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Antiquated Market Structure
Centralized exchanges have historically not existed in the fixed income markets, leading to market structure problems. Due to their diverse and dynamic nature, fixed Income markets have traditionally been relationship based, quote driven OTC markets. Fair values for bonds can be calculated, but marketable prices were known to investors only after revealing their intention to a dealer over the phone. This inefficient system resulted in poor market quality as liquidity was fragmented and market data was opaque. Prices for identical securities often varied between dealers.
In 1998, Tradeweb launched the first electronic, multi-dealer platform with the intention of addressing these market structure problems. The solution was to bring multiple dealers to a centralized venue, where participants could simultaneously request quotes from all of them and pick the best price. This was the beginning of a major overhaul to fixed income markets.
Tradeweb was formed in 1997 with the intention of enhancing market quality for institutional investors. Since launching its original treasury platform with 4 dealers, Tradeweb has onboarded more than 50 liquidity providers, and ventured to nearly every corner of the fixed income universe. Today, the company offers investors electronic access to global government bonds, mortgages, interest rate swaps, corporate bonds, credit default swaps, repurchase agreements, money markets, and the ETF block market.
For most of its history, Tradeweb was owned by Thompson Reuters. In 2018, Thompson Reuters sold 55% of its “Financial & Risk” unit, (which included Tradeweb), to Blackstone, forming a new company called Refinitiv. Thompson Reuters retained the remaining 45% stake of Refinitiv. Tradeweb recently IPO’d in April, 2019, however Refinitiv still owns a controlling stake in the company, which was ~54% at the time of the IPO.
The company has expanded upon its original multi-dealer “request-for-quote” trading protocol. It offers innovative new workflows such as:
- “AiEX” – a request for quote system that automatically executes based on preset conditions
- Treasury “Spotting” – an automated system that applies interest rates hedges to corporate bond trades with one click
- All-to-All – allows participants to request liquidity from other platform participants, in addition to dealers
- Click-to-Trade (CTT) – provides a continuous streaming quote for liquid instruments that participants can interact with
- Central Limit Order Book (CLOB) – a continuous trading session, similar to the stock market, that allows participants to interact with resting bids and offers of other participants anonymously
This is all available to clients through Tradeweb’s modern trading software. Clients can also connect to Tradeweb’s marketplaces via third party platforms.
Today, the fixed income markets still exist in a far less electronic state than more liquid asset classes like equities and futures. Electronification is taking hold of the fixed income markets, and adoption is trending higher. The opportunity for Tradeweb is to continue to drive change and penetrate these less electric fixed income markets.
Electronification has improved the quality of the equity and futures markets. The fixed income markets should be no different. Participants in the fixed income markets who demand liquidity and transparency should naturally gravitate to electronic trading venues that enhance market quality and lower their trading costs.
Execution & Market Share Growth
Tradeweb makes a variable revenue stream from trading, as well as a fixed revenue stream from market data, minimum activity fees, and membership fees.
The fixed revenue segments can be expected to be stable, low single digit growers as the company onboards new clients to its platform and begins to mine and sell data from their trading activity. The exciting part of the business, however, is the variable transaction revenue segment, which is driven by volume growth. Volumes are rapidly growing in the double digits in all asset classes as electronification takes hold.
Although, the rates segment is still the largest, Tradeweb is gaining market share in corporate credit, particularly in the investment grade space. The company is achieving this by capitalizing on its roots in treasuries. As mentioned earlier, Tradeweb offers an innovative hedging solution called treasury “spotting”. This is serving as a boon for the investment grade business, as most investment grade bonds are hedged for interest rate risk.
Tradeweb has also recently added the ability to trade Chinese bonds on its platform, further widening the total addressable market. China recently opened its bond market to foreign investors through the China “BondConnect” program, which was launched in 2017. The Chinese bond market is massive. It is the third largest market in the world, behind only the US and Japan. Just like China’s equity market, its bonds are now being included in global indices. Bloomberg announced that Chinese sovereign debt would be added to the Bloomberg Barclays Global Aggregate Index beginning on April 1, 2019. This is expected to result in $100 billion in foreign inflows into these credits. Other index providers are expected to follow suit. Tradeweb has a first mover advantage in offering electronic access to this rapidly expanding, newly opened market. Tradeweb even has an office in Shanghai.
Valuation and Potential M&A Upside
Although Tradeweb may look expensive based on its trading multiples, the stock remains at a discount to its closest peer, MarketAxess, even though it is growing at about the same pace. MarketAxess offers a very similar electronic fixed income platform spanning various asset classes.
Additionally, Tradeweb operates in a heavily consolidating industry. Exchanges are motivated to combine liquidity pools and eliminate overlapping fixed costs. The most relevant examples in recent history are the 2013 acquisition of eSpeed by Nasdaq, the 2018 acquisition of NEX Exchange by CME Group, and the 2018 acquisition of Bondpoint by ICE. These are all electronic fixed income trading platforms similar to Tradeweb.
As mentioned earlier, Refinitiv still owns a controlling stake in Tradeweb. Refinitiv is currently in the process of being sold to London Stock Exchange Group, making London Stock Exchange the new controlling stakeholder in Tradeweb. It is reasonable scenario that the London Stock Exchange, makes a bid for Tradeweb given Refinitiv already offers complimentary systems for trading equities and FX. This would also give London Stock Exchange, a market operator in its own right, an excellent foray into the fixed income markets.
Alternatively, a MarketAxess – Tradeweb combination seems plausible given the similarity between the two companies.
The principal risk to Tradeweb is competition. Competition could put pressure on its capture rate, (the effective “commission” the company makes for facilitating trades. Its most natural threat is MarketAxess who provides a very similar offering. Tradeweb also competes with CME’s NEX and Nasdaq’s eSpeed in the rates business, and ICE’s BondPoint in the credit business. These competitors could drop their transaction fees in an attempt to steal market shares away from Tradeweb. I believe this risk is mitigated given Tradeweb’s blend of fixed and variable fees. This fee structure provides economies of scale for larger participants on the platform who easily exceed the minimum activity threshold.
Unforeseen slowdowns in market activity, regulatory changes, or a systematic rotation out of high multiple stocks could also hurt the company and/or its share price.
Despite the risks, Tradeweb offers a few elements of safety. The company has no debt, offers ~40% EBITDA margins, and is cash generative. The company is also soon to have the backing of the London Stock Exchange by way of its acquisition of Refinitiv.
Tradeweb is a secular growth story. It is driving change in an industry ripe for disruption. It was the first to apply technology towards fixing the market structure issues of the fixed income space, and it is continuing to do so today. The antiquated methods of trading fixed income will eventually die, and electronification will take over. Tradeweb will be one of the beneficiaries of this. The platform offers innovative features that are allowing it to accelerate its market share gains. It also has an interesting call option on foreign participation in the Chinese bond market. The company is more attractively priced than MarketAxess, and I believe it could emerge as a potential takeout target. Tradeweb is a great pick for any investor with a tolerance for high growth names.
Disclosure: I am/we are long TW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am also long MKTX