For investors who like a share price that grows steadily, few companies can match Intercontinental Exchange Inc.'s (ICE, Financial) consistency and generally low volatility:
Best known as the operator of the New York Stock Exchange, Intercontinental also operates in other areas as well, providing diverse but related sources of income. In its 10-K for 2020, the company wrote, "Today, we are a Fortune 500 company, providing our customers with an array of marketplace infrastructure, data services and technology solutions that span a diverse set of asset classes."
The company was founded in 2000 and debuted on the NYSE in 2005. In 2001, it acquired the International Petroleum Exchange. The New York Board of Trade was bought in 2007 and the Climate Exchange in 2010.
It made its entry into the data services business in 2003, the clearing house business in 2008, fixed income in 2015 and mortgage services in 2018. Today, it operates in three segments and primarily in two countries, the U.S. and the UK:
- Exchanges: This segment delivered $3.6 billion in net revenues in 2020, an increase of 10% over the previous year.
- Fixed Income and Data Services: This segment produced revenue of $1.8 billion in 2020.
- Mortgage Technology: This segment produced revenue of $1.2 billion, which includes contributions from its acquisition of Ellie Mae last September.
Revenues come in two forms, transactions (one-time) and recurring (subscriptions):
Risks
In its 10-K, the company lists numerous risks, including:
- Conditions in financial markets.
- The effects of Covid-19.
- Changes in laws, regulations and government policy.
- Volatility in the prices of commodities, equities and financial benchmarks.
- The inherent risks of operating clearing houses.
- Debt: The company advised that it carries a substantial amount of debt, which could adversely affect its financial condition and operations.
Competition
Intercontinental breaks down its competition by segment:
- Exchanges: "We face competition from other exchanges, electronic trading systems, third-party clearing houses, technology firms, market data vendors and trading facilities in the U.S. and globally." It also notes that competition is intense; for exchange listings, the competition is with Nasdaq, Inc. (NDAQ, Financial) and Cboe Global Markets, Inc. (CBOE, Financial).
- Fixed Income and Data Services: On the fixed income side, it competes with other electronic trading venues. Data Services competes, broadly, with "purchased third-party information and services from large global suppliers of financial market data."
- Mortgage Technology competes with other digital mortgage solution providers, including Black Knight, Inc. (BKI, Financial).
Elsewhere in the 10-K, it reports that its peer group includes CME Group Inc. (CME, Financial), Deutsche Boerse AG (listed in Germany), IHS Markit LTD (INFO, Financial), London Stock Exchange Group PLC (LSEG, Financial), MSCI Inc. (MSCI, Financial) and S&P Global Inc. (SPGI, Financial).
Financial strength
As the red on this table suggests, Intercontinental has a lot of debt. The following chart shows how it has grown in relation to cash:
Part of the reason for the growth of debt is acquisitions. The company has made many of them since going public; most recently, it bought the mortgage software company Ellie Mae. The latter provides technology to credit unions and non-bank lenders, helping them originate residential mortgage loans. Since Ellie Mae currently processes 35% of American mortgage applications, the acquisition will widen Intercontinental's reach in the mortgage industry.
The deal also added to the debt load. Of the $11 billion paid, 84% was in cash ($9.24 billion) and 16% was in Intercontinental's shares. At the end of the second quarter, just before the deal was finalized, the company had just $880 million in cash and cash equivalents. Thus, we have to conclude most of the cash in the deal involved debt.
Note, too, that the current weighted average cost of capital (WACC) is higher than its return on invested capital (ROIC), indicating the company's growth is not profitable.
Profitability
The profitability table is more promising, with a series of green bars indicating Intercontinental generally outperforms its peers and competitors in the Capital Markets industry.
On the other hand, it is underperforming its own history over the past decade. Here, for example, are the operating margin and net margin:
On the growth lines, we see both revenue and Ebitda are making gains while earnings per share (without non-recurring items) appear to have slipped over the past three years. Yet, when we look at a chart of diluted earnings over the past 10 years, we see that while earnings slipped in 2018 and 2019, they began to recover in 2020:
Dividend and share buybacks
Intercontinental's current dividend yield is 1.06%, roughly half of the S&P 500 average, but there's more to see behind the curtain.
Over the past three years, the three-year dividend growth rate has been 14.50% per year. However, that nearly has been overshadowed by the growth of the share price, which has averaged 14.41% per year over the past three years.
This 10-year chart of the share price and the dividend yield helps put the yield into perspective:
Investors who bought for the dividend have been better rewarded than first impressions would suggest:
Regarding share repurchases, Intercontinental has been active on both sides of the ledger:
In 2015, the year that saw a big increase in the number of shares, it bought Interactive Data Corp for $5.2 billion. Of that amount, $3.65 billion was in cash and $1.55 billion was made up of Intercontinental's stock. At the end of 2014, it had just $1.852 billion in cash, cash equivalents and marketable securities.
Valuation
The GuruFocus Value Line concludes that Intercontinental is fairly valued:
The price-earnings ratio comes in on the high side at 30.71 when compared with the industry median of 17.61 and the company's own 10-year median of 23.00.
The PEG ratio (which is the price-earnings ratio divided by the five-year Ebitda growth rate) is above fair valuation as well. It is 2.65 compared with the industry median of 1.89 and its own historical median of 1.45.
The discounted cash flow (DCF) calculator arrives at a fair valuation using the below assumptions:
Comparative returns
This 10-year chart shows Intercontinental outperforming some of its competitors, but not keeping up with the Nasdaq:
Gurus
The investing gurus were net buyers of Intercontinental during the final quarter of 2019 and the first two quarters of 2020. Since then, their interest has faded:
Eleven gurus held positions in the stock at the end of 2020, with the three largest holdings being:
- Catherine Wood (Trades, Portfolio) of ARK Investment Management, who loaded up in the fourth quarter of 2020, adding 215.98% to finish the year with 4,557,974 shares, representing 0.81% of Intercontinental's shares and 1.40% of her firm's assets.
- Pioneer Investments (Trades, Portfolio) held 3,895,521 shares after reducing its holding by 15.16%.
- Ruane, Cunniff & Goldfarb finished the year with 3,469,593 shares, 0.42% fewer than at the end of the third quarter.
Conclusion
Intercontinental Exchange is a stock the has delivered consistent growth with little volatility. For aggressive income investors, I think it might even be considered a substitute for a bond. For those seeking even higher returns, Nasdaq stock might be a better choice.
We know its financial strength is compromised by the amount of debt it has taken on to make acquisitions and to earn future revenue and income. Profitability is very good, and it appears to be fairly valued. The dividend is better than it might appear, and it may continue to buy back its own shares.
For value investors, there are two strikes against Intercontinental, its debt and no meaningful margin of safety. Prudent growth investors might see this stock as providing solid capital gains with less-than-average volatility. Income investors may see this as an opportunity to get both capital gains and a dividend in one package.
Disclaimer: I do not own shares in any of the companies named in this article and do not expect to buy any in the next 72 hours.
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