Commodity exchanges around the world exhibit the
following characteristics: Oligopolistic in nature, high operating leverage,
capital light, fatty EBITDA margins and above average ROE. MCX reflects all
these characteristics as well.
How does it make money?
MCX charges 18 INR for every 1 million INR of transactions traded. Therefore
for a round trip it would be INR 36. They have 2 main costs components to their
business which are - Software cost and Employee cost.
Before 2013
Back in 2012-2013, MCX clocked an average daily turnover of 503 Bln or 50,300
crores. At 32 INR round trip transaction fees, the revenues per day was
roughly 16 Mln INR or 1.6 cr a day which translates into around 5.45 bln INR or
545 Cr a year of topline. As mentioned above their main costs are Software cost
and Employee cost. FTIL was and is the software provider to MCX. In 2012-2013
FTIL charged INR 20mln/month as a fixed fee and charged a 12.5% variable fee
based on turnover. If you do the math, then software cost was around 785 Mln
INR or 78.5Cr a year. Employee costs were about 290 Mln or 29 cr a year. After
including other expenses, the EBITDA was roughly 3.152 Bln or 315 crores – 60%
margins which translates into a PAT of 300 Crs a year. Depreciation and
interest costs were miniscule.
Post 2013
The Company went through a rough patch in 2013. First the Commodity
transaction tax (CTT) was imposed in July of 2013, then its promoter FTIL was
deemed unfit and third commodity prices around the world began a downturn. As a
result of all these events, the revenues and profits took a hard knock down by
50%. Average daily turnover currently which was 503 Bln in 2013 is now at
approximately 220 Bln in 2015. PAT has shrunk to 125 Cr a year compared to 300
Cr in 2013.
Despite this triumvirate of bad luck, the company managed to stay above water.
After the FTIL/NSEL scam, the company renegotiated its software contract with
FTIL. Now, FTIl is paid 15 Mln/month plus 10% of trading revenue. This is
payable quarterly after services rendered as opposed to annual contract earlier
which was paid in ADVANCE! The duration of contract is now 10 years vs 99 years
earlier with a clause to exit software contract if they see necessary. This
will reduce software charges to 400-450 Mln INR vs 785 Mln INR for the next 2
years.
Now what from here?
The company has no capex lined up in the foreseeable future and this business will be driven by operating leverage. Incremental increase in daily turnover will flow straight to the bottom line. The key question is how MCX can grow from 200 BLN INR of daily turnover to 500 Bln INR of daily turnover to perhaps 1 trillion INR. There are a few ways:
1. SEBI merger with FMC: Will have a long lasting impact on the revenues of MCX and many analysts are underestimating this. The implications of the merger are significant. Stock exchanges will be able to become universal exchanges wherein equities, debt instruments and currencies and commodities are traded under the same roof. SEBI cannot be biased towards any of these asset classes which means it will allow MCX to launch a Commodity Index and other derivative instruments such as Options which are currently unavailable. The launch of an Index and Options can have a disproportionate impact on volumes and here is the reason why. The top 4 commodities traded on the Exchanges are Crude, Gold, Silver and Copper. Of these 4 commodities 20-40% are Prop Trades, 50-60% is Client Trade and remaining 15-30% are HFT.
Now, with an Index being launched, most Index Arbitrageurs will seek to profit from mispricing and basis differentials between Index and individual commodities. Nifty ‘s Index Arb business was a big business from 2000-2007 and has built fortunes for individuals and prop desks in HK and Singapore. This could be a large revenue booster for MCX. Nifty Futures volume rose massively in the years to come despite competing with SGX in Singapore.
Second more lucrative aspect of the SEBI/FMC merger is the launch of derivative Options.
This could be that game changer as it has been for Nifty Index Options over the last 5 years.
The big player in the Options business could be the HFT traders. HFT Traders would definitely come in to trade the MCX options as Options are cheaper to trade. Currently HFT trading firms (I won’t name them) transact 30-40% of all Nifty’s Option turnover. Trading options also gives rise to increased trading in Futures and Index since these are usually delta neutral trades.
Third, if SEBI allows institutional participation in MCX traded instruments, then the volume growth will be far more than what we can imagine. Statistical Arbitrage Funds will trade MCX commodities against the ones listed on CME or LME or Dubai and other regional markets. These will be arbitrage trades. AIFs registered in India will be able to launch innovate products in this space as well. I don’t think Mutual Funds in India will do much in this space as it won’t fit the bill and they can’t leverage.
2.
Commodity cycle: We are at the bottom of the commodity cycle space. Gold and Crude are at multi year lows and downsides from here are limited. If these commodities rise from here then the average traded value moves up without any effort.
MCX is now in a sweet spot. Margin of safety is there and this stock could deliver handsomely from here. My sense is that the Index can deliver 1 trillion of daily turnover by 2017. That would translate into a turnover of 850-900 crores with PAT of about 450 crores. At CMP that would translate into a fwd P/E of 11x. This stock could be one of those that you could hold for years to come. Expect handsome returns of 35-45% in this year.
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