This is the story of an ancient king, a lost crown & hidden treasure.
Poetry aside, this is about:
- The world’s fastest stock exchange with execution speed of 6 microseconds
- The oldest stock exchange in Asia
- Lists the highest number of companies in the world
More importantly, a past hero who lost to a newcomer (NSE) in the last 20 years.
BSE limited (formerly, the Bombay Stock Exchange) was formed on July 9th, 1875. It was the first stock exchange in Asia. As of Jan 2021, BSE is the largest exchange by number of listed companies (5500+ companies). It is India’s first & world’s 9th largest exchange by market capitalization $2.2 Trillion as of Jan 2021.
*Click to enlarge
How do they make money?
The company operates in three businesses:
The Listing business (Primary market):
Issuance of new securities like IPO, FPO, Private placement, SME platform & Fixed Income securities. Every company has to pay a listing fees & maintenance fees for the exchanges. This segment is not very dependent on market cycles.
The Market business (Secondary market):
Transaction fees from Equity cash, Equity derivatives, Currency derivatives, Commodity derivatives, BSE StAR mutual fund platform, Bond market, ICCL, India International exchange, BSE Ebix Insurance borking etc. This segment is highly dependent on the market cycles.
Data Services:
Data products to market participants, data vendors & media companies. These are made available to subscribers in real-time as and when the information is made available to BSE.
Equity Cash:
Average daily turnover of Equity cash segment is currently at 3,703 Cr which had grown at a 5Y CAGR of 4.3%. NSE dominates this business with 93% share of this segment.
BSE had earned 67.8 Cr (11.1% of total revenue) in the form of transaction fees in FY20. For H1FY21 it is at 42.3 Cr.
Currency Derivatives:
Average daily turnover is at 1,9211 Cr, growing at 26% CAGR in the last 5Y. It contributes 6.8 Cr which is 1% of total revenue.
Commodity Derivatives:
BSE is the second largest commodity derivatives exchange in India (after MCX). It commands a market share of 31% in Gold contracts. It has an average daily turnover of 3,074.4 Cr.
StAR MF Platform – The Crown Jewel
In 2009, BSE had launched a web-based mutual fund order placement & settlement system called BSE StAR. Through BSE StAR, mutual fund intermediaries are able to take applications & redemptions in open-ended schemes. This platform over a period of time had grown to:
- 41 registered AMCs
- 10,479 Mutual fund schemes
- 4.42 Cr registered investors
- 69,037 distributors across 675 cities & towns
The daily orders processed had grown at a CAGR of 101% in the last 5Y and is currently at 32,904 Cr. The average value of orders had grown at 50% in the last 5Y and is currently at 1088.5 Cr.
STAR MF platform has a market share of 79%. They charge Rs. 5/- per transaction. This platform currently generates ~45 Cr of revenue with a net profit margin of 35%.
The company is looking to unlock the value in StAR MF platform & appointed ICICI Securities for the potential stake sale.
How do they make more money?
BSE derives most of its value from its Investments, Subsidiaries & Joint ventures.
- It holds 20% stake in CDSL
- 90% stake in India INX exchange
- 100% stake in Indian Clearing Corporation Limited (ICCL)
- 40% stake in BSE Ebix Insurance broking
Cream of the crop – CDSL
For over 15 years, NSDL was the leader in the depository space. Things started to change in 2018-19 when CDSL overtook NSDL to become the largest depository.
*Snippet from CDSL investors presentation
CDSL commands 58% market share with more than 3 Cr demat accounts compared to 2.1 Cr for NSDL. It earns its revenues from annual maintenance & fee per transaction.
BSE has been continuously reducing the stake in CDSL. In 2017 BSE sold 26% stake via IPO & recently offloaded another 4% to current holding of 20%.
The key driver for growth of both NSDL & CDSL has been the backing of stock exchanges & the broker community.
Also biggest advantage for both NDSL & CDSL is the entry barrier in a duopoly environment. This would ensure no cut throat competition that could lead to losses.
Since its listing in 2017, CDSL company has been a steady compounder. It holds ~615 Cr in Cash & cash equivalents. Just like BSE, the return ratios looks weak because of high cash components on balance sheet.
India International Exchange
India INX is a subsidiary (90.1%) of BSE Limited. It is India’s first international exchange located at the GIFT City & commenced its operations on Jan 16, 2017.
First things first, What is an International Exchange?
- It provides direct access for foreign entities without any base in India.
- Access to multiple asset derivatives like Equity & Index F&O, Commodity, Currency, Euro bonds, Masala bonds etc.
- Unlike domestic markets, FPIs can trade in commodities in an International exchange.
- Raise funds from Global markets in any foreign currency. Recent MTN issuers include Yes bank ($1B), NTPC ($6B), NHAI ($3.4B), EXIM Bank ($10B).
- Markets open for 22 hrs per day.
- All trades are cleared & guaranteed by ICCL (subsidiary of BSE)
- No currency risk. No capital gain tax. No Dividend distribution tax, 10Y Income tax holiday.
However things are still at nascent stage for India INX. Even though the trading volumes & liquidity is increasing, the exchange is yet to turn profitable. The cumulative turnover crossed $ 1.62 Trillion as on December 31, 2020. The investments in INX exchange are continuing.
The company is not able to charge for the services on INX because of the anti competitive practices of NSE which is providing their services for free. Management has informed SEBI about this practices & awaiting their response.
In Aug 2020, ICICI Bank had increased its stake to 9.9% valuing the exchange at 200 Cr.
Indian Clearing Corporation (ICCL)
Incorporated in 2007, ICCL is a wholly owned subsidiary of BSE Limited. The market share of clearing corporations largely mirrors the market share of parents BSE (ICCL) & NSE (NSCCL).
In 2019, SEBI introduced Interoperability of clearing corporations. It allows one clearing corporation to execute and settle trades of any other exchange. Market participants can choose any clearing house to settle their trades, irrespective of the exchange where the trades are executed.
Unlike INX exchange, ICCL is profitable with strong financials. As of now, BSE doesn’t have any plans to divest ICCL.
BSE Ebix Insurance Broking
BSE Ebix is a JV between BSE Limited (40%) & Ebix Fincorp Exchange Pte Ltd (60%). It was launched in 2020 with Auto & Health insurance services. They haven’t yet launched Term and Endowments.
Still insignificant in the sheme of things. They have collected a total premium of ~2.2 Cr as of Dec 2020. BSE had invested a sum of 14 Cr in this venture till date.
Robust Technical Systems
BSE hasn’t yet had a technical glitch disrupting trading. NSE has two instances in the last 4 years including the outage on 24th Feb, 2021. MCX had one in 2017.
BSE spends 24.1% of revenues on Technology & IT Services while NSE spends 4.9%. To put the numbers in perspective, BSE spent 130 Cr for its size compared to 194 Cr for NSE.
Are we betting on the lost crown?
No. We don’t expect BSE to get back its market leadership.
We are looking at BSE as a combination of both Value & Growth.
SOTP approach gives us a 5600 Cr valuation for BSE.
- We have valued BSE core business at 30 times CFO.
- StAR MF was only valued at 450 Cr (expected valuation is much higher)
- 50% holding company discount for CDSL
- We are not even considering other businesses & subsidiaries
Growth Triggers:
- Volumes going up in Debt markets. BSE is the market leader in Bond market with a market share of 59%.
- Smart order routing enables the brokers to systematically choose the execution destination based on factors like price, costs & speed. Any small % shift from NSE with 94% marker share can be a huge booster to BSE with 6% market share in Equity cash segment.
- Strong growth in StAR MF platform & monetisation of it.
- Growth in turnover in India International Exchange.
- Commodities Derivatives segment where BSE has a market share of 41% & growing.
Capitalmind Checklist
Can BSE stand the competitive intensity from NSE?
The exchange business is a duopoly & will remain so for the foreseeable future. BSE is a market leader in Bond Segment. It is giving good competition to NSE in Currency & Commodity derivatives. However there hasn’t been much success in Equity derivatives.
BSE is strategically focusing on niche segments to capture market share from NSE.
Pass
Is the company financially healthy?
Yes. As discussed above, they have Cash & Investments of 1603 Cr. It generates FCF of ~60 to 70 Cr every year. Return ratios were depressed because of high cash levels. It is a low capex & high margin business. 38% of revenues are recurring & not linked to market.
Pass
Is the management sketchy?
No.
BSE is a professionally managed company. LIC is the largest share holder with 5.6% followed by SBI (2.39%), Zerodha (1.9%) etc. The management is focused on its line of business and has not ventured into unrelated areas. BSE was viewed as a problem earlier, when the Exchange president Anand Rathi once got rapped by SEBI for having asked the BSE surveillance department for position status of a few institutions, when Rathi could have benefited from the information for his company. This has since changed with management that is not allowed to be from the brokers themselves. Management compensation is below the ceiling of 10%.
Is the stock cheap?
The stock is currently trading at 21 times PE (TTM) with a Dividend yield of 2.85%. At this valuation we are paying very little for growth. We believe it has potential to surprise us on the upside.
Pass
What are the key triggers over the next 3-5 years?
- Inter operability & Smart order routing to increase liquidity on BSE. Introduction of weekly options by BSE.
- Monetisation of StAR MF platform.
- BSE got the approval to launch Power exchange in JV with PTC & ICICI Bank.
- Growth in Bond market in India. BSE is the market leader in Bond market with a market share of 59%. Approx 3L Cr debt was raised through BSE Bond platform in 9MFY21.
Pass
Can we hold the stock for the next 10 years? what would make us change our opinion on this stock?
As of now the company is taking right steps in right direction. As long as they are on the right track, holding the stock over long period shouldn’t be a problem.
We would change our opinion if the below events occur
- Misallocation of cash
- Diversifying into unrelated businesses
- Couldn’t able to scale its platform businesses
- Losing its market share in niche segments like Bonds, Currency & commodity derivatives segments.
Pass
Overall,
we believe BSE is available at an attractive valuation with reasonable growth triggers. The company continue to distribute its cash via dividends & buy backs. In 2019, they did a buy back at 680/- per share. We expect the company to clock 650 to 680 Cr sales & a PAT of ~160 Cr by FY23. This is driven by both standalone performance & stake sale in its subsidiaries. Without any PE rerating at 22 times, we would expect a market cap of 3500 Cr. This coupled with a Dividend Yield of 2.85% provides a decent return from current market price.
NOTE: As a disclosure, some Capitalmind authors & the company may be invested in the mentioned stock in their portfolios. Please do not consider this article as a recommendation, It is for informational purposes only. Stocks discussed might be part of Capitalmind Premium portfolios.
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