ICE

Intercontinental Exchange Inc.

97.91
USD
1.27%
97.91
USD
1.27%
90.05 139.79
52 weeks
52 weeks

Mkt Cap 55.14B

Shares Out 563.16M

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Why Intercontinental Exchange Is A Dividend Growth 'Must-Own'

Summary Intercontinental Exchange is down 30% year-to-date as a result of market panic, mortgage weakness, and the announced deal to buy Black Knight. ICE has a stellar balance sheet, very high free cash flow, and a big benefit from the Black Knight deal given its current business model. While buybacks have been paused, I have zero doubt that ICE will provide its investors with strong, double-digit dividend growth and accelerating buybacks. It's hard to call for a bottom, but the current valuation of ICE stock is causing me to turn bullish. Mr. Market - he's kind of a drunken psycho. Some days he gets very enthused, some days he gets very depressed. And when he gets really enthused, you sell to him, and if he gets depressed you buy from him. There's no moral taint attached to that. - Warren Buffett Introduction On April 24, I wrote an article titled "Intercontinental Exchange: Where Dividend Investors Go For Outperformance". Intercontinental Exchange, Inc. (NYSE:ICE) has become one of my favorite dividend growth stocks in the finance sector together with Chicago-based CME Group (CME), which I recently added to my portfolio. Multiple followers asked me to write an update on ICE and they're completely right. A lot has happened since that article as the stock is down roughly 16% since then. Year-to-date ICE is down 30%, which is ridiculous. In this article, I'm not just going to write an update, I decided to cover the stock again for investors who are new to the stock. I will explain why I'm incredibly excited that the stock continued its decline as we're at a point where investors are just panic selling while the S&P 500 is close to a bear market with even more weakness in the tech space. The announced acquisition of Black Knight (BKI) adds to uncertainty as it reduces repurchases for the time being. Yet, I think ICE made a smart move and I'm even more convinced that the stock is an attractive dividend growth stock at current prices. So, let's dive into it! Market Weakness & My Personal Approach Before I discuss ICE, let me quickly comment on the market and my recent investment. Right now, the S&P 500 is down roughly 16%. Technically, that's 4 points away from a technical bear market. While I'm still outperforming the market by a mile this year due to a lack of "growth" exposure, I've witnessed some cracks as certain stocks started to take a beating in recent weeks. What we're dealing with here is a market environment of fear. A 16% downturn is the third-worst sell-off since 2012. In 2016, markets were spooked by a global manufacturing and basic materials recession. In 2018 markets briefly sold off due to economic growth slowing. In 2020, a novel virus caused growth to implode. Now, it's a mix of economic weakness caused by high inflation and supply chain issues, geopolitical tensions in Russia and China (new lockdowns), and a Federal Reserve that's hiking into economic weakness. These are reasons for investors to de-risk their portfolios while some are just panic selling. Because the Fed is actively draining liquidity from the system, we're dealing with a scenario that's generally speaking "bad" for markets. The graph below was part of a newsletter my friend and macro expert Nick Glinsman published earlier this month (my apologies for the small letters, but the explanation in the graph is what matters): With that said, my philosophy is simple. When it comes to my dividend growth portfolio (as seen below), I change absolutely nothing. Zero. Nada. Bear in mind that this portfolio consists of 95% of my net worth, so it's a serious endeavor. The reason I spend so much time talking about my own portfolio is that the way I pick stocks is key. Both for me and readers (obviously). When I buy a stock, I know that bad times will occur that cause temporary stock price declines. Hence, I only ever add stocks to this portfolio that I believe will withstand severe economic headwinds. As a result, I haven't lost a single second of sleep. Yes, ICE declining 16% after I make the case that it's a good dividend stock isn't great as we all like to nail the bottom. Yet I think it's not a bad thing as ICE remains in a good spot as I will tell you in this article and because we can now average down (or initiate a position even cheaper in case you want a piece of this company). I have been talking about breaking up investments for weeks now, and it's exactly what I've been doing. I bought CME Group at $221.35 recently. It continued to dip. Hence, I bought more at $201.20. I know have roughly 70% of a "normal" position invested. I will add in the weeks ahead or buy a full ICE position depending on my personal cash flows. So, now that you know a bit about the market and my view on things, let's dive into Intercontinental Exchange. ICE Stands For Quality Dividend Growth Over the past few weeks, I had long discussions about both ICE and its peer CME. It's fair to say that I like both. Both are financial powerhouses making money when people trade their futures, options, and related and both have recurring revenue services. The main difference from an investor's point of view is that CME distributes almost all of its free cash flow using regular and special dividends while ICE is a more aggressive company when it comes to acquisitions. CME also has a higher yield (excluding special dividends). ICE is currently yielding 1.6% based on a $0.38 quarterly dividend and a $97 stock price. The most recent hike was announced on February 3, when the company hiked by 15.2%. ICE paid its first dividend in 2013. Since then, the dividend has increased from $0.13 to $1.52 (as of 2022). The 5-year average annual compounding dividend growth rate is 19.0% according to Seeking Alpha data. Below, I'm listing the most "recent" dividend hikes: February 2022: 15.0% October 2021: 10.0% February 2021: 10.0% February 2020: 9.1% February 2019: 14.6% February 2018: 20.0% Generally speaking, the company distributes most of its free cash flow via dividends and buybacks. Note that free cash flow is operating cash flow minus capital expenditures. It's cash a company can spend on distributions and related without having to worry that it spends cash it needs for other purposes - unless a high debt load needs to be prioritized. This is what the historic breakdown of distributions looks like (dividends & buybacks). As you probably noticed, 2021 repurchases were lower. That's because the company tends to engage in big acquisitions. In 2020, the company bought Ellie Mae to add mortgage services to its portfolio. The graph below shows cash spent on acquisitions. And speaking of acquisitions, we now need to discuss the announced Black Knight acquisition. On May 5, the company announced its intention to buy Black Knight in a cash and stock transaction, valuing the company at $85 per share, or a market value of $13.1 billion (equity). Right off the bat, I wasn't surprised that the company engaged in a big acquisition. Even without acquisitions, the company is set to do $3.5 billion in free cash flow next year. That's 6.5% of the company's current $54.0 billion market cap. It provides opportunities to maintain very high dividend growth and to buy new companies. In my prior article, I wrote that the company was about to lower its net debt to $11.8 billion in 2023. That's barely 2.3x expected EBITDA. In other words, its financial basis was fantastic to buy new growth. The graph below shows the company's many acquisitions and the leverage ratio, which displays how carefully the company conducts these deals with regard to financial stability. In this case, the company offered to buy Black Knight for $13.1 billion with an enterprise value of $16 billion - in other words, the deal comes with roughly $3.0 billion in net debt that will be added to the ICE balance sheet (that technically increases the deal value). The transaction breakdown is 80% cash and 20% equity. 20% equity will consist of shares ICE issues to Black Knight shareholders. The company bought Black Knight at a 15x 2022 adjusted EBITDA valuation (EV/EBITDA). ICE will have to "find" $10.5 billion to get the deal done. This will consist of $8.0 billion in new debt consisting of commercial paper, a term loan, and bonds. The company has $2.5 billion cash on hand. It will increase the company's own leverage to 4.1x gross debt to adjusted EBITDA at transaction close in the first half of 2023 (pending regulatory and BKI shareholder approval). As a result, ICE will work on reducing gross leverage to 3x EBITDA by the end of 2024. The company will "temporarily suspend share repurchases" until gross leverage is below 3.25x EBITDA. The dividend will NOT be impacted as the company "expects to continue to pay and grow the current quarterly dividend of $0.38/sh". Needless to say, I cannot say what will happen to dividend growth. I assume it will be reduced to the lower double-digit range, which is still OK. Especially because we're now dealing with a 1.6% yield after the stock price decline. With that said, why did ICE buy BKI? It's a move to enhance two things: mortgage-related revenue and recurring revenue. BKI is a software-focused company with products that realize efficiencies, reduce risk, and achieve greater levels of success within the US mortgage and real estate markets. The company offers mortgage loan servicing software for approximately 36 million active first and second lien mortgage loans. ICE calls it highly visible and predictable revenues with strong operating margins. As a matter of fact, the company did $681 million in adjusted EBITDA in 2021 (46% margin). In 2016, these numbers were $443 million and 43%. That's a CAGR of 7.4%. By adding these services to its own business, ICE creates a service capable of way more services that increases its total addressable market from $10 billion to $14 billion. The overview below shows where and how Black Knight and existing ICE services operate in the long mortgage process. Moreover, as I already briefly mentioned, it increases recurring revenue. Currently, roughly half of mortgage technology revenues are recurring. That number is set to rise to 70%. It will also increase the share of recurring revenue to 55% of total ICE revenues. Currently, that number is at 48%. After the deal closes, the combined company will generate 30% of its money from mortgage technology. 22% from fixed income and data services, and 48% from exchanges. 45% of total revenue will come from transactions. ICE is down 30% year-to-date. As I already briefly mentioned, it's a mix of investors de-risking their portfolios, overreacting traders, and some fundamental weaknesses. In 1Q22, ICE benefited from high volatility. The company saw 11% higher sales in its exchange segment with strong growth in energy, financials, and OTC products. Even listings were up 13%. In fixed income, the company saw 9% higher revenue due to strong clearing services and a 6.2% growth rate in annual subscription value. Recurring revenue was up 6%. Mortgages, the one segment the company wants to grow did very poorly. Sales in this segment fell by 13% due to rising mortgage rates and falling demand. The average 30-year mortgage rate in the US is now at 5.3%, the highest level since the Great Financial Crisis and up from the lows below 3.0% last year. This is doing a number on affordability as prices are still sky-high, forcing people to delay home purchases. Given that my ICE thesis is a long-term thesis, I'm not worried about this. If anything, it's one of these events that provide us with an attractive entry or opportunity to average down as bad news is being priced in. If we consider ICE as a standalone company, we're dealing with a $54 billion market cap. If the company does $3.5 billion in free cash flow next year, it would imply a 6.5% free cash flow yield, which is ridiculously high, in my opinion. It means investors are getting access to a lot of free cash flow at current prices (undervalued). In 2019, the company traded at a 5.4%ish free cash flow yield, which is already rather high. The current EV/EBITDA multiple is also far from overvalued. Using the $54 billion market cap, $11.4 billion in 2023 expected net debt (pre-acquisition), $200 million in pension-related liabilities, and a mere $36 million in minority interest gives us an enterprise value of $65.6 billion. That's roughly 12.9x 2023 expected (pre-acquisition) 2023 EBITDA. Combining the companies, we're dealing with a combined enterprise value of $81.6 billion, which consists of ICE's $65.6 billion EV and the $16 billion EV ICE is paying for Black Knight. ICE gives BKI a fully synergized EBITDA estimate of $1.06 billion. This is based on an adjusted EBITDA guidance estimate of $786 to $803 million in addition to synergies the company expects to generate. ICE is looking to do $5.1 billion in EBITDA next year, which I am going to use to price in growth on the side of ICE. This gives us a combined EV/EBITDA valuation multiple of 13.2x. Is it deep value? No. However, it's a great price to initiate a position or to add to an existing one. The risk/reward is so good that I'm going to change my rating from neutral to bullish. Yet, it does not mean that this is the lowest point. We could see more weakness as irrational markets are hard to time. So, please be careful and only buy this stock if you want to make it a part of your long-term dividend portfolio. I wouldn't recommend trading this stock. It's far better used as an investment "tool". Takeaway In this article, I not only updated my long-term ICE investment thesis but explained to new readers why I am such a big fan of the company. I believe that the Black Knight deal will bring tremendous long-term value on top of its existing business. While the current sell-off isn't fun, I think it's a great opportunity to either initiate a new position or to add to an existing position. ICE has very high free cash flow, its transaction business is providing growth while mortgages struggle, and ICE bought BKI at a reasonable price. Long-term, I believe that investors will benefit from strong, double-digit dividend growth, buybacks after deleveraging, and outperforming capital gains. The only reason why I don't own ICE is that I bought CME first. I like both companies and I'm considering buying ICE as well next month depending on my personal cash flows (hard to predict sometimes). So, long story short, this sell-off isn't fun but ICE is a high-quality company that will bounce back. The valuation is good and buying dividend growth at a great price doesn't happen without these selloffs. If you buy, make sure to break up your initial investment. I.e., buy 25% now and add gradually over time. That way one can average down if the bottom isn't in while having a foot in the door when the stock starts to rise. (Dis)agree? Let me know in the comments! Disclosure: I/we have a beneficial long position in the shares of CME either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation. 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