Punch missing in BSE's IPO

Barely a month since the National Stock Exchange (NSE) filed its prospectus with the markets regulator to get listed, the BSE exchange has launched its initial public offering (IPO) of equity. While BSE’s asking valuation is reasonable, compared to peers, there are some factors that long-term investors need to consider before investing. To begin, its revenue growth has been rather weak at an 11 per cent compounded annual rate over FY14-16. Operating profit margin has been under pressure in the past two financial years. These have led to a fall in its earnings. There is a high correlation of volume of transactions (which are volatile) at the exchange with its revenues, as transaction charges form a meaningful part of these.

So, if stock market sentiments take a knock, it will reflect on the exchange’s fortunes. Importantly, BSE has failed to compete efficiently with NSE in the equity derivatives segment. Analysts at Religare Stock Broking note BSE’s market share in equity trading has been stagnant at 13-14 per cent in the past five years, a concern. These issues give rise to concerns around effective execution by the company.

Additionally, BSE’s depository subsidiary, CDSL, could get listed soon, as the parent has to pare its stake in the latter to 24 per cent, from 50 per cent currently. According to BSE’s prospectus, this will slice away a fifth of BSE’s FY16 revenue and 16 per cent of its earnings. The impact will be compensated, if only in part, by the one-time money flowing into BSE via the CDSL public issue. Also, 29 per cent of its FY16 revenue came from non-core and volatile investment income, which lends further volatility to BSE’s financials. Already, BSE’s net profit has fallen in the previous two years. While increase in listing fees has fuelled its revenue in recent times, similar hikes might not accrue as it goes forward.

Investors should also note the issue comprises purely an Offer for Sale. Hence, none of the IPO proceeds will flow into BSE. Importantly, most of the existing shareholders are likely to book losses (in dollar terms) as they sell their holdings.

Positively, there are long-term triggers. Given the under-penetration of India’s exchanges, there is scope to grow profitably. BSE has recently launched an international exchange at GIFT City near Ahmedabad and is also looking to foray into commodities trading. And, an international clearing corporation at GIFT City. The exchange aspires to launch innovative products, as well as enter into tie-ups with global exchanges. Though these are in the right direction, they will bear fruit only over the coming years. Its distribution business (mutual funds and insurance) is growing at a healthy clip but is too small in size, as of now, to make a material difference. On the whole, right execution and profitable growth of its new venture is a pre-requisite to any improvement in prospects.

From the stock perspective, BSE’s market capitalisation, according to the IPO price, is Rs 4,400 crore. While this is a small fraction of NSE’s reported valuation of Rs 44,500 crore that is due to the latter’s larger size, better financials and market leadership in equity transactions business. Nevertheless, at the upper price band, BSE is valued at 21 times its FY17 annualised earning, much lower than the 25 times commanded by other listed Asian exchanges. Back home, MCX trades at about 40 times the FY17 estimated earnings, though it is not strictly comparable to BSE or NSE. Hence, many experts believe BSE can comfortably deliver decent listing gains.

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