A rising market that exhibits above-average stability finds few detractors on Wall Street, yet exchange operator Cboe Global Markets (CBOE 1.25%) has reason to bemoan the benign market conditions of the first few months of 2019. The pioneer of hedging instruments and volatility-based income strategies saw trading volumes wilt in the first quarter. Cboe's earnings report, released May 3, demonstrated its difficulty in scaling revenue and profits when the perception of risk in the markets declines. Below, we'll break down the last three months and review management's answer to suboptimal trading patterns.
Note that all comparative numbers in the discussion that follow refer to the prior-year quarter.
Cboe Global Markets: The raw numbers
|Diluted earnings per share
What happened with Cboe Global Markets this quarter?
A decline in trading volume of both index options and multiply listed options pressured net transaction fees in options trading. The segment's top line slumped 17% to $138.5 million. Average daily volume (ADV) fell 22%, while the segment's revenue per contract (RPC) dipped by 7%. Cboe's market share slipped by nearly 400 basis points to 36.8%. This indicates that in addition to reduced volatility, which crimped demand for options to hedge stock positions, Cboe also lost some volume to competitors.
Futures net revenue fell by 30% to $29.5, as ADV in futures tied to the company's proprietary S&P 500 Volatility Index (VIX) slumped by 37%. Last quarter's pop in VIX futures trading proved short-lived; the first quarter marked the third out of the last four quarters in which ADV fell on a year-over-year basis.
Cboe's equities businesses weakened but fared relatively better during the quarter. U.S. equities net revenue dipped 5% to $75.8 million, while European equities net revenue decreased by 7% to $22.8 million. The U.S. equities business lost 340 basis points of competitive position for a total market share of 16% at quarter-end, while European equities market share inched up 90 basis points to 22.1%.
Global FX followed the pattern of its peer segments, as average notional daily volume, or ADNV, dipped 12%, pushing foreign exchange net revenue down 5% to $13.9 million. However, the company's smallest segment managed to gain a half percent of market share, ending the quarter with a 15.8% share of the total exchange-based foreign-exchange market.
- After removing the amortization of intangibles acquired through the Bats Global Markets purchase in 2017 and other minor adjustments, the company's operating margin was even with the first quarter of 2018 at 66.5%. Lower compensation expense and benefits, reduced incentive compensation from slimmer profits, and cost control kept overall expenses in check as revenue declined.
- The company repurchased $35 million worth of its own shares during the quarter.
- Recurring revenue of proprietary market data and access and capacity fees expanded 10% year over year, providing a small but welcome offset to waning trading volume.
What management had to say
As it has often done in periods of relative market calm, Cboe ramped up its outreach to institutional and private investors during the first quarter. CEO Edward Tilly explained the strategy during the company's earnings conference call:
As you know, market conditions were challenging throughout the quarter, negatively impacting volume across our business lines. As we have in previous low-volume cycles, we have used this less-volatile period to seed potential future growth in our proprietary index products through increased customer outreach and education efforts. As a result, we are confident we are even better positioned to grow our business and to define markets globally to deliver value to our customers and shareholders.
Cboe doesn't issue revenue or net earnings guidance, but it does project a few key items, including total expense for each calendar year. Due in part to lower expenses in the first quarter, Cboe revised its 2019 total adjusted operating expense range for 2019 to $415 million to $423 million against a prior expectation of $420 million to $429 million.
As we look ahead to the next few quarters, investors should remember that the complexion of the markets can change suddenly. CEO Tilly emphasized this toward the end of Cboe's earnings call:
[T]here will be something new. There will be more uncertainty. I guarantee it. We've seen it every cycle, but we just don't know what it is yet.
Indeed, in the trading sessions following the company's earnings release to date, the VIX has spiked more than 30% on renewed fears over U.S.-China trade negotiations. Even as investors digest Cboe's trading slump, activity may already be starting to revive.