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Record VIX Trading Continues to Catalyze Cboe Global Markets' Earnings

Options exchange operator Cboe Global Markets, Inc. (NASDAQ: CBOE) reported record revenue on its release of third-quarter 2017 earnings on Tuesday. In addition to enjoying acquired revenue from its Bats Global Marketplace purchase earlier this year, the company was also able to boast of vigorous organic top-line growth. We'll review the highlights from the quarter after first walking through summary numbers.

Cboe Global Markets: The raw numbers

Metric Q3 2017 Q3 2016 Year-Over-Year Growth
Revenue $269.7 million $136.2 million 97.6%
Net income $59.7 million $40.3 million 48.1%
Diluted earnings per share $0.53 $0.50 6%

Data source: Cboe Global Markets, Inc.

What happened with Cboe Global Markets this quarter?

New Cboe logo. Image source: Cboe Global Markets.

  • The company rebranded itself in October 2017, ditching the "CBOE" moniker, which was pronounced as it reads (C-B-O-E) to "Cboe," which is pronounced "See-bo" and is intended to reflect a more contemporary, global organization. 
  • Revenue gained from the Bats acquisition in February totaled $112.6 million. Organic revenue improved by 15%, to $157.1 million. This quarterly leap was driven by a surge in average daily trading volume of the company's proprietary VIX (Cboe Volatility Index) instruments.

  • Average daily trading volume (ADV) in VIX options expanded by 56% during the quarter, and ADV in VIX futures rose 36%. For the second consecutive quarter, VIX futures contracts notched record volume, with 331,000 contracts trading hands, besting the high of 307,000 contracts achieved in the second quarter of 2017. VIX products have proved popular even as overall market volatility has declined in recent quarters.
  • As in the second quarter of 2017, the company's non-trading revenue rose significantly, thanks to the Bats purchase, and accounted for 42% of total revenue, versus 33% of the top line in the third quarter of 2016.

  • Cboe's operating margin declined by roughly 410 basis points to 44.2% versus the prior-year, pre-merger combined operating margin of Cboe and Bats. But after adjustments for acquisition-related expenses, operating margin improved to 62.2% versus a combined 2016 tally of 57.8%.
  • If you're wondering why earnings per share (EPS) only increased 6% when net income jumped nearly 50%, the difference is due to a stock issuance of $2.4 billion that Cboe conducted in the first quarter to complete the Bats purchase, which resulted in diluting existing shareholders.

  • The company's five segments posted mixed results when compared to 2016 on a combined basis. Options net revenue advanced 10% to $130.7 million, and Futures reported a 37% rise in its top line, to $38.9 million. Similarly, European Equities' net revenue expanded 16% and Global FX's net revenue rose 9%, to $18.4 million and $11.3 million, respectively. But Cboe's second largest segment, U.S. Equities, declined by 1% to $70.2 million, due to lower net transaction fees, which were partially mitigated by higher non-transaction fees.

  • Cboe paid down $100 million of its long-term debt in the third quarter, and has now repaid $325 million of the $1 billion in borrowings incurred for the Bats purchase. The company was obligated for $3.1 billion in long-term debt as of the balance sheet date of Sept. 30, 2017.

What management had to say

During Cboe's earnings conference call, management covered a number of pertinent topics, including the realization of expense synergies from the merger (proceeding as expected), and the migration of Cboe's Futures Exchange to Bats' more advanced platform, which is on track for completion in February 2018. CEO Ed Tilly also addressed a significant question on the mind of many investors: Now that the Bats acquisition appears to be a resounding success, will we see more huge corporate purchases in the near future? Tilly said:

"Don't expect us in large-scale M&A in the short-term. We will always keep our eye out over time on how to grow this business, but it's really business as usual here as far as M&A.

Think bolt-on -- we will be growing our various asset classes, but focused on the proprietary index complex."

In other words, the current emphasis is on small purchases that enhance Cboe's ability to create and license proprietary index information, as well as offer exchange traded products (ETPs) based off the major index families (S&P, FTSE, DJIA, etc.) with which the company enjoys strategic partnerships.

Looking forward

In addition to realizing synergies from the Bat's merger, Cboe achieved reductions in compensation, benefits, outside professional services, and other general and administrative expenses during the quarter. As a result, management revised its full-year adjusted operating expense guidance, from a range of $415 million to $423 million, to between $413 million and $415 million. As for the top line, Cboe traditionally doesn't provide revenue guidance, so shareholders will have to wait for the last quarter of the year to see where 2017's trading and service revenues land.

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Asit Sharma has no position in any of the stocks mentioned. The Motley Fool recommends CBOE Holdings. The Motley Fool has a disclosure policy.