Earnings Call: Q3 2018

Oct 19, 2018

Earnings release

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to today's London Stock Exchange Group Q3 Results Investor Call. At this time all participants are in a listen only mode. There will be a presentation followed by a question and answer session I must advise you this conference is being recorded today on Friday 19th October 2018. And now I would like to turn the conference over to your speaker today. Paul Froud. Please go ahead, sir. Thank you. Good morning, everyone. Thank you for joining us on the call. With me this morning, David Warren, group CFO, Tom Woodley, and myself. So normal format, we're going to summarize the Q3 performance very briefly, then we're going to turn it over to questions at the end of that. So let me hand you over to David. Thanks, Paul, and good morning, everyone. We've delivered another quarter of progress in growth Let me give you some of the highlights. Q3 income increased 8% year on year to £522,000,000 And for the year to date, we are up 10% at 1,580,000,000. Gross profit for Q3 is up 8% after cost of sales and up 11% for the 9 months year to date. As you will have seen from our statement this morning, we are now incorporating the impacts of adopting IFRS 15. This accounting standard affects the way we recognize revenues in the primary markets businesses within the Capital Markets segment. The effects of the changes are backdated to the start in the announcement. In summary, the net P and L effect is to reduce admission fee income by 1,000,000 which is an aggregation of the changes for the 9 months in Q3 revenue for capital markets to an 8% reduction at a group level Q3 income would have risen 9% rather than by 8%. To be clear, This does not impact the It is just that we recognize the revenue over a period of between 4 to 11 years in most cases depending on the service. And we'll give more detail on the effects when report our full year numbers. So now let's pick out a few highlights. Starting with Information Services, where reported revenues increased 17% and up 9% on an organic and constant currency basis. This comprised 20% headline growth at Footsie Russell, or 9% growth after adjusting for FX and revenues from yield book. Real time data revenues were flat while revenue from other services Turning next to LCH, total income increased 15% on both a reported and like for like basis. OTC clearing performed strongly as revenue increased by 12% with swap clear growth driven by increases in client clearing. NTI increased 49%, partly reflecting a 5% year on year growth in average cash collateral and mostly following the effects of better investment returns with an increase in September as U. S. Interest rates rose again. Post trade services in Italy saw a 4% reduction in total income. Clearing revenues increased following higher equities, repo and derivatives volumes, were offset from a decline in custody and settlement revenues, which is largely the effect of netting T2S costs against revenue. Gross profit was up 3%. Turning to Capital Markets, Q3 revenue declined 8% and by 7% on a constant currency basis. As stated earlier, without the IFRS 15 adjustment to primary markets, revenue would have been 2% higher year on year. In secondary markets, revenues were 1% higher in equities and up 6% for fixed income derivatives trading. And finally, technology services here, revenues increased 15% on a like for like basis at £16,000,000. Now let me just point out a few more things, before I wrap up. We announced this morning that we are in a process to acquire up to a further 15.1% stake in LCH group, which we expect will take our ownership to over 80%. And we expect to complete this before the end of Q4. As we are a natural buyer sound, strategic, and financial sense. It is accretive to earnings on completion and achieves a return on invested capital that is above our medium term WACC. In sum, it reflects our continued confidence in LCH's opportunities for further growth as it develops its business. 14 minority shareholders remain invested and committed to the success with banks fully part of the governance process as well as contributing to new product development and the extension of services. So we are happy to increase our holding in this valuable strategic asset. Our financial position remains strong with a good level of funding flexibility in place. As at 30 September of this year, the group had available committed facility headroom of circa £500,000,000, having paid the interim dividend to shareholders and other normal course payments on a pro form a basis, including the acquisition of up to a further 15% stake in LCH for up to circa 1,000,000. The group's debt to EBITDA ratio would be towards the top end of our target leverage range, though normal strong cash generation will bring leverage down again in 2019. So continued good strategic and financial momentum in the third quarter. And now I will turn it back to Paul. Thank you, David. Right. We're going to go to, Q And A now. I know we don't normally do this, but if we could just ask people to limit themselves to 1 or 2 given we got quite a number of people on the line that are queued up to ask. Okay. In that case, we'll go to the first question, please. Thank you. Your first question comes from the line of Arnaud Giblat. Please go ahead. Your line is open now. Yes, good morning. Could I ask two questions then? First on your leverage, are you indicating post the acquisition? If you get the 15% stake, you'll towards the top end of your net debt to EBITDA. Does that mean, you're probably going to wait a while to do another acquisition or for the right kind of deal? Are you willing to go above that, net debt to EBITDA targets? And secondly, on LCH, on so on the OTC business, We've seen three quarters now where revenues have been broadly flat. How are you thinking about growth there? What's specifically should we be looking out for you to start seeing growth in the region sequentially? And so more specifically, is there a price renegotiation in there that's all clear coming up? Thank you. Right. Okay. Let me take first question, and then I'll turn the second question to Paul about it. But I'll make a few comments on the OTCD arrangement first. With respect to our leverage, as I said, we'll be toward the top end of the range. We have said in the past that nothing really changes. We are committed and we have in the past and would continue to take that leverage above the top end of the range, if there was a compelling transaction. So we would do that. We still have some flexibility here as we get to the top end of the range. I think the important part of our program will still be as it is with the acquisition of the LCH State, that with good strong cash generation we can bring the leverage down within a reasonable period of time back into the target range. There is nothing that we are announcing with respect to the OTCD agreements, but as to the swap clear growth, I think, I think it has exhibited strong growth over a period. I can turn it to Paul for more specifics. Yes, thanks David. On it, you're right. I mean, it's it varies, and it has varied over a number of periods. It's exactly what level of growth you see from quarter to quarter. I mean, it's still showing good year on year growth, obviously. Half the business in swaps here line is the client, the client business is very much driven by volumes on the market. So we've clearly seen a slower naturally quieter Q3 period than the summer period. So probably not surprising, we're not seeing a big increase from that side. Longer term, of course, we've been talking about the range of services in this area. So software is exhibited very strong growth, but naturally that does start to slow down. We have been talking very much more about FX and the opportunity to grow there. We've launched the options at the start of Q3. Again, will your expenses see some pickup there in the OTC line going forward, other initiatives, including things like swap page and in time, we'll also start feeding through to increase the growth in this line. So I think we're at a good point. The business is performing very much as we would expect it to be at this stage, but there's further growth opportunities as we move ahead. If I could just follow-up on one thing. On FX options, how many members do you have? I think we've got 6 paying members now on the auction side. A percent of about 9 firms in total, but are connected in there. So we'll begin to see a pickup now in the FX options, but it's still but it's still very early days for that. We know from conversations with banks that they are, they have been testing and they're in the process of connecting. Thank you. Comes from the line of Philip Middleton. Please go ahead. Your line is open. Yeah, good morning. Just one question then. I wondered if you could tell me a little bit about how you're thinking about the forthcoming negotiations about UK leaving Europe, given you're just buying 15% more of an asset, which does appear to be sensitive to that debate? Yes. So I think we feel very confident in the business under any number of scenarios. And I think our commitment, represented by our purchase of further shares is showing that support. I think it's also important that that we have 14 minority shareholders, including 13 banks that are major customers, of LCH and they are remaining shareholders of the business. And in a number of cases, those banks are also part of the OTCD network. So I think it it as I've said in my prepared remarks, I feel that it is a very good business. It's a strategic asset for us, and it's one that we feel good about making a further commitment to, with respect to Brexit overall, I'm not going to really comment are on any of the ongoing negotiations. Obviously, we're trying to predict an outcome I think that, we are encouraged, by the recent meetings with regulators and central banks We think there is a new urgency, obviously, about getting some solutions and some legal certainty in the very near future. And it's very clear that our customers want continuity of service. And they have They have made that increasingly clear, they put their views on an increasingly clear way through organizations such as FIA, ISDA, and Afni. So Philip, back to the original part of your question, very strong support for this, and it reflects our continued confidence in LCH under any range of outcomes. K. Thank you. Thank you. And your next question comes from the line of Carl White. Please go ahead. Hi. Yes. I guess just one on the hotel business, just continued good growth there. Given the recent pullback that we've seen in equity in the past month or so, and just given the revenue mix has changed over the past few years for that business, given the number of deals can you just remind us that the current percentage of that revenue line item that's market sensitive or as fees paid on AUM? Yeah, it's about it has it's been over time, it's been between 35% 40%. It's right now about 35% cent. And that is split between, between tracking funds and ETFs. And there's also a portion that are licenses for traded derivatives products. So that's where it is. We don't, we don't generally break that down further. But I think the, but that Patrick, that is basically the amount of our revenue right now that's volume sensitive. And I guess in your kind of medium term target of achieving that 10% growth, is there a level of kind of market returns that's assumed in that? And if so, could you please provide that? There is definitely some there are clearly some assumptions in our targets. Of course, But I think the important part about the business overall, and we're giving targets for the overall business, is that it's a very diversified business. You know, 65% of the revenues comes from subscription revenues And there is increasing demand for data and analytics, as we continue to go through, as you know, the secular shift from active to passive There's more demand for data and analytics and indexation and fixed income. So all areas where we have where we are well positioned for that growth. So I think the confidence in in the target that we put out in the fact that on a reported basis, we're achieving 20% rise I think that speaks to the diversity and mix of businesses within that business. Thank you. Your next question comes from the line of Chris Turner. Please go ahead. Yes. Good morning. It's Chris Turner from Berenberg. Just one question for me then on your treasury income. That was very strong again this quarter. Can you kind of decompose that into how much of the strength or some changes in the way that you run that book? I see you've increased your value at risk substantially you've termed out the duration of that book over time. And then how much of that is driven by just the conditions in the money markets in Q3? That might may be mean reversed in Q4? Thank you. Yes, Chris, most of it was from, most of it, as I said in my prepared remarks, most of it was coming from, the increase in U. S. Dollar yields, in anticipation of of the Fed move, which occurred, as you know, in September. That happened again at the big that happened at the beginning of the year. Where we saw a strong NTI performance. And I think we were saying that, in the absence of that for Q3, you wouldn't expect to see, NTI growth continue. But in fact, we did have, further upward right, further upward actions within rates. So I think that's what drives most of it. I think there is a small increase in the collateral And Paul, would you add anything to that? No, you're right, David. It's kind of about 5%. But Chris, there's no change reason about your risk thresholds themselves haven't changed. So it's not been driven by any change of policy or approach. It's more about markets. Thank you. And your next question comes from the line of Martin Price. Good morning. Most of my questions have been answered actually, but I was just wondering if you could share some thoughts on when you expect the shared services facilities to be fully operational and perhaps the magnitude of the savings that you might expect to accrue as a result any updated thoughts on cost guidance for next year would also be helpful? Thank you. I think I now understand your question. Look, we're on to we are continuing to be on, you know, we're continuing cute on that plan, of changing, and developing our share, our business service centers. There's no update I would give on costs. This is a quarterly update. And as you know, we just give income revenue income and gross profit. And those have achieved, as I said, within the LCH and FTSE Russell, good double digit growth, but there wouldn't there's no update on on how we're progressing, that I would say today, on, on our continuing investment of the new target of the new operating model. I see. Thanks, Dave. And your next question comes from the line of Johannes Thormann. Please go ahead. Good morning, everybody, on someone at HSBC. One follow-up and one other question. First of all, on the outlook for treasury income, just to clarify, if we see another increase in Q4, this would imply that we should expect another uplift in net Treasury income at LTH. Is that correct? And secondly, regarding LTH swap cleared, there was this Bloomberg article around the termination of some clearing contracts on 29 December if you could share some color on, and give more info on this and probably also say, if if we come to worst case Brexit, has you already applied for an IRS steering license in Paris now? Thank you. So, Johanna say, on the first part of your question, if, again, really consistent with what we were saying, at the interims. If there really isn't any further rate moves, particularly in the U. S, you would not expect to see that continuing growth in NTI. So So absent that, I would think that for Q4, NTI would be probably in the low 40s. I think with respect to the last part of your question, as we've said before, we're we are committed to providing continuity of the existing service. Our customers do not want us to make an application to Paris And so we continue to work with our customers, to work through the Brexit situation and be in a position to provide a continuity of service. That's the second part of your question. Yes, on the termination of contracts, Johannes, I mean, there's a public rule book which people have seen. Which gives a period of notice of 3 months on both sides, both from us to members and members back to us. But just to be clear, no notice has been served at all, and we're not at the point of time where we would need to do anything. And the next question is from Neil Sharma from Morgan Stanley. Just two questions, please. First on the indices business, has the sort of repricing on the yield book in the 50 position has that been done now? And so is that sort of in the numbers, or is there more to kind of come? And then on LCA, just to kind of I guess, follow-up really. You talked about continuity of service. So what sort of conversations are you having with your banks? How are you actually going to provide that in a hard brick at no deal scenario because I guess if we rewind the clock sort of 18 months ago, there was, I think, maybe not direct quotes from yourselves, but there was at least an indication that you could apply to Paris and more other jurisdictions to get a license. So now that it sounds like that's not what you're going to do, what is the kind of contingency plan? And if you could just kind of quantify how much of EU based clients are the volumes in Top Care, that'd be helpful. Right. Okay. So with respect to the first part of your question, the integration of yield book, into the company continues to go well. The various changes that we are making to commercial policies are continuing. So some of them are reflected in the numbers now in the reported numbers, but we're still in process of delivering all of the synergies that we announced that we spoke of when we announced the transaction last year. With respect to the other part of your question, I'm not going to comment on them publicly on this call. But we are having discussions with banks on various contingency planning. But I won't, I'm not going to convo's are really between LCH and the banks, and I'm not going to say anything more about that other than to say, that those discussions have been ongoing. In terms of the impact, this continues to be a relatively small part of our total IRS clearing. As we've said before, Most of this is U. S. Dollar. The actual euro flows are about 25% and the actual amount of euros that originate from EU entities, is, is about 25% of that So depending on how you count it, it's it's sort of in the 7 to 14% range. So it is a small part of a business And we have been saying that consistently over the last year, and nothing has really changed in terms of the various flows that we're seeing by currency, in the swab clear business. Okay. Sure. If you don't mind just one quick follow-up, that's So that's EU based clients doing euro currency, but if you include all currencies from euro based clients, what percentage would it be? We haven't given that and that exact number. Thank you. There are no further questions at the moment. Please continue. Okay, great. That looks like we're through everyone's questions. So thank you very much for joining the call. We are around for the rest of the day. Obviously, if you've got any more follow-up questions, but otherwise we'll finish things now. Thanks very much. Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you all for participating. You may now disconnect.