|Shares Out. (in M):||84||P/E||0||0|
|Market Cap (in $M):||3,375||P/FCF||0||0|
|Net Debt (in $M):||-285||EBIT||0||0|
|Borrow Cost:||General Collateral|
Bolsas Y Mercados Espanoles (BME)
BME operates the Spanish stock exchange. The company derives more than half of its revenue from the most commoditized, lowest growth and most competitive segment of the industry, namely European cash equities trading.
The introduction of MiFid (European Markets in Financial Instruments Directive) in 2007 opened European cash equities trading to competition from multilateral trading facilities (MTFs). MTFs are basically alternative trading venues which compete with the primary exchanges for trading volume in all the major European stocks. The launch of MTFs marked the end of the cash equity trading monopolies. Within a short period of time, Europe’s new trading venues captured significant market share away from the primary exchanges and industry pricing started coming under pressure. Initially, the most immediate casualty was the London Stock Exchange. After capturing 10% share of trading volume in FTSE100 stocks, the MTFs gathered significant steam. LSE’s market share of trading volume in its own listed companies, declined from 90% to less than 60% in just 18 months. In order to avoid further deterioration the LSE eventually reduced its all-in trading prices by >50% and the market shares eventually stabilised around the 50%-60% levels. The same subsequently happened to the other European primary exchanges including Xetra and Euronext.
This deterioration in business quality, from monopoly status to commoditized businesses with relatively low barriers to entry, combined with the lack of growth in European cash equity volumes also caused investors to lower the earnings multiples awarded to cash equity trading houses. Whilst in the past, these businesses traded at similar multiples to other parts of the market infrastructure industry, investors now value them at P/E ratios in the 12x-14x range compared to post-trade and index businesses selling for >20x forward earnings estimates.
There was one major exception to all this, namely BME. While all its European peers were suffering heavy market share losses and price compression, BME managed to maintain close to 100% share and its pricing continued to increase.
In 2014, the all in average cost of equity trading on BME was 1.55bps, compared to 0.92, 0.74 and 0.64bps at Euronext, Xetra and LSE respectively. The average cost of a trade on BATS is just 0.15bps.
As short sellers scrambled to cover their positions and European cash equity trading volumes began to show some cyclical improvements in the 2nd half of 2013, BME’ shares rallied heavily from the c.€20 level at which the shares had been stuck for nearly 5 years to >€30. Then, in the 1st half of this year, benefitting from the excitement around the potential impact that European QE may have on trading volumes, the shares rose further, exceeding €40 in April. In the context of this year’s consensus earnings per share expectations of €2.1, the shares reached a peak of valuation multiple c.20x P/E, on par with the levels at which it traded before the 2007 introduction of MiFiD and a premium to the likes of Deutsche Boerse and LSE.
Interestingly, the timing of this huge rerating of BME could not be more misguided. The company’s ability to fend off the MTFs and avoid the fate of its European peers is about to take a significant turn for the worse. The reason that MTFs have been unsuccessful in Spain is that there are some unique regulations around Spanish equities trading that act as a deterrent against trading away from the primary exchange. However, due to the need to comply with certain new European regulations, the country is in the process of implementing significant financial market reforms. Some of these reforms are already in place while others are going into effect on October 9th of this year. The effect of the reforms already in place is clearly visible as BME’s market share of IBEX35 trading volume has already fallen to below 80% by the end of last year and has continued to deteriorate so far this year.
However there remain some post trade complexities that create higher operational risk when trading on MTFs vs trading on the primary exchange which we highlight below:
On October 9th those differences will be eliminated and MTFs will finally be able to compete on equal footing with BME. By then we expect BME’s market share losses to accelerate and its pricing to begin falling precipitously.
It is worthwhile noting that the effect on BME from MTF competition could end up being more severe than what other exchanges experienced because of the heavy concentration of Spanish trading volume. The key barrier to market share gains for an MTF is to build sufficient trading liquidity in a particular stock so that bid/ask spreads would be narrow enough. A wide bid/ask spread offsets any benefit a trader has from the lower price charged by the MTF. The extent to which the primary exchange has narrower spreads than the MTF dictates that extent to which it can charge higher prices. At BME, 3 stocks (Banco Santander, BBVA and Telefonica) account for nearly half of the total volume on the exchange. The top 6 stocks account for c.60% of total volume. This means that MTFs should be able to easily achieve narrow spreads in those key names which in turn will force BME to reduce prices further than simply getting to par with the other European exchanges. In addition, BME’s market share could decline further as well.
On top of the competitive issues discussed, there is new European regulation called Target2Securities (T2S) under which the settlement of cash equities in Europe is going to be outsourced to the ECB. When Spain joins T2S (scheduled for early 2017) BME will lose another €30m in revenue which given the fixed cost nature of the business will drop straight the bottom line, representing another 15% earnings headwind.
Finally, there are 2 more regulatory headwinds facing BME:
Putting it all together we see significant downside to BME shares over the next 12-18 months. Even if we assume equity volumes continue their current cyclical recovery and BME’s market share and pricing does not decline further than what we saw at other European exchanges, we derive an earnings per share forecast of €1.5 for 2017. Applying an appropriate 13x multiple to this we get a stock price below €20, which is nearly half the current price.
On the flip-side, we perceive limited upside risk in the shares. Fundamentally, the shares are pricing in a scenario that is frankly unrealistic because the shares are currently priced for growth while we believe a best case scenario for this business would be flat earnings. The key risk would be some kind of takeover as the market infrastructure sector is still consolidating. That said, we view this as only a remote possibility for a number of reasons. Buying BME at a premium would cost at least $4 billion so that only the larger exchange groups could even consider it and it so happens that none of these groups are currently interested in acquiring a European cash equities business. The best proof of that was the recent IPO of Euronext. ICE was desperately looking for a buyer, but there was none. Given that Euronext represented a far more interesting acquisition target because of its higher cost base (i.e. more synergy potential for the acquirer) and the fact that its earnings are already post the competitive onslaught form MTFs and yet there was no buyer, we believe that it is highly unlikely that a buyer will suddenly emerge for BME. In addition, BME’s high valuation makes a deal even less likely because there are far superior assets around trading on similar multiples.
Accelrating market share declines
Deterioration in pricing
Cosnsensus dwongrades to adjust for adverse regulatory developments
|Subject||Re: Too early?|
|Entry||08/27/2015 09:40 AM|
BME's post trade infrustructure ownership is no different than e.g. Xetra where Deutsche Boerse own EurexClear and Clearstream and yet Xetra's market share in DAX stocks averaged only 56% in Q2 so owning a CSD and/or clearing house doesn't prevent MTFs from market share gains. Post T2S there won't be settlement revenue so "aggressively raise prices for settlement of trades originating from non-BME Clear members" is not a possibillity.
"denying the MTF CCPs access to BME Clear." is also not relevent because a)MTFs clear with LCH, not BMEclear and b) as you alluded, under MiFiD 2 open access rules BMEClear will lose its relevance as BME trades will be cleared anywhere.
Re-timing, we believe the timing is excellent because the stock has rallied in anticipation of the huge volume benefit while due to market share losses and pricing pressure this is not feeding through to BME's financials, leading to downgrades. In the first half of this year,although total Spanish equity value traded increased 40% y/y BME's equity trading revenue rose only 4% as they lost c.11% of market share and average pricing declined as well. Note that the high volumes create a perfect environment for MTFs to build liquidity in key IBEX stocks.
|Entry||08/27/2015 12:24 PM|
Thanks for the write-up.
I have heard that BME should not be expected to lose share to the extent DB and LSE have (lost 40-50% share to MTFs), but will rather go the way of Italy (lost 25% share) due to the much higher proportion of trading done by retail clients in Spain as in Italy. Retail trading is done through the banks and Renta4 which tend to use BME not MTFs. Apparently Borsa Italiana's market share has stabilized around 75% and their pricing is only 10% below BMEs. (Unfortunately I got those numbers from a broker and haven't been able to verify since LSE doesn't seem to dislcose these details about Borsa Italiana).
I also share ndn86's concern that the high dividend payout (and the likelihood of special dividends being reinstated) and large volume increases with high incremental margins will be big headwinds for the short. I believe that we're still 30% below 2007 in terms of equity trading volume.
P.S. While I'm here I'll also thank you for your LSE write-up, it was excellent. Thanks.
|Subject||Re: Retail Traders|
|Entry||08/27/2015 04:15 PM|
Thank you for your kind words re-LSE. Let me return the compliment for your Fagron write-up and repsonses. It was top notch
These are excellent questions by the way. It took us quite some time to figure out the Italy anomaly. Borsa Italiana's market share has been steadily declining, but at a much slower pace than the other primary exchanges. In Q2 the avg market share was 74%, which is down from 79% in 2Q14 and 83% in 2Q13. It is possible the retail mix plays a role as retail accounts for an estimated 40% of trading, however, i think the more likely answer lies in pricing. Our understanding is that Borsa charges a euro amount per trade rather than bps. This means that as value per trade increases their take in bps declines. As a result their pricing has historically been much lower than other exchanges which has made it more difficult for MTFs to compete (MTF flows from institutional investors are larger than average ticket sizes so the pricing expressed in bps would be considerably lower). To compare pricing with BME on an apples-to-apples basis, we believe that Borsa currently charges c.0.66euro per operation (which has been stable at that level) while BME charges c.2.20 euro or >3x.
In addition, BME's retail driven volumes are estimated at c.25% which is not as low as LSE's 5%, but still quite a bit lower than Italy's 40%.
Finally, though i don't have the exact stats, my impression is that trading in Italy is less concentrated than Spain where 3 stocks account for half of volume as discussed in the write-up (pls correct me if this assessment is wrong).
Note that BME's market share has already dropped below 70% and the remaining competitive bariers haven't been removed yet so we should expect another drop after October 9th. Our expectation of 50-60% market share is not that far off anymore. The next big shoe to drop will be pricing.
Re-the div, agree that it's a pain, but note that the annual final div which is c.2/3 of the annual div was paid in May so the next one in November is not that big and then you have a while for the short to play out before having to bear this cost...
Lastly, re-volumes, i disagree. 2Q15 ADV at BME was in line with the pre-recession peak levels.
|Subject||Re: Acquisition Risk|
|Entry||08/28/2015 10:03 AM|
I have tried to address the acquistion risk in the last paragraph of the write-up. Specifically, to your question, NYSE is now owned by ICE which which just got out of the european cash equities last year so it would seem highly unlikley that they would get back in now by purchasing BME. DB and LSE have both explicitly said they have no interest in cash equity acqusitions. They both skipped the opportunity to acquire Euronext last year which was arguably a far more attractive asset than BME at a significantly lower valuation.
I have no knoweldge of the lending practice you allude to re-Borsa Italiana. BME's balance sheet is unlevered and their equity clearing house (BMEclear) is new as equity trades previously weren't cleared through a CCP in Spain.
|Subject||Re: Re: All in cost|
|Entry||09/09/2015 06:14 AM|
Yes, although it's somewhat hard to quanitify. Although perhaps we're approaching it incorrectly; I would love to hear your views.
One of the drivers, for example, of the BME's argument against MTFs (BATS) is that the spread that BATS offers is wider than BME, which is a less transparent "cost" to trades on BATS vs. BME. We haven't quantified this analysis yet. The BME's argument may not be justified. And clearly the spread is likely to tighten at BATS (if it is indeed wide), so that argument may dissapate with time.
We are speaking with BATS and the BME again on the topic this week, so I am happy to share the insights we gain. But from our conversations with a few of the sell-side analysts we've spoken with, the BME comments do, to a degree, have some validity, though the analysts were also not particularly helpful at quantifying the 'friction costs' beyond the headline prices. Hence my question; I thought you might have some views. Please don't worry if not.
|Subject||Re: Re: Re: All in cost|
|Entry||09/09/2015 09:13 AM|
your question was about clearing and settlement costs, not spreads, which is why i asked if you tried to quantify them because both are much cheaper at MTFs+the trading cost is a fraction as discussed.
Re-spreads, obviously the exchange with the largest liquidity pool has the narrowest spreads.This why all the primary exchanges are still able to charge 4-5x what BATS and Turquoise charge. However, they used to charge 10-15x (like BME) and had to bring their prices down to a level where the trading cost+spread roughly equals the trading cost+spread at BATS. At that point their market shartes stabilised. The same is happening at BME now. This is why it is so important to understand how concentrated trading in Spain is around very few names because this means that BATS only needs to build liquidity in these few names to get spreads down and be competitive...and this is clearly happening as evidenced by BME's accelerating market share losses in recent quarters.
|Entry||09/29/2015 01:36 PM|
Thank you Alvahaz for such a good write-up,
you show great understanding on the industry. Just wondering if you have a view on Oslo Bors, that small highly iliquid stock owned by a reputed European AM house...
Though not as concentrated as in Spain, volume is concentrated in 5-10 companies or so, so there would be less than a problem for MTFs to gain share then offering narrow spreads.
I know Norwegian Market is local and I guess a good client from Oslo Bors is the Sovereign Wealth fund (any kind of commitment to Oslo Bors there??).
I know Oslo Bors has lost market share vs MTFs, but is there any kind of regulation or specific characteristic of the Norwegian market that makes the long thesis still hold?
Thanks a lot
|Entry||10/05/2015 04:49 AM|
due to technical and bureucratic problems those changes you mention on the write-up have been put off from Oct 9 2015 to at least February 2016 and more probably to February 2017, when T2S system starts to work in Spain.
In addition there is another mitigant factor to the "quick flight to MTFs". Some relevant banks (BBVA, LA Caixa,etc) are significant BME's shareholders, which means that they are likely to continue operating via BME and not via MTFs.
It is basically a cost-benefit analysis. How much these banks/brokers directly save transactioning through a MTFs vs. how much they foregone as BME shareholders if they operate via BME. What they would miss would be direct fees generated by them + lower liquidity in the markets, especially for small companies, then other brokers/operators would also flee from BME to an MTF, following also also fewer fees in BME.
All the best