IntercontinentalExchange Earnings: Top Line Growth, Improved Margins Despite Pressure On Volumes

IntercontinentalExchange Group (NYSE:ICE) reported its Q1 earnings on May 8, with the NYSE Euronext business fully integrated for the first time. ICE’s derivatives trading volumes declined over the prior year quarter with weakness in the natural gas (-14%), oil (-10%) and interest rate (-26%) derivative classes. However, the company’s transaction-based revenues were resilient as a result of the influx of clearing revenues as well as a rise in the rate per contract (RPC) charged by the exchange operator. The relatively higher RPC led to 10% organic growth in trading and clearing revenues. Moreover, the contribution of the NYSE-Euronext businesses led to a 150% inorganic growth in trade-based revenues. ^[1]

While ICE’s trading business was originally just comprised of derivatives trading, the company now has cash equity operations with the acquisition of NYSE. Derivatives trading, which contributes almost 60% of the company’s value according to our estimates, saw a 13% decline in activity during Q1 2014 compared to the combined NYSE Euronext and ICE volumes for the prior year quarter. With the decline in derivatives trading volumes and improved margins we have revised our price estimate for the company’s stock. Our $225 price estimate for IntercontinetalExchange Group is nearly 20% ahead of the current market price.

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Increase In Revenues Despite Low Derivative Trading Volumes

Most of the derivative classes traded on the ICE platform saw a decline in volumes compared to prior year quarter. As we noted in our earnings preview, trading activity declined for foreign exchange products (-20%), equity derivatives (-25%), short-term interest rate products (-27%) and long-term interest rate products (-5%) compared to the year ago period. On the other hand, the subdued activity in natural gas derivatives trading picked up in early 2014 due to the volatility in gas pricing caused by extreme cold weather. However, the surge in trading lasted only during the months of January and February, then plummeted in March as gas prices stabilized. Consequently, the trading volumes for natural gas derivatives during the March quarter were about 10% lower than the year ago period. ^[2]

Power and agricultural commodities were the only segments with year-over-year growth in trading activity during the quarter. Power derivatives, which include futures and options for U.S, Europe and U.K. markets, were exceptionally high both sequentially (35%) and y-o-y (50%), with significant growth coming from European power derivatives trading. Additionally, trading activity was up for agricultural commodities derivatives such as sugar, cocoa and coffee contracts, which witnessed an increase largely due to the sustained growth of agricultural commodity products in Latin America. ^[3]

As a result, the overall average daily volume (ADV) of futures and options declined by 13% y-o-y to 6.6 million contracts a day. Despite comparatively lower volumes, the company reported an increase in revenues due to the addition of the clearing business for interest rate products as well as a favorable mix of high-revenue agricultural and metals derivatives.

SMX Integration, Euronext IPO, NYSE Technologies Divestiture In Focus

The company acquired the Singapore Mercantile Exchange (SMX) and clearing house earlier in the quarter, which has now made ICE the only operator in the world with exchanges across the U.S, Europe, Latin America (Brazil) and Asia (Singapore). SMX has now been renamed ICE Futures Singapore and the clearing house is now called ICE Clear Singapore. The company expects strong growth in Asia in the long run, which it intends to capitalize on with its Singapore-based exchange and clearing house. ^[4]

ICE management has decided to divest certain businesses under NYSE Technologies as a part of its cost management measures. With some of the redundant technology-related businesses divested, ICE intends to have a single integrated technology platform rather than five separate technology platforms. Divesting non-core NYSE technology businesses should help the company to reduce expenses and manage its market data and technology division more efficiently.

The ICE Group plans to launch Euronext’s IPO next month, due to which the company provided separate revenues and margins figures for Europe-based exchange. Euronext’s net revenues stood at $136 million for the quarter, with revenue growth in both derivatives and cash equity trading segments, despite a decline in trading volumes. The company also pointed out that Euronext’s strong quarterly figures did not include clearing revenues, which Euronext started earning in April, or the cost synergies (~$80 million) which Euronext management expects to deliver over a period of three years. Going forward, ICE intends to keep a 25-30% stake in Euronext, which is valued at about $2-2.5 billion.  ^[5] ICE mentioned in its filing that the proceeds from the Euronext IPO will be used to pay off outstanding debt. Following the Euronext IPO, the company plans to merge Liffe, its London-based futures exchange, with ICE Futures Europe.

Margins Improve More Than Anticipated

At the beginning of 2013, the combined operating margins of NYSE Euronext and IntercontinentalExchange Group were estimated by ICE management to be around 42%. During the year, the company realized $95 million in synergies, bringing the margins up to around 45%. Since Euronext is a lower-margin business (~41%), spinning it off should contribute to improving ICE’s overall margins. With the Euronext IPO and divestiture of certain NYSE businesses in mind, the company originally guided for margins around 49% for 2014.

However, the company reported operating margins of 50% for the March quarter. The company attributed the improvement in margins to “disciplined expense management” by successfully achieving expense synergies of over $220 million on a run rate basis. Going forward, the company expects margins to stay at 50-51% for the full year. Given that the company is successfully maintaining its targeted synergies on a run rate basis, we expect the company to meet its target of generating margins of over 55% in 2015. ^[6]

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1. ICE Q1 2014 Earnings Call Transcript, Seeking Alpha, May 2014 [↩]
2. ICE Combined Historical Monthly Volumes, ICE Investor Relations, April 2014 [↩]
3. ICE NYX Merger To Boost Commodity Derivatives, Markets Media, September 2013 [↩]
4. ICE Earnings Call Presentation Q1 2014, ICE Investor Relations, May 2014 [↩]
5. Euronext Said To Plan Sale Of Up To 30% Stake Before IPO, Bloomberg, January 2014 [↩]
6. ICE Earnings Call Transcript Q4 2013, Seeking Alpha, February 2014 [↩]