Exchanges have been some of the better-performing financial stocks during the COVID-19 crisis. They're often safer in recessions because they take little to no credit risk, and their business doesn't suffer during market volatility because more trading activity typically results in more fees.
But exchanges still aren't associated with high growth, which is why it's interesting that Intercontinental Exchange (NYSE:ICE) shows up in three of Cathie Wood's exchange-traded funds. Wood is the founder and CEO of Ark Invest, whose investment philosophy focuses on finding "the leaders, enablers, and beneficiaries of disruptive innovation." As of Tuesday's close, Intercontinental Exchange was a top 10 holding in Ark's Fintech Innovation ETF.
Intercontinental Exchange grew revenue in the single digits for three straight years before turning in 16% growth last year. But it has been building a mortgage business that should diversify its exposure from stock trading and create new opportunities. Does it have something for investors focused on growth as well as defense?
Mortgage technology presents a huge growth opportunity
Intercontinental Exchange is best known as the owner of the New York Stock Exchange, but it operates in three distinct business lines. The exchanges segment focuses on trading, clearing, and listing securities. The fixed income and data services segment provides pricing data, indexes, credit default swap pricing, and clearing services. Finally, the mortgage technology segment includes a technology platform that allows mortgage bankers to streamline workflow.
The exchanges segment accounted for 60% of Intercontinental Exchange's revenue in 2020. Fixed income and data accounted for 30%, and mortgage technology accounted for the rest. But mortgage technology will grow in importance in 2021 as a full year of Ellie Mae revenue will be included in the financial statements.
The mortgage technology segment has huge potential given that mortgage banking is still a largely in-person, paper-intensive business. The company views this business as ripe for disruption. This segment includes Ellie Mae, which is best known for its loan origination system, Encompass. This system helps bankers complete the entire assembly using one software solution. The Mortgage Electronic Registration System (MERS) is a central database for mortgage servicing and title information.
Despite the recent increase in interest rates, 2021 will be another fantastic year for mortgage origination. The Mortgage Bankers Association forecasts that origination will hit $2.5 trillion in 2021, which will be a slight downturn from 2020, which was the best year since 2003. Since Encompass is basically a subscription model, the revenue is recurring and Intercontinental Exchange will benefit if there is a price war between the big originators. As the big firms compete to drive down costs, Intercontinental Exchange's offerings will be a big part of that.
Intercontinental Exchange is building out a digital asset platform
Intercontinental Exchange also has a majority investment in Bakkt, which plans to launch a platform that allows consumers to buy, sell, store, convert, and spend digital currencies. Note that these assets are more than just cryptocurrencies; they include things like loyalty cards, in-game assets, and rewards points. Bakkt also offers a custodial solution for Bitcoin futures which are exchange-traded. This is another huge potential growth opportunity for the company.
Mortgage technology and Bakkt provide a good future growth story, while the exchanges and data lines provide a steady stream of cash flow. Note that exchanges net revenue grew 10% last year, so it is still growing faster than the economy. Data and fixed income grew only 3%, which was probably driven by super-low interest rates, as CME Group has observed.
Average daily volumes are picking up
Intercontinental Exchange recently reported that average daily volumes rose 30% versus the fourth quarter of 2020, so the good times for the exchanges business continues. The increase was driven primarily by commodities, as cash equity average daily volumes were up only 7%. Interest rates products rose 47%, which is a sign that rising rates are helping things.
Intercontinental Exchange trades at 24 times expected 2021 earnings per share, and the company is expected to grow earnings per share by 10% this year. That growth may be exaggerated somewhat by a full year of Ellie Mae results, but Intercontinental Exchange has a powerful competitive moat and some assets that are really second to none. Growth investors will be attracted to the potential for disruption in mortgage and cryptocurrencies, while the exchanges business will provide a steady basis for earnings growth and cash flows. The mortgage disruption potential is probably the reason why Cathie Wood's Ark Investment holds the stock -- and why growth investors looking to diversify should give it a look.