Chit Chat Stocks - MarketAxess (Ticker: MKTX) Not So Deep Dive

Episode Date: February 14, 2023

MarketAxess is a leading electronic trading platform that enables institutional investors to trade fixed-income securities globally with a range of tools and functionality. At the end of the month, we will publish an Arch Capital episode that will cover the company: Nelnet. Listen closely as Brett and Ryan go through the history, financials, and future prospects of MarketAxess. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:40) Industry | (15:43) Management & Ownership | (20:36) Earnings | (22:26) Balance Sheet | (25:23) Valuation | (26:40) Our Analysis | (28:55) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in to Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. As always, today is our Tuesday not-so-deep-dive episode where we analyze

one stock by covering its business model, ownership, financials, and future growth opportunities. We just finished our mega cap technology month. If you're interested in any of those companies check out the feed for the month of january today though we are kicking off our financials month and covering what are we going to do market access which is today electronic bond trading platform we're doing american express nelnet uh it's gonna go we own and then block slash square it's gonna go market access block american express and then we're going to conclude with Nelma. It's not all those that are that similar, but they are all tangential, I guess, to the... I love using that word, even though it's probably never right,

to the financial sector. So that's what we're trying to cover. Yep, exactly. And they're really all financial technology when we get down to it. And today we are covering market access, which is the, I think, premier or one of the two premier electronic bond trading platforms in the world. Ryan won't get into all the products they offer fixed income investors. In a minute before we do housekeeping items, subscribe to the newsletter to get show notes, especially if you like listening to these episodes. It's free and you'll get all the charts we look at during this episode and give us a review on either Spotify or Apple Podcasts. If you like watching the video, seeing some of the screenshots we use, you can do

so on YouTube or Spotify. Today's episode is presented by Stratosphere, our investing home screen for fundamental research. They are presenting sponsors as of right now, and we love working with them. If you are using a legacy provider for your home screen as an investor, whether that be something like Yahoo Finance or some of the other ones out there, you need to upgrade to a modern solution like Stratosphere.io. Stratosphere's dashboard tools let us easily track our investments and stocks. We're researching with a nifty news feed, SEC file aggregation, and a fundamental charting tool to compare companies. We're in Stratosphere every day, and there is plenty more that Stratosphere has to offer,

and they're getting better day by day by day. They just released a new update for their formatting, and it's really, really great. And you can try it for free. There's no payment hurdle to try it out by going to stratosphere.io. That is stratosphere.io and use promo code CCM for 15% off any paid plan. If you are a professional who is interested in one of those products, but tell them we sent you and please head on over to stratosphere.io. We use it every day. We think if you're using something like Yahoo Finance, you got to switch over because it's just light years ahead of the spammy stuff that they use. All right, Ryan, introduce market access. What is an electronic bond trading platform? Yeah, I think this is a universe that a lot of

our investors or listeners, I mean, they probably are investors, but they're listeners too. Maybe aren't that familiar with, everyone kind of knows what bonds are, I think if you're in the investing universe, but the actual transacting of them and the platform to do it is maybe an experience that a lot of people aren't used to. I think maybe they go through ETFs as a way to buy bonds, like a bond ETF. But when we're talking about actual bonds, market access is really one of the premier platforms to do it. So in one sentence, they're an electronic trading platform for fixed income securities, but kind of delay the groundwork. Bonds themselves, historically, they've been traded by, you get in contact with an actual broker who would connect you with other

investors that are looking to sell their bonds and you pay the broker in the meantime. Market access is trying to democratize and really digitize that process. And so they make money in three ways. They make money through commissions, they make money through information and data services, and then post-trade services, but really the bulk of their revenue comes from commissions. And so they earn a mix of both distribution fees and then variable fees. So distribution fees are monthly charges that allow users, which in most cases, the users are like big institutions, to trade unlimited volume, but you pay that one month fee. And then variable fees are fees per transaction that depend on the type of bond that's being traded,

the duration of the bond, the size of your purchase. Basically, it's very simple, like old school equities trading platforms or stock trading platforms, they would charge you a per transaction commission. That's what market access does. And variable fees still make up really the majority of their top line. So that's how they, that's their primary way for making money. And they do this kind of through three different platforms. So they have the, what they call disclosed request for quote, which is RFQ. This is their traditional, what they call protocol and they love their buzzwords, or platform that makes up 60% of their credit trading volume. And so when I say, typically, if I say fixed income, if I say bonds, if I say credit,

kind of lump it all into one, there is two different, they have basically two businesses in credits and rates, but really the bulk of their business is in credit. And so this disclosed RFQ allows their institutional investors to request bids or offers from brokers or dealers and they get competing bids simultaneously. So this allows them to, instead of previously how they would have picked up the phone and called four different brokers to try to get a quote, they can request bids from 15 different brokers that are all selling the bond at the same time. This gives them the best price. It saves them a ton of money. And so that's really the bulk of where the credit trading volume is right now. However, they're rolling out this new platform

called Open Trading, which functions a lot more like an exchange. And it's growing quickly. And this is one where it allows participants to trade bonds or fixed income securities from anyone else on the platform. And they can do so anonymously. So they don't know who the buyer the seller is. It's basically all to all is the term they use. I would say this is the closest thing bridging the bond, the electronic bond trading to equity trading kind of makes it more like your typical equity exchange. Would you agree with that, Brett? Yeah, that is correct. It's not technically an exchange or they don't call it that, but it is similar to that where you're going to send out the price. And yeah, it is all to all trading. You're going to try to match a bid

and ask. Although, as you'll probably mention, I don't know if you have it here, there are not that many people trading bonds. There's, I don't think any retail traders within them, unless it is someone that's just an individual that's mega rich. And it's just the whole point for them is to solve the liquidity problem for bond traders. Because since there's so few traders, sense, there's not that many bonds out there. There's not that many people trading. There aren't as many transactions. You want to connect them and make the marketplace as large as possible because sometimes it's really hard to sell a bond. Yeah, that's a really good way of describing it. It's beyond a lot of the technical capabilities that they talk about. Really, the reason market

access has grown and their value that they provide is they connect people that want to buy bonds with people don't want to sell bonds. And it seems simple, but it's a platform more and more people or more and more institutions are turning to. The last thing that they earn commissions on is what they call automated trading protocols. This is really not that big in the grand scheme of things, but it's just automation. It allows clients to set parameters to trade automatically. So I kind of think about this like, what do they call it? Not a limit order, like a, what do they call it? When like, if your stock drops and you sell it immediately, it's like automated.

Oh, stock loss. Yeah. And it also could be indexes. It also could be algo funds who want to have a specific, you know, or a quantitative fund, excuse me, not an algorithm fund, or I guess those are similar, but you know, like a quantitative to find that one's a certain percentage of something or whatever, but yeah, it's just automated stuff through some of the tools they have. Yeah. It's really not a big part of the business. And then the other two elements that they have both account for about 5% of the top

line. Keep in mind commissions on credit trading is still 90% of the business, but the other two are information services. So there's a number of products here, but basically market access aggregates and sells the data on their platform to clients for a monthly price. If you use something like interactive brokers, they offer this as well, where they're selling additional data, more up-to-date pricing, that kind of thing. It's just an added service if you really want it. And then the last one is post-trade services. I think this is interesting because market access is a global business. And in Europe, all investment firms are required to submit their transactions to regulators within a day of the sale or purchase. This is all news to

me. Apparently, Market Access just provides those investment firms with a reporting solution for all different asset classes. So it sounds like if you're a big investment firm, you can either do this in-house, report them directly, or you can just record and report with Market Access's tools and Market Access will kind of do it for you. Both those are relatively small though. Ultimately, this is a commissions-based business. The other part that I think is important for understanding this business is there's a lot of different types of the bonds are fixed in some income securities. And they segment it into six different parts. So there's US high-grade, which is just like corporate investment grade bonds, which they classify as either triple B minus or better,

which is the S&P or the standard poor's grading of the debt. And they also use a Moody's one as well. And then there's, so there's US high grade, US high yield, which is a little more risky debt, higher yield, emerging market debt, Euro bonds, which is corporate bonds from companies in Europe, municipal bonds. So this is when a state, a city or a county kind of issues a bond, tries to raise money for, let's say like a public project. And then there's US government bonds. US government bonds is the largest, but it's not the largest in terms of fees. They're really not collecting that much fees on it, probably because it's so well-traded that the prices have really come down on it. But really, the bulk of their revenue comes from trading of US high-grade bonds

on their platform. And then in terms of history, kind of an interesting founding. And I actually like when i see this but so the company was founded in 1999 by rick mcveigh and mcveigh was actually an executive at jp morgan at the time working in their fixed income division for me it's a bit of i actually like it when people come from wall street or um and i know some people probably disagree with this but it shows me and usually it requires some years of results as well Well, it shows me that they probably have a shareholder orientation, that they try to optimize and focus on the shareholders because that's kind of the culture that's cultivated in a lot of those big investment banks and so forth. Anyway, so he was working at J.P. Morgan. And at the time, J.P. Morgan had an incubator project called Lab Morgan, which backed McVeigh's effort to build a web-based credit platform.

And there were apparently a lot of web-based credit platforms kind of popping up at the time. Dot com bubble, baby. Yeah. 1999. Yeah. However, I guess McVeigh, whether it was execution or just better financial backing, they were one of the few that kind of made it through. They also received funding from Bear Stearns. They were pretty well capitalized.

I think they received like $24 million in their initial financing. I'm guessing those are customers as well, kind of to get some of the few big dogs on there. Yeah, at least a portion of their trading. I'm sure they wanted to digitize. I'm sure JP Morgan did at least a part of it. And so either way, they just kind of had this strong start. And they parlayed that basically into an IPO in 2004. Another green flag I look for is IPOs that were not in bubble years.

so a lot of the like companies the ipo like 03 04 you know they were kind of they were real businesses probably because they weren't just uh it wasn't just easy money so um that i like that um since then they basically bought a lot of competing platforms um and they they buy those platforms. The most recent one was Mooney Brokers or Muni Brokers to, in most cases, acquire the broker dealers or the institutional firms that trade on there. Because the goal of market access is to get as many people buying bonds and as many people selling bonds as possible to get the best possible prices for their customers on the platform. And so they have that network effect where you can get both sides growing. And so one way to do that is to acquire

other marketplaces similar to them. So that's the basics of the business. It's been growing over time as bonds have continued to become more electronically traded. Although, and you're about to talk about this, I think there's still a lot of room to grow in terms of electronic trading. Yep. That's what they would say in their investor presentation. So the fixed income market, as people know, is huge and has a very complex addressable market, which thankfully market access breaks down for investors. If you're interested, they have some really good investor presentations to kind of outline some of this stuff. Yeah, they're going to use the buzzwords. You're going to have to look up and know the definitions, which is a bit of a hurdle, but you can really get where they're winning and stuff within those IR pages. So they outline it as an addressable average daily volume for the credit market. And for their products, they estimate it to be $72 billion. And this is everything excluding US treasuries. And then in the treasury market, they estimate the ADV or the average daily volume to be $589 billion. So spoiler alert, the US treasury market is quite big. Last year, the company did $11.8 billion in ADV excluding treasuries, and they estimate they have approximately 20% market share across its product categories. If I want to share my screen here one second, I can show a chart that outlines their growth in market share over time. One of those from their investor relations page, and then for the audio listeners, I will describe what it is.

So basically, in one of their IR pages, and I hope everyone can see this. If you can't, I will explain it. They have basically their quarter, kind of Q4, going from 2011 to 2021, and then estimated market share within high-grade and high-yield US bonds. And it's really, you call this very linear, Ryan, outside of the pandemic, where they kind of got a little bit of a boost, where they went from about 7% market share in 2011, and then each year gained about 1.5% market share. And today, we're sitting around 20%. Their thesis, I think, and a lot of maybe the investors' thesis when looking at this company is that that will continue. Yeah, so I guess let's see. Okay, next thing here. For every 1% market share gaining credit, this is a really interesting stat they give out. So for every 1% market share they gain, they estimate that'll add about $40 million in

incremental revenue. So if they double their market share, that is $800 million in new annual revenue, excluding treasuries. And then treasuries is a lot less lucrative. So they'd only gain about $4 to $5 million for every 1% market share gain. So the real value here is going to be the credit markets, even though the US Treasury market has higher volume. If we look at competitors, I will outline two main ones. First is the traditional and analog method that Ryan mentioned for bond selling, phone, email, instant messaging. If you watch Margin Call, that's what they're doing with those bond salesmen at the end there. And this is what the digital platforms have tried to disrupt. Second is their competitors are other digital platforms like TradeWeb. The TradeWeb is

the biggest competitor. They are slightly different where they have a big market share in rates. Although I didn't, for this episode, do a deep dive into them as well. That would take too long. Ryan, you have something to add here? So if you're familiar with margin call, there's a point when they're trying to unload as many bonds as they can. And he says, I'll give it to you for 60 cents on the dollar or something. They're like, why are you doing this? My loss is your gain or something like that. If this was done on market access, you could get all the prices quoted to you from competing sellers. So theoretically, this alleviates all those bag holders. Well, maybe not entirely, but it helps. It makes it more efficient, stuff like

that. But back to the trade web, they are slightly different, but they have an ADV estimated for the credit markets at about $10 billion, so slightly different, but they are the two largest players in electronic bond trading today. If we look at their 10K or their annual report, market access specifically outlines that they are worried about information service providers like Bloomberg, ICE, which is Intercontinental Exchange, and other people within that sector offering electronic trading to clients who they already have a relationship with. in the sub stack, I outlined a quote from a Bloomberg article about why electronic trading is growing market share, especially since the start of the COVID-19 pandemic. And it's pretty

clear why they basically say, look, there's no reason why it shouldn't be like that. There's these people from Goldman, the Fed, Guggenheim partners saying that they're calling the old methods archaic. They're saying they need to get into the 21st century. It's pretty interesting how There seems to be now a lot of momentum to go from these analog ways and embrace the digital platforms, which I thought was a positive sign when looking at market access. If you look at management ownership, let's go through this one quickly. Not very many important things here. We have the founder, CEO, and chairperson is still Richard McVeigh. He's been running the business since the beginning. However, they just announced that the COO, Chris Concanon,

will take over the reins as CEO on April 3rd. So this is really, really important as it's the one They've had the same CEO forever, and it seems like this Khan Cannon guy was kind of groomed as the successor, and he has a great track record within the financial space. He worked at CBO Global Markets when he worked at BATS, which was acquired by CBOE. He worked at Virtu Financial. He worked at Nasdaq. So he has a lot of experience within this sector of kind of the back end of the financial world. Look at their board of directors. They have 13 members.

No real egregious compensation there. Total executive compensation from 2021 is about 2.7% of 2022 revenue. So no concerns there, not too high. They're not paying themselves too much. And then if we look at their incentives, I thought it was quite interesting. So their annual cash bonuses were pretty basic. It was just on adjusted operating income, which is fine. But their equity compensation, the ones that are performance stock units, are based on

three things. credit market share gains, revenue growth, excluding US credit, and operating margin, which I really liked. That was one of the best incentives I've seen so far. And it seems like that is pushing them to be aligned with all their stakeholders. And when I looked at the proxy statement in general, I really had trouble finding any red or yellow flags that concerned me about the company's values or how much they're paying the executive team, which is a good thing. And then ownership, another dude crazy, McVeigh owns 1.4% of the company. And then we got a bunch of the boring old stodgy ones, Vanguard, BlackRock, T. Rowe Price.

All right, Ryan, what did you find interesting in their latest earnings report? I guess not that much, but just in terms of context for the size of the business, they did in 2022, so they just finished their financial year. They did $718 million in revenue. And I guess this was definitely a positive. 45% of that revenue drops down to operating income. So they had 45% operating margins. And then a lot of that converts to free cash flow as well. So 36% free cash flow margins. This is a very profitable business. They prioritize growing profitably. They return a lot of cash to shareholders as well in the form of both a dividend and repurchases. As for the most recent quarter, what's going on with the business? Revenue was up 8% year over year. I know a lot of people would probably think, all right, interest rates shot up, wouldn't revenue trend in line,

they'd be huge beneficiaries of that. However, like I said earlier, the variable fees are charged on a number of different factors, including one of the big ones is duration. So how long the bonds are extended out to or what the maturity is. So the duration on most of the bonds that were traded in the last year or so actually came in a lot. People were willing to buy shorter duration bonds because you were getting a higher return in a shorter timeframe than previously. So that offset some of the increases in trading volume. They did have a 24% increase in trading volume. So they are seeing more people get on the platform as rates go up and trading fixed income securities becomes more lucrative. But the average fee per transaction,

or the, they call it fee per million, came down 10%. So that's kind of what led to the offset in revenue. Still strong revenue growth, 8%. I think it was 10% in constant currency and total active firms on the platform grew 10% as well. So they continue to add more clients. Trading volume is growing in a higher interest rate environment. However, and they say It's primarily due to the tightening in duration. Fees per transaction are coming down. They're still very profitable, 44% operating margin. They did mention on the conference call that they're hiring a lot right now. They're launching into new markets. They want the employees in those markets. They want to be, I guess, well-employed in those areas. And

basically they're in an investment period. So margins may hover around the 45% to 50% range. It can vary. And then I guess balance sheet, very, very simple here. Really no debt at all. And then $500 million in cash. So $500 million in net cash, basically probably one of the more simple balance sheets I've ever looked at. This is a positive because they got to be a little bit of a counterparty risk sometimes. So that, I guess, is good because you want them to be a bit conservative just in case something goes wrong in the bond markets for a short period of time and they're able to weather that.

Yeah. And they mentioned that on their 10K in the risk factors is that they are the counterparty for some of these trades. And so they are putting up some of the capital and there's the risk that the other counterparties or their clients don't fulfill their obligations. So say those clients go bankrupt or something, can't fulfill the obligations as the counterparty market access can kind of be at risk. So being well capitalized is great. I think it's kind of ironic that they're one of the biggest debt exchanges in the world and they don't have any of it. So kind of funny, but it's probably the right strategy for them.

Yep. Don't get high on your own supply. Exactly. All right. Valuation. We'll keep it quick. Enterprise value, taking out that cash and equivalents. We're at about exactly $13 billion.

If we go EV to sales, they're at 18.1. EV to operating income, 39.7. And EV to free cash flow of 49.8. I wanted to share the screen on Stratosphere here and show a little bit of... look at here, it's basically the top chart is operating income and the bottom chart is free cashflow. And for any of the listeners, both have grown over time, but they've consistently under-converted operating income to free cashflow. And I think some of that does just do the receivables from some of their clients, kind of outpacing the payables to some of their clients.

So I think that's interesting. They have a bit of a working capital disadvantage. And I also wanted to check at some of the ratios for just the valuation to look at over time because we are trading at a premium earnings multiple today. So let me just load that up here over the last couple of years. Let's go to EV to EBITDA just because that'll be fine for a capital-led business like this. If we see today, we're at close to... And EV to EBITDA is going to be different than EV to operating income. If we see that, we're in the 30 to 40 range. But historically, if we go back kind of closer to the GFC, this one traded much, much lower, kind of in the 10 to 15 times earnings range. And you can see on stratosphere here, they're EBITDA taggered at 12% a year. That's probably not what you want to see when trying to evaluate a good buy point. But either way, I think that is interesting. It doesn't mean it's not a good buy today, but we are trading at a premium valuation relative to its history. Okay. Anecdotal evidence, Ryan, this one will be tough, but I guess what, as someone, you know, we're equity buyers and sellers. What do you think on this? Does this make sense here? I guess we have no experience with fixed income, but yeah.

Well, I think it is worth noting that this is – it's more expensive than it was in .com. I don't think that's a surprise, but I think it's a better business today. It's a more proven business today just because of the network effect that we've kind of mentioned that they have so much more clients on their platform today. As for anecdotal evidence, yeah, we have zero, I assume, we have zero product experience unless you've been buying bonds behind my back. I will say, however, though, it is very refreshing to see a growing tech business that operates so efficiently. um this is a what was it 13 14 billion dollar market cap business and they only had 676 employees as of the last 10k they updated yeah they haven't done the 10k for 2022 but they did have it in the press release snuck it in there 744 um at the end of 2022 still i mean i think that's solid relative to some comparable businesses uh of that size i just uh and one more note on that uh for the sub stack i'll be putting this chart in there the revenue per employee has

hovered around 1 million which is quite strong yeah certainly um and then i like management as well i this is more highlights i guess than anything but i don't know i just kind of look at the business it uh i mean i don't know the industry that well but it seems like they take care of their shareholders and i kind of like to see that they have weathered some difficult financial periods especially given that they are um counterparty now in some transactions i guess they probably weren't big counterparty in sort of 08 but um yeah and that's not a huge risk but it just you know you just don't want it to bite you in the butt yeah exactly uh So not really any huge anecdotal evidence.

What about you? Yeah, for me, no personal one, but the pitch for why their products need to exist seems sound. I don't see why bond trading can't be like equity trading, at least as much as possible. And I also like management's frugality, like you talked about. One low light, though, on anecdotal side is that they talked about on the conference call

that they use their buyback program to offset share-based compensation, which at their premium multiple is just the exact wrong way you want to look at it. It's not a sell signal because we own companies that do that as well, which is why I picked up on it so quickly, as it's something that's concerned us with some of the companies we own. But again, anecdotally, I did not like that from their finance department, but everything else anecdotally looked great. All right, Ryan, what's your future growth opportunity for market access?

besides, you know, the market share stuff is kind of their North Star, but what are their other things? Well, I guess this is one way to get there, but acquiring other bond marketplaces. So this is what they did with Muni Brokers in 2021. Muni Brokers in this case was a platform that connected municipal securities brokers to institutional traders, very similar to, So I guess market access is traditional request for quote marketplace that they have. I think ultimately a lot of their clients, and they talked about this on the conference call, they aren't just trading in one single fixed income asset class. They're trading across different ones. And so there's areas where market access has really high liquidity and there's some areas where they're kind of lagging.

I think having as much liquidity and as much counterparties as they can in every asset class that they offer is, I mean, that's the North Star. That's the name of the game for them. And acquiring other marketplaces, if there's ones that fit and that have some scale, seems like a really easy way to do that, especially now if they can, I think, do some stock deals given sort of – they do have, I think, a premium valuation. it feels like a great way to to solidify their position in the industry and kind of grow market share so i would say continuing to uh continuing to buy other bond marketplaces yep all right and mine's going to be open trading this is the thing that ryan mentioned earlier which is kind of the stuff it's the one product they're really trying to push on everyone and open trading for just a reminder although ryan talked about it earlier allows clients to trade directly with each other

anonymously, among other things. If confused, I would check out the graphic that we have in the newsletter, which will show in a graphic form how they went from kind of one-to-one to all-to-all for all the bond traders interacting with each other. So this seems to be the logical next step in bringing bond trading to the digital age, and it makes them more like equities. I think it makes market access more like an exchange. For reference, open trading volume has gone from 23% of volumes in 2018 to 36% of volumes last year. As Ryan mentioned, he said 38%. That was in Q4, I believe. So they've even started... Throughout the year, they've continued to grow on open trading. I think it's a great chance as well to widen market access's moat over the next decade

as it provides both better liquidity to clients and saves them tons of cash. For reference, in 2022, they saved an estimated $945 million for clients on pricing through open trading. I think that value proposition is strong. There should be network effects, plus some economies of scale here where they're the ones that can offer the most savings because they're the most scaled to their clients while also making money, as we've seen with that strong operating margin. All right, let's get close to the end here, wrapping these up. Ryan, highlights, lowlights, what'd you like, dislike about this business? I like the network effects. I mean, the more brokers that are on the platform, the better prices that are being quoted to traders, which means theoretically more money is saved. Vice versa, the more traders that are on the platform, the more likely the brokers are to get bids for their bonds that they're selling. or so i like that it kind of helps uh the value prop of the platform for the next incremental or the next potential user um i also think it seems to me and i've seen some reports or some people that have said like bond trading will never go all digital um there's certain limitations and that's they would probably know it better than me but from what i can tell i think there's still

room to go in terms of moving bond trading to digital platforms. For reference, US high yield municipal bonds and emerging market debt, they all have 25% or less of their bonds traded digitally. So still kind of relying on this archaic system. And as that quote you talked about earlier, they're like, it feels archaic. It doesn't, and I think the industry is kind of taking note of that as well. Last highlight for me is the possibility of sustained high rates.

This would just, put simply, would draw more trader interest over time because more people want to buy bonds in that environment. Yeah, and then as the yield curve doesn't, it's not going to be inverted forever. They're not going to face that headwind as they did the last kind of five to six quarters. Yeah. And that kind of leads to one of my concerns is the duration stuff.

There is... So I talked about that fee model that they have where distribution fees are part of it and then variable fees are another part of it. They've been trying to push the distribution fee model on a lot of customers, but customers aren't really adopting it that quickly. Variable fees are still growing quicker. So it kind of makes me think that... Are investors just using multiple platforms and seeing where they could get the best price. If they aren't migrating over to the distribution fee model, is the market access platform really that unique compared to a lot of the competitors? And then second one for me, US high-grade bonds. This is their biggest fee driver. Their market share is stagnated there. They've been going everywhere

else except US high-grade bonds. Someone asked about this on the call and they give a mixed answer and didn't really talk about it or didn't answer it directly. So not really sure what's going on there. I'd like to see them continue to grow share over time as that's kind of the thesis here. Yeah. That's a big concern as me for a while. I think if you're an investor in this company, you got to be watching that market share to see what's happening. Are they losing the trade web? Whatever. My highlights, yes, I agree. The network effect is great. We've discussed that. I think another thing that could highlight their moat would be the expansion into emerging markets and new credit products. I think that's really smart as well. Like a stock

brokerage, if you're interested in this company, which I know some people get bored out of their mind with this episode, but I find these companies extremely fascinating because I think they can develop really, really strong competitive advantages. Listen to our interview with Luis Sanchez on IBKR. This reminds me a lot of this company. But like a stock brokerage, like IBKR, market access can provide the most value to its customers, the more offerings it has on its platform, which can also widen its moat. I was thinking as an example, for ourselves, if we wanted to trade bonds, if we were a big fund, we would want access to as many emerging markets as possible. The access there, yeah, this is not something we actually do. But say,

for example, if we did, if you have, say, I don't know, another competitor that only offers a few of the products, but market access offers everything, they even offer you a connection to China. That is extremely valuable and it provides some economies of scale. I think in the same light, there is a potential regulatory mode here. For example, I have a quote here. I'm not going to read the whole thing in the podcast, but for the newsletter, there is a proposal for market access, trade web, and Bloomberg for the euro market to create a, say, consolidated ticker tape for the bond trading, which I think shows to the fact that at least historically within all these sort of financial services, kind of the backend stuff, whether it is the rating

agencies, whether it is the exchanges, whether it is brokerages, or even stuff like credit card networks, these markets tend to turn into duopolies. I think part of it is because from a regulation standpoint, you don't want dozens of providers. It makes things too complicated. Oh, also, we're about to do an interview with FICO. I mean, that reminds me of the FICO score as well, which if interested, we're going to have an interview on that with someone this week. Fourth one here, I think they are inflation protected over the long term just because bonds will kind of go in line with that and they get

fees based on credit volume. But lowlights for me, I think management transition provides uncertainty with the guy stepping down, McVeigh stepping down. That will be tough. No reason that this new guy can't succeed, but it always provides uncertainty. Then I think the big lowlight for me is the competitive stance versus TradeWeb and any of these other newer electronic trading platforms. I think it's unclear. Here's some questions I have. Why do clients choose TradeWeb over MarketAccess or vice versa? Can they or do they use both? And what does that mean for pricing power? Will these two companies end up becoming a duopoly that has rational pricing power? Can some of these other financial technology companies like Bloomberg,

iceberg, ice, et cetera, use their distribution to cut in on some of this market share. I think it's just a little bit unclear what market access this market share will be a decade from now, although I think it's likely going to be higher. Buzzman to Bullcase, Ryan, let's wrap things up. What are some of your final thoughts here? Well, touching on your point, the difficulty for me is that if they grow market share, potentially it's because their fees per million are coming in quicker. They're offering the lowest prices, or they're offering the lowest fees to attract more

traders. That would be my concern. Anyway, the bull case for me, though, for starters, I think you have to believe the rates are going to stay high for a little while. And I know they actually kind of ballooned in 2020, but I don't think there's a situation where that's going to happen again, where rates are going to go to zero and new issuances are going to explode so um well you know i don't know there's some dislocation there or a connection there where if rates are at zero a lot of people might be incentivized to put out some debt but i get what you mean more people are going to investors are going to have on the secondary market are going to want to buy and sell bonds when the rates aren't no that's what i'm i'm

saying yeah i mean they they succeeded in 2020 because newish and new issuances were so high because rates went to zero i don't think there's a scenario where rates will go to zero like that again. So I wouldn't forecast that. So it would be probably better for rates to stay relatively high. But there is some benefits if rates are really low and new debt issuance is really high or something like that. But the other thing I think you have to factor, you probably have to assume that trading volume on the platform grows by at least 15% per year over the next five years. And their take rate stays relatively flat and their operating margins stay flat. So if that happens, so here's just my assumptions. I'm going to do some math.

I know people probably hate hearing me talk through the numbers on here because it's hard to kind of follow along. But if you think trading volume on the platform grows by 15%, their fees per million stays flat and operating margins are 48%. In five years, they'd be doing about $700 million in operating income. If you put a multiple of 25 times on that, you'd get a market cap of $18 billion, which really is just a low single-digit kegger from here versus... Because the market cap today is like $13 or $14 billion. So as much as I think this is a pretty good business, I don't see the upside unless trading volume just explodes yeah our margin explodes yeah the uh you are pricing that

multiple compression but i think the reason they get a premium valuation we're looking at this chart here at the revenue cagger uh from 2001 to the trailing 12 months i do not know if they had the latest quarter it it's 25 annual growth so yeah it's not going to continue like that yeah they're either they're slowing down right now but it's quite interesting i think how how durable their growth has been and i think the question is do they grow at 10 for the next decade do they grow at five percent for the next decade do they grow at 15 for the next decade big big question there i think 15 would be a little bit aggressive because i i mean and there's no way they grow at 25%, but we'll see. My bull case is similar, I think, at an EV to operating income of 40 with

already high profit margins. I outlined three things I was looking at in order to make money here. First, you need to believe they are under-earning right now due to the stuff that Ryan talked about with the fees per million, with the duration stuff, plus some of the foreign exchange headwinds they're getting at international markets where not a huge deal, but still part of But second, I think you need to believe operating margins still have room to expand. I think they do, because most of their costs are employee and technology. And as they scale this up, you could probably see them hitting 50%, 60%. But it's unclear of whether they will get there.

And then third, I think you need to believe they'll get steady market share gains that continue this decade. If that linear chart that we showed of basically year after year, they steadily march higher on their core market for their market share gains, I think you can make money buying today over the long term. But again, at a premium valuation, it's hard to bet on getting, say, a giant total return here

compared to just buying a company at, you know, 10 times earnings, which I think is obvious. But I think we have the same bear case here, Ryan. What do we want to wrap things up here? It's just probably all multiple compression. Yeah, multiple compression, take rate compression.

So that fees per million, if that compresses, and then if margins don't expand, I think a combination of those three things, you'd probably get low returns. Even maybe two of them, you'd probably get low returns. The thing I'm probably going to look at, if I'm following this business from here, is the distribution fee growth. If distribution fees start to really outpace variable fees, then that's, for me, validation that this is a platform that provides a lot of value to its clients. So that would be a great indicator for me,

but we're just not seeing that yet. Yeah, I agree. I really don't know why this trades at 40 times earnings because the revenue growth is not... I mean, it's been durable and it's been strong, but it hasn't been crazy. And they've grown their revenue the last decade at about 12% to 14%.

If that slows down to 5% to 10%, which is happening right now, there's no question to me that the multiple re-rate's lower. And an EV to operating income of 40, I think that'd be bad news for shareholders because you're not going to get that outsized growth. And yeah, I mean, that's just the main concern. I had no concerns with the actual business model. But let's wrap things up. More or less interested, Ryan, you go first.

More interested. I'm finding a lot of interest in these companies that are tied to the financial market, just because it seems like they really prioritize shareholders and are really optimized for profits. But I'm just really not interested at this price. and i would still like to see like i said that distribution fee growth like accelerate because i don't have a great grasp on the competitive landscape but from that that would be a good indicator that they are maybe competitively advantaged in some way yeah i'm in a similar boat at 20 times earnings i'd be super interested in this thing i think this is one of the strongest moats that could like i see a clear path to it being higher five years or a strong a wider

moat five years from now than we've looked at in a long time um but just at today's valuation it's a bit expensive so yeah more interested not at today's price i think we're on the same page there next week as we wrap things up on this show we're talking block which is the company otherwise known to Square. Will be a fun one. They do Bitcoin, Cash App, Square, Tidal, music streaming, watch out. But we'll cover that one. It'll be a very, very fun episode. Thank you all for listening. Remember, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all again for listening. Subscribe to the Substack. Remember to get all

those quotes, notes, charts, along with the episode. We'll see you all next time. Do you want to step up the ladder? I want Conrad dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren. Do I have to do everything myself? You want more? I'll give you more! Mobland. New season hits September 18th on Paramount+.