Description

Note: shares of The Philippine Stock Exchange Inc. (PSE) are only liquid enough for personal accounts or very small funds. Per local regulations, no single entity can own more than 5% of the total shares outstanding, making this a small cap with small maximum shareholding potential.

Summary:

The Philippines as a stock market has been in the doldrums for years, but we’re old enough to have experienced at least two prior bull market cycles. In our view, the PSE’s stock price today – just ~1.5x tangible assets with a trailing 6.1% cash dividend yield – offers buyers a) a level of asset backing listed stock exchange operators don’t usually come with, and b) a high enough dividend yield (> domestic CPI) to pay a patient investor to wait.

We feel that’s really cheap for the sole stock market of a country of 114 million, with 21% equity in the sole fixed income exchange / securities depository to boot. For example, the PSE’s market cap today is even smaller than the New Zealand Exchange, which operates in a country with ~40% less GDP, even fewer publicly traded companies, and 1/25 the domestic population.

Yes, the PSE has only 285 listed companies, but market weakness over the last decade hasn’t prevented the creation of a REIT market or mega IPOs. Market optimists can point to the PSE’s first US$1 billion IPO in 2021, the start of a pipeline of US$1 billion IPO candidates.

Even if the Philippines never sees another bull market, we list some structural reasons below why the number of listed companies, market cap, and average daily turnover could permanently step up.

In particular, we’re eager to see if the impending launch of single stock trading on GCash, the financial super app that over 2/3 of Filipinos now rely on daily, can create incremental growth in retail brokerage accounts (now <2 million) and stimulate the PSE’s average daily turnover (now stuck at ~US$100 million). The timing of the launch was originally slated for 1Q2023, but this being the Philippines, delays are common. Users of the app are nonetheless still being told that the single-stock trading feature will launch soon (see recent app screen shot below).

In a longer-term “blue-sky” scenario, the PSE’s US$250 million market cap might eventually match the Bursa Malaysia’s (US$1.1 billion), a market with 1/3 the population of the Philippines but 3x more publicly traded companies.

Philippine Stock Exchange Inc. (PSE PM)

07/08/2023 market cap at PHP 163.40 per share: PHP 13.9 billion (USD 250.40 million)

The Philippine Stock Exchange Inc (“PSE”) is the sole stock exchange of the Philippines. PSE is also a 20.98% shareholder in unlisted PDS Group (“PDS”), owner of the nation’s sole fixed income exchange and securities depository.  Excluding liquid assets, treasury shares, prime office properties, and a minority shareholding in PDS, PSE is trading at roughly 6x trailing 12 months after-tax profit.[1]  We believe this represents a bargain valuation based on our view of PSE’s long-term growth potential (see below).[2]  

Source: Bloomberg, PSE, and KMC Savills data

Source: Bloomberg and PSE data.

• Organic growth potential:

Despite occasional flashes, over the long-term the PSE as a stock exchange has been a regional laggard, both as a national capital market and as an investment for shareholders.[3]  Due to recent reforms, we believe that PSE is poised to begin catching up in terms of total listed companies, market capitalization, fundraising, average daily volume, and turnover velocity. In the event that PSE improves these key performance indicators, we believe this could potentially have a positive effect on PSE’s growth.

Our view is that the PSE has an exciting growth opportunity in its collaboration with GCash, a Philippines’ mobile wallet app, to bring single stock trading to the app’s 71 million users as of 09/30/2022 via a new in-app trading platform called GStocks.  As the Philippines only had 1.6 million stock brokerage accounts as of 12/31/2021, our view is that GStocks could potentially lead to greater trading volume and liquidity to the Philippine equity market. According to GCash projections, nine million new retail investors could become active stock market traders over the next five years. 

  Based on our research, which includes a live demo of GCash’s investment functionality (see screenshots below), that GCash is already a convenient fundraising channel for Filipino mutual funds. As such, we believe that GCash has the potential to be a positive catalyst for PSE trading volumes, the same way it has catalyzed mobile gaming recently.

• Non-organic (M&A) growth potential:

For many years, PSE was in breach of local regulations prohibiting brokers as an industry group from collectively owning more than 20% of PSE’s outstanding shares.[4]  To fall back into compliance, PSE reduced the shareholder voting power of the brokerage industry to under 20% via a rights issue and share repurchase in 2018-2019.   

Assuming PSE has complied with all other regulations, keeping broker shareholding to under 20% should theoretically allow the PSE to be fully compliant with local regulations, and also should theoretically qualify it to re-apply for regulatory approval. Such approval is a precursor to PSE’s eligibility and ability to acquire the remaining 79.02% of PDS that it does not own.[5]   This would potentially allow PSE to realize certain synergies of merging with PDS.[6]  If successfully acquired, which is certainly not guaranteed and could be subject to delays, we estimate PDS could increase PSE’s proforma consolidated after-tax profit by at least one-third, to PHP 1.1 billion.[7] 

Certain Pro forma “fair value” estimates of the combined entity could be as much as PHP 379 per share (market cap: PHP 32.3 billion).[8]  Notably, this does not give PSE any credit for a) significant non-core liquid assets and real estate, or b) longer-term profit growth potential from increasing the number of listed companies or average daily turnover.

Key Investment Merits:

1. Material underlying asset value unrelated to the PSE’s core stock exchange operations:

• As of 03/31/2023, the PSE owned cash and securities (i.e., government bonds) worth PHP 5.4 billion or 39% of market cap at PHP 155 per share.  Our research indicates that this amount was not due to irrational cash hoarding, but most likely the result of a 2018 rights issue to raise cash to attempt an acquisition of the 79.02% PDS Group that PSE did not yet own.[9]
• As of 03/31/2023, the PSE also owned treasury stock worth PHP 0.6 billion or 4% of market cap.  Like the large cash balance above, PSE’s treasury stock on hand is the result of a share repurchase in 2019 that was designed to reduce broker shareholding in preparation for yet another bid for PDS Group.  
• The PSE also owns two Manila office buildings that, according to an 18 November 2021 desktop appraisal conducted by KMC Savills, possess market values of PHP 2.5 billion.[10]  Based on our research, these office buildings seem to be unencumbered by any liabilities and are partially leased to commercial tenants. 

• The PSE also owns a 20.98% shareholding in the PDS Group currently valued at PHP 1 billion.[11]  PDS is owner of the nation’s sole fixed income exchange (PDEx) and share registry/depository (PDTC).  We believe the PDTC, the profit center of PDS Group, is an attractive business for two reasons.  First, the PDTC is a sticky “AUM” business (i.e., it earns fees based on the market value of a growing pile of lodged securities owned by third parties).  Second, the PDTC has clear growth potential from a) the lodging of all new equity/debt securities going forward (now a legal requirement), b) the increased lodging of older equity/debt securities (historically it was not a legal requirement to lodge securities), and c) the market price appreciation of lodged securities. 
• Lastly, though it is not reflected on the financial statements, the PSE retains what we consider to be a de facto “option” or implicit “right-of-first-refusal” to acquire the remaining 79.02% of PDS Group it does not own. 

2. Potentially on the cusp of growth.

The PSE has developed slowly relative to other Asian equity exchanges.  For example, the PSE ended 2020 with 271 public companies, just 42 more public companies than were in existence at the end of the year 2000.  Likewise, in the four years ending 2020 there was actually more listed fixed income fundraising in the Philippines (via the PDEx) than listed equity fundraising (via the PSE).  

PSE’s current management team, led since 2017 by CEO Ramon Monzon, recently implemented several major reforms that aim to accelerate the exchange’s growth trajectory.  These reforms, coupled with the spike in bad loans at Philippine banks owing to COVID-19 seem to have convinced many more Filipino companies to use the PSE as a major fundraising channel.  As a result, 2021 was the PSE’s best fundraising year since 2012 and even featured the country’s first ever US$1 billion IPO.[12]  2021 average daily turnover and total market capitalization of PSE-listed equities have also reached levels not seen for the last five years.

Specific PSE reforms spearheaded by current management include:

• Rapid increase in brokerage trading accounts:
  • In particular, the PSE’s recent deal with mobile fintech app GCash to offer stock trading to its 66 million existing users – many of whom have never traded stocks before – aims to materially increase the total number of equity brokerage accounts in the Philippines from just 1.6 million today. 

• Permanent removal of the dreaded “IPO tax”:
  • Until recently the Philippines was the only country in Asia that levied an IPO tax on issuers equivalent to 1-4% of total listing proceeds.  The PSE successfully lobbied for the removal of this tax in late 2020.[13]  Thanks to these efforts, two of the PSE’s largest IPO candidates ever (Converge and Monde Nissin) were exempt from IPO taxes.  
  • The listing of growth companies like Converge seem to have had an enormous impact on the PSE’s average daily turnover (“ADT”).
• More flexible lock-up provisions on pre-IPO investors:
  • The PSE successfully lobbied for more flexible lock-up provisions on pre-IPO investors like sovereign wealth funds and private equity funds, which we believe should incentivize such investors to consider more “exits” via the stock market.[14]  Prior to early 2021, pre-IPO investors in Filipino companies were subject to onerous 365-day lockups.[15] 
• Higher free float requirements for benchmark index constituents:
  • It is not unusual to find companies listed on the PSE, even major companies, with free floats of less than 15%.  By December 2022, however, all constituents of the PSE’s benchmark PSEi index must keep a free float of no less than 20%.[16]  By December 2023, the 20% free float requirement could be extended to all PSE-listed companies.   
• Working to require certain companies to IPO if they have availed of tax incentives:
  • “The PSE is proposing that BoI-registered companies with 20 or more investors or those qualified to be a publicly listed company will be required to list at the exchange and offer their shares to the public ‘in exchange for the incentives they’re trying to avail from the government,’ such as tax exemptions.”[17]
• Relaxed IPO requirements to woo more SME listing candidates:
  • The PSE replaced an arbitrary IPO capital requirement with a profit track record requirement, exempting track record years directly affected by COVID-19.[18] 
• Increased retail investor participation only scratches the surface of total potential:
  • Thanks to increased individual investor education initiatives and streamlined access to IPOs via PSE EASy, in 2021 Filipino retail investors took up the slack left by local institutions and foreign investors.[19]  In 2022, foreign investor participation increased markedly versus the lows of 2021— albeit, still as net sellers.

Source: PSE data

• • Despite slightly higher GDP per capita and total population versus Vietnam, the Philippines had only 1.6 million retail brokerage accounts at the end of 2020 versus over 5 million retail brokerage accounts in Vietnam today.[20]  If the history of more mature Asian stock markets like Taiwan are any guide, stock brokerage penetration is a necessary precursor for market growth.

• We believe short-selling is primed to begin sooner or later:
  • PSE management has been lobbying regulators to approve equity short-selling.[21] According to PSE management, any delays to the launch of short-selling are simply a matter of bureaucratic approval. Should equity short-selling finally launch, this could increase the PSE’s average daily turnover.
• The successful launch of real-estate investment trusts:
  • The PSE successfully lobbied for the launch of REITs as a new asset class.  At least five REITs have already listed since late 2020, raising at least US$1.5 billion in primary and secondary share sales.[22]  More REITs are expected to list in the future.[23]  Existing REITs are also expected to grow their market caps via further acquisitions.[24]

Key Downside Risks:

In addition to the comprehensive list of risk factors described in the PSE’s 2018 stock rights offer prospectus (page 19 onwards), there are two key risks to an investment in PSE shares today:  

• Management continuity risk: in our view, PSE’s CEO Ramon Monzon is critical to seeing through many of the aforementioned reform and growth initiatives (including the GCash cooperation and potential merger with the PDS).  Mr. Monzon’s sudden retirement or resignation from his current role could derail many initiatives the PSE is working on.
• Management incentive risk: as of 30 September 2022, PSE CEO Ramon Monzon owned 185,147 shares worth PHP 28.7 million (US$514,897) at PHP 155 per share.  As of the same date, PSE COO Roel Refran owned 107,259 shares worth PHP 16.6 million (US$298,289) at PHP 155 per share.  While not a trivial amount of capital at risk for non-founder executives like Messrs. Monzon and Refran, it’s unclear what percentage of their net worth today is tied up in PSE shares.

Key Upside Risks:

There are at least five major upside risks to the PSE’s organic profitability:

• The PSE’s deal with GCASH to offer stock trading accounts for the first time to many of its 67 million users could significantly increase equity trading volumes.  According to the The Philippine Daily Inquirer:

“This would allow GCash’s 67 million users to directly invest in the stock market beginning November this year, [PSE CEO Ramon Monzon] added.

Monzon said projections from GCash showed they could add nine million new investors to the stock market in five years from about 1.7 million participants today.

‘It’s really going to be a game-changer in terms of the number of retail investors that will participate in the market,’ Monzon told One News.

‘The Philippine Stock Exchange was organized in 1927. So, you’re talking about 95 years and we only have 1.7 million stock market investors,’ he added.”

• Potential fee price increases:
  • Our research indicates that the PSE can seek regulatory approval to raise prices on listing maintenance fees (19% of 2020 revenue) and SCCP service fees (24% of 2020 revenue).
    • In terms of listing maintenance fees, the PSE applied to increase the maximum fee leviable to mainboard-listed companies to PHP 3.5 million (from PHP 2 million currently).
      • Current listing maintenance fee structure: 1/100 of 1% of market cap per year, but not less than PHP 0.25 million and not more than PHP 2 million.
    • In terms of SCCP service fees, the PSE has applied to increase the clearing charge levied on both buyers and sellers to 1 basis point from the current 0.89 basis point rate.
• Potential growth of the PSE’s subscription data and stock market indices business:
  • The PSE has been actively building out a stock market indices business from scratch, where percentage-of-AUM fees will be earned on all funds/ETFs that license the PSE’s index constituent data.[25]  Our research suggests that local institutions will be launching new funds based on this data.  Should the assets under management of these initial funds meet the PSE’s initial expectations, incremental annual revenue in the tens of millions of PHP could potentially materialize.  
• Sustained return of foreign investors:
  • Foreign investors have been net-sellers of Philippine equities for five straight years. Foreigners as a percentage of total market turnover have declined from 55% in 2019, to 43% for the week ending 7 July 2023. Should the recent rebound in foreign activity sustain to the point where net selling flips to net buying, the PSE’s average daily turnover should significantly increase from current levels.

Source: PSE data

• Adoption of PFRS 15 accounting standards from 1 January 2019 significantly understates “listing fees” (26% of 2020 revenue) versus pre-2019 periods.
  • Prior to PFRS 15, the PSE booked 100 % of listing fees in the year in which an IPO or follow-on offering occurred.  From 2019 onwards, however, the PSE only recognized a minority of listing fee revenue upfront while amortizing the remaining majority of revenue over multiple (ten-plus years).[26] 
    • On a cash basis, however, the vast majority of equity listing fees are actually collected upfront by the PSE and reflected on its balance sheet as a “contract liability.”  The growth of this non-refundable contract liability has ballooned in 2021-2022 versus 2019-2020, a forward-looking indicator that more listing revenue will be recognized in future periods.  Any additional after-tax profit that results from more listing fees should improve the PSE’s ability to pay dividends. 

Appendix I: How does the PSE Earn Revenue?

Appendix II: How does the PDS Earn Revenue?

Catalyst

Gcash single stock trading takes off

More/bigger IPOs

Greater trading volume from locals or foreign investors

Merger with PDS Group

Continued high dividend payout