Summary

• ICE conducts business through 3 reportable business segments: Exchanges, Fixed Income and Data Services, and Mortgage Technology.
• In September 2020, ICE completed the ~$11B transformational acquisition of Ellie Mae whose digital lending platform provides technology services to participants in the mortgage supply chain.
• ICE has historically generated very strong Free Cash Flow and this trend can be expected to continue.
• ICE will be spinning off Bakkt in the first half of FY2021 and ICE has made other opportunistic investments which it expects to unlock in the future to create additional shareholder value.
• Shares currently appear to be very slightly overvalued. As Treasury rates start to rise we may experience a broad market pullback which could provide investors with a better valuation than at present.

Introduction

In this August 21, 2020 article I disclosed that I had initiated a 300 share position in Intercontinental Exchange, Inc. (ICE) @ ~$103.60 in an account for which I do not disclose details; this FactSheet provides a very high level overview of the company.

I initiated my position shortly after ICE announced that it had entered into a definitive agreement to acquire EllieMae from Thoma Bravo for $11B; the August 6^th investor presentation can be accessed here.

Although this meant ICE would be taking on significant debt I viewed the acquisition of Ellie Mae as a strategic transformative acquisition that would greatly enhance shareholder value over the long-term. Looking at ICE’s track record of generating significant positive Free Cash Flow (FCF) I was also of the opinion that management would not waiver from ensuring that positive FCF would remain a key priority.

On February 4, ICE released its Q4 and FY2020 results and provided FY2021 guidance so I now take this opportunity to revisit ICE to determine whether I should acquire additional shares.

Business Overview

ICE operates regulated exchanges, clearing houses, and listings venues for commodity, financial, fixed income, and equity markets in the United States, the United Kingdom, the European Union, Singapore, Israel, and Canada. It operates through its Exchanges, Fixed Income and Data Services, and Mortgage Technology segments.

A comprehensive overview of ICE can be found commencing on page 6 of 173 in the 2020 10-K and on the company’s website. You can learn about the company’s history here.

On January 11, 2021 ICE announced that that Bakkt Holdings, LLC, the transformative digital asset marketplace launched in 2018 by ICE in collaboration with Microsoft and Starbucks, had entered into a definitive agreement to combine with VPC Impact Acquisition Holdings (VIH), a special purpose acquisition company (SPAC) sponsored by Victory Park Capital.

The transaction values Bakkt at an enterprise value of approximately $2.1B, of which ICE will retain a 65% economic interest and a minority voting interest in the combined company.

The decision to merge Bakkt was threefold.

• the combination is expected to provide significant incremental capital, enabling Bakkt to maximize its future growth potential;
• by listing as a public company on the NYSE, Bakkt will benefit from elevated consumer brand recognition;
• the transaction is expected to unlock value for ICE shareholders.

Completion of the business combination is expected to occur in Q2 2021. Details can be found here.

ICE has made investments in a number of businesses, such as Bakkt, that are adjacent to it where management thought there was some strategic advantage by having a relationship with the company, either by partnering with them or by knowledge transfer.

One such investment was in Coinbase in its early rounds because ICE was trying to understand the blockchain and the significance of digital currencies in payments. That company has been phenomenally successful and management is of the opinion the value of its stake in Coinbase has increased.

ICE also made an investment in Euroclear which is a European custody solution. That company is also performing well.

The value in these interesting assets may be unlocked in the future to enhance ICE shareholder value as those partnerships and knowledge transfers come to some fruition.

ICE’s results and accompanying Earnings Presentation of February 4, 2021 can be accessed here.

FY2020 was another successful year with 2020 marking ICE’s 15th consecutive year of record adjusted EPS, a track record of growth that began with the company’s IPO on the NYSE in 2005.

On the earnings call with analysts, management indicated 2021 adjusted operating expenses will be $2.83B - $2.88B with the spinout of Bakkt expected to reduce expenses versus FY2020 by $50 million. Roughly $20 million of additional Depreciation and Amortization expense in the Mortgage segment is projected and the plan is to invest $25 - $30 million to enhance ICE’s Mortgage Technology platforms to support the significant growth in customers and volumes evidenced over the past few years and which is expected to continue.

FY2021 compensation expense across ICE is expected to increase $40 - $50 million with expenses tied to revenue growth expected to increase $15 - $25 million, and FX, based on current spot rates, adding $10 - $15 million. These expenses, however, are expected to be more than offset by a positive impact to revenues.

In Q1, expected adjusted operating expenses will likely be in the $0.72B - $0.73B range which includes ~$23 million related to Bakkt.

Credit Ratings

It would appear that many investors in our current environment are taking positions in companies without giving much consideration to the degree of risk they are assuming. I am not prepared to assume an inordinate level of risk and this is why I like to look at how the major credit ratings agencies view a company’s debt.

I also take into consideration that as a common share equity investor I am last in the pecking order if a company defaults and needs to be liquidated or restructured. This is why I am highly reluctant to invest in any company whose unsecured long-term debt is non-investment grade.

In the case of ICE I was not surprised to see a downgrade in its credit rating given the amount of debt it intended to raise to fund the EllieMae acquisition.

Moody’s now rates ICE’s unsecured long-term debt A3 (down from A2). This is the lowest tier of the upper medium grade and this rating defines an obligor as having a STRONG capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

S&P Global has assigned a BBB+ rating which is one notch lower than that assigned by Moody’s. This is the top tier of the lower medium grade and this rating defines an obligor as having an ADEQUATE capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

Both ratings are investment grade and are satisfactory for my purposes.

Free Cash Flow (FCF)

I view FCF as a critical metric when analyzing a company because this represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.

Looking at ICE’s earnings presentations we see that ICE provides the amount of FCF generated but I like to double check the numbers for myself.

I typically calculate FCF by looking at the Consolidated Statements of Cash Flows (page 98 of 173 in the FY2020 10-K) and taking the net cash provided by operating activities and deducting the capital expenditures and capitalized software development costs. In the case of ICE we also need to deduct Section 31 fees payable. These fees are a nominal Securities Exchange Commission fee attached to the sale of exchange-listed equities, above and beyond any associated brokerage commissions, which may ultimately be absorbed by investors. This fee is defined in Section 31 of the Securities Exchange Act of 1934 and is often referred to as the Section 31 Transaction Fee.

Naturally this fee will not apply to companies in other industries but it is a fee ICE must incur to operate much like the necessary capital expenditures it must incur annually to remain in business; these amounts have historically been negligible in the grand scheme of things.

In FY2016 – FY2020 ICE generated FCF of $1.77B, $1.73B, $2.286B, $2.32B, and $2.402B.

Dividend, Dividend Yield, and Share Repurchases

As noted in my previous ICE article, the Stock Information section within the Investor Resources segment of ICE’s website does not include historical dividend and stock split information. I, therefore, draw your attention to this external site where you will find ICE’s dividend history; the quarterly $0.85/share to $0.17/share drop in late 2016 is because ICE had a 5 for 1 stock split in the form of a stock dividend. Shareholders of record as of Oct 27, 2016 received on November 3, 2016 an additional 4 shares for each share held and shares began trading on a split-adjusted basis on Nov 4, 2016.

We see from the dividend history that ICE has recently increased its quarterly dividend to $0.33/share from $0.30/share (a 10% increase). The annual dividend yield on the basis of the current ~$110.30 share price is ~1.2%.

When the Ellie Mae acquisition was announced management indicated share buybacks would be suspended until leverage fell below 3.25 times; this is anticipated to occur at some stage in the second half of 2022.

Q1 201 guidance calls for Weighted Average Shares Outstanding of 562 - 568 million shares, an increase from 555 in FY2020.

Valuation

When I acquired shares in August 2020, the low/high and mean adjusted earnings estimates for FY2020 were $4.28 - $.4.81 and $4.40. I erred on the side of caution and used $4.30 with the $103.60 share price to give me a forward adjusted PE of ~24.

We now have FY2020 results in which ICE reported adjusted diluted EPS of $4.51. Using the current $110.31 share price we get an adjusted diluted PE of ~24.5.

Current adjusted diluted EPS FY2021 guidance from 17 brokers is $4.69 - $5.09 and a mean of $4.92. Using the current share price of $110.31 we get a forward adjusted diluted PE range of ~21.7 - ~23.5 and a mean of ~22.4. This level is slightly better than when I initiated my position. These, however, are adjusted results

If we look at GAAP diluted EPS we see that ICE reported FY2020 diluted EPS of $3.77. Using the current $110.31 share price we get a diluted PE of ~29.26. It is somewhat difficult to compare these valuations with 2011 – 2019 diluted PE levels of 18.52, 16.46, 29.52, 66.86, 24.11, 23.09, 25.66, 17, and 25.15 because following the Ellie Mae acquisition, the ICE of the present and future is very different from the past.

Looking at ICE using the P/FCF metric for the 2016 – 2020 timeframe, I took the annual FCF and divided same by the weighted average number of diluted shares outstanding. The results of this exercise gave me FCF per share for 2016 – 2020 of $2.95, $2.91, $3.95, $4.11, and $4.33.

I then took the average monthly share price for every month during this period so as to arrive at an average share price for the year. The average share price for 2016 – 2020 was $49.54, $61.31, $82.18, $84.46, and $96.48.

The third step of this exercise was to divide these average share prices by the FCF/share. My P/FCF results were 16.76, 21.05, 18.20, 20.57, and 22.29.

On the basis of the P/FCF metric I think ICE is just a shade above the level at which I would like to acquire additional shares. I would like to see a share price of $100 or lower which is based on FCF per share of ~$4.50 and a P/FCF of ~20.

Final Thoughts

As much as I like ICE and intend to add to my position I think the broad market is ripe for a correction if Treasury rates continue to tick up.

I am prepared to wait on the sidelines on the expectation that ICE’s share price could very realistically pullback in the not too distant future. I wish to add to my ICE position but, naturally, doing so will be dependent upon what other opportunities exist if/when ICE becomes more attractively valued.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Thanks for reading!

Author bio: I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 33 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.

I disclose our holdings which are held in the FFJ Portfolio and the dividend income generated from these holdings but for confidentiality reasons do not disclose details of holdings held in various tax advantaged accounts. 

Disclaimer: I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article. I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long ICE.