Opportunity in adversity?
Multiple concerns have weighed on the stock…
MCX’s stock price has corrected by a significant ~25% year-to-date (YTD) owing to a number of factors. These include:
* Lackluster volumes in Options since its launch in October 2017
* Universal licenses becoming effective in October 2018, allowing for entry of competition and, thus, putting MCX’s market share under threat
* Recent media articles citing CBI investigations into wrong-doings by erstwhile Forward Markets Commission (FMC) officials in granting MCX a nationwide commodity derivatives exchange status, as well as relaxation of rules for promoter shareholding before the company’s IPO in 2012
…but much of these appear overdone
SEBI’s latest regulation – a positive from competitive intensity perspective
* In its 26th March 2018 circular, the Securities and Exchange Board of India (SEBI) has stipulated requirements for liquidity enhancement schemes (LES) for commodity derivatives. It cites that “If any commodity derivative product is 'liquid' on any of the exchanges i.e. there is at least one exchange where the average daily turnover in Options or/and Futures on similar underlying commodity is more than or equal to INR2b for agricultural and agri-processed commodity, and INR10b for non-agricultural commodity during the last six months, then no other exchange is eligible to launch LES on the same derivative product, unless the exchange where the product is liquid, has itself also launched a LES on said product” (access the circular here).
* It further stated that “Exchanges shall put in place a mechanism to ensure that the LES does not create artificial volumes, does not take away liquidity form the market, is not manipulative in nature and shall not lead to misspelling of the product in the market.”
* This limits the probability of prospective competitors like the BSE and the NSE going aggressive on the transaction charges. However, as we have cited in the past, of the total trading cost (including brokerage) of ~INR240 per million of underlying (both sides), ~INR45 accrues to the exchange, while the remainder is composed of brokerage, CTT, GST and stamp duty.
Recent CBI investigations may not have significant bearing on MCX
Media articles on 23rd March 2018 cited that the CBI’s raids at locations including MCX, erstwhile parent 63 Moons (FTIL) and former FMC officials were in connection to the following:
* Alleged irregularities in granting recognition to the MCX as a national commodity exchange, which happened 15 years ago.
* Clearance given by the FMC to MCX for an initial public offer (IPO) in 2012, allegedly against certain regulations. MCX sought temporary exemptions from some norms to float an IPO in 2012, which were granted by the FMC, according to media articles.
* Regulator’s drive in sync with our positive thesis: Our positive thesis on MCX stems from the belief that it is a platform on its transformation journey, from catering largely to speculative interests of a small set of participants to a deeper ecosystem that eventually acts as a platform for hedgers across commodities. The SEBI’s recent announcements have been in sync with the overall agenda of attracting hedgers on the commodity derivatives platform. We expect FY19 volumes to exit at INR300b+/day from FY17 levels of INR235b, driving earnings CAGR of 30% during this period. Our price target of INR1,300 discounts FY19E earnings by 30x. Maintain Buy.
* Options criteria currently protect MCX’s turf: MCX’s monopolistic hold in nonagricultural commodities was strengthened by the criteria for an exchange to launch options – INR10b + average daily turnover for a year in the commodity of interest. We believe this criterion protects MCX’s turf amid the likelihood of competition being allowed in the commodities derivatives segment.
* Any policy relaxation for new exchanges is a potential risk: It is natural that the new exchanges will seek relaxation on this criterion, and any change to the prevailing regulation is a risk. It will further the competition's agenda to undercut MCX's prevailing charges, thereby eliciting a response from the leader with requisite aggression. Even if it holds on to its leading market share, the interim financial performance will take a dent. Our price target of INR1,050 discounts FY20E earnings by 30x. Maintain Buy.
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