Value Investors Club / Bolsa Mexicana de Valores (BMV: BOLSAA)

Description

Bolsa Mexicana de Valores (BOLSAA.MX) – compelling long-term compounder

Bolsa Mexicana de Valores (“BMV”), the Mexican Stock Exchange, is trading at a compelling 8% FCF yield with an unlevered balance sheet and tailwinds to continue growing at a double-digit CAGR over the next 5+ years. With 2/3 of revenues coming from high-quality, growing, fee-based businesses, BMV will thrive regardless of market conditions, with a clean balance sheet providing additional optionality for the Company to pursue accretive acquisitions. Moreover, BMV pays out ~75% of FCF as dividends, which todayrepresents an approx. 5% yield.

BMV's stock price has suffered as investors have focused on the Company’s cash equity business and the weak economic/stock market performance in Mexico over the past 5 years. A new competitor, Bolsa Institucional de Valores (“BIVA”), has also emerged in 2018 and stoked fears of potential market share losses. However, the market is both overly focused and mistaken on both these issues.

Instead, investors should be focusing on the high-quality, growing, fee-based businesses “Central Security Depository” and “Information Services & Connectivity” businesses – collectively 48% of 2019 revenue and growing at 15-20% due to BMV’s disintermediation of local custodians and the growing importance of fast data in the investment world. A third fee-based business, “Maintenance and Listing Fees” (17% of revenue), is similarly recurring, though with a growth profile more closely linked to GDP/inflation.

BIVA has no ability to compete with the first two, fast-growing fee-based businesses, and instead since its launch in 2018 has been hoping to make inroads in “Maintenance and Listing” and “Cash Equity Trading” (8% of revenue). And frankly – their progress to date has been underwhelming. While it’s possible that they can turn the ship around, we expect BIVA to be no more than a minor drag on BMV’s growth in those two areas, and to have zero impact on the larger, more promising businesses for BMV.

In our base case scenario, BMV will provide an 84% return over the next 2 years as the recurring revenue streams become the vast majority of revenue/earnings and as BIVA runs out of steam.

High Quality, Growth Businesses

Central Securities Depository (28% of 2019 revenue)

In simple terms, a central securities depository (“CSD”) is responsible for the custody of all securities (both equity and non-government debt) in the market in order to efficiently transfer ownership of securities via book entry during the settlement process. This set-up leads to CSDs becoming natural monopolies in their respective markets, as having multiple databases recording transfer of ownership of a security would be highly inefficient and introduce excess costs into the financial system.

Indeval, Mexico’s CSD, is wholly owned by BMV. The largest piece of revenue is generated by an inflation-linked fee on $25 trillion in assets under custody meaning BMV gets paid a recurring fee every year to simply hold the assets! In addition, there are fees generated every time they settle a trade, pay out dividends to underlying investors, etc.

Indeval has grown at a 20%+ CAGR over the last 3 years, primarily as a result of a change in the global equities business (e.g. Apple listing its stock in Mexico in pesos). Prior to 2017, listing foreign securities on the Mexican exchange was a cumbersome process, as each ETF sponsor nominated its own custodian, meaning Indeval had nine different custodians holding non-Mexican securities listed on the BMV. The complexity of this model resulted in higher post-trade costs, delayed settlement and often failed trades, which would result in a penalty placed on the investor from the Mexican clearinghouse. All of this disincentivized local investors from purchasing these global securities.

In 2017, the Mexican government changed the regulation in order to rationalize the custody chain, making Indeval responsible for both selecting the custodian on global securities, as well as making them the sole sponsor for all issues. As Indeval disintermediated these custodians and sponsors, they were able to reduce transaction fees for the underlying clients by 50%, encouraging more trading, all while capturing those fees at high incremental margins.

Going forward, Indeval will continue to grow through both inflation escalators and as the global equities business extends to new geographies, ETFs and increasingly UCITS funds, but the real opportunity for BMV is to continue to identify ways to disintermediate certain ancillary services offered by third parties by providing international investors direct access to their infrastructure. The largest of these opportunities is the recent upgrade on their messaging platform to AMH by SWIFT, which will enable the company to connect more efficiently with international custodians, in effect bypassing the local custodian. In a playbook that should be relatively similar to what was executed in prior years, disintermediating local custodians should allow Indeval to offer better pricing to end clients, while capturing that entire fee at high incremental margins. In addition, the company is planning to roll out new value-added services related to corporate actions, securities lending, growing electronic bond trading, cash management products, tax services, selling settlement data, etc. that should all provide incremental growth opportunities.

All-in-all, we expect Indeval to grow at a 15-20% CAGR over the next 3 to 5 years given the numerous growth drivers available to the business.

Information Services & Connectivity (20% of 2019 revenue)

Anyone who follows the exchange sector has seen the growing importance of market data to the mega-cap global peers such as LSE and ICE, as it provides a recurring revenue stream unaffected by swings in market volatility, ultimately providing more visibility to earnings and higher valuations. Beyond the fact that the regulatory need for best execution essentially requires institutions to purchase market data from BMV, the growing demand from underlying investors for faster pricing and reference data, exchange data, analytical services and index development, all provide significant long-term tailwinds for BMV’s information service businesses.

For BMV, information services, which includes market data/indices as well as a price vendor and risk management software provider, is significantly underpenetrated relative to global peers. The Company has multiple initiatives in place in the segment and continues to sell data to more endpoints and commercialize new products at a fast rate (evidenced by the 15% CAGR over the last 3 years).

The Company will continue to generate significant growth from:

- The recent establishment of a hub in New York opening the door to thousands of asset managers, brokers, etc. to establish direct connections to BMV rather than going through an intermediary such as Bloomberg.

- Increasing connectivity fees, as the introduction of the new competing exchange in the Mexican market, coupled with regulatory requirements for best execution, have effectively required any financial institution trading in Mexican securities to purchase data from BMV.

- Introducing new fixed income data products in both trade and post-trade segments.

- Increasing number of index products, as the Company has an exclusive relationship with S&P to produce Mexican equity indices.

- And most importantly, the Company is launching the Latin America Data Exchange partnership in conjunction with BME, with the goal of distributing a standardized data feed across the LatAm exchanges directly to middle and back offices of financial institutions,

In total, we see enormous potential in this segment and note that the Company itself is conservatively guiding to 15% CAGR over the next 5 years from the information services business, believing the Latin America Data Exchange itself could potentially provide that level of growth.

Misperceived Competitor Risk

In July 2018, BIVA officially launched as the first competing cash equity exchange in Mexico. BIVA came to the market with the promise of correcting the mismatch of Mexico being the 13thlargest economy in the world, but only having ~140 listed companies on the stock exchange, essentially laying the blame at BMV’s feet for all the cultural and social reasons that Mexico does not have a more robust financial ecosystem. BIVA promised to correct this mismatch by IPOing 50 new companies in its first 3 years of operations, although to date BIVA has not IPOed a single company.

For years, investors have been incorrectly concerned about BIVA taking significant market share from BMV in their cash equity trading business and maintenance & listing fees, but we believe that these fears are unfounded, not only because those two businesses represent a relatively small portion of the overall business, but also because BIVA has had trouble gaining any real traction in either segment.

Maintenance & Listing Fees (17% of 2019 revenue)

One part of BMV that is considered under threat are maintenance & listing fees, which are annual fees paid by companies or the government to maintain their listing of their equity or debt. These fees are inflation linked, providing growth even in a flat volume market, but still set well below that of most other developed and emerging markets.

In absolute terms, these fees are de minimus to the underlying companies (only tens of thousands of dollars to maintain a listing), meaning there is little to no incentive to switch listing because 1) there is virtually no cost savings even if BIVA attempted to undercut BMV and 2) switching off BMV means you are no longer eligible for the S&P IPC Index, the largest Mexican equity index, given BMV and S&P have an exclusive relationship.

As such, while BIVA might win some new listings, evidenced by its current market share of 4% of listings, primarily on the debt and CKD (private equity) side, this remains a growing annuity for BMV purely based on its existing book of business.

Cash Equity Trading (8% of 2019 revenue)

In Mexico, there are two types of cash equity trades: local securities (~60% of traded value), which are standard Mexican listed companies such as WalMex, and global securities (~40% of traded value), which are companies such as Apple that maintain a listing on the Mexican exchange.

This distinction is important because local securities are required to have best execution, based on price, volume and probability of execution. In the domestic market, BIVA has only been able to take 2-3% market share even though the liquidity pool is shared between the two companies,BMV still offers the best execution. In the global market, BIVA has taken approx. 15% share but that is entirely a function of cross-trades, whereby 3 pension funds (who happen to be investors in BIVA) instruct their brokers to push volume to BIVA since they are both the buyer & seller of the stock.

In all, BIVA has taken ~9% share of total value traded since launching and that share, although volatile on a month-by-month basis, appears to have stagnated, only modestly increasing for the past 12 months.

Remaining Monopolies & Well-Positioned Trading Related Businesses

The remainder of the business consists of monopolies in the Mexican equity clearinghouse (6%), the Mexican derivatives exchange (3%) and derivatives clearinghouse (3%), as well as the #1 position in OTC trading services in both Mexico and Chile (17%). Mexico is well behind the rest of the developed world in terms of penetration of a listed derivatives market, as the OTC business has continually captured share from listed derivatives. Going forward, the Company plans to work with the government to develop the derivatives market and clearing services for government bonds in Mexico, a significant opportunity, although we make no growth assumptions with respect to this opportunity.

Capital Allocation and Management

In general, the Company has distributed ~75% of FCF as dividends each year and looks to maintain a similar rate going forward, which today represents an approx. 5% dividend yield on the stock.

The Company holds significant net cash, compared to global peers that have been able to successfully operate with 2-4x net leverage given the general stability and infrastructure-like nature of exchange businesses. This provides significant headroom for M&A, as management cites opportunities in the post-trade space in both Mexico and internationally.

We have found the management team to be open and transparent with shareholders. We also find them thoughtful and competent with respect to the various initiatives they are implementing to drive profitable growth.

Valuation

BMV currently trades at an 8% FCF yield for a business that will conservatively grow FCF at a double-digit CAGR over the next 3 years, driven by two high quality, stable, recurring revenue streams.

While we assume that the Central Depository and Information Services businesses will continue on the growth trajectory described above (i.e. 15-20% CAGR), we feel that we are quite punitive on the “market” related businesses. We believe that 2020 will be an particularly strong year for the cash trading businesses given the volatility in global markets and a slower growth year for certain pockets of the recurring revenue businesses, given certain regulatory approvals needed to launch their Direct Custody and LED businesses. After 2020, we anticipate a decline in the trading related businesses of 25% in 2021 before being flat for the next two years. Additionally, we assume that BIVA ends up taking 25% share in equity trading (~9-10% today) and 20% share in maintenance fees (from <3% today). Even with those impacts, the revenue will still grow at a healthy HSD/LDD pace, coupled with the natural operating leverage on these high fixed cost businesses, which will allow for meaningful margin expansion and FCF growth.

And all of this ignores the fact that Mexico, as the 13th largest economy in the world, is underpenetrated in terms of listed companies (only 140) relative to a country of its size. We do not assume that Mexico will grow the number of listed companies despite the government’s attempts to promote more IPOs in the country but that remains upside optionality that would benefit all aspects of BMV’s business.

We value BMV at 84% above today’s price. We believe that a 10% FCF yield on 2022 and 11% FCF yield on 2023 is far too cheap for an unlevered high-quality asset with a significant growth runway ahead. We apply a 6% target FCF yield on 2023 which is likely conservative, especially compared to global exchange peers that operate in more mature markets and have a more muted growth outlook with more trading-related exposure yet trade at a significant premium to BMV.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

- Central Depository and Information Services segment grows to be the majority of revenues, prompting the market to place a higher multiple on the recurring revenue nature of the business.

- If the Mexican capital markets show signs of further development in terms of new listings, BMV would be a significant beneficiary.

- Takeout by a global peer (ICE, NASDAQ, TSX, B3) as the exchange space is in constant consolidation mode.

- Enthusiasm re-emerges for investing in emerging markets, including Mexico.

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			2020	2021
Price:	43.70	EPS	0	0
Shares Out. (in M):	593	P/E	0	0
Market Cap (in $M):	25,914	P/FCF	0	0
Net Debt (in $M):	-3,904	EBIT	0	0
TEV (in $M):	22,328	TEV/EBIT	0	0