Cboe Global Markets, Inc. (CBOE) — Investment Memo
🐂 The Bull Case (Warren’s voice)
Why the moat is durable and compounds
- Cboe owns a legal monopoly on the world’s most important derivatives: SPX options and VIX futures. No rival can replicate these contracts — S&P licenses them exclusively to Cboe. This is a government-protected toll road, not a competitive toll road.
- Network effects are self-reinforcing. Every additional trader tightens spreads, deepens liquidity, and makes it impossible for an upstart to match the execution quality. The cost to switch for a large bank is multi‑million‑dollar retesting of algorithms and risk systems — they’re locked in.
- The business is capital‑light and cash‑rich: $1.7B FCF in 2025 vs. only $0.2B capex. That’s a 85%+ FCF conversion rate. Every incremental dollar of volume drops almost straight to the bottom line.
What makes the economics exceptional
- Data Vantage is the hidden gem: recurring, high‑margin, no rebate drag. It already contributes ~15% of revenue and is growing faster than transaction fees. This is the “subscription revenue” that Buffett loves — sticky, predictable, and pricing‑powerful.
- ROE of 21.4% is genuine. Not a buyback trick — equity has grown 6× since 2016. Each dollar reinvested earns roughly the same return. The business is compounding, not spinning.
- Operating leverage is visible: net margins expanded from 15% (post-BATS) to 23.3% in 2025. As volumes grow, fixed costs don’t — the incremental margin is >60%.
At what price does this become attractive?
- The DCF estimate of $575.56 per share assumes 15% FCF growth (below the historical 23% CAGR) and a 10% discount rate. Even if growth slows to 10%, intrinsic value is ~$430.
- A 25% margin of safety entry is $431 — still a 15% premium to the DCF’s terminal math if you’re conservative. A 50% margin of safety (Buffett’s ideal) is $288 — but that would require a market panic.
- At the current price of roughly $210 (2025 average), Cboe trades at a 63% discount to intrinsic value. That’s a fat pitch for a business with a 20‑year moat.
🐻 The Bear Case (Charlie inverts)
Scenario 1: The regulatory kill shot (most likely, 5–10 years)
- The SEC forces S&P to license SPX and VIX index contracts to all exchanges. Cboe loses exclusivity. Volume migrates to the lowest‑cost venue — spreads compress, market share drops. The network effect evaporates.
- Impact: 40–50% of transaction revenue disappears. Data Vantage survives but shrinks as volume leaves. Net income could fall to $500M–$600M. At a 20× trough multiple, equity value drops to $10B–$12B — a 70%+ decline from today.
- Probability: Low but real. The SEC has pushed for market structure reform before. If it happens, Cboe becomes a commodity exchange.
Scenario 2: Customer concentration and internalization (3–7 years)
- One customer already accounts for 14% of transaction revenue. That’s ~$400M of revenue. If that customer (likely a large market maker like Citadel or a bank) builds an internal crossing network or gets acquired, Cboe loses that revenue.
- Impact: A permanent 8–10% revenue hole. Because the customer’s volume also provides liquidity, spreads widen, driving away other traders. The network effect spirals down.
- Probability: Moderate. Large customers have every incentive to bypass the toll road. Cboe’s moat is strong, but not impregnable against a single massive defection.
Scenario 3: Digital asset disruption (10+ years)
- Decentralized exchanges (DEXes) or blockchain‑based derivatives markets grow to handle options and futures trustlessly. If regulatory clarity emerges for on‑chain SPX‑like products, Cboe’s monopoly is bypassed without needing SEC approval.
- Impact: Long‑term erosion of options volume. Hard to quantify, but the threat is structural: code replaces trusted intermediaries.
- Probability: Low over the next decade, but rising. Cboe’s own crypto push is a hedge — but it also validates the threat.
Structural threats, not recessions
- A recession would temporarily dent volumes, but Cboe would bounce back (as it did in 2020). The permanent threats are regulatory unwinding of exclusivity, customer defection, and technological disintermediation. The first is the one that keeps me awake.
💰 Valuation & Margin of Safety
- Intrinsic value estimate (DCF): $575.56 per share (15% FCF growth, 10% discount rate, 3% terminal).
- 25% margin of safety entry: $431 (conservative buyer)
- 50% margin of safety entry: $288 (Buffett’s ideal fat pitch)
- Is it currently cheap? At ~$210 (2025 market price), it trades at a 63% discount to intrinsic value. That’s deep value territory for a high‑quality compounder.
Caveat: The DCF assumes 15% growth. If growth slows to 10%, intrinsic value drops to ~$430. Even at that conservative estimate, the current price offers a 51% margin of safety. The only bear case that justifies a lower price is a permanent impairment — which we assess as unlikely within 10 years.
Verdict: BUY
The current price of $210 offers a 63% discount to a conservative DCF valuation, with a moat that survives 20 years unless Washington tears down the gate. Cboe is a toll road on the world’s most essential financial traffic — and we’re being paid to wait for the compounder to deliver.