Indian Exchanges - The Final Countdown! (Part I)

[Allies Fin Serve]

A near US$500trn – 10x world’s GDP – is the turnover on global exchanges today! Intrinsically an annuity business, sticky ‘liquidity’ renders the industry quasi-monopolistic where ‘winner takes all’. High operating leverage with EBITDA margins of 60-80% as also limited capital needs, albeit a one-time heavy investment, imply strong cash flows. The nascent Indian exchange landscape is finally evolving from ‘only equity’ into an inclusive blend of asset classes (commodities, forex, power, etc) with underlying physicals warranting a 2.5x growth in industry turnover to US$10trn by FY14. Now demutualized and electronized entities, the compelling business model is bound to translate scale into profitability. With exchanges inherently commanding high strategic valuations (CBOT acquired at 55x earnings; NSE valued at $2.3bn), logical for their risk-free model, we believe it’s time for ‘value creation’ on Indian exchanges. We are BULLISH. Financial Technologies, the only listed player in the space and Asia’s largest exchange conglomerate, is our BIG bet.

Business model…flawless: Revenue sustainability (20% CAGR in global volumes for two decades), high operating leverage (60-80% EBITDA margin) and strong cash flows make exchanges a near-perfect business. With liquidity, the key success factor for an exchange, difficult to ‘poach’, entry barriers in the industry are well defined and lend further resilience to the annuity model.

Indian exchanges – on a high: Indian exchanges (US$4trn turnover), synonymous to equity markets, are finally coming of age. Inclusion of varied asset classes – commodities, currencies, power, etc – is set to impart scale and depth to the industry. Based on underlying physicals, industry turnover is expected to reach US$10trn by FY14, primarily spear-headed by the nascent but high-potential commodity exchanges (4x from US$1tr currently).

Time for value unlock: Having undergone a swift evolution, the demutualized and electronic entities have overcome structural inefficiencies. Catching the eye of global players, the big-ticket sector has garnered high strategic valuations (NSE valued at US$2.3bn, MCX at $1.1bn and BSE at $0.8bn), which is now set to convert into market capitalization. We are bullish. In the listed space, our big bet is Financial Technologies. We recommend Outperformer with a price target of Rs2,000 – a 40% upside from the CMP.

Indian exchanges industry potential

Turnover (US$ bn))	FY09	Size by FY14E	5-year CAGR (%)	Basis of estimates
Commodity	1,050	4,184	32	50% discount to global multiple of futures to underlying physical market
Equity	3,042	5,256	12	25% discount to global average for Value traded to GDP
Currency	240	960	32	50% discount to global average of OTC:Exchange derivative markets
Total	4,332	10,400	19

 SoTP Valuation of Financial Technologies

Entity	Basis of	Resulting entity	FTIL	Resultant value
	valuation	value (Rs bn)	stake (%)	for FT (Rs bn)
FT Core Business	15x FY11 earnings	23.9	100	23.9
MCX	25x FY11 earnings	45.4	31.2	14.2
NBHC	20x FY11 earnings	8.9	86.2	7.7
MCX-SX	2x strategic valuation	27	53.1	14.3
Invested capital in group cos	2.5x inv cap	24.2	100	24.2
Cash and Other investments	1x investments	7.7	100	7.7
Total				92.2
			Per share value	2,000

Allies Fin Serve
www.AlliesFin.BlogSpot.Com