Oct 27, 2017
Executives
Jan Strecker – Investor Relations Gregor Pottmeyer – Chief Financial Officer Erik Mnller – GMC Member-Deutsche Boerse
Analysts
Peter Lenardos – RBC Benjamin Goy – Deutsche Bank Johannes Thormann – HSBC Philip Middleton – Merrill Lynch Kyle Voigt – KBW Gurjit Kambo – JPMorgan Martin Price – Credit Suisse Mike Werner – UBS Peter Lenardos – RBC Roland Pfander – ODDO Arnaud Giblat – Exane
Operator
Good afternoon, ladies and gentlemen, and welcome to the Deutsche Boerse AG Conference Call regarding the Q3 2017 Results. At this time all participants has been placed on a 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 our third quarter 2017 results. With me are Gregor Pottmeyer, Chief Financial Officer; and Erik Mnller, GMC Member of Deutsche Boerse.
Gregor will take you through the presentation. After the presentation, we will be happy to answer your questions.
The presentation materials for this call has been sent out via email 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
Welcome ladies and gentlemen. Let me start today’s presentation with an overview of today’s topic.
The trends we saw in the first half year of 2017 continued into the third quarter. Secular net revenue increased, as planned, by 5%.
But the continued low equity volatility resulted in an overall decline of cyclical net revenue by 2%. Adjusted operating costs increased only slightly despite inflation and higher share-based compensation.
Depreciation increased, as expected, due to investments in future growth. As a result, the adjusted net income increased by 4%.
For the first nine months, this means that the net revenue improved by 3% and earnings by 5%. As we already made clear in our release of the result of the first half year 2017, reaching our full year target depends on the cyclical improvement in the second half.
Given that the historic low equity market volatility persisted in the third quarter, we are very likely not going to achieve the lower end of our net revenue and earnings guidance for the full year. Nevertheless, we continue to be very well-positioned to benefit from secular and cyclical growth in the midterm and are confident that we can achieve our earnings growth target of 10% to 15% in 2018 and 2019.
This expectation is based on a number of secular opportunities, which will help us achieving double-digit net revenue growth in 2018. In addition, we are also expecting a certain normalization of the market environment.
At Eurex, secular areas where we expect growth for next year include OTC clearing, continued product innovation, commodities trading at the European Energy Exchange, and the trading and clearing of FX product at 360T. Regarding Brexit, we are observing that market participants are now shifting from planning into implementation mode to ensure uninterrupted access to trading and clearing menus and continued coverage of their Continental European client base.
With regard to the clearing in systemically relevant Euromarket, it has become increasingly clear that EU central banks, regulators and policymakers are unlikely to accept the status quo in certain markets, as expected. I can assure you, this makes a substantial number of our clients quite nervous, to put it mildly, especially buy-side firms are, in many cases, so far only connected to one European CCP for interest rate swap clearing after the Category 2 clearing obligation on the EMEA were introduced.
Against this background, Eurex Clearing has launched a far-reaching partnership program to accelerate the establishment of alternative liquidity pool for clearing interest rate swaps in the Eurozone. We believe that a market-led solution is the right way forward, and we are partnering with major international players in the interest rate swap market to offer such alternative.
For commodity trading at EEX, we expect the temporary causes for depressed volumes to fade until the end of the year and the catch-up of volumes next year. For FX product at 360T, we expect a bright future because we will increasingly realize revenue synergies generated from fully electronic trading and clearing of currency terms.
At Clearstream, 2018 will be the first full year where clients have the opportunity to benefit from TARGET2-Securities by pooling their custody business in one CSD. In our Investment Funds Service business, we deliver state-of-the-art solutions to standardize fund processing and to increase efficiency and safety in the investment fund sector.
For 2018, we expect further growth through a growing number of funds on our platform and a larger market share. Last but not least, we expect continued growth in our index business at MD&S as we see an ongoing trend towards process investment strategies.
Before I move on to the details of the quarterly results, let me briefly touch upon yesterday’s news flow. Yesterday, the CEO of Deutsche Borse, Carsten Kengeter, informed the Supervisory Board that he would like to step down with effect of December 31, 2017, in order to allow the company to focus its energy back on to clients, business and growth and to avoid further burden caused by the ongoing investigation.
The details of the transition will be announced in due course as decisions are made. In the interim, Carsten will leave the company and has the Supervisory Board’s full confidence.
Equally, the management team is fully committed to continue to implement the growth strategy that has been jointly developed. This brings me to the details of the result of the first nine months and the third quarter on Page 2 and 3.
Net revenue in the first nine months of 2017 amounted to EUR1,832 million. Adjusted operating costs without depreciation were flat.
And the EBITDA and net income increased both by 5the same period last year. In the third quarter, net revenue compared to Q3 2016 increased by 3% to EUR576 million.
As part of net revenue, the net interest income rose to EUR32 million. Operating costs, adjusted for exceptional items, were up only 1%, despite higher share-based compensation and inflation.
Exceptional items totaled EUR16 million, which, among others, included legal expenses, cost for M&A integration and restructuring charges. The adjusted EBITDA increased by 5%, and the EBITDA margin stood at 58%.
The net income increased by 4% to EUR198 million, and that is adjusted for a one-off positive tax effect of EUR18 million related to the restructuring of one of our subsidiaries. I’m now turning to the quarterly result of the individual segments, starting with Eurex on Page 4.
The Eurex development continued to be mainly driven by cyclically weaker activity in index derivatives, in line with lower equity market volatility. This was partly offset by the continued growth in interest rate derivatives.
In our commodity business, we saw slight growth, mainly because of the consolidation of U.S. Energy Exchange model in the second quarter.
The core power derivatives business still suffered from the uncertainty around the German and Austrian price zone. The date for the split has now been decided, and EEX launched new products to reflect the new price zones.
Liquidity is now returning from OTC markets into the new Felix [ph] German future. In total, net revenue in the Eurex segment stood at EUR221 million, adjusted EBITDA at EUR150 million and the EBITDA margin at 53%.
In our cash market Xetra, we saw an increase of the order book turnover by 16%. Therefore, net revenue in this segment increased to EUR43 million.
EBITDA on an adjusted basis improved to EUR3 million, and the EBITDA margin stood at 53%. At Clearstream, total assets under custody increased by 2% to EUR13.4 trillion.
The 2% decline in the ICSD business was more than compensated by a 3% growth at the CSD and the very encouraging 16% growth of the Investment Funds business. With the introduction of TARGET2-Securities, we have decided to merge the ICSD and CSD net revenue line items.
This is mainly because clients under T2S have the choice to deficit their assets either as a CSD or the ICSD of Clearstream. Outstandings in the collateral management business of GSF continue to be negatively affected from central bank monetary policies, which reduced the need for secured money transactions.
Due to a more favorable business mix, this growth in the higher-margin securities lending business, GSF net revenue increased by 11%. The cash balances at Clearstream, adjusted for blocked accounts, decreased by 3% to EUR10.9 billion.
The net interest income was not really affected by this decline as it mainly occurred in euro balances. In total, net revenue in the Clearstream segment amounted to EUR240 million.
The adjusted EBITDA came to EUR128 million, and the EBITDA margin stood at 60%. Net revenue in the Market Data + Services segment increased by 8% year-over-year.
This was mainly driven by a 23% net revenue growth in the index business, i.e. STOXX.
The major driver of this favorable development was a strong increase of assets under management in ETFs. This is viewed by many as a secular trend and thus improves our longer-term growth prospects.
Total net revenue in the MD+ S segment amounted to EUR99 million, the adjusted EBITDA reached EUR66 million and the EBITDA margin was a quite comfortable 67%. This brings me to Page 8 and the net revenue drivers in the first nine months of 2017 and our guidance.
With our secular initiatives, we generated around 5% net revenue growth in the first nine months this year, which is in line with our plan. The main contributors were custody, Investment Funds Services, new Eurex products, the index business, collateral management services and OTC clearing.
This was partly offset by a net decline in the cyclical part of our business, which was mainly driven by the weaker development in index services and negative consolidation effect. In total, this resulted in a 2% decline of net revenue.
In addition, we saw some pressure on the cost base arising from staff cost inflation of around EUR15 million, depreciation and amortization due to higher investments of around EUR23 million, and higher share-based compensation, especially due to the share price increase of around EUR10 million. We were able to offset most of those pressures by further improving the efficiency of the group.
As I mentioned earlier, while the persisting historic low equity market volatility, we are most likely not going to achieve the lower end of our net revenue and earnings guidance for the full year, but we firmly believe that we are very well-positioned to benefit from secular and cyclical growth in the midterm. Therefore we’re confident that we can achieve our earnings growth target of 10% to 15% in 2018 and 2019.
This concludes our presentation. We are now looking forward to your questions.
Operator
[Operator Instructions] The first question comes from Peter Lenardos, RBC. Please go ahead with your question.
Peter Lenardos
Good afternoon, Gregor, it’s Peter Lenardos from RBC in London. I had a question for you on Eurex, specifically with regards to the price increases.
I was just hoping you could walk us through the impact that, that had on revenue development in Eurex in the Q3 and how you expect that to impact revenue going forward? Thanks.
Gregor Pottmeyer
Yes. As you are aware, we did some adjustments with regards to prices.
So we started to increase prices this July 1 in different areas. We did it at Eurex, and we also did it in our data and index business.
And overall, this is a positive impact of 1% to 2% increase of net revenues on group level when we have the full year impact.
Peter Lenardos
Great. Thank you very much.
Operator
The next question comes from Benjamin Goy, Deutsche Bank. Please go ahead with your question.
Benjamin Goy
Yes. Hi, good afternoon.
Maybe one question on Clearstream and TARGET2-Securities. I thought in the quarter, settlements were nicely up year-on-year.
You first indicated that your market share gains are playing out, and how would you see the time line to gain custody volumes as well going forward?
Gregor Pottmeyer
Yes, thanks for the question Benjamin. I think from a strategic point of view, so TARGET2-Securities is an absolute game-changer.
And Clearstream can now be used as a single point of access for our settlement and custody business, in the ICSD business and in the CSD business. And so you have a much more efficient liquidity and collateral management if you use here Clearstream as your single point of access.
As we own 40% of the euro liquidity roughly, and Euroclear is in the range of 20% to 25%, so there are 35% to 40% what is now in our view as opportunity to get something out of that. So – and here, we see continued interest of local market participants to grow up together with Clearstream, but that’s obviously not a short-term exercise.
We have good progress here, in principle, but it will take longer, over a period of two years to three years, before you see bigger movement of settlement activity. But specifically, in our Investment Funds Service business, here, you see really nice interest from market participants to use our platform in a much more advanced way than they did before.
Benjamin Goy
Great, thank you.
Operator
The next question comes from Johannes Thormann, HSBC. Please go ahead with your question.
Johannes Thormann
Yes. Two questions from my side.
First of all, could you just give us an indication what triggers your confidence for the strong growth of 360T? You’re forecasting now, after we see a sideward movement, around EUR 16 million revenues for, I don’t know, seven quarters or so.
And secondly, you flagged in your short – very short Q3 report that you are giving – generating and expecting a USD 50 million gain from a transaction portfolio optimization. Will this also be available for distribution via dividends?
Or is this restricted in some kind? Thank you.
Gregor Pottmeyer
Yes. And so for the first question, 360T development, so currently, on a global basis, FX market is under pressure.
So it’s cyclically downwards on a global basis. And in this difficult environment, it’s even good to show them 4% to 5% increase.
And therefore, we are able to show that increase, so that means we are able to further gain additional market shares, as our main competitors on a year-to-date basis are basically flattish. And so overall, that’s not a bad development, what we see here at 360T.
Obviously, it’s below our expectation, and our expectation is that this is an asset that should grow double-digits on a net revenue basis. Our confidence comes from the general trend that we, say, we will benefit from the movement from OTC to on-exchange.
And we will be the first one who really offers a standard limit order book functionality, and that’s already technically implemented. And we are in good conversations with customers to use that as a platform.
And in the first quarter 2018, we will, in addition, implement a clearing solution. So we think we are very well-positioned from benefiting from this general trend from OTC to on-exchange.
And now it’s a question of timing, how fast are we able to deliver on that basis. In addition, on a stand-alone basis, so we have seen already a quite favorable development in Q3, so a much, much, much better increase.
And that’s also our expectation that even on a stand-alone basis, so we should see better growth rate in 2018 compared to 2017. Second question, with regard to the $15 million, yes, that’s a onetime effect, and it increased our cash and it will most probably also increase our dividend capacity.
Johannes Thormann
Okay, thank you.
Operator
The next question comes from Philip Middleton, Merrill Lynch. Please go ahead with your question.
Philip Middleton
Hi, Gregor. Turning back to Eurex, if we look at the index revenue of 84 – profits of EUR 84 million, given the volumes, that looks quite thin, particularly given, if anything, profits have been edging upwards.
Is there anything behind that or what’s going on there?
Gregor Pottmeyer
Yes. There’s a onetime impact of roughly EUR 5 million where we have booked it differently compared to the first months in 2019.
And that’s the reason why, even if you did some nice price increases on a net basis, you don’t see it in our RPC numbers.
Philip Middleton
Okay. So run rate had been nearer sort of EUR 89 million on that line then?
Jan Strecker
Adjusted for the EUR 5 million exactly, which would bring us to an RPC of roughly EUR 0.48, which is roughly EUR 0.02 above the second quarter. And one of the reason is the fee change, but the other reason is the mix between futures and options that we’ve mentioned already on the second quarter call.
Philip Middleton
Thank you.
Operator
The next question comes from Kyle Voigt, KBW. Please go ahead with your question.
Kyle Voigt
Hi, good morning. I guess, a question on the revenue or the profit share programs for interest rate swaps clearing that you developed with some of the dealers.
Can you just give us a little bit more color, like how many dealers have signed up at this point, and if they have any specific agreements where they have to put a certain amount of – when they sign up for the partnership, did they end up putting a certain amount of volume through Eurex Clearing? Or is it just specifically performance-based?
Thanks.
Erik Muller
Yes, thank you. It’s Erik.
We put out the program on the 9th of October, and the early sign-up period ends on the 20th of November. You will have seen that already in the initial press release, there were four out of the five major U.S.
players in the IRS market in the press release, and we had the two largest banks in Germany. So now we are broadening especially our European base, so we’re talking to all the different banks in those different countries.
The interest is enormous. So our confidence that there will be a second liquidity pool is very high because Europe needs it under these circumstances.
And we will inform once that period is – that early sign-up period is over on the entire participation in the program, but expect it to be very broad-based U.S. EU interest.
So that’s the status of our current book on the service.
Kyle Voigt
And just a follow-up on the OTC clearing. Can you give us any, I guess, the size of the revenue that you’re generating there right now?
And I guess, are they growing year-over-year?
Erik Muller
Yes. If you go back to 2016, we essentially have zero revenue, so in 2017, we will have double-digit million revenue.
It’s at the lower end of a double-digit million number, but it’s not zero anymore. The growth we have seen this year has been exponential from a low base, and the program will further accelerate that.
But in terms of the midterm guidance on OTC IRS, that is entirely unchanged. It’s in the EUR 50 million to EUR 70 million area, as we have said before at our Investor Day.
But I would say the probability of reaching that has increased materially with that program.
Kyle Voigt
Thank you.
Operator
The next question comes from Gurjit Kambo, JPMorgan. Please go ahead with your question.
Gurjit Kambo
Hi, good morning. So it’s Gurjit here.
Just in terms of the other line in Eurex, it’s kind of sort of declined sequentially and also year-on-year. Is there any sort of particular reason in that, so the EUR 18.8 million?
Erik Muller
Well, if you compare it to the preceding quarters, then we have adjusted those as well, so around EUR 2 million have been moved into the EEX line item because they relate to a commodities piece of technology called XBit. And sequentially, versus the second quarter, we have roughly EUR 2 million less of NII at Eurex, which relates to lower cash collaterals throughout the summer.
And the rest, so maybe another EUR 1 million or EUR 2 million, is simply volatility in that line item which already occurred in previous quarters.
Gurjit Kambo
Okay. Great.
Thank you.
Operator
The next question comes from Martin Price, Credit Suisse. Please go ahead with your question.
Martin Price
Good afternoon. I was just wondering if you could provide an update on your growth aspirations in Asia.
You talked quite a bit about this in the past, but perhaps not so much recently. And Asia seems to have dropped out of your list of secular growth initiatives.
So I’d just be interested in what’s going on there at the moment, particularly at Eurex? Thank you.
Gregor Pottmeyer
Yes. So Martin, as you are aware that currently, our focus is really around the Brexit discussion and the potential opportunity we see to help our clients and our customers to have here a market-led solution.
Therefore, from a priority and focus perspective, that’s clearly number one on our agenda. With regard to Asia, so there are still activities where we want to improve our presence, improve getting additional business, getting new customers onboard.
So that’s another business we do here, but focus is currently on euro – on Brexit and on Europe.
Erik Muller
And to add for Eurex, we are consulting with the market an extension of trading hours, so that would expand the window of some of our flagship European benchmarks into the Asian time zone. And that’s something that you can expect to see going forward, but it’s in the consultation stage right now.
Martin Price
That’s very helpful. Thank you.
Operator
The next question comes from Mike Werner, UBS. Please go ahead with your question.
Mike Werner
Thank you. Gregor, the – I’m asking about the net interest income that was earned at Clearstream.
We saw it flat quarter-on-quarter, and you mentioned that most of the decline in cash balances came from the euro side. I was just curious, I was expecting maybe a bit more of an uptick given the interest rate hike in the U.S.
in mid-June and the full quarter impact that would have. I was just wondering if there is anything else in that line item.
Gregor Pottmeyer
Yes. So in Q3, we really saw a decline in our euro cash balances.
It was also a decline in the U.S. business, but we also saw, now in October, already an increase specifically in the U.S.
area. So we are still on a level of roughly EUR1 billion, so that’s even more than 50% out of the EUR10.9 billion what we have today.
And it’s a little bit volatile, the customer cash balances, in principle. But as I mentioned, there’s already an increase in October back.
But the main driver for our NII development is the U.S. dollar as we have an interest rate level of more than 1% there, also the other currencies, but they are quite stable.
And so that’s the structure of our cash balances.
Mike Werner
Thank you.
Operator
The next question comes from Peter Lenardos, RBC. Please go ahead with your question.
Peter Lenardos
Hi, gentlemen. It’s Peter from RBC again.
Just a follow-up question, please. Given the changes in management announced yesterday, I guess, is there any update or impact on the ongoing investigations into the company regarding this?
And maybe an update on when those investigations will allow you to buy back shares. Thank you.
Gregor Pottmeyer
Yes. Thanks, Peter, for the question.
And you have seen our announcement yesterday where Carsten Kengeter informed the Supervisory Board that he would like to step down until end of the year. And Carsten will leave the company at interim – in the interim period and have the full Supervisory Board’s confidence.
And under the leadership of the Chairman of the Supervisory Board, so the Personnel Committee has already started its work yesterday. A search firm is already mandated, and it’s a target to have here an accelerated process to get the decision as soon as possible, ideally before year-end.
With regard to the prosecutor’s process, now you are aware that the local court refused to approve the closure of the investigation proceedings. So – and it’s now in the hands of the public prosecutor who has to decide what kind of further procedures that he would like to see.
Peter Lenardos
Great. So it just remains ongoing with no impact from.
Gregor Pottmeyer
Share buyback, I forgot that. So you are aware that we said the extent, the period when we want to do our share buyback program of EUR200 million, and we extended it until end of the first half year through 2018.
And we have not decided today to start it immediately, so – but we want to – some – and we still need some flexibility towards current development and market conditions
Operator
The next question comes from Roland Pfander, ODDO. Please go ahead with your question.
Roland Pfander
Good afternoon. Two questions, if I may.
Firstly, on your secular growth. Right now, you have an underlying secular growth of around 5%.
Would you expect that to go up going into 2018 or 2019, and how much could that be? And second, what’s your outlook for future cost savings going into 2018 as your internalization of jobs, I think, might have been finalized this year?
Gregor Pottmeyer
Yes. With regard to the first question for the secular growth for 2018, so we have a lot of opportunities.
And I refer to in my – speaking at the beginning, just to remind us again, so OTC interest rate swap clearing is a good opportunity where we expect nice growth. We expect the highest growth rate in the commodities.
But as also now, we have a lower starting point in 2017 FX business, we expect double-digit growth; Investment Funds Services, index business, so new products at Eurex, TARGET2-Securities, so there are many initiatives around that. If we are in all of these areas successful, then it could be more than 5% structural growth rate in 2018.
But in general, we say, look, we want to grow net revenue by 5% to 10%. Structural opportunities, we see at least in the range of 5%.
And we also expect for the next year that – some cyclical – from a cyclical perspective, we see tailwind instead of headwind. With regard to the cost, so we are committed to deliver on the scalability of our business model.
So if revenue just increased by 5%, our target is to have flattish growth. If revenue increased by 10%, cost can increase by up to 5%.
We have all the measures and instruments in place to react on that. We still have some smaller positive impacts out of the internalization in 2018 as it’s been finalized.
But it’s even more important that we have a fully transparent, a very detailed P&L steering mechanism in place where you, on a very granular basis, are able to see which kind of business and projects deliver what they promised and which not. And if projects and business do not deliver, then we consider to postpone or even to stop that.
It can be in a much more active and proactive way than in the past, and that’s why we are confident that we have a good cost management in place.
Roland Pfander
Okay, thank you.
Operator
The next question comes from Arnaud Giblat, Exane. Please go ahead with your question.
Arnaud Giblat
Hi, good afternoon. I’ve got a question on Clearstream, please.
The merger of the ICSD and the CSD business, I’m wondering if there are any implications in terms of pricing. Roughly, the yield on the ICSD assets is double that of the CSD, and actually, the settlement fees tend to be tends on higher.
So does this mean we were looking at a repricing there, and what impact could that have? And second, in terms of cash balances.
How should we think about the drivers of cash balances going forward? It seems as though the decline in cash balances, 22% decline since Q1, has come in conjunction with rate hikes in the U.S.
So I’m wondering here whether higher interest rates available to your clients lead them to optimize their cash balances a bit better? Thank you.
Gregor Pottmeyer
Okay. Arnaud, thanks for the question.
So in principle, the main driver for the cash balances are the settlement activities. So market participants have to make sure that there’s a smooth settlement process in place, and therefore, they have to put in the cash in place.
Otherwise, there’s a risk that it’s not a smooth process. And obviously, if our settlement activity increase, then, in principle, our cash balances increase.
With regard to your thinking about, is Clearstream used as a safe haven basis, so we do not see that. So if interest rate in principle increase, there’s a tendency obviously that you do a much more optimized treasury activity in a bank.
But the levels are still very low. But at a certain point of time, you could also see that customer cash balances could be reduced.
But again, the main driver is the settlement activity, and we expect that the settlement activity will also increase in the future, and we will benefit from the TARGET2-Securities development. So in principle, that should be the main driver for that.
And with regard to the ICSD, CSD, so there is no change in the pricing. We changed the pricing at the beginning of this year with regard to the TARGET2-Securities development as we increased our pricing in the custody business as we looked.
And the low CSD business, that was the only price adjustment we did at the beginning of the year, no further price adjustment so far.
Arnaud Giblat
Okay. Thank you.
Jan Strecker
All right. We have no further questions in the pipeline.
So thank you very much for participating in today’s call, and have a good day.