Seven of BSE Ltd’s top 10 shareholders are selling large chunks of their stake in the exchange’s initial public offering (IPO). Three of them, including Singapore Exchange (SGX), are selling their entire holding, while the remaining are selling 40-50% of their holding.
According to reports, they are likely to receive the same price they paid for the shares, or about Rs400 per share. But the rupee has depreciated sharply against the dollar since the time some of them bought these shares, resulting in huge losses. For instance, on 2 September, one of the publicly listed funds managed by Caldwell Investment Management Ltd valued its BSE investment at a 39% discount to its purchase cost (bit.ly/2cSsCv7 ).
The fact that so many prominent investors are rushing for the exit door, and that too with negative returns, is clearly a bad advertisement for the BSE IPO. But that doesn’t necessarily mean that new investors will be put off entirely. Patrick Young, executive director at DV Advisors, says, “The selling by SGX and Caldwell, a long-term investor, may not be a great advertisement; but (it) isn’t a deal killer either. The move to go public will be very productive for Indian exchanges; it will improve efficiency significantly, and there would be a number of investors who want to latch on to that opportunity.” Young advises institutional investors on investments in exchanges and other aspects of market infrastructure.
It’s also important to note that while SGX will sell its entire stake in the IPO, Deutsche Boerse AG has decided to retain its entire stake. It’s the latter that has a much closer association with BSE, and it would have been a far bigger concern if Deutsche Boerse was selling shares. It not only has a seat on the Indian exchange’s board, but has also provided BSE its trading architecture, making it the fastest exchange in this part of the world.
Of course, it’s pertinent here to ask why Deutsche Boerse hasn’t yet exercised its option of increasing its stake to the newly permitted 15% level.
But the European exchange clearly has a lot on its plate, trying to manoeuvre a merger with London Stock Exchange Group amid growing opposition to the deal. Note also that large Indian institutions such as State Bank of India and Life Corporation of India are not selling shares in the IPO, expecting higher returns at a later stage.
Hirander Misra, co-founder and chief executive officer of London-based Global Markets Exchange Group, says the high barrier to entry in the Indian exchange space makes BSE a fairly attractive investment. The entry barriers have resulted in an effective duopoly in the cash equities business. Exchanges are typically seen as a good proxy for a play on an economy. As Caldwell wrote in a note to prospective investors, “The best way to participate in the growth of a nation is to own a piece of its stock exchange, because the best and most profitable commercial ideas eventually become publicly listed companies.”
Also, the fact that regional exchanges are now defunct has meant that BSE’s revenues from listing fees have grown at an impressive pace. They now account for the lion’s share of all operating revenue and income, and are about 2.5 times the amount BSE earns from transaction fees.
National Stock Exchange of India Ltd (NSE), as a strategy, chases transaction fees, leaving BSE to milk the listing fees cash cow. And the latter’s track record in capturing share in the mainstay cash equities and equity derivatives businesses has been abysmal. In equity derivatives, BSE has all but given up trying to gain share, having discontinued its incentive schemes for market makers in the segment.
As such, investors are likely to view it as a value play, rather than a growth play. In the past three years, BSE’s profit before tax and exceptional items has declined by 15%.
It may be foolhardy, then, to expect very high valuation multiples. As it is, the reported IPO price of Rs400 per share discounts FY16 earnings by around 26.8 times and annualized June quarter earnings by 21.7 times. Note that since cash forms a large part of BSE’s balance sheet, its return on net worth worked out to just 5% in FY16 on a consolidated basis.
Another reason investors may put a cap on valuation multiples is the fact that NSE too is likely to issue shares in an IPO, close on the heels of BSE’s IPO. With an 86% market share in cash equities and nearly 100% share in equity derivatives, investors will naturally prefer buying NSE shares.
What may support BSE’s valuations, on the other hand, is a steady stream of revenues, a high cash balance which again earns steady treasury income, and the growth potential of relatively new ventures such as currency derivatives and an international exchange planned at Gujarat International Finance Tec-City.
But all told, much depends on the state of the primary markets when BSE eventually receives the regulator’s go-ahead for the IPO. And if the Securities and Exchange Board of India takes an unduly long time for vetting the IPO proposal, which blunts its first mover advantage vis-a-vis NSE, it could materially affect BSE’s valuation prospects.