Highlights From ICE's Q3 Conference Call: Achieved Record Revenues with OTC at 49% and Futures Producing 40%

November 3, 2009 2:23 PM EST

IntercontinentalExchange, Inc. (NYSE: ICE) reports Q3 EPS of $1.18, 3 cents better than the analyst estimate of $1.15. Revenue for the quarter was $256 million, which compares to the estimate of $255.72 million.

Highlights From ICE's Q3 Conference Call:

• (CFO) We once again achieved record revenues in Q3 reflecting broad demand for our markets, clearinghouses and services despite ongoing market challenges.
  
• These results show continued healthy trends in our core commodities business across futures and OTC markets and were achieved while continuing to invest in several key growth initiatives including a launch of our European CDS Clearing business.
  
• During the quarter, ICE achieved record consolidated revenues of $256 million, an increase of 27% over last year's third quarter.
  
• Consolidated operating income was up 17% over 3Q '08 to $140 million and up 4% over this year's Q2.
  
• Operating margin once again improved sequentially to 55% in Q3.
  
• Importantly operating margin for our non-CDS business was 65% during the quarter.
  
• 3Q adjusted EBITDA was up 33% year-to-year to a record $154 million. For the first three quarters of 2009 this measure of financial performance is up 10% despite the global recession.
  
• Since we acquired NYBOT in January 2007, we have more than doubled both operating margins and quarterly revenues.
  
• OTC revenues represented 49% of our consolidated revenues during Q3. Futures represented 40%, and market data contributed 10%.
  
• Q3 transaction revenues increased 34% to $229 million. This includes nearly $104 million from futures, $82 million from OTC energy and $43 million from OTC credit. Markit revenues were stable year-to-year and quarter-to-quarter at $25 million.
  
• On the expense side, consolidated operating expenses were $116 million compared to 82 million in 3Q '08. The expense growth was driven by $27 million year-to-year increase related to the addition of our OTC credit business and a $6 million increase in amortization related to our Russell life.
  
• In ICE Futures Europe we achieved record transaction revenues of $66 million, up 44% year-to-year with average daily volume or ADB of 676,000 contracts. The rate per contract or RPC for energy futures was $1.53, up from $1.22 in 3Q '08.
  
• Turning now to Slide Eight, you'll see the third quarter performance of our agricultural and financial futures business. ADB was 386,000 contracts per day, up 33% year-to-year.
  
• Agricultural RPC in Q3 was $2.08 compared to $2.22 in 3Q '08. As with our oil market, while RPC for our ag contracts was down, volumes were up materially especially in our benchmark sugar contracts which drove solid revenue performance.
  
• We reported that October ADB for ICE Futures U.S. declined 15%. The first full month of Russell trading occurred in October 2008 and our volumes reflect the aforementioned difficulties in the index market.
  
• OTC transaction revenues rose 39% year-to-year, third quarter average daily commissions or ADC in our OTC energy markets were $1.25 million up 12% from 3Q '08 and up 11% sequentially from our second highest quarterly ADC on record.
  
• The healthy OTC energy performance reflects our second consecutive quarter of revenue records in both OTC oil and power. It was also driven by the 150 new products that we've introduced for clearing since last November. These new products contributed $2.8 million in net revenue or roughly $0.02 of earnings per share in Q3 and reflecting the markets move in advance of regulatory and political calls for clearing solutions 96% of our 3Q contract volume was clear.
  
• Our OTC Energy business continued to perform well in October with average daily commissions for the month of approximately $1.4 million, up from our Q3 average and up significantly from the prior year's period.
  
• Turning to our Credit business revenues totaled $43 million during Q3. This includes $30 million from Creditex which was down roughly 27% over Q3 of 2008 on a pro forma basis.
  
• ETS clearing generated $13 million of revenue during the third quarter and as updated previously we now expect full year revenues to be at or above $30 million.
  
• Our forward visibility in the CDS clearing revenues remain limited. However, we've established ourselves as the global leader in the space, and we are confident that this initiative will yield further revenue growth in 2010 even as costs decline as investment levels subside beginning in Q4.
  
• (CEO Since March, ICE has cleared CDS swaps totaling $3.5 trillion in notional value.
  
• As of October 31, the cash in ICE Trust U.S. guaranteed fund was $2 billion, which we believe is the largest cash guarantee fund of any global clearing organization and it all supports just one single product, credit.
  
• In addition to providing the only large dedicated default fund for CDS, we believe that we have the most stringent risk standards of any competing model and we're working with regulators to ensure the competing risk models are more consistent and adequate across all solutions.
  
• During the quarter we expect to roll out additional phases within our derivative's clearing effort.
  
• In the soft Ag commodities market a significant number of commercial participants were credit constrained but volumes are now recovering with sugar volume up 11% in October.
  
• On the energy side historically high oil inventory are being offset by resurgence in Asian demand, a reduction in refining capacity and improving global economic indicators.
  
• Given these conflicting signals and the volatility that they produce our energy futures market continue to perform path or near record levels.
  
• 38% open interest growth in our over-the-counter markets, 20% open interest growth for Brent crude oil, 44% for gas oil and open interest in our key soft Ag markets up 21%.
  
• You can also see that our emerging utilities and emissions markets are truly a source of opportunity with open interest up 130% year-over-year.
  
• (Q&A) I'd love to dive a little bit deeper into kind of the financials around the CDS business. You spent a lot of money building up the CDS business and now that it's off the ground I'd love to know if you could update us on the targeted return you expect on the investment. And even if you give us something more generic like an IRR that you are expecting in deals. Like I'd take that. But I'd love to figure our what needs to happen for your to get there. Because I think what we don't understand is what is gravy and what part of your expectations. So, for example, is buy-side clearing gravy or is that part of what you need to make CDS really work for you from an investment standpoint? (A)All right, thanks for the question, Ken. Look, we look at the overall credit investments we made the same way we that we look at any deal. We take a very disciplined approach. We look for returns that are in excess of our weighted average cost-to-capital which around 11 to 12%. So we typically target deals that will yield at least the 12% return. So you can think of that kind of the hurdle rate. And again, we're looking at the investments we've made collectively across the Creditex acquisition and the ICE Trust and ICE Clear Europe build out as the investment upon which we'll deliver that return. I think you'd be hard pressed with any investment six months in to say that it's exactly where you expected it to be, but I would tell you that we have established a global leadership position in the CDS clearing business. We've cleared over $3,000,000,000,000. We're up to 13 banks in the U.S., 13 clearing member, excuse me, in the U.S., 12 clearing members in Europe. We've got talk he index clearing going in both places. We're in tests right now with the buy-side solution, the single name, and we're operationally ready on both of those. So I feel very good about the position we've established. The things that we need in order to make the return on the investment come to fruition are continued performance in index, we continue to add new clearing members, we continue to bring the buy-side in through our customer segregation platform, we get single names launched. And then, frankly, as we made the investment I don't think any of us envisioned the CDS market quite imploding the way it did the month that we did the Creditex deal. It's not something we haven't seen before. It's the same thing that happened in the energy business. And so our expectation is what will really drive the return on this investment is the CDS market recovery and people going back to viewing that product as a key place where they can hedge their credit risk, and frankly, treat the CDS almost as if they do equity today. So I think we've got all of the elements in place that we expected to have in place. I think we're very well positioned in terms of the leadership position we've established, and I think we're well on our way to generating above hurdle
  rate on the investment.
  
• Yes, I guess my question is more broad in general. Your results have been good on the beat, but cost of trading companies, whether it be equities, whether it be interdealer brokers, the agency, even with credit sector, trading companies have underperformed - to my knowledge, every single one of them. So I guess the question is, is there some explanation in this economic turmoil to explain this, and then, more specifically, with you - the only trading company you have is Creditex, and I've seen your electronic portion went down a bit. Is there a shift going on between exchanges and sort of the customer or so? (A) Rich, let me just walk you back in time to the point of our IPO and when we first started talking to the public about our business. I think you will recall that we have always made a conscious effort to try to figure out where there are emerging asset classes where we can provide services and position ourselves in those, basically set our sails in that wind to ride the growth. And I think our exchange business has outperformed other exchanges because of the decisions we made a long time ago that commodities were being globalized and that electronic trading was taking streams around the world and trading was moving to 24-hour real time risk management. And so, if you think about ICE in particular, we've really targeted, and very selectively targeted, markets that are growing because of the growth of right now largely Asia and the BRIC countries, that in our exposure to energy which is obviously global but also soft ags, which are really non-U.S. products like sugar, cocoa and coffee are non-U.S. products. These are all consumptive products by emerging nations. We moved into the credit business because it's in our mind it's the one asset class that is never electronified. The management of credit is a huge - it is the banking industry, the global banking industry. Obviously, the global banking industry has been turned down, but we expect it to recover like most, and that industry has never risk managed using anything other than telephone. So we think - we've seen how global the interconnected banks are now, and we think that it's going to move off the telephone onto the screen and it's going to be clear. And so that's the positioning that we've made in that OTC market. I think in terms of you looking at the energy of the brokers and other kinds of platforms, there's no question that in interest rates and in equities and in inter-dealer services the velocity has slowed down. And banks themselves who have trading companies have made a lot of money in this because they're doing a smaller number of trades with larger spreads. And so those markets, where you can capture the spread, are doing well. That happens to be the bond market and some of the interest rate markets if you happen to be a dealer. So but as you know the platform business that we're in really is based on velocity and the number of trades because that's how we charge our commission. We've avoided that because we haven't really been levered to the industries that have turned down other than credit. But
  we've made a conscious decision that, that is the one business that is still analog in Additional World. And I think you'll see long term that taking a small piece of our effort and equity to get into the credit business will pay long term results.
  
• That's very helpful. And then my one follow-up would be I guess more what do you call it, concrete is they've talked, these headlines about the Saudis moving away from the WTI benchmark, and just give your thoughts as I know you'll be very neutral and unbiased bystander. You're actually not with your WTI bond . What are your thoughts on their move, I guess, and the impact on ICE and CME? (A)The Saudis have never used the exchange trade at WTI futures as a benchmark. They actually lack confidence in the WTI market that we trade. So they have not been relevant per se. I'm sure people, major oil companies that the Saudis do business with may have used the WTI markets as a hedge, but the Saudis themselves have not. There are now - we've talked a lot about even on past earnings call, how the WTI market is really structurally lost because there is no such oil as many more as west Texas intermediate crude. That's particularly relevant and Cushing, Oklahoma is not really the center of the oil industry any longer. And so really what the Saudis are doing is because Cushing is hooked via pipelines to the Gulf of Mexico. And really oil going into Cushing comes from Canada and from the Gulf via pipeline. They're simply moving geographically closer to the Gulf to get rid of the pipeline and storage constraints that exist at Cushing. And that's probably a positive move for the exchanges because they will start hedging with a contract that is traded in the world right now and that is this differential contract between and it's a locational differential between the Gulf and Cushing, Oklahoma.
  We've seen that even though ICE talks about WTI as being a flawed marker, it's still a highly traded contract because people do hedge and speculate around those storage problems at Cushing because the pipelines do go through there. But I think it's accretive ultimately to the business. I should mention we have the rights to that license at Argus that they're going to be benchmarking to. We licensed that just recently in anticipation of this move. We have a relationship with the Saudi's. We know and understand their concerns, and we've built that product into our systems. We haven't announced its launch yet or exactly what we're going to do, but we will be a player in that market as well. And so net, net I think, frankly, you could think of it's just a new contract that's going to provide a new differential
  to the market and that's probably a net positive for exchanges.

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