Tightening regulations, mainly the Volcker Rule, Dodd-Frank Wall Street Reform and Consumer Protection Act and Basel II/III, have created an unprecedented catalyst for the increasing adoption of electronic trading in the bond market.
MarketAxess (MKTX, Financial) is an undeniable beneficiary from the trend so far, and it is one of the fastest-growing FinTech businesses. As you can see below, the annual free cash flow nearly quintupled over the past decade, creating tremendous value.
New York-based MarketAxess operates a leading electronic trading platform for fixed-income market participants to trade corporate bonds and other types of instruments efficiently. The currently $13 billion market-cap business leverages scalable technology to add to the efficiency, liquidity and transparency of bond trading and, in return, charges commissions for executed trades and monthly distribution fees (89.7% of fiscal 2018 sales), both of which are high recurring once the client gets on-board.
The active user base, including more than 1,700 institutional investors and broker-dealer firms, naturally builds an economic moat through a network effect, especially in the categories of high-grade, high-yield and emerging markets bonds. This factor, along with a first-entry advantage, has led to the market-leading status of MarketAxess in terms of the institutional trading network for U.S. credit products.
According to the chart below, MarketAxess earned an above-average return on assets that is higher than the like at its main rival, Tradeweb Markets (TW, Financial), and roughly in line with OTC Markets Group (OTCM, Financial), the FinTech leader in the OTC market space. At the same time, investors should also acknowledge the competitive threat from FinTech giants Bloomberg and Refinitiv in the U.S. government debt space.
It is worth mentioning that the idea of MarketAxess was initially proposed by Richard McVey, the then head of North American fixed-income sales at JPMorgan (JPM, Financial), to Lab Morgan, a technology incubator-type of a program at JPMorgan, in 1999. One year later, Mr. McVey launched MarketAxess as an independent venture with the capital raised from other market participants, including Bear Stearns. Fast forward to today and he is still the company’s Chairman and CEO, with a 2.58% equity stake.
Compared with equities, the fixed-income space is relatively immune to economic downturn. As described below, the sales and operating profit were only mildly impacted throughout the 2008 financial crisis.
The management believes that the rapidly-increasing electronic trading market share is still in its early stage of penetration, creating a long-term tailwind for the business. As of fiscal 2018, it estimated a $71 billion average daily volume for the total addressable credit market (including $8 billion of U.S. high-yield, $21 billion of US high-grade, $20 billion of emerging markets and $9 billion of Eurobonds), comparing to the less than $7 billion average daily volume handled through MarketAxess. In the meantime, it appears to us that the company has a clear growth strategy, which focuses on increasing penetration of existing and new markets, investment in next-generation technologies and expanding internationally.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of OTC Markets Group.
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