Why optimism should be tempered

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Even as BSE’s initial public offering of shares breaks records and brings cheer, a critical question remains: How long will the party last? No clear answers, but ordinary financials of exchange firms listed abroad put sustainability in doubt. 

Today, the parent company of one of the oldest stock exchanges in the world faces merger with London Stock Exchange Group. Frankfurt Stock Exchange's Deutsche Börse AG has seen its net profits dwindle year after year since 2010; revenue growth has been flat. Three years ago, London Stock Exchange Group was weak, too, until aggressive product launching and tech push - steps needed to combat lacklustre trade volumes - kicked in. But Nasdaq Inc, which owns the Nasdaq exchange in the United States, hasn't seen the same success with new products. Its revenues have grown just over one per cent since 2010, while net profit, if not for investment income, would have grown lower than seven per cent over this period. Hong Kong Stock Exchange and Clearing Limited, which owns the Hang Seng Index of China, has at least performed better than its peers in the West. While its revenues over FY10-15 have increased 12 per cent, its net profit has increased only 8.6 per cent in this period. As a result, its market capitalisation grew only eight per cent in the past five years, indicating not much reward for investors. 

Interestingly, stocks of a few exchange companies saw a good spell in the early part of 2016, despite poor financials. "Large institutional houses across the world pumped in money into these stocks as other opportunities within the financial space dried up. But, this money is unlikely to last long, given the unpredictable nature of their business and the risk associated to them. These stocks haven't done much in the past, and I doubt they would in the future as well," a chief executive of a foreign brokerage said. Aswath Damodaran, professor of finance at New York University Stern School of Business, offers an interesting take on these businesses: "Having a physical space and inviting thousands of people to trade there is a 17th century proposition. I'm surprised why people would invest in stocks of physical exchanges anymore."

All the cheers for the listing of India's BSE (formerly Bombay Stock Exchange) and National Stock Exchange (NSE) need review against this backdrop. Trade volumes don't show healthy growth for both. And BSE's less than three per cent CAGR (compound annual growth rate) in revenue over FY12-16, as well as 6.7 per cent decline in net profit over the period, don't come as a surprise either. NSE, too, hasn't been great, with revenues increasing just 5.6 per cent CAGR and net profit growing 1.8 per cent over this period. Both these exchange companies have largely benefitted from revenues of their depository businesses: Central Depository Services Limited, owned by BSE, and National Securities Depository Limited of NSE. Central Depository Services Limited is gearing up for public issuance, which may reduce investment income support for BSE. National Stock Exchange runs the same risk. Investment incomes, after all, can help the exchange company meet operating expenses and even make up for declining income from core operations. Business from mainstay (trading and listing of shares) has grown only two per cent at BSE and six per cent at NSE since FY12. While both celebrate newer streams of revenue such as data solutions, mutual fund distribution, and corporate services, the core business shows weakness. Nonetheless, home-bred status and overall positive sentiment may assure good listing gains for BSE and NSE, but looking at past and peer performances, sustainability of these gains will remain in question. 


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