MCX as the name
suggests is an electronics commodities exchange where users can trade on future
contracts of 49 commodities as present. The main volumes are derived from 4
major commodities – Gold, Silver, Copper and Crude. Deriving technological edge
from the use of trading platforms (primarily ODIN) provided by the promoters –
Financial Technologies, MCX has gained sustained monopoly in commodity trading
in India.
It commanded a
premium 86% market share in commodities (FY12) with more than 2,170 registered
members operating through over 346,000 trading terminals (more than 150k
terminals have been added in the last one year which would mature in terms of
trading volume with a lag), spread over 1,577 cities and towns across India.
MCX is the
exchange with 3rd largest global volumes in commodities in terms of contracts
traded with record highest volumes in Silver, second highest volumes in Gold
and natural gas and third highest in Crude.
It has been
certified to three ISO standards, including ISO 9001:2008 Quality Management
System standard, ISO 14001:2004 Environmental Management System standard, and
ISO 27001:2005 Information Security Management System standard.
Huge growth potential ahead
The Indian market
is at a nascent stage with only 2 million entities trading in commodities as
compared to around 20million in equities. Also global futures commodities
volumes vis-à-vis physical trades are much higher than they are in India. For
example: futures gold volumes are 70-80x that of physical trade v/s 17-18x
times in India
Commodity
exchanges were authorized in India only in April 2003, and the industry is far
from mature. Hence continued demand for underlying commodities in a growing
economy and expansion in the mix of hedgers and speculators will facilitate
continued growth in traded volumes.
The market is at a
relatively nascent stage with Gold, silver, crude oil and copper being the four
largest commodities traded on the Indian exchanges, constituting 70%+ of the
total traded value in FY11 and 80%+ of the total traded value in FY12.
The increase in
physical market volumes consequently increases the hedging requirements for
industry players, influencing derivative trading volumes. Growth in trading
volumes of any commodity on the exchanges has been a function of price
volatility. As long as there is volatility in the prices of a particular
commodity, it will act as a volume growth driver for the exchange.
Though the total
volume, an annual value traded of US$3.7 trillion appears substantial, the
underlying capital invested is not substantial, given the leverage implicit
from use of very low margins in the futures instrument. Currently, the average
daily value traded is ~US$12bn. Assuming a margin requirement of 10%, the
underlying margin money of ~US$1.2bn (Rs 6,300 Cr) is only 0.1% of India’s
deposit base. Hence there are huge opportunities to growth ahead.
Understanding the ‘MCX’ advantage: Entry barrier and Moat
It is important to
understand what forces equip an exchange to gain leadership and sustainability
of that leadership going ahead.
The growth in
industry has been driven mainly by the top 4 commodities (Gold, Silver, Copper
and Crude) which accounted for highest majority of turnover. MCX has created
deep pools of liquidity in these commodities, thereby creating high entry barriers for
new participants.
Furthermore, and
more relevant, is the impact cost (spread between highest bid and lowest offer)
for which MCX has a relative advantage as it can offer a narrower bid-offer
spread than other exchanges can because it offers access to large pools of
liquidity.
From an end-client’s perspective, the benefit derived from a lower exchange fee at other exchanges is negligible when compared with the advantage gained from a better transaction price by trading at MCX.
Note: It is this
deep pool of liquidity that made NSE a lethal force and garner majority
market share from incumbent BSE in equities market.
Leadership in new technologies from parent Financial Technologies
MCX is provided
with technology platform by its parent, Financial Technologies India, who are
one of the leading developers of exchange related software and technology. This
gives MCX a competitive edge that is difficult to replicate.
Exchanges require
constant technology upgrades and support, necessitated by regulatory regime and
market forces. MCX is able to obtain speedy and efficient technology solutions
from FTECH. MCX’s current technology infrastructure is sufficient to handle daily
trading volumes of up to 10 million transactions. So far, it has handled a high
of 1.8 million trades in a day.
MCX will have a
much shorter lead time to introduce newer products like Options, as and when
they are permitted. This market readiness leads MCX much ahead of the
competition.
Operating Leverage
Since a large
portion of MCX’s costs are fixed ones so any upside triggers in volumes and
hence the topline can significantly boost the profitability. The only
significant variable cost in its expenses is the fees paid as a percentage of
transaction revenues towards technical services agreement to its parent Fin
Tech.
Fixed costs are
60-70% of the overall expenditure at MCX hence potential growth in volumes
implies better profitability going forward.
Newer revenue potentials: Data Services
Being the largest
commodity exchange in India MCX is the key source of data on commodity trends.
This provides MCX the opportunity to benefit from market data product and
information offerings, as is the case for various leading exchanges in India
and the rest of the world.
Internationally,
revenues from selling market data products, analytical tools and price-feeds
constitute 5-15% of exchanges’ revenues, on average. As the market for
commodities trading grows, algorithmic trading systems, sophisticated
quantitative approaches to risk management, will create demand for
trading-related data and analytics.
The company currently has such arrangements with the following entities:
- Bloomberg Finance L.P.
- NewsWire 18 Private Limited
- IQN Data Solutions Private Limited
- Reuters India Private Limited
- Interactive Data (Europe) Limited
- TickerPlant Limited
Cash and Investments: Stakes in subsidiaries
MCX’s residual
stake is now 5% in Dubai Gold and Commodities Exchange (DGCX) with a book value
of Rs2.18 Cr and it has a direct equity stake of 5% in MCX-SX plus 634.17
million warrants (each warrant entitles the holder to subscribe for one equity
share of Rs1 each of MCX-SX).
The company has
negative net debt with huge investments in liquid mutual funds. This
contributes to around Rs 170 of cash per share. The holding of 5% in DGCX is
currently valued at 100 Cr+ which is marked at book value of ~2 Cr under
investments. So effectively we have 190
Rs cash sitting on per share.
The new MCX
exchanges are mostly in areas with negligible competition (Bahrain, Botswana,
Mauritius) and replication of the India story can generate good returns.
Shareholding pattern: distributed ownership
The promoters
Financial Technologies (India) Ltd holds 26% as they are stipulated by SEBI
norms to hold max 26%.
Jun-12
|
Mar-12
|
(IPO)7-Mar-12
|
|
Promoters (Fin
Tech)
|
26.00%
|
26.00%
|
26.00%
|
Public
|
74.00%
|
74.00%
|
74.00%
|
FII
|
31.44%
|
33.27%
|
7.81%
|
DII
|
23.54%
|
22.41%
|
26.27%
|
Bodies Corporate
|
8.80%
|
8.89%
|
7.46%
|
Retail
|
10.22%
|
9.43%
|
32.46%
|
What is
significant is that retail has sold off its stake to more long term mature
holders (FIIs and DIIs) who have steadily accumulated. Going forward this will
be a low liquidity thinly traded stock as most investors will simply hold this
for long term.
The major point to
note here is that no individual investor (barring promoters) can hold more than
5% in MCX, which leads to distributed ownership. MCX’s top 10 non promoter
shareholders (as on 30-06-2012)
Sl No.
|
Investor Name
|
%age Stake
|
1
|
Fid Funds (Mauritius)
Ltd
|
5.00%
|
2
|
Passport Capital
LLC
|
4.90%
|
3
|
Merrill Lynch
Holding (Mauritius)
|
4.79%
|
4
|
Aginyx
Enterprices Ltd
|
4.79%
|
5
|
Euronext N V
|
4.79%
|
6
|
IFCI Ltd
|
4.79%
|
7
|
NABARD
|
3.06%
|
8
|
Corporation Bank
|
3.00%
|
9
|
NSE India
|
2.45%
|
10
|
Bennett Coleman
(Times Group)
|
2.24%
|
Major future triggers: FC(R)A bill approval
The Forward
Contracts Regulation Act [FC(R)A] bill if passed can potentially unlock huge
opportunities in terms of
- Introduction of commodity options trading
- Introduction of trading in intangibles (e.g., freight, rainfall and commodity indices) which are not permitted in India at present. Trading in commodity indices, in particular, if allowed, could provide a boost to turnover.
- Allowing participation from banks, mutual funds and institutional investors in the Indian commodity futures market.
Major future triggers: Value unlocking from stake sale in subsidiaries
The second trigger
and value unlocking potentially arises from stake sale in MCX-SX which
currently offers trading in currency futures and options and has been permitted
to start operations in equity future and options by SEBI. The approval is
subject to the condition that the combined voting rights of FTECH and MCX in
MCX-SX will not exceed 5%. This paring down needs to happen within next 18
months.
Earlier, FTECH
held 31% and MCX held 38% in MCX-SX. Then, to comply with SEBI guidelines for
starting equity trading, they reduced their stake in MCX-SX to 5% each through
conversion of excess equity stake (beyond 10%) to warrants. The warrants will
be sold to banks and financial institutions. This stake reduction contributes
to a one-time gain of around Rs 110-120 per share for MCX shareholders.
MCX-SX is expected
to go live in the equities segment by November 2012.It has successfully
launched currency options in the recent past and has a market leadership in
currency futures (market share of ~44% in FY12).
Key risks
Higher regulatory risks due to speculative nature of trades
The commodity
futures exchange industry is highly regulated. The key regulatory body, the
FMC, has in the past prohibited trading in certain commodities.
For example, in
May 2009 it ruled that no new sugar contracts could be launched. Similar
suspensions have taken place for commodities such as wheat and rice.
Recently, the FMC
banned all futures trading in guar and launched an investigation into potential
price manipulation of other farm commodities, as per an article in the Business
Standard dated March 29, 2012. These risks may not have a significant effect on
MCX, in particular, given that trading in agricultural commodities is a
relatively small component of its trading volumes.
However, similar
bans on any of the top traded commodities – Gold, Silver, Crude and Copper may
pose significant risk on volumes and hence revenues.
High proportion of costs incurred towards parent and group companies
Over 40% of MCX’s
operating costs are towards various fees paid to the parent, Financial Technologies
(Fin Tech) and promoter group companies. Its agreement with Fin tech for IT
infrastructure and software services, costs MCX 12.5% of its transaction fees
in addition to a fixed charge of INR12 Cr per annum, constituting a major
portion of operating costs.
What is alarming
is that costs incurred towards Fin Tech have gone up from ~19% of operating
expenses in FY08 to ~47% in FY12. Also, the variable fee was revised upwards to
12.5% of transaction fees in FY11, from 10% in FY11 and will come up for revision
again in October 2012. This overhang of increase in technical services fee (as
a % of transaction fee) could be potential threat to MCX’s profitability.
Significant dependence on a few commodities
The aggregate
value of commodity futures traded at MCX has been concentrated mainly in four
commodities – gold, silver, copper and crude oil. During FY12, over 90% of
volume contribution comes from the top 4 - Gold (27%), Silver (37%), Crude Oil
(16%) and Copper (10%).
During FY12, 94%
of the total traded value has been from these four commodities. Any period of
low volumes in any of these 4 would impact overall volumes adversely.
Revenues tied to
value traded fee and commodity price volatility.
As seen in April
2012, a downward spiral in Gold volumes in physical markets significantly
affected the volumes in gold futures thereby affecting revenues for MCX. Spurt in trading volumes in the recent
past (50% CAGR over FY09-12) was mainly attributed to an increased
volatility and rise in commodity prices coupled with launch of mini futures and a ramp up in
customer base. All these has effectively set a higher base in FY12.
Repeating the earlier success and surpassing it on the higher base of FY12 may prove to be quite challenging.
Repeating the earlier success and surpassing it on the higher base of FY12 may prove to be quite challenging.
Sharp fall in commodity prices : Double Impact
With a lower
volatility in leading commodities and a visible pressure in prices of leading
commodities (gold, silver, crude oil), growth in trading volume may moderate to
low double-digit over FY12-14E.
Trading volumes are highly dependent on volatility in commodity prices, which may be dictated by overall price trend in key commodities across the world. Growth in quantity traded correlates with the increase in volatility. Furthermore, in the case of precious metals, growth in quantity traded also correlates with price rises.
Trading volumes are highly dependent on volatility in commodity prices, which may be dictated by overall price trend in key commodities across the world. Growth in quantity traded correlates with the increase in volatility. Furthermore, in the case of precious metals, growth in quantity traded also correlates with price rises.
Rising prices usually drive higher volatility because a sustained price increase in a commodity
potentially attracts higher participation and hence potentially higher
volatility. Changes in commodity prices have a two-fold impact for MCX: they
influence both the quantity traded and the value traded (as value traded =
quantity traded x value per unit of quantity traded).
As MCX charges a
transaction fee on value traded, as prices fall, quantity traded growth will
also be lower, resulting in a lower turnover and hence lower transaction fees.
The impact of price movements on turnover growth and hence transaction fees is
thus amplified.
Lock-in period for pre-offer shareholdings
MCX completed its
IPO in Feb, 2012. The pre-offer shareholding is subject to a lock-in of one
year from the date of allotment (February 27, 2012) in the offer with the
exception of
- Shareholdings of current employees of the company who were allotted shares pursuant to ESOP schemes
- Venture capital funds/venture capital investors who have held shares for at least one year as on the date of the red herring prospectus (Feb 10, 2012)
- 20% of the promoters’ shareholding which is subject to a three-year lock-in period.
Cannibalization of Future volumes from introduction of Options trading
If Options trading
is introduced with the approval of FC(R)A bill part of options growth could
cannibalize futures trading (similar to what happened at NSE which introduced
equity options trading in June 2001).
Disclosures: No current positions, have invested in the IPO and during subsequent downward spiral. Have booked profits and currently have no open positions in the stock.
Disclosures: No current positions, have invested in the IPO and during subsequent downward spiral. Have booked profits and currently have no open positions in the stock.
