TW - Tradeweb: Potential Upside Despite High Valuation Multiples

Summary

• Tradeweb Markets has been a typical growth story over the past years, driven in large part by the expansion of its two largest businesses, credit and rates.
• Based on the P/E valuation, there is a theoretical 35% upside to the current stock price level, assuming that valuation will eventually return to the historical average.
• Despite these challenging times, investors with patience to navigate this current turbulent stock market should be rewarded with healthy returns holding shares of Tradeweb over the coming years.

After suffering steep losses last year, stocks started 2023 rebounding on the heels of an improved sentiment in financial market. However, this move has stalled in February, and it now appears that the overall market is vulnerable.

The same goes for shares of Tradeweb Markets Inc. ( TW ), as they are up roughly 9% in 2023, but off recent highs reached in mid-February.

This weakness in the stock prices seems an opportunity for investors looking to companies with strong fundaments like Tradeweb. Trading at lower multiples than the historical average, the comparison with its peers looks more favorable, as its valuation premium is currently much lower now.

Meanwhile, Tradeweb continues to show strong topline growth and margin expansion, as growing addressable market and market share gains have benefited the company. With this positive backdrop not expected to change anytime soon, Tradeweb is well-positioned to keep its growth path and reward long-term investors with strong returns over time.

Strong Top-line Growth

Tradeweb has been a typical growth story over the past years. As the figure below shows, the company experienced annual revenue growth of 14.8% CAGR over the last 7 years (2016 - 2022), driven in large part by the expansion of its two largest businesses, credit and rates, which accounted for more than 70% of total growth.

As a leading company in building and operating electronic marketplaces, Tradeweb has been successfully growing its business, taking advantage of the trend toward electronic trading and the growing market volume in financial instruments, such as money market and interest rate swaps, where Tradeweb is a strong player.

Last year was not different, Tradeweb's FY 2022 revenue increased 10.4% on a yearly basis, led by strong volume trading in credit, such as municipal bonds and U.S. corporate credit trading. On top of that, we saw substantial growth coming from equities, led by institutional exchange-traded funds ("ETFs") and a more diversified equity product offering, while the money market segment hit record levels, thanks to growth in certificates of deposit ((CD)) and institutional repurchase agreements (repos).

On balance, Tradeweb delivered a broad-based revenue growth in 2022, despite a more moderate expansion in the rates segment, which saw yearly 8% growth, dragged down by an unfavorable environment for swaps and mortgage, notably in the fourth quarter.

What we have seen over the past years is a combination of several factors. Firstly, there is no question that the addressable market has been expanding. As we can see below, TAM (total addressable market) grew from $3.9 T in 2015 to roughly $7.9 T in 2022, which translates into a 10% CAGR, given tailwinds like the electronification of financial markets and the underlying assets growth.

In addition, Tradeweb has been able to increase its market share over the years, fueled by its success in the migration to the electronic markets and new product offerings across asset classes.

Margin Expansion and New Investments are Well-balanced

Driven by this solid revenue growth, Tradeweb saw margins expanding in 2022, with the adjusted EBITDA expanding 111 bps to 51.9%, logging a 1,300 bps total expansion since 2016. Meanwhile, investments have been a clear priority for the company, as it has increased nearly 50% over the same time span, as shown through the figure below:

Going forward, the company plans to continue to invest in 2023 primarily on rates and credit areas, looking to long-term growth, while keeping margins expansion, although probably at a more modest pace now, given they are already at relatively elevated levels after recording meaningful growth over the past years.

Trading at High Multiples

It is not surprising to see companies with higher revenue and margin growth profile trading at a premium valuation.

This is the case of Tradeweb, which currently trades at a P/E Forward of 33.2, compared with the peer group average of 19.2, and gives the company a premium valuation of nearly 42%. As a remark, the peer group includes companies from financial exchanges, brokerage, and investment banking industries (CME, MKTX, IBKR, ICE, LPLA, SF, BOE, NDAQ, SCHW, RJF).

The silver lining here is that Tradeweb has usually traded at much higher valuations over the past years prior to the stock market downturn underway. As the figure below shows, Tradeweb's P/E Forward 5-year average is as high as 44.9 and gives a theoretical 35% upside to the current stock price level, assuming that valuation will eventually return to the historical average.

In contrast, the peer group's P/E Forward 5-year average of 22.4 offers a much lower upside of 16% to the peer group. Therefore, on a comparative basis, there is a roughly 19% valuation gap favoring Tradeweb. This creates the potential to outperformance the peer group when the market recovers.

Outlook is Positive for the Stock

While the current environment is driven by uncertainties relative to the inflation trajectory, central banks' restrictive policies, and geopolitical tensions in place are affecting most industries, Tradeweb Markets Inc. has a relatively more stable business model.

For example, Tradeweb Markets Inc.'s largest revenue contributor comes from trading activity, which is likely to benefit in times of higher uncertainty. Furthermore, this higher yield environment underway can be a positive for the fixed income market as well.

On top of that, current consensus estimates from financial analysts seems to confirm a positive view for Tradeweb Markets Inc., with revenue growth of 11.7% and 10.3% for 2023 and 2024, respectively, and EPS growth of 12.5% and 12.7% for the same period. Therefore, despite these challenging times, investors with patience to navigate this current turbulent stock market should be rewarded with healthy returns holding shares of Tradeweb Markets Inc. over the coming years.

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