Deutsche BöRse Stock: European Exchange Leader With Room To Run

European exchange group Deutsche Börse (OTCPK:DBOEF) has long been a personal favorite for its dominance across most touchpoints of the region’s capital markets. Specifically, the group leads on derivatives (Eurex), commodities (EEX), and equities exchange (Xetra), as well as post-trade clearing (Clearstream), among others. The only real drawback in prior years has been its cyclical income streams, which tend to ebb and flow in line with broader capital activity. Management is looking to change this, though, most recently outlining a path to rebalancing from cyclical to secular over time. While not quite there yet, there has been progress, with a string of acquisitions, most recently for Danish software company SimCorp, being a case in point.

The slight catch is the valuation of Deutsche Börse stock, which has also re-rated quite sharply in recent months. Much of the market optimism is likely due to an ECB/Fed rate pivot and its impact on capital markets, though, rather than the market underwriting the mid-term plan. Minus the rate tailwind, it’s worth noting that the stock was flat to down for most of last year; thus, the market likely still isn’t convinced of the mid-term strategy nor of the accretion potential from pricey acquisitions like SimCorp. Q4 wasn’t ideal either, as below-consensus revenue and EBITDA guidance numbers for 2024 confirmed that the path to unlocking synergies won’t be a straightforward one.

Still, low expectations, both on M&A synergies and on net interest income, are good in that it keeps valuations reasonable. At a high-teens forward earnings multiple (~21x trailing) for a quality exchange capable of through-cycle growth and returns well above its cost of capital, I’d argue Deutsche Börse still offers a very decent risk/reward here.

Top Line Growth Leans on Rates; Below Par Guidance Rebases Expectations

Given management had only just outlined its mid-term outlook in November, the status quo Q4 result came as no surprise. To recap, net revenues for the quarter came in at +23% YoY, though this was mostly due to inorganic contribution from SimCorp at +18%. The organic portion, at +5%, on the other hand, was about evenly split between secular growth from its key businesses and higher net interest income (the result of higher rates). The dependence on rate-sensitive income is a concern, given the European interest rate cycle is poised to reverse; this means revenues will be bumping up against an unfavorable base going forward. Similarly, the lack of contribution from Russia now that Clearstream has exited adds to the challenging YoY comparison in the coming months.

The good news is that management has also guided expectations lower post-Q4. For 2024, revenue guidance has been set below consensus at >EUR5.6bn (albeit still up from YoY), reflecting the fading interest rate tailwind. As for the mid-term, the +4% cyclical growth target leans on net interest income declining to EUR0.5bn based on a rather conservative mid-term rate assumption of ~3% and 2.25% for the US and EU, respectively. In sum, a low bar. On the secular growth side (+5% through 2026), ongoing efforts to build a bigger recurring revenue base will be the needle mover. Assuming no execution mishaps here, the 9% ex-M&A revenue growth target (i.e., +5% secular and +4% cyclical) should be well within reach, in my view.

M&A One-Offs Cloud Operating Profitability

The expense side was also up, though, like revenues, was mainly impacted by ~EUR42m of one-off costs from M&A consolidation. On an organic basis and even after including higher compensation, costs were well contained at +1% YoY in Q4 (+5% YoY for the full year). While profitability was in line, EBITDA guidance for the full year at >EUR3.2bn, while also up YoY, fell short of consensus expectations.

Like on the revenue side, I view the EBITDA guidance delta as adding buffer for more one-offs – not only from SimCorp integration but also from the buildout of Investment Management Solutions, a key segmental driver of management’s mid-term outlook. In addition to keeping post-M&A costs low while management extracts its targeted synergies, EBITDA guidance upside will also hinge on a 5% organic cost growth guidance, which seems very doable in light of the Q4 performance.

Capital Allocation Focus Shifts to Consolidation

Given the scale of M&A integration work at hand, the focus on extracting synergies over more acquisitions is good news. Recall from the recent ‘Horizon 2026’ event that management’s chief area of focus for now is on building out its Investment Management Solutions segment, which houses new ‘secular growth’ engines like software (SimCorp and Axioma), along with its data assets (ISS and Stoxx). In effect, there won’t be any further M&A, most likely until early next year.

Making M&A work won’t be straightforward. Note that the company has rightly come under scrutiny for the price paid for its acquisitions, particularly SimCorp, which has seen fairly sizeable one-off expenses but little benefit. Recent stock price rally notwithstanding, the market has also reacted with skepticism to the M&A news, so good execution will be key to convincing investors. To be clear, this won’t be an easy feat, as it isn’t just the usual cost synergies that need to be extracted; making SimCorp work will also hinge on revenues, where upselling to Deutsche Börse’s broader Asia and US client base is the focus.

Beyond M&A integration, de-levering the balance sheet could yield some P&L upside as well. Not so much from interest expense savings, as getting net debt/EBITDA back to the targeted 2.25x should be straightforward given the cash generative nature of the core business. Instead, I would keep a close eye on how much excess cash goes into buybacks and the resulting impact on earnings per share (via a shrinking share count). Note that Deutsche Börse is already well on track to completing its current buyback authorization (already at ~40%), so assuming no big M&A, an upsized program is likely on the cards soon.

European Exchange Leader with Room to Run

Deutsche Börse didn’t end Q4 on a particularly strong note fundamentally, as guidance numbers fell short of consensus expectations. But progress on the mid-term has more than made up for this, and the market, it would seem, is increasingly willing to look through the speedbumps. Going forward, all eyes will be on the buildout of the new Investment Management Solutions segment, as well as the integration of SimCorp, an acquisition that does add a recurring revenue base but will need lots of synergies to justify its valuation. In any case, the stock is priced below historical levels and well below key peer London Stock Exchange plc (OTCPK:LNSTY) on earnings, so there’s still room for the stock to grind higher.

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