Description

I’ll try to keep this one simple. Deutsche Boerse (DB1) is one of the higher quality publicly-traded exchanges in the world. DB1 enjoys high quality revenue streams (ie, low exposure to commoditized cash equities revenues and high exposure to derivatives trading & clearing and market data) and has a track record of compounding EPS at double-digit levels. Despite that, it trades at a discount to peers and its own historical average multiples.

DB1 is a high-quality business (relative to both exchange peers and the broader market):

Unlike many of their peers, DB1 has little reliance on revenue streams related to cash equities trading (transaction fees, listing fees, regulated data fees):

Why are cash equities related fees less desirable? Cash equities are portable – in most geographies, I can buy shares of a company on one exchange and sell them at a different venue (this is not the case for derivatives trades). As a result, cash equities trading tends to be a fairly competitive business in most geographies (and in the geographies where it isn’t competitive, there is always the risk of future competitive entry). Moreover, cash equities trading tends to be mature and relatively low-growth in most geographies as well.

As a result of an attractive mix of revenue streams, DB1 has been able to compound EPS at a double-digit rate:

DB1 is currently one of the cheapest exchanges in the world (and is trading towards the lower end of its (15x-24x range over the past decade):

Why is DB1 trading at a discount? I think there are two factors at work. First, DB1 likely suffers from a conglomerate discount. In recent years, they’ve acquired several tangential businesses in the market data and software space. As I explain more fully in the “Company Description” appendix below, I think DB1’s Data & Analytics businesses are strong, but the increasing number of activities in this area makes the company more complex to analyze.

Second, sentiment on DB1 suffers from the fact that earnings growth is likely to decelerate over the next couple years. In recent years, DB1 has been a beneficiary of higher interest rates boosting float income from its Clearstream subsidiary (see “Company Description” section below for more color on this). DB1 generated ~€700 million in net interest income in 2023 and is on track for a similar amount in 2024 – this represents a ~4.4% NIM. As interest rates come down, this income stream will shrink. Management is guiding to ~€500 million in net interest income by 2026 (~2.9% NIM). This ~€200 million revenue headwind, net of taxes, equates to an EPS headwind of ~€0.80 (~8% hit to current LTM EPS). This is likely to temporarily turn DB1’s underlying high-single digit/low-double digit EPS growth over the next couple years into mid-single digit growth.

Saying something bad “is priced in” can be dangerous, but in this case, I think the headwind is priced in. If we haircut DB1’s LTM EPS (adjusted for intangibles amortization) of €10.47 by the ~€0.80 headwind from interest rates normalizing, the stock trades at ~19x, still below where most other exchanges trade.

Is there an obvious catalyst for a re-rating in DB1’s stock? Not really. It may well continue to trade at a discount for some time, especially as interest rates remain a headwind. But I think the company is a good bet to continue to compound underlying earnings, and I think there is more re-rating upside than downside at these levels. Over the medium and longer term, I think that’s a good setup.

Appendix: Company Description

I’m going to break out DB1’s business slightly differently than company itself does. The company has changed its segment definitions from time to time over the years, and I find it useful to break its business into four major categories, three of which are high quality, one of which is mediocre (but only 5% of revenues).

Derivatives Trading & Clearing: 37% of LTM revenue (included within DB1’s “Trading & Clearing” segment)

• Mostly transaction fees (but some recurring fees as well) from trading of derivatives, commodities and foreign exchange.
• Derivatives trading & clearing tends to be a very attractive business
  • Unlike cash equities (where you can buy shares of a company on one exchange and sell them on another), derivatives contracts are not “portable” – they must be opened and closed on the same exchange.
  • For derivatives, the cost of trading is typically very low compared to the cost of margin that needs to be held against it. Therefore clearing efficiency (ability for investor to reduce clearinghouse margin by netting off positions) encourages investors to consolidate their trades on a few exchanges as possible.
• Subsegments include:
  • Eurex = Largest European derivatives exchange with particular strength in Euro-denominated interest rate derivatives
  • EEX = World’s largest power trading exchange
  • 360T = Foreign currency trading exchange
• Over the last 5 years, DB1’s derivatives trading & clearing revenues have grown at an 8% CAGR, and DB1 generates ~60% EBITDA margins on these revenues.

Fixed Income & Equity Settlement and Custody Services: 37% of LTM revenue (encompassing DB1’s “Securities Services” and “Fund Services” segments)

• Custody, settlement and other fees paid by banks/brokers using DB1 to settle trades as well as interest income from earned on the collateral posted by banks/brokers
• Revenues in this segment primarily generated by Clearstream, one of two players, along with Euroclear, that form a duopoly for equity and bond settlement in Europe
  • In the US, post-trade settlement of equities and bonds is done by DTCC (owned by a consortium of banks and brokers). In Europe, post-trade settlement of equities and bonds is done by either Clearstream or Euroclear
• DB1 also provides settlement services to mutual funds and ETFs, and they run a B2B fund distribution business that helps open architecture fund distributors easily allow their clients access to a broad range of funds (in this business, DB1 is a direct competitor to Allfunds).
• Revenues in this segment are interest-rate sensitive. Pre-COVID, DB1 was earning ~1.2% on float in this segment. Now, they are earning ~4.0%, generating ~€700 million in net interest income. Roughly 50% of the float is in USD (earning short-term US interest rates, roughly 30% is in Euros, and the remaining 20% is in other currencies (primarily pounds).
• Absent changes in interest rates, this is a mid-single digit growth business that generates ~70% EBITDA margins.

Software, Market Data, ESG and Indices: 21% of LTM revenue (this is DB1’s “Data & Analytics” segment)

• A variety of activities, many of which have been added via acquisitions in recent years, including:
  • SimCorp (~10% of total company revenue): Acquired in September of 2023, SimCorp sells software used by investment managers (competitors include Charles River and Aladdin).  Prior to being bought by DB1, SimCorp was generating double-digit topline growth and ~25% EBITDA margins. SimCorp is a good business, but the market hasn’t loved the acquisition, in part because DB1 paid a high price for it (nearly 20x EBITDA).
  • ISS (~6% of total company revenue): Acquired in February 2021, ISS is part of the proxy advisory duopoly along with Glass Lewis, as well as a provider of ESG data.
  • Indices: (~4% of total company revenue): DB1 owns the DAX and STOXX indices. Index businesses are often amazing (MSCI and FTSE Russell are both gems), but DB1’s index business isn’t as impressive (their indices just aren’t as popular for ETFs and benchmarks as MSCI’s and FTSE Russell’s indices). DB1’s index revenues have grown at a ~6% CAGR over the last 5 years, and believe EBITDA margins here are above 60%.
• Overall, this segment comprises a number of good businesses. Management views the segment as a high-single digit grower, and it generates ~30% EBITDA margins. The downside is that it is a hodge podge of businesses, which makes it harder to understand and track.

Cash Equities Trading: 5% of LTM revenue

• DB1 operates Xetra, the incumbent stock exchange in Germany.
• Transaction fees based on value of shares traded as well as listing and other fees.
• Unlike derivatives exchanges, developed markets cash equities exchanges these days tend to be mediocre businesses. Because cash equities are portable (you can buy shares on one exchange and sell them on another), the business is somewhat commoditized.
• DB1 has done a good job maintaining high margins in this segment (I believe EBITDA margins here are still ~60%, although they no longer break out EBITDA margins for cash equities), but revenue from this stream has declined at a 3% CAGR over the last 5 years.

Risks:

• Bad acquisitions/overpaying for acquisitions
• Unfavorable regulation (eg. financial transactions taxes et al.)

Catalyst

• Continued earnings growth
• Normalization in interest rate income (so it is no longer a headwind)