Jul 25, 2014
Executives
Jan Strecker – IR Gregor Pottmeyer – CFO
Analysts
Bruce Hamilton – Morgan Stanley Arnaud Giblat – UBS Johannes Thormann – HSBC Peter Lenardos – RBC Capital Markets Jillian Miller – BMO Capital Markets Philip Middleton – Bank of America/Merrill Lynch Jochen Schmitt – Metzler Equities Michael Adams – Sandler O’Neill Anil Sharma – Morgan Stanley Benjamin Goy – Deutsche Bank Daniel Garrod – Barclays Capital
Operator
Good afternoon, ladies and gentlemen, and welcome to the Deutsche Börse AG Conference Call regarding the Second Quarter 2014 Results. At this time, all participants have been placed on the listen-only mode and the floor will be opened for questions following the presentation.
Let me now turn the floor over to, Mr. Jan Strecker.
Jan Strecker
Welcome, ladies and gentlemen, and thank you for joining us today to go through Deutsche Börse’s second quarter 2014 results. With me is Gregor Pottmeyer, Chief Financial Officer.
Gregor will take you through the presentation, and after the presentation, we would be happy to take your questions. The presentation materials for today’s call have been sent out via email earlier today, and can also be downloaded from the Investor Relations section of our website.
As usual, this conference call will be recorded and is available for replay. Let me now hand over to you, Gregor.
Gregor Pottmeyer
Yes, thank you, Jan. Welcome ladies and gentlemen.
In the second quarter, the historic low equity volatility and the low interest rate environment rate on derivatives and cash activity. This was partly compensated by record volumes in custody at Clearstream and a positive development in Market Data & Services segment.
In the first half of 2014, net revenue and earnings per share were up slightly, as a result of a stronger first quarter. To address the ongoing cyclical weakness in some of our businesses, we continue to develop new growth areas and expand in higher growth regions like Asia.
Since the beginning of the year, we made further progress towards our strategic growth, roll out and development of new infrastructure [audio gap] OTC clearing, collateral management and the expansion in Asia. In the first six months 2014, net revenue increased 2% to around €1 billion.
Operating costs, on an adjusted basis, increased 6% to €493 million. The main reasons for the cost increase are the consolidation effects of EEX and Scoach, but also the increased investments in growth and infrastructure.
Annualized, this is still somewhat below our full year guidance of €1,050 million but we expect an increase of project spending in the second half, and the usual seasonal effects in the fourth quarter. Adjusted for the one-off gain in relation to the Direct Edge and BATS in the first quarter and cost for efficiency measures earning per share in half year one, amounted to €1.9.
In the second quarter, net revenues stood at €488 million. The decline against the previous year was mainly driven by the net revenue development at Eurex, in light of low equity market volatility and ultra low interest rate environment.
This cyclical trend which affected all other derivatives market was partly offset by the positive development of the Clearstream and the MD&S segment. Operating costs of €249 million are adjusted for around €500 million exceptional items, which mainly relates to restructuring.
The adjusted EPS stood at €0.90, a decline of 7%. I’m now turning to the quarterly results of the individual segments, starting with Eurex on page four.
In financial derivatives, the number of traded contracts decreased by 20%, due to the negative cyclicality in both the equity and the interest rate related derivatives. In commodities, the power product of the European Energy Exchange which account for roughly two-third of the commodity’s net revenue, increased by 13%.
The Repo business saw a decline of the volumes outstanding by 4%. As a result, net revenue in the Eurex segment stood at €183 million and adjusted EBIT amounted to €88 million.
In the cash market, we saw a decline of the order book turnover across, Xetra, Börse Frankfurt and Tradegate exchange by 9% in the second quarter. Due to the consolidation of Scoach in the third quarter 2013, however, net revenue in the [inaudible] segment decreased only slightly to €37 million.
EBIT on an adjusted basis stood at €20 million. Clearstream continued its positive development over the last couple of quarters in Q2.
Assets under custody increased 5% year-over-year, to a record average of €12.2 trillion. This was the result of higher index levels and market share gains in the international businesses.
Settlement activity declined by 4%, driven by the decline in equity volumes, which was not offset by the growth in OTC bond settlement activity. In the collateral management business, GSF, we saw a positive development.
Volumes outstanding are up 4% year-over-year reaching an average level of more than 600 million which we last saw back in 2011. Due to a better product mix, GSF net revenue increased by 12% to €60 million.
The cash balances at Clearstream adjusted for blocked accounts increased to 5% to €11 billion, but due to lower average rates, net interest income decreased slightly to €10.4 million. In total, net revenue in the Clearstream segment amounted to €173 million, and the adjusted EBIT stood at €86 million.
Net revenue in our Market Data & Services segment increased, by 4% year-over-year in the second quarter. The index business was the best performing part of the MD&S segment with a 14% increase of net revenue.
But also the information and tools business showed service growth year-over-year, while the market solutions area saw consolidation related decline of net revenue. Total revenue in the MD&S segment amounted to €95 million, and the adjusted EBIT stood at €48 million.
Selective areas of the Group continued to show significant growth in the second quarter. At Eurex, the fixed income derivatives on Italian and French government bonds, the dividend derivative and the volatility derivatives continued to develop very favorably.
In total, volumes in innovative Eurex products increased 22%. At the European Energy Exchange, volumes in power and gas products increased 39%.
At Clearstream in the investment fund services business, the assets under custody increased 20%. Complementary to our existing fund business, the acquisition of CIDCO’s hedge fund custody unit announced in April this year, will help us to become the leading global front market infrastructure for all types of funds.
And at MD&S, the assets under management in exchange credit funds increased by 11% to €78 billion. Let me now give you a brief update on our strategic priorities, cost and capital management summarized on page nine of our presentation.
With our Eurex OTC clear offering, we have achieved substantial progress. Our market leadership in listed derivatives, in combination with unique products such GC pooling under a single leader framework, provides the ideal basis to deliver unparalleled capital efficiencies to our clients.
At the same time, we are increasing safety through our unique market tested clearing model, real-time risk management and access to central bank liquidity. As an important step in the underlying technology for our Eurex OTC clearing offering, we rolled out our first release of our new clearing technology C7 in June.
After Eurex successfully migrated to the new trading technology T7 last year, the new C7 clearing technology introduces greater flexibility, shorter lead time for new services and new functionality. These elements put us into an excellent position to be successful in OTC derivatives clearing.
By now, we have signed up more than 30 major global sales settings as clearing members, and around 145 firms are currently in the on-boarding process as we [inaudible] the customers. The EMIR authorization for our clearing received in April was an important milestone and confirms full compliance of our clearing services with the applicable rules.
We are very pleased that at this stage, Eurex clearing can provide its clients and members with a clarity and reassurance needed to undertake that readymade planning and on-boarding preparation for the upcoming clearing mandate in Europe. Regarding the timing of the OTC clearing obligation has recently suggested the introduction of the new phased approach similar to how [inaudible] had introduced in the U.S.
According to the consultation proposal, the first group already admitted clearing members would have to start clearing six months after the final regulatory technical standards are effective, which is expected for late 2014 or Q1 2015. The second quarter financial counterpart including small and mid-tier bank, as well as asset management and hedged funds would need to start clearing 18 months into third group non-financial counterparts including corporate that’s the clearing threshold 36 months after the RTS are effective.
This approach is still subject to industry review and comments until mid August. While the phased approach could have some impact on the timing of the ramp of clearing volumes, we currently do not expect any material impact regarding our volume and revenue expectations for 2017.
With the global liquidity up at Clearstream, we are at a unique position to provide best practice solutions for our customers under new regulatory landscape. In the new landscape, collateral will become as cash to us and enable customers to mobilize collateral and use it in the right locations at the right time and in the most efficient rate.
We have already established access to global liquidity pool by working with international strategic partners like Cetip in Brazil, ASX in Australia, Strate in South Africa, Iberclear in Spain and the custody business of BNP Paribas. Partnerships with Citi and Standard Chartered will go live this year and further developments are underway with CBS in Canada, SGX in Singapore and VPS in Norway.
Earlier of this week, we announced the collateral management agreement with Deutsche Bank. Another significant opportunity for Clearstream is TARGET2-Securities initiatives by a European Central Bank.
T2-S is a prime European platform for settlement in terms of bank money that will replace the existing domestic models until 2017. We believe that T2-S will bring about a structured transformation of our industry.
It will commodify settlement substantial strength in capital market amortization and that, in the long run increase the growth potential of this market. While most CSDs in the euro zone have joined T2-S only few have the means to become the preferred access partner to T2-S.
We believe Clearstream will be one of these preferred access point and that be one of the main T2-S winners. The reason for this is that clients benefits on our offering across various dimensions, cash pooling and securities pooling across their account excess to a prime European collateral pool, auto collateralization, settlement efficiencies and lower records for their settlement activities.
Our portfolio of unique assets also enables us to further increase our geographic coverage. As you are all aware, our special focus lies on the Asian market.
This is mainly driven by the increasing importance of global and markets. The growth in Asia over the past decade has significantly exceeded the development in Europe and the Americas, and we are expecting this outperformance to continue for the foreseeable future.
We have already built a very solid revenue base that Asian products and clients reaching more than €100 million in 2013. With initiatives like the derivatives clearing hours the strategic collaboration with Bank of China and the partnerships in derivatives and cross trade services, we have further accelerated the expansion.
In addition, we have started new partnerships with Asian exchange organizations. For instance, most recently with TAIFEX, Taiwanese derivatives exchange.
The model builds on our very positive experience our corporation with our Korea exchange. In trading for derivatives products based on the Blue chip index in one of the most strongly traded worldwide.
Overall, we believe that the opportunities for Deutsche Börse Group to grow over the last couple of years are very significant as summarized on slide 14 of the presentation. This slide illustrates the three different categories in which we expect incremental net revenue; new products, structural growth initiatives and ultimately also, cyclical improvements.
Due to our scalable and cash flow generating business model we are able to combine a strong rating profile with attractive distributions to our shareholders. In the first half of 2014, the interest coverage ratio has improved further to 27 times due to the favorable refinancing completed in 2013.
The gross debt to EBITDA ratio which is the primary leverage ratio, the rating agencies are looking at for Deutsche Börse, remains tight at the level of 1.5 times. On the distribution side, we paid a stable dividend of €2.10 per share for 2013 to our shareholders in May this year.
This concludes our presentation, and we would now like to open it up for Q&A.
Operator
[Operator Instructions]. And the first question comes from Bruce Hamilton from Morgan Stanley.
May we have your question please?
Bruce Hamilton – Morgan Stanley
Yes sure. Thanks.
Afternoon guys. Just a quick one, on the cost guidance, I know you sort of reiterated I think the cost guidance €1.05 billion for the full year.
I just wanted to check that I have that number right. And also if we presume that the second half is quite challenging from a top-line given the Q3 started pretty soft in derivatives, what sort of room do you have to reduce that cost level or should we see that really as a firm number that you can’t really change now?
Gregor Pottmeyer
Yeah, thank you, Bruce for the question and the clarification. So you have rightly understood.
So our cost guidance is still on to 1,050 million. Yes we are in the first half year below and half of this number you know that specifically we have a strong seasonal effect.
And in addition, when we look on our project plans so a bigger part of our portfolio investments were already planned for the second half year of 2014. And that’s the reason why we still do not change the cost guidance.
We are still convinced that all our strategic investments are and we will benefit from that level. So our BAU cost, our plans are stable as planned and the movements just relate from our strategic initiatives in growth initiatives and infrastructure.
Bruce Hamilton – Morgan Stanley
Got it. That’s helpful.
Thank you.
Operator
The next question comes from Arnaud Giblat from UBS. Please your line is open now.
Arnaud Giblat – UBS
Good afternoon. A question please if I see a few months ago there were some reports that some news reports on being looked at potentially being up for this.
Can you confirm your options for that business I mean the way we see it is perhaps it doesn’t fit as synergistically well in the rest of the portfolio, and it doesn’t seem to be on your four, five year growth plan to go in the U.S. most probably towards Asia.
So I’m wondering your thoughts how ISE fits in the general picture and the portfolio? Thank you.
Gregor Pottmeyer
Yeah thank you Arnaud for the question. We did not comment these kind of rumors as you know, but I can confirm from today’s perspective that we did not opened up a selling process or did not concrete process with any bank.
But all of these are just speculations and rumors. Secondly, we still earn a nice margin out of this ISE business it’s roughly one-third margins which we get out of this business or good revenues what we get out of this.
Obviously the U.S. options market declined more than 10% and into second quarter and even ISE was impacted by that when you have mid to long term view on to U.S.
options market we are still positive on the growth perspective for the next year.
Arnaud Giblat – UBS
Okay. Thank you.
Operator
The next question comes from Johannes Thormann, HSBC. May we have your question please?
Johannes Thormann – HSBC
Good afternoon everybody. Johannes Thormann, HSBC.
I appreciate – could you just clarify if there’s been any one-off from the net income from banking accretion as it has been in Q2 in the last year? And secondly, what is your view – do you see any impact of the ECP TL TRO on the GSF or Eurex business?
Thank you.
Gregor Pottmeyer
Thank you, Johannes for the questions. Short answer to your first question there is no one-off at Clearstream in the second quarter, secondly obviously you know that the program of ECP does not support our business as we our interest rates are very low.
Obviously our net interest income is under pressure and the same is true for our GSF business, where the banks are flooded with money by the European they have no need to get money from elsewhere. And therefore that is really a for our GSF business.
But we are also convinced that at a certain point of time there is a chance when the LTL program or the QE in the U.S. would stop or refuse and this will positively impact our business.
Johannes Thormann – HSBC
Okay. Thank you.
Operator
The next question comes from Peter Lenardros with RBC. May we have your question please?
Peter Lenardos – RBC Capital Markets
Hi, good afternoon. It’s Peter Lenardros from RBC in London.
A quick question on extraordinary returns to shareholders I know you keep referencing that it will be possible at some point as it was in the past, but it hasn’t occurred now in about three years. And I was just curious what needs to change from a leverage and a financial performance point of view for you to recommence extraordinary returns to shareholders?
Thank you.
Gregor Pottmeyer
Yeah thanks Peter. Shareholder returns I think we’ve made it quite, quite clear even in last call on our Investor Day.
So in addition to our share buyback programs requires really a material increase especially in our trading volumes. And as we have seen specifically in the second quarter, there was clearly a decline and out of this currently I do not see a chance to do business in the next quarter a share buyback program.
Peter Lenardos – RBC Capital Markets
Great. Thank you.
Operator
The next question comes from Jillian Miller, BMO Capital Markets. May we have your question please?
Jillian Miller – BMO Capital Markets
I’m sorry. So there is a debate kind of going on about whether clearing has its handling trades and yours should be acquired to be based actually in the euro zone.
And I was just wondering how serious is the debate? Do you think there is a real chance of it that it becomes mandated and if it does it seems like it could potentially be an opportunity for you guys to take some business away from some of your UK based competitors?
So just wanted to get your thoughts on it?
Gregor Pottmeyer
So far you are aware that in the midst there is currently discussions about a trading obligation for derivatives. Unfortunately the timeframe is very long so you know this 2.5 years for technical details and for another 2 to 2.5 years before national implementation.
So we do not expect on a short term to get here nevertheless, you have also seen that we introduced new product. So we will introduce Euro-Schatz Futures, and Euribor Futures in November this year.
In addition, EUR Secured Funding Future based on GC pooling repo market. So our strategy here is basically that the to our customers that they are allowed to play the whole interest weight curve with Eurex and we are currently in a good dialogue with market participants, but it will be most probably a slow start, but we are prepared for that.
Jillian Miller – BMO Capital Markets
Okay. Thanks.
Operator
Our next question comes from Philip Middleton from Merrill Lynch. May we have your question please?
Philip Middleton – Bank of America/Merrill Lynch
Thanks very much. I wondered if could you say a little bit about profitability of liquidity because at your Investor Day, you were talking optimistic about because obviously given the investment quite heavily so you are going to be asked for the consistently about actual returns on profitability on that.
So I wondered given that Clearstream seems to have a good second quarter how is the liquidity hub looking in terms of profitability as well in terms of kind of operating roll out you talk about?
Gregor Pottmeyer
Yes in general it’s very positive and it a little bit challenge to allocate the success of offers specific single product. So, when we talk to our customers we have the whole value change what we talk about.
We talk about collateral management opportunity for our customers to increase capital efficiency we talk about target to securities the banks have to make their decisions what is their access points in future with regard to the euro systems. And we can show them high double digit million euro penalties can be generated when they work together with Clearstream.
And we can also use our funds business in order for some banks offer other market participants a nice opportunity to work together with us. In general, you see a nice profitability of Clearstream business overall in the range of 50% and they are also products contributed.
Philip Middleton – Bank of America/Merrill Lynch
Thank you.
Operator
The next question comes from Jochen Schmitt from Metzler. May we have your question please?
Jochen Schmitt – Metzler Equities
Thank you. Good afternoon.
I have just one question Eurex the trade for equity index contract increased in Q2 compared to Q1 this year. What are the main reasons for this higher margin?
Was it just due to the mix of products traded or were there also other reasons for that? Thank you.
Gregor Pottmeyer
Yeah, Jochen, the increase by round about €0.02 from $0.48 to $0.50 is purely a result of the product mix as the headline fees have been unchanged. And one particular answer would be the dividend index derivatives they have a much higher margin compared to some of the other products where there is just small change in the mixed and we already see a positive impact on the entire product group.
Jochen Schmitt – Metzler Equities
Okay. Thank you.
Operator
And the next question comes from Michael Adams from Sandler O’Neill. Please [inaudible] now.
Michael Adams – Sandler O’Neill
Good afternoon, gentlemen. I’m hoping you can update us around your thoughts around a couple of regulatory issues, specifically the European financial transaction tax and the open access requirement within
Gregor Pottmeyer
That’s not very easy to give a very short answer for all these questions, but just regarding to financial transaction tax, now I think it becomes very clear that the original European commission portfolio will not be implemented. Nevertheless, the political virtue into FTT is still very high.
But from our perspective, no change, so we continue to believe that the most likely scenario is an introduction of a tax on equity transactions and this obviously would have not a material impact on our revenues. With regard to open access so now we got the 850 pages and technical stand backs we are into discussions into pleading and understanding but our view is still unchanged that European commission will not go for our interoperability between clearing houses so that is still our understanding but there will be more competition on the trading layer but interoperability is still not in the part of that.
Michael Adams – Sandler O’Neill
Got it. Thank you.
Operator
The next question comes from Anil Sharma from Morgan Stanley. May we have your question please?
Anil Sharma – Morgan Stanley
Afternoon everyone. Just had a couple of questions many clarifications really.
The remarks you made about OTC clearing in the phasing the consultation paper, I guess question number one, when does that consultation period shut? Secondly, am I correct in my understanding what you said in that Phase 2 that is largely the buy side don’t come until 18 months after so that’s looking like mid 2016 late 2016, so therefore the €50 million to €100 million revenue guidance which you have on your slide, should we be thinking about that as €50 million in 2017 at the earliest and then the €100 million possibly 2018 once Phase 3 goes on?
And then my final question is just going back sort of going back to wanted to double check something, the opening of the Singapore sort of caring house early next year is that included in your 2014 cost budget or is that we should be expecting for next year?
Gregor Pottmeyer
All right starting with your first question, so we have time to give feedback on mid end of August with regards to this approach second question as you have in the beach so we have the to achieve at least €50 million in 2017 and yes they will potentially some delay as a customers and some delay as a customer get now roughly 18months time to do some. But in Q3 2016 the bank majority of the market participants would have to use a clearing house and therefore our view is that we still have the chance to achieve the level we have communicated.
With regard to the inclusion of the cost of the clearing house obviously these costs are included in our 2014 guidance.
Anil Sharma – Morgan Stanley
Right. Thank you.
Operator
The next question comes from Benjamin Goy from Deutsche Bank. May we have your question please?
Benjamin Goy – Deutsche Bank
Yes good afternoon. My question relates to growth in market data and securities segment.
So o would you consider M&A in particular a larger deal which might include a capital increase or is there a preference on your side organic growth or some other deals that can be find and existing cash reserves? Thank you.
Gregor Pottmeyer
Yes Benjamin, thank you for the questions. Yes, our strategic focus is really on organic growth but we want to realize our strategy.
In addition, complementary M&A opportunities or measures are evaluated on a continuous basis. So when we would see something what would make sense, then we are opened to discuss that is also true for the MD&S segment.
Operator
The next question comes from Daniel Garrod from Barclays. May we have your question please?
Daniel Garrod – Barclays Capital
Thank you. Good afternoon, Gregor.
Just one question for me around your leverage gross debt to EBITDA ratio 1.5 times in your comment that remains tight and I think you previously said likely to remain tight for the rest of the year. Am I right in my thinking with the gross debt actually gone up quarter-on-quarter?
Can you provide any color around the driver of that? Is there any seasonality in that?
What is your ability? What have you been to, to bring down I guess to paying through cash to bring down some of the gross debt in later quarters of the year if the EBITDA doesn’t grow and can I what are discussions with the credit ratings do you feel that that they take a product linear view as long as they are moving to the right direction there is no need to get it aggressively down below 1.5 times, what are the state of your discussions there?
Thank you.
Gregor Pottmeyer
Yeah. Thank you, Daniel for that question.
So the 1.5 times is a tight number as we said to have to AA waiting, rating agencies expect to have just maximum just as 1.5. As it is influenced by seasonal effect as we bathed the dividend in Q2 the €380 million and we do financed it partly by CP programs, those are level increases from Q1 of €90 million to €200 million that’s more than €101 million additional debt that’s the reason why it increased on Q1 compared to half year one number.
For the rest of the year, obviously the CP levels as we generate additional cash flow and this will have positive impacts on this number. The main driver for this number is the debt level we think makes sense from our perspective so the main factor is the EBITDA and EBITDA is mostly driven by our revenues and specifically by our trading activities or MD&S.
They are positive and constantly recurring but more volatility on the trading activity side and this will influence our ratio to here. And we discussed it with the rating agency so far.
But our focus is unchanged so midterm we want to grow and from a midterm perspective we expect that we should improve this number by just a point.
Daniel Garrod – Barclays Capital
Okay. Thank you.
Jan Strecker
With this, we would like to conclude today’s call. Thank you very much for your participation.
Have a good day.