumes. As TW grows as I expect, valuation should revert back to its historical average of 40x forward PE. Based on my current outlook and analysis of TW, I recommend a buy rating. I expect growth momentum to continue given the updates in this quarter and see a catalyst that could drive further growth if the regulatory and market structure developments play out in favor of TW.

Review

TW experienced a sequential growth of 6% and an annual growth of 14% in total net revenue during the third quarter of 2023 , reaching a total of $328.4 million. The total expenses amounted to $203.6 million, resulting in an adjusted EPS of $0.55. I anticipate solid TW performance to persist through October as the strong revenue growth momentum continues, with overall revenues up mid- to high-teens y/y. Historically, the final months of the year exhibit strong revenue performance for TW. Therefore, the current trend of October month-to-date revenues showing a growth of mid-to-high teens year-on-year is a highly encouraging indication for the fourth quarter of 2023. There is a good chance for an acceleration in growth subsequent to the 14% year-over-year revenue growth observed in the 3Q23, indicating positive prospects for the stock's sentiment in the near-term. In particular, global government bonds, global interest rate swaps, corporate credit, equity derivatives, and global repos were all highlighted by management as having experienced significant volume growth. In addition, the credit market share trends in the United States investment-grade sector remain robust, as evidenced by the October month-to-date share surpassing the September levels of 15.8% share. Importantly, I perceive the cyclical tailwinds resulting from the configuration of the yield curve as a favorable circumstance for clients to initiate the extension of duration. This action is expected to contribute positively to the volumes of long-duration swaps, as well as enhance fee capture. As of October, the management has observed an increase in duration, accompanied by heightened volatility on the longer end of the curve. This development is favorable for the fee per million metric.

In the long run, I perceive the regulatory and market structure advancements as favorable factors that contribute to the growth of fixed income electronification and positively impact TW's business. In my opinion, the stock will benefit from the imminent release of the final rules for the expansion of U.S. Treasury Central Clearing, which management has indicated could happen within the next two to three months. The integration of technology and risk management systems may necessitate a multi-year phase-in period, owing to its inherent complexity. However, management expresses confidence that the adoption of this rule will have a positive impact on their business in terms of direction. The immediate consequence is that the increased central clearing of trades, coupled with the absence of settlement risks or credit checks, is expected to facilitate the growth of electronic trading. One precedent that indicates this scenario will unfold as anticipated is the transition of the dollar swap market to central clearing, which resulted in an increase in electronic trading and the adoption of anonymous protocols. Another notable illustration referenced by management is the culmination of Basel II.

So the Basel III endgame is sort of in the process of finalizing and then implementing these rules. Essentially, what I think about -- how we think about it is, it's the prospect of yet more additional capital charges on banks, which continues the trend that we've seen since the GFC and the Dodd-Frank rules came out.

So what that means is, unfortunately, I think it's harder for banks to continue to grow their balance sheets. They're committed to these markets, and certainly can't grow in line with the continued growth in fixed-income markets, because of growing deficits and debt loads. So, I think what this allows for, as far as market structure is the continued emergence of these non-traditional market makers.

We should probably stop calling them that, because they're huge factors in the market already, but these other types of market makers will continue to grow to fill in the gaps. The PTFs, the algorithmic and systematic market makers continue to come in and grow. These types of dealers, they're heavily quant-oriented, they're data data-oriented, they lead with technology, and they trade most of the business electronically. So this should continue to grow, this development and these trends should continue to grow the electronic share of the market and lead to higher velocity. 3Q23 call

The expansion of the ecosystem with new types of market makers, which I expect will boost the speed and increase the electronic share of fixed income markets, bodes well for TW's future.

On the other hand, an additional noteworthy advancement pertains to TW's announcement regarding the signing of an extension for its current market data licensing agreement with Refinitiv. According to management's projections, the revised data contract with LSEG is anticipated to yield $80 million in Refinitiv data revenue in the year 2024, followed by an expected increase to $90 million in 2025. This suggests a projected year-over-year growth rate of approximately 21% in 2024 and 12% in 2025. To provide context, it is worth noting that there has been a historical renegotiation of the contract, resulting in an approximate 10% increase in revenues when comparing to the reference year of 2019. Therefore, the current round of advancement serves as a promising indication that Refinitiv is demonstrating a willingness to offer a higher compensation, suggesting that the value proposition of TW is sufficiently compelling. Looking towards the future, I maintain a positive outlook on the demand for and expansion of TW's suite of data products. I anticipate that the renewed contract will offer increased flexibility for the growth of its proprietary data business.

Valuation

I believe TW can continue to grow as I expected previously, but I have adjusted upwards my FY25e expected growth rate as I see potential for growth to sustain in the low teens ahead. Holding the same assumption for earnings margin, my FY25e earnings expectation increased by ~$12 million to $635 million. Another adjustment that I have made is to increase the forward PE assumption by 1x to 40, as I gained more confidence that TW is able to trade back to its historical average given its improved business outlook (extension of the Refinitiv deal at higher rates, market structure development catalyst, etc.). With these updated assumptions, my price target has increased to $110.83, suggesting a 22% upside from the current share price of $90.48.

Risk and final thoughts

TW faces a potential risk related to the macroeconomic environment, which could have adverse effects on rates trading volumes. It is essential to consider that the macro environment may prove to be more challenging than initially anticipated, leading to a scenario where industry trading volumes fall short of expectations. Potential reduction in industry volumes may exert downward pressure on Tradeweb's volume growth.

I reiterate my buy rating for TW due to its strong performance and growth prospects. The company's recent revenue growth, particularly in areas like global government bonds and interest rate swaps, is a positive sign, and the expected regulatory and market structure developments will likely benefit TW. The expansion of the fixed income electronification ecosystem and the renewal of the data licensing agreement with Refinitiv are promising factors for the company's future. I've adjusted my FY25 earnings expectations upward, and with a higher forward PE assumption, my new price target for TW is $110.83, indicating a 22% upside from the current share price.

For further details see: