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CBOE: Exchanging Profits

07/27/2020 5:00 am EST

Focus: FINANCIALS

Douglas Gerlach

President, ICLUBcentral, Inc.

Cboe Global Markets (CBOE) strikes us as one of the few reasonably priced growth companies, suggests Douglas Gerlach, editor of Investor Advisory Service — and a participant in the upcoming MoneyShow virtual event, August 3-5. Register for free here.

Cboe was founded in 1973 as the Chicago Board Options Exchange (CBOE). Its original market was the trading of call and put options on individual stocks. In 2010, it became a public company after almost four decades of ownership by traders who owned seats on the CBOE.

Primarily as a result of acquisitions, it has diversified into other trading markets. It now operates the largest options exchange in the U.S., the third largest stock market trading platform Better Alternative Trading System — known as BATS — as well as one of the largest stock markets in Europe.

It also offers trading in financial futures, foreign exchange, volatility products based on Volatility Index (VIX), and a marketplace for exchange traded funds. Following the acquisition of BATS in 2017, the company switched its listing to BATS from NASDAQ. BATS traded 16% of U.S. equity volume in 2019.

In Europe, it captured 20% of the volume in the equities it traded. Its share of the foreign exchange market was 15%. Cboe is big enough to matter in these large markets, but small enough to have significant runway ahead of it.

The company is in the process of acquiring EuroCCP which clears equity trades for Cboe European operations. It also recently acquired a risk analytics company and a small options rival. Cboe has interesting financial characteristics that investors need to consider.

Cboe has exclusive licenses to operate derivatives markets (options and futures) on indexes from S&P, Dow Jones, MSCI, and FTSE Russell. The most important products are based on S&P indexes, and that license is set to expire at the end of 2033.

The company generates revenue predominantly through fees on trades processed on its platforms (69% of 2019 revenue). It also charges fees for access to its markets and equipment (9% of revenue), for market data (9% of revenue), and in the form of regulatory fines in its role as a self-regulatory organization (SRO), 12% of revenue.

The stock's P/E ratio is lower compared to most other publicly traded U.S. exchange operators. The stock becomes even more appealing when measured by cash flow. The stock trades for 15.5x the last 12 months’ free cash flow.

At 10% annual growth, EPS could reach $6.30 in five years. We capped the high P/E ratio at 30, below the level of any of the past four years. The potential high price is $189.

We see the downside risk as 20% to $72, the low price reached in the market meltdown earlier this year.  The low price is also comparable to the average low over the past five years despite the firm's growth. Adding in a 1.6% dividend yield, the potential total annual return could exceed 17%.

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