We recommended BSE with a report titled Bombay Stock Exchange (BSE): Strong Growth Ahead on 29Mar2017 at a price of Rs. 945. We reiterate our view of BSE at a current market price of Rs. 910.
The report below brings in the detailed update on BSE’s income profile, its growth possibilities and its subsidiaries. To summarize the same,
- BSE’s operating income is growing consistently led by equity segment volume growth.
- Within its operating income, the fixed nature of operating income already covers a large portion of its total expenses.
- Contrary to the belief of many, the transaction charges income have only a small dependency on exclusive group of shares (XD, XT, SS, etc)
- The cash on hand provides a great margin of safety through consistent investment income for the company.
A) Understanding BSE Income Profile:
1. Revenue Bifurcation: BSE has two major categories of income as shown below –Operating Income and Investment income.
The operating income can further be categorized by its nature of income. The fixed part of operating income is not dependent on market fluctuations whereas the variable part of operating income is mainly dependent on the trading activity at the exchange. As per the estimated annualized FY18 data, BSE will earn nearly 58% (Rs 238 crores) of its operating income (Rs. 408 crores) from income heads that are fixed in nature. This fixed nature of operating income provides a very strong base for BSE’s income.
2. Achieving Breakeven from Operating Income looks quite easy: BSE has a total expense including depreciation of around Rs. 350 crores. For BSE to achieve breakeven without considering any of the investment income, BSE has to earn an operating income of Rs. 350 crores.
In FY18, BSE is expected to earn a total of Rs. 238 crores of fixed operating income that is 68% of the total expenses of BSE. So it only requires another Rs. 112 crores from variable operating income to achieve an break-even. Against this, BSE is expected to clock a variable operating revenue of Rs. 170 crores in FY18, far higher than what is required to achieve breakeven.
Considering the increase in listed companies, over the next 5-7 years, BSE should be able to cover a large part of its costs only from fixed operating income, leaving the variable operating income as well as investment income directly flowing to the profits of the company.
3. Transaction charge Income Not largely dependent on the Equity Exclusive Group:
During H1FY18, Transaction charges (Rs. 67 crores) contributed 33% of total operating income (Rs 204 crores) and 21% of total income (Rs 317 crores). A major portion of these transactional charges comes from the Equity segment. BSE levies the transaction charge at the different rate on different scrips according to their group. Scrips under the group like A, B, M (SME), MT are called non-exclusive groups. Whereas scrips under the group like X, XT, XD, Z, SS, ST fall under the ‘exclusive’ group category. The transactional charges for the same are as follows:
- A & B Group: On per trade basis
- Other Non-Exclusive Group: Rs. 275 per crores
- Exclusive Group: Rs. 10000 per crores
Majority of exclusive group scrips are listed only on BSE but are very thinly traded scrips. Though BSE has not indicated any move to reduce the transaction charge on the exclusive group. However, even in case of any reduction in transaction charge for scrips in exclusive group materializes, it will not impact BSE’s total income due to the lower proportion of transaction charges coming from the exclusive group.
B) BSE Growth Possibilities:
1. Growing income from transaction charges: The growth of BSE is largely dependent upon the growth of its variable income which mainly includes equity transaction charge.
The above table clearly indicates that income from transaction charge is increasing every year as a result of the increase in turnover and dynamic transaction charge tariff. The equity turnover depends on the number of market participants, number of listed companies, its market capitalization and the overall market sentiment. In last 4 years, transaction charge income had grown by 4 times i.e. from Rs. 29 crores to Rs. 117 crores due to increases in all of the above four factors. With the current optimism in the market, there is a strong upward trend in average daily turnover which will eventually help increase the transaction charges. As the market itself is expanding, even if BSE maintains its market share, BSE should see its transaction charges increasing from current levels over next few years.
2. Book Building software charges: BSE offers a book building platform through the Book Building software for IPO, FPO, Rights issue, OFS, Buyback, Takeover and Delisting for which it charges fees.
Income from Book building software charge has been doubled from Rs. 7.4 crores to Rs. 14.3 crores in last 4 years. Even in the first half of the current year, BSE has earned Rs. 13.1 crores. The current and expected buoyancy in the stock market will see increased use book building process by companies coming in IPO, FPO, Rights, OFS, Buyback, takeover and delisting. This should auger well for this category of income.
3. Currency Derivatives Charges: BSE has an active currency derivative segment where it enjoys 46% market share.
Increase in average daily turnover and dynamic transaction charge tariff has resulted into increase in income from currency transaction charges. In H1FY18, BSE has already matched its FY17 full year currency derivatives transaction charges of Rs. 4.5 crores.
4. BSE StAR Mutual Fund: BSE had launched BSE StAR mutual fund platform in 2009 to provide the facility to mutual fund distributor to purchase and redeem mutual fund units on behalf of their clients. BSE StAR mutual fund enjoys 76% of market share. However, so far BSE has not charged any fees for the usage of this platform.
In June 2017, BSE has shown their intention to levy transaction charge at Rs. 10 per transaction on lump sum investment and Rs. 5 on SIP. However, BSE could not implement the same due to opposition from mutual funds association (AMFI). At some point in time, when the volumes of BSE StAR platform increases substantially and irreversible, BSE will start to collect some form of fees for using their platform. The investment culture through SIP is increasing rapidly. Approximately 90000 SIPs are added every month. At this point, this segment is not contributing anything; however, it surely should contribute something in the future.
C) Subsidiaries Updates & Contribution:
1. Subsidiary Updates:
- BSE has partially divested its stake in CDSL on 29Jun17 in order to comply with SEBI direction and guideline. Now, BSE holds 24% in CDSL and is valued at Rs. 878 crores at the current market price of Rs. 350.
- BSE is now focusing on developing its new venture INX (Indian International exchange) situated at gift city. Currently index futures, stock futures and commodity futures are available for trading through this exchange. The average daily turnover is slowly increasing. However, as on date, it is making a loss of Rs. 2 crores per month.
- BSE has entered into MoU with Ebix Inc (Nasdaq listed entity) to develop the insurance distribution platform, just like BSE StAR Mutual fund.
2. Subsidiaries Contribution:
- BSE has 100% holding in ICCL (Clearing Corporation) which generates a decent amount of profits each year.
- CDSL, now an associate company, provides a significant positive contribution to BSE per year.
- However, as discussed above, Indian International exchange (INX) is likely to report loss of Rs. 6 crores per quarter.
We estimate that the net impact from subsidiaries and associates will most likely be nullified and the consolidated profit of the company should be equal to standalone profits.
Valuations: BSE has a large surplus of cash invested into tax-free bonds, FPI, Mutual funds, and in subsidiaries which provides tax-free investment income. This cash surplus provides a significant margin of safety by generating investment income of Rs. 200 crores per year to the company.
In addition, BSE is now able to generate a healthy net operating surplus from business estimated at Rs. 58 crores in FY18.
However, even if we consider breakeven from operating income, investment income of Rs. 200 crores alone will provide an EPS of Rs. 37 per year making BSE an attractive investment option at the current levels.