Description

Overview 

Euronext offers investors a unique opportunity to invest in a defensive, high-quality compounder trading at 14.5x 2022 P/E. The company is run by a heavily incentivized CEO who was appointed in 2015 and has done an excellent job transitioning the company into a valuable market structure business. We believe Euronext’s current valuation is dislocated and does not reflect the compounding potential of the company as it continues to consolidate the European market infrastructure industry. Shares of Euronext have underperformed the European indices quite dramatically and we believe that current prices present a great entry point to invest in a high-quality business led by a proven CEO.  

Business Overview 
Euronext spun out of the Intercontinental Exchange in 2014 with a heavy exposure to cash equity trading in France, which the market viewed as a low growth, structurally challenged market. Under the leadership of CEO Stephane Boujnah, Euronext has transformed from a sleepy cash equity exchange to a pan-European market infrastructure asset with an opportunity to further consolidate market structure businesses across Europe. Today, ~60% of its business is in post-trade infrastructure, listings and technology. 

Market infrastructure assets, including trading exchanges, clearing and settlement venues, are excellent businesses.  They are regulated monopolies that act as toll-takers on the financial markets. Typically, these businesses charge subscription fees for market participants in addition to nominal fees based on volume within the venues. Volumes tend to correlate very highly with volatility, resulting in higher revenue for exchanges during times of heightened volatility. To this point, the exchanges industry saw record volume growth in 2020 given the extreme level of volatility and is seeing even higher volumes today given the geopolitical situation.  

Historically, these venues have been run as mutually owned utilities with bloated cost structures and misaligned incentives for management. Euronext has a track record of acquiring these assets, increasing margins, and improving topline growth, resulting in a tremendous amount of value creation. Under Euronext’s ownership, these assets grow mid-single digits through product enhancements and increased penetration, generate over 60% EBITDA margins and produce a vast amount of free cash flow. This strategy has helped Euronext grow its EBITDA almost 3.5x since 2014 with the stock generating an annual shareholder return of almost 25%.  

Thesis Point 1: Euronext’s acquisition of Borsa Italiana is underappreciated by the market 

We believe now is a particularly interesting time to invest in Euronext as it just closed its acquisition of Borsa Italiana with the potential for meaningful synergies to be realized over the next 2-3 years. Borsa Italiana was owned by the London Stock Exchange and was sold to Euronext as part of a remedy to the EU’s competition concerns for its acquisition of Refinitiv. Euronext announced the acquisition of Borsa Italiana in October 2020 and financed the deal with a mixture of debt and equity (via a rights offering). The deal closed on April 29, 2021. 

The assets within Borsa Italiana are high quality and are very congruent with Euronext and will allow Euronext to insource several functions of its business, leading to expanded revenue and cost synergies. These insourcing opportunities include moving profitable data center functions from a third party to its own data center (happening 2Q’22) and self-clearing trades as opposed to using a competitor’s clearinghouse. Euronext originally announced €60m in total synergies related to the Borsa Italiana transaction and increased the synergy target to €100m at its most recent analyst day. We expect management to significantly outperform this target and create a lot of value in the process with the Borsa Italiana acquisition.  

We have studied the history of the exchanges industry and created case studies on past market infrastructure M&A transactions. Because of the nature of market infrastructure businesses with established IT platforms and virtually no variable costs on incremental revenue, the synergy potential is quite large when two exchanges merge. Typically, platforms can be consolidated from two to one with little need for separate cost structures without impacting revenue. The resulting value creation for the acquirers is meaningful and we have found that the best time to invest in market infrastructure stocks is during deal integrations. 

Thesis Point 2: Euronext’s runway for further value-enhancing M&A is underappreciated by investors 

Euronext management has a strong track record of M&A and capital allocation. The company’s acquisitions have historically been accretive to earnings at closing and the company has outperformed its original synergy targets on every deal. 

Euronext has emerged as the buyer of choice for European market infrastructure businesses. Market infrastructure assets can be complicated acquisition targets given nationalistic and anticompetitive issues. Given its history of successful acquisitions and its relatively modest market capitalization versus other potential bidders, Euronext has established itself as the natural buyer for these assets. 

Furthermore, the fact that Euronext is headquartered in the EU makes deals that much more likely, especially post-Brexit given regulatory resistance to American, Asian or even UK businesses trying to buy important EU market infrastructure assets. After speaking with industry experts, competitor management teams and former employees, we believe there is a large opportunity for Euronext to continue to consolidate the space in Europe with value-enhancing deals.  

Thesis Point 3: Current macro environment is great for Euronext’s business 

The current geopolitical environment is leading to increased volatility across nearly all asset classes, which is translating into a meaningful increase in nearly 100% incremental margin revenue for Euronext. Few other companies globally directly benefit from an increase in volatility and an increase in uncertainty, but Euronext directly does and can be purchased for 14.5x P/E. In fact, if current volume trends hold, consensus expectations for this year will need to move almost 15% higher.  

Thesis Point 4: Euronext is incredibly cheap compared to peers and the quality of the business 

The accretive Borsa Italiana acquisition is just now starting to be reflected in consensus figures. Despite the higher quality mix shift in the business and increased growth profile, shares still trade at a meaningful discount to peers, which we do not believe is justified. Euronext’s business mix is comparable to peers and its EPS growth is amongst the highest in the peer group. We think there are several catalysts that will help the shares trade near peer multiples: 1) Borsa Italiana synergies will be higher than guidance, which will lead to upward revisions to consensus estimates; 2) given the addition of Borsa Italiana to Euronext’s business and resulting larger market capitalization, Euronext has been added to major indices, including the MSCI World Index, which will result in more long only/passive demand; 3) Further M&A announcements with will lead to further increases in out-year consensus estimates and higher interest in Euronext shares. 

Common misperceptions about Euronext 

Misperception 1: Euronext is the slowest growing exchange and therefore deserves a lower multiple 

Many investors cite Euronext’s official long-term growth guidance of 3-4% as a reason for why ENX trades at such a discount to peers. What investors are missing is the extreme conservatism in management’s guidance. For example, management guided to 2-3% medium-term growth in 2018 and the company actually grew 6.4% CAGR over the ’18-’22 time period. In addition, from a pure earnings growth standpoint, Euronext has grown earnings faster than any exchange globally, regardless of the starting date. We do not believe Euronext is a slower-growing exchange nor does this argument justify its extreme discount to peers. 

Misperception 2: Euronext is a cash equities exchange and cash equities is a bad business 

Cash equities represent around 20% of Euronext’s total business, down from 36% at the time of the IPO in 2014. This compares to ~30-35% for CBOE and ~15% for Nasdaq, two exchanges that trade at meaningful premiums to Euronext.  

Looking at the characteristics of Euronext’s cash equities business, we believe the cash equities business is solid. It has a highly defensible, incumbent position in Europe, grows MSD+, increases pricing, and has nearly 100% incremental margins. Since 2012, Euronext has grown its cash equities revenue by almost 7% organically. It has increased market share while also extracting more pricing. As an example of the quality of this business that is often overlooked, Euronext benefits from monopoly-like positions in the closing auction across Europe, an instrument where all buyers and sellers meet in the final moments of the trading day to guarantee orders being filled. The closing auction is an increasingly important market mechanism for passive instruments and has seen tremendous growth over the past few years with more growth to come and is only part of the reason why Euronext’s cash equities business will continue to grow profitably.   

Exchanges that trade at a ‘cash equities discount’ have proven to be excellent investments historically. ICE traded at a discount after it purchased the NYSE in 2013 and has CAGRed at ~20% since. NDAQ has CAGRed at 22% since 2015 despite having a heavy cash equities exposure. Investors who avoid owning exchanges with cash equities exposure have missed out on massive outperformers and will again with Euronext.    

Conclusion 
In summary, we think Euronext is trading at a dislocated price and believe it has an excellent risk/reward. We expect 50% upside over the next 12-18 months as management executes on the Borsa Italiana integration and the stock re-rates to a more appropriate multiple near-peer levels. Note that we are not contemplating additional returns that could be generated from outsized volumes or further consolidation of the market. Finally, given the relatively modest market cap of Euronext compared to international peers, it is very possible that Euronext could be sold to a larger buyer. The exchange space has a long history of consolidation and it is reasonable to assume that Euronext would be a target if this trend continues.  

Catalyst

-Volume Growth

-Continued execution 

-Incremental M&A