How To Value The Bombay Stock Exchange?
India has seen a host of distinct businesses go public in 2015-16. What makes them unique is the lack of listed peers, be it insurance firms, manufacturers of enzymes or diagnostic service providers. Valuing such business models, however, can be a challenge with no clear benchmarks to go by.
The Bombay Stock Exchange Ltd. (BSE), which has filed a draft prospectus for an initial public offering and may become the first national stock exchange to go public, could face a similar issue.
So how should a potential investor value an exchange?
Investors in stock exchanges and analysts both agree that the price-to-earnings (PE) multiple, a commonly used metric to value businesses, is the most relevant for stock exchanges too. The PE ratio is the price one pays for a share compared to the profit or earnings generated by that company per share.
Global Stock Exchanges And Their PEs
According to Bloomberg data, listed exchanges in developed markets, like the London Stock Exchange Group Plc, the Intercontinental Exchange Inc or the Deutsche Boerse AG trade at a one-year forward PE multiple of between 15 to 20 times.
Sohil Chand, Managing Director at Norwest Venture Partners, India and an investor in the National Stock Exchange of India Ltd. (NSE) says that a fairer comparison for an Indian stock exchange would be with those operating in emerging markets. The range here is wider with the most expensive exchange being the Hong Kong Stock Exchanges & Clearing Ltd. (HKEX), which is trading at a PE ratio of 40 times, while the cheapest is the Moscow Exchange MICEX-RTS, which trades at 11 times.
The closest comparable to India would be to look at other developing countries. The market people typically look at is Hong Kong and the reason for that is that HKEX is a proxy for China and as a large developing economy it is similarly sized to India. So you could look at HKEX’s trading multiples here.Sohil Chand, Managing Director, Norwest Venture Partners India
So where will BSE figure in the list?
Typically, the forward price-to-earnings ratio factors in the growth prospects, inherent strengths, profitability margins and the dividends a company pays. As such, to determine an appropriate valuation for the BSE, let’s consider the following:
- Revenue streams
- Financial performance over the past few years
BSE’s Revenue Streams
The BSE differs from other stock exchanges in contribution from income streams
The sources of revenue for the BSE remain the same as other stock exchanges but contribution from various segments differs substantially from its peers. The BSE gets less than 9 percent of its revenues from transaction charges as compared to 50 percent for the NSE, 45 percent for HKEX and over 50 percent for the Singapore Exchange (SGX). The low turnover in the BSE’s equity derivatives segment is partly responsible for this.
More than a fifth of BSE’s income comes from listing fees which accounts for less than 10 percent in income for the NSE, HKEX and SGX.
Patrick L Young, a consultant to financial market intermediaries and CEO of HanzaTrade, says that the BSE has an advantage of being the home to more listings than any of its regional peers and this means strong and steady annuity income. He adds that there should be no dearth of new listings in India given the growth trajectory of the country.
Depository income contributes another 20 percent to BSE’s revenues. The proportion of this segment is less than 7 percent for its peers.
Income from investments contributes nearly 30 percent to BSE’s revenues. This is similar to NSE, which gets 32 percent of its revenue from this category, but much higher than HKEX which earns 5 percent from investments and SGX which gets 11 percent from investments.
Higher Treasury Income = Lower Margins For The BSE
The break-up of BSE’s revenue hurts the exchange’s margins.
BSE’s earnings before interest, taxes, depreciation and amortisation margin has fallen to below 50 percent over the last five years whereas the NSE and the HKEX have been able to maintain their margins above 70 percent. This is partly because BSE has a higher amount of revenue coming from investments where returns are much lower. The NSE’s income from treasury operation is just as high but a higher contribution of transaction charges helps them push up their EBITDA margin.
The BSE is getting a great deal of its income from investments and that part of the income is great for the balancesheet but it is not something the investors are going to capitalize on with a huge multiple.Patrick L Young, CEO, HanzaTrade And Publisher, Exchange Invest
BSE’s Financial Performance
BSE’s financial performance has lagged its peers over the last 4 years
The BSE posted revenues of Rs 658 crore in financial year 2015-16, with a compounded annual growth rate (CAGR) of only 3.3 percent over the last four years. The exchange posted a net profit of Rs 122 crore but this has fallen at a compounded annual rate of 8.2 percent over the past four years.
Hypothesis On BSE’s IPO Price
The BSE’s financial performance and revenue streams are less impressive than some of its peers like NSE or HKEX. Also, the fact that some existing investors are looking to fully or partly exit through the offer for sale may unnerve potential buyers. This could mean that BSE will begin trading at a price to earnings discount to its listed peers.
Given that HKEX trades at 40 times its PE multiple, let’s assume three scenarios to arrive at BSE’s IPO price per share. Under these scenarios, the BSE would trade at 20 times, 25 times and 30 times PE respectively.
Within the above band, the BSE’s market capitalization would be among the smallest in the world.
What Can The BSE Do To Shore Up Its Valuation?
The BSE has much ground to cover in terms of its equity derivatives turnover if it hopes to match the NSE which is dominant in this segment. The exchange may also need to be more aggressive in its fight for market share in currency derivatives. An increased contribution from both these areas will bring down the proportion of revenue received from investments, which, in turn, could improve return ratios for the BSE.
Young adds that exchanges like NYSE, NASDAQ and the LSE are highly branded and sell their services like a country club membership. The BSE will need to work on its core branding in order to grow both revenue and the flow of listings, which should eventually push up its valuations.