At the same time, we expect higher volume for metals contracts and newly launched contracts going forward. We also look for revenue leverage in 2021 as the company maintains strong cost controls. We expect the acquisition of London-based NEX Group, which closed in November 2018, to generate significant cost synergies in CME’s derivatives clearing business as well as on its FX and cash execution platforms. In all, management has estimated synergies of $200 million by 2021. We note that CME has typically exceeded projected synergies in prior acquisitions.
The beta on the shares is a low 0.33.
Adjusted 3Q EPS included a net $0.25. During the quarter, the company launched several new contracts. The company launched options on its Micro E-mini S&P 500 and Micro E-mini Nasdaq-100 futures contracts. It also announced plans for a new futures contract on the Nasdaq Veles California Water Index, set to launch late in 4Q20. The company also introduced new tools providing clients with better trading information. The new tools are the FX Options Volatility Converter tool, launched on September 9, and the TreasuryWatch Tool, launched on October 6.
Third-quarter revenue fell to $1.08 billion, down 15% from the prior-year quarter. Average contract volume fell 23%, with decreases in interest rate, foreign exchange, and energy contracts. Interest rate average daily volume (ADV) fell 51% to 5.3 million contracts. Equity index ADV rose 38% to 5.4 million contracts. Energy ADV fell 25% to 1.9 million contracts. Metals ADV rose 0.5% to 825,000 contracts. Agricultural ADV rose 4% to 1.4 million contracts and Foreign exchange fell 3% to 829,000 contracts. The average rate per contract rose to $0.716 from $0.693. Expenses fell 6% to $555.7 million. Amid the COVID-19 pandemic, the company took several steps earlier this year to maintain safe operations. It closed trading floors, transitioned clients to electronic trading, and allowed most employees to work remotely. In August, CME reopened its Eurodollar Options pit with limited access.
EARNINGS & GROWTH ANALYSIS
Revenue growth for CME is mainly driven by increases in average daily contract volume (ADV), a measure of the average number of contracts traded and/or cleared in a day, and by growth in the rate per contract (RPC), the average transaction and clearing fee generated from a contract. Average contract volume fell 23% in 3Q, with decreases in interest rate, foreign exchange, and energy contracts. Despite the declines in these segments, we believe that the revenue growth outlook remains healthy for most CME products, including recently added contracts. With the addition of new products, we look for revenue growth of 10% in 2021. CME expects to generate $50 million in run-rate synergies from the NEX acquisition by the end of 2020. The company has maintained strong control over compensation costs, which have totaled 18%-20% of revenue in recent quarters.
FINANCIAL STRENGTH & DIVIDEND
In 3Q, it paid out $304 million in dividends. CME has a strong record of increasing its payout. Since implementing its variable dividend policy in 2012, the company has returned $14.1 billion to shareholders in the form of dividends. The payout ratio on projected 2020 earnings is 48%. The company also occasionally pays an annual special dividend based on operating results, potential merger and acquisition activity, and other forms of capital return, including regular dividends and share buybacks. It paid a $2.50 per share special dividend in January 2020.
MANAGEMENT & RISKS
Terry Duffy became chairman and CEO at the end of 2016. Mr. Duffy had been president of CME Group since 2012. Bryan Durkin, previously chief commercial officer, currently serves as president. John Pietrowicz has been the CFO since 2015. Management’s growth strategy focuses on new product development, new customer acquisition, and global expansion. In our view, management has done a good job of launching new products that respond to regulatory changes. It also provides helpful financial guidance to the investment community. Price competition is a key risk for CME. Key exchange competitors include Intercontinental Exchange, Hong Kong Exchanges and Clearing, and the Eurex Group. The company’s clearing operations also face increasingly stiff competition due to the implementation of Dodd-Frank. Many exchanges, such as ICE, have their own clearing houses. Other clearing houses include Depository Trust & Clearing Corp. New regulations and regulatory uncertainty also pose risks for CME. As well as by overseas regulators. Other risks include market weakness in Europe, cyber security threats, and legal and counterparty risks.
CME Group is a futures and derivatives exchange and clearing company. In addition, CME offers a range of market data and information services.
The recurring annual special dividend adds to the total potential return.